To sell or not to sell?

Posted by Yin Lin in Economics 11 on Saturday, August 17th, 2013 at 9:20 am

Review exercise IB Economics Exchange rates

You are a forex trader trading in IDR /$US. You have to make a decision to hold your US assets of currency valued at US$1,000,000.00 or to sell them on the forex for  IDR.

1. Current value of $US in terms of IDR:

1USD = 10309.28 IDR

2. Convert this to IDR in terms of $US:

1 IDR = 0.000097 USD

3. What is the value of your currency assets in terms if IDR?

1,000,000.00 USD = 10,309,280,000 IDR

4. Describe and explain the recent performance of the IDR/US, using appropriate economic terms

IDR is experiencing depreciation of their currency value, whereas USD is experiencing appreciation over the past few months. The reason for the depreciation of IDR currency is that recent inflation is high, hence investors refuse to hold on to rupiahs. Another reason is that Indonesias imports are greater than exports due to high salaries that people are getting, hence the supply of IDR in the market increases, and that demand for USD increases! Furthermore, it is expected that there will be increase in demands of manufactured products from the US, which will indeed strengthen USD. Also, “a study from BI shows that the rupiah’s volatility has more implications for imports rather than exports. Thus, a weak rupiah is disadvantageous for Indonesia, as it might burden the economy more from the import channel, rather than making export goods cheaper and improving the country’s trade competitiveness.

We can see the increase in US$ as shown by shift of demand curve to the right from D1 to D2, due to the increasing domestic demand of Indonesia for imports (e.g-oil, manufactured goods), which requires Indonesia to buy more US$ currencies. This can be because of the rise of middle class families in Indonesia leading to overall increase in income, hence they demand more imports from foreign countries, which means buying more US$ currencies.

On the other hand, we see increase in supply of the IDR by rightward shift of the supply curve from S1 to S2 due to the relatively high rates of inflation indonesia is experiencing. Higher rate of inflation means that Indonesian goods are more expensive for other countries, hence investors of other countries would not want rupiahs and sell the IDR currency (This is also why Indonesias imports are greater than exports).

5. Describe and Explain the role that the Indonesian Central Bank has played in recent currency moves using economic models to assist your explanation. Read the following article from May bank.

The central bank of Indonesia stepped back from intervening and controlling Indonesias exchange rate because the central bank believes IDR can find its market value with less intervention. However while the central bank could allow the USD/IDR to search for its new equilibrium, the central bank would intervene when necessary to stem too much volatility in the market and guide the spot lower. When a new equilibrium has been reached, the central bank would then defend the spot at that new level. (Maybank)

6. Our Decision?

Hold on to the US$. Wait until IDR depreciate even more, or when there is sign of US dollars depreciating, then we sell. We made this decision because we are already told that the Central bank of Indonesia made decision already to let IDR devalue, and we see no sign of BI stepping back in in recent time. Indonesia has been facing trade deficit for a while, and we believe the currency will continue to depreciate until it finds its balance in trade, or depreciate until foreign investors are willing to buy enough IDR for Indonesian goods to make up the deficit, hence it would be better to hold it at the moment.

Sources:

en.tempo.co/read/news/2013/07/26/056499911/Analyst-Rupiah-to-Depreciate-Further

info.maybank2u.com.sg/pdf/investment-insurance/insight/fx-insight-24-07-13.pdf