Why Indonesia's central bank believes rupiah may be undervalued

It's actually getting comfortable in its zone.

According to DBS, net foreign flows in both markets are still positive in June. In fact, foreign ownership of IDgov bonds stands at 35.7% of total outstanding bonds (as of 16 June), which is pretty much the record-high seen in late-2011. 

This occurs even when the rupiah has come under pressure in the markets, stemming from importers’ demand amidst risks from rising oil prices.

Here's more from DBS:

Presumably, this suggests that investors remain attracted in the long-term despite the near-term volatilities in the rupiah. On a NEER basis, the rupiah is currently trading about 20% lower than its 10-year average (or 5% lower on a REER basis).

These are certainly arguments that the rupiah maybe undervalued at current levels. At least the central bank seems to believe so. On Tuesday, the Bank Indonesia (BI) Deputy Governor indicated that the central bank is tolerant of some relative weakness in the rupiah in an attempt to support export competitiveness.

But the rupiah is said to be undervalued and the central bank is also said to be more comfortable with the USD/IDR trading in the 11,400-11,800 range.

The central bank will maintain its presence in the market to avoid excessive volatility in the rupiah. One quick look at rising foreign reserves in the year-to-date provides some explanations on why the rupiah has been relatively lacklustre despite more than USD 10bn in foreign portfolio inflows seen since the start of the year (a record for the first 5 months of any year).

And now that market sentiment has turned against the rupiah, expect the central bank to be active again in the market.

In fact, Tuesday’s comments could be meant to calm the markets, just as the USD/ IDR touched the 12,000 psychological level once again. In any case, we think that the central bank will not be hasty to alter its monetary policy stance for now. Expect stable BI rate at 7.50%.