Emerging market crisis pulls in India, Indonesia

The bad news is that the emerging market crisis that has sent financial markets plummeting in Argentina, Turkey, and Brazil has added India and Indonesia to its list of victims.

The good news is that the inclusion of India and Indonesia is exactly what analysts and economists have been expecting. Like Turkey and Argentina, these two countries run current account deficits that make them extraordinarily dependent on flows of overseas cash to balance their books and support their currencies.

Despite intervention by the central bank, the Indonesian rupiah is now down 7.8% in 2018. That makes it the second worst performing Asian currency this year. The award for worst performance goes to India’s rupee, which has fallen to a new record low against the dollar and is looking at its bigger monthly decline in three years.

Indonesia’s case demonstrates how a current account deficit can send a currency into a downward spiral and how that drop in the currency can then make the current account deficit worse. Indonesia’s current account deficit rose to $8 billion in the second quarter, or 3% of the country’s GDP. That’s up from $5.7 billion in the past three months. Foreigners own about 40% of Indonesia’s government bonds making the country especially vulnerable to slides in investor sentiment and declines in the rupiah against the U.S. dollar.

In the short term Indonesia’s central bank has sought to defend the rupiah and prop up the country’s bonds by raising interest rates with four interest rate increase since May. The bank last raised interest rates on August 15 to 5.5%. That’s well below the record high of 12.7% in December 2005 but a significant and rapid increase from the low of 4.25% in September 2017.