Bank of Indonesia struggles to keep the rupiah stable

The rupiah is currently the worst performing currency in SE Asia having depreciated by 4% against the US dollar.

The BI will likely keep the reference rate steady at 5.75% for the rest of the year to provide support. Concerns over inflation are mounting due to the weakening local currency and higher imported prices of goods and services are already anticipated.

Here's more from OSK-DMG:

For the fourth consecutive meeting, Bank Indonesia held its benchmark reference rate unchanged at 5.75%. This decision was not unexpected given the need to maintain stability of the rupiah following the volatility in the domestic currency market in recent days because of global risk aversion. Rupiah stability has replaced inflation as a major concern at the moment. The central bank still expects inflation to come in at 3.5-5.5% in both 2012 and 2013.

On the growth front, the central bank continues to expect the economy to expand by 6.3-6.7% in 2012, though it believes the risks are now tilted on the downside as a result of the ongoing crisis in Europe and the economic weakness of its major export markets, namely the US, China and India.

On the currency front, the rupiah has depreciated about 4% against the US dollar to date, making it the worst performing currency in SE Asia. This raises concerns about the impact that the weakness in the rupiah could have on inflation for the rest of the year through higher imported prices of goods and services, especially oil and gas.

The weakening rupiah could limit BI’s ability to cut rates to support domestic growth should the global economic and financial environment deteriorate. The BI is expected to continue to hold its reference rate steady at 5.75% for the rest of the year to provide support for the rupiah. Other measures that BI is likely to use to shore up the rupiah include introducing foreign currency term deposits and hiking interest rates of its bills and domestic currency term deposits.

In its fight against inflation now, BI’s preference for tempering inflationary pressures is to use macro-prudential measures like minimum down payments for mortgages and motor cycle loans and the required reserve instead of its policy rate.  It seems likely that the BI would move its policy rate only if growth falters or inflationary expectations begin to unhinge.