Exchange rate performance in Indonesia

1. Exchange rate performance in
Indonesia

2. Introduction
The main goal of research is to investigate what variables
determine the exchange rate performance.
Why Indonesia:
 is the 18-th largest economy in the world and Southeast
Asia's largest economy;
 is emerging and fast growing economy;
 managed floating exchange rate regime;
 an appropriatecandidate to be included in the BRIC
countries as the country is rapidly showing signs of similar
newly advanced economic development;
 the recent upgrades in the country's credit ratings by
international financial services companies such as Standard
& Poor's, Fitch Ratings and Moody's.

3. Theoretical background
Monetary approach
exchange rates are determined in the process of
aligning or balancing the overall demand and
supply of the national currency.
Money Supply
 Ms ↑, P ↑ and E$/€ ↑ → Depreciation of $against
to €
Interest Rate
 R ↑, L(R$,Yus) ↓, P ↑ → Appreciation of $ against
€
Output Level
 Output ↑, L(R$, Yus) ↑, P ↓ → Appreciation of $
against to €

4. Theoretical background
o Monetary approach (dominant model of exchange
rate determination (Diamandis and
Kouretas, 1996, p. 351) - focuses on domestic and
foreign Ms and Md and proposes that exchange
rates are affected by the money supply, income
level, and interest rates in the long run
(Frenkel, 1976; Dornbush, 1976; Frankel, 1979);
o Relative PPP approach - exchange rate changes
over time are assumed to be dependent on inflation
rate differentials between countries
(Ricardo, Cassel, 19th century).
Inflation Rate
If the Indonesian inflation rate exceeds the US inflation
rate, then the dollar will appreciate by that differential
over the same period.

5. General background
The main changes to the exchange rate regimes in
Indonesia
 1 January 1996 The Bank Indonesia (BI) within a system
of managed float determined the exchange rate;
 28 February 1998 A foreign exchange subsidy for food
was introduced, which led to the reclassification of the
exchange rate system from unitary to dual;
 De Facto Indonesia has floating exchange rate with
inflation targeting framework.

6. 0
Q2-…
Q3-…
Q4-…
Q1-…
Q2-…
Q3-…
Q4-…
Q1-…
Q2-…
Q3-…
Q4-…
Q1-…
Q2-…
Q3-…
Q4-…
Q1-…
Q2-…
Q3-…
Q4-…
Q1-…
The US and Indonesian interest rates
60
50
40
30
the US
20
Indonesia
10

7. -10
-20
-50
-60
-70
-80
Q2-2012
Q3-2011
Q4-2010
Q1-2010
Q2-2009
Q3-2008
Q4-2007
Q1-2007
Q2-2006
Q3-2005
Q4-2004
Q1-2004
Q2-2003
Q3-2002
Q4-2001
Q1-2001
Q2-2000
Q3-1999
Q4-1998
Q1-1998
The US and Indonesian trade balances
10
0
-30
the US
-40
Indonesia

8. The US and Indonesian GDP growth rates

9. The US and Indonesian inflation rates

10. Exchange rate performance (RUP/USD)

11. Methodological framework & data description
 Ordinary Least Squares and quantitative methods;
 Quarterly data from OECD database for the period from the 1st
quarter of 1998 to the 4th quarter of 2012.
 Hypothesis: exchange rate behavior between IDR and USD depends
on the analyzed variables.
ER - quarterly averaged spot exchange rate (IDR/USD)
DGDP - difference between Indonesian and USA nominal GDP (in billions of
USD);
DINTR- difference between Indonesian and USA short-term interest rate
DINFL - difference between Indonesian and USA inflation rate (CPI)
DTB - difference between Indonesian and USA net export (in billions of USD)

12. Methodological framework & data description
Proxies
 Inflation in Indonesia is , depreciation of IDR
against USD (by the amount of inflation rates
differential);
 Nominal GDP growth rate in Indonesia is
, appreciation of IDR against USD;
 Short-term interest rate in Indonesia is , IDR
appreciates against USD;
 Trade balance surplus in Indonesia (USA
deficit), IDR appreciates against USD.

13. Results
Augmented Dickey-Fuller test
Variable
Dickey-Fuller Test
results
Stat.
Critic.
Value (1%
level)
gdp (GDP)
-1.9862
-3.5482
intr (Interest
Rate)
-4.5902
infl (Inflation)
Results
Dickey-Fuller Test results
Stat.
-4.7985
-3.5482
-3.5482
Stationary
-
-
-5.0494
-3.5461
Stationary
-
-
tb (Trade
balance)
-2.1120
-3.5482
genrdtb=d(tb)
-4.6782
-3.5482
er (Exchange
rate)
-3.8311
-3.5460
Stationary
-
-
New
variable
Stationary
dgdp
Stationary
-
Stationary
-
Stationary
dtb
Stationary
-
Critic. Value
(1% level)
genrdgdp=d(g
dp)
Results

14. Results
Estimated results of the model
Value
Conclusion
0.7090
70.9% of the variation in the
response variable can be
explained by the explanatory
variables
R-squared
Adjusted
R-squared
0.6871
DGDP(-1)
0.0000
Variable is significant
INTR(-1)
0.0053
Variable is significant
INFL
0.0000
Variable is significant
DTB(-1)
0.0174
Variable is significant
Prob.

15. Results
The results of Jargue-Bera test, White test and Breusch-Godfrey test
Value
Normality (JargueBeratest)
Conclusion
0.6828
The critical value of Jargue-Bera test is lower
than 5.99 so residuals are normally distributed
Heteroskedasticity (White
test)
0.8971
Prob. is higher than 0.05 so we reject H1
hypothesis and accept H0 hypothesis about
homoscedasticity
Autocorrelation (BreuschGodfrey test)
0.1959
Prob. is higher than 0.05 so we reject H1
hypothesis and accept H0 hypothesis about the
absence of autocorrelation

16. Results
Variables with direct correlation: GDP and inflation (positive
signs).
If the difference between Indonesian GDP and the US GDP
increase by 1% it indicates that exchange rate will surge by 0.47%;
if the difference in inflation rates increases by 1% than the exchange
rate rises by 201.95%.
Variables with indirect correlation: rate and trade balance
(negative signs).
If difference between interest rates in two countries increase by
1%, the exchange rate decrease by 23.85%;
The exchange rate surges by 48.15% if trade balance rises by 1%.

17. Conclusion
The exchange rate is a dynamic variable, mobility of which is
determined by a wide range of economic, financial, political and
social factors.
Among them, the most important are the following: GDP, inflation
rate, money supply, interest rate and trade balance. The latter
variables are described in relative PPP and monetary theories. The
research showed that all of them, with the exception of money
supply, are significant.
Also,
the
model
was
successfully
checked
for
heteroskedasticity, normality and autocorrelation. The variables
passed the test for stationarity.
Generally, proxies explain the behavior of the analyzed exchange
rate except the GDP. However, the behavior of GDP is an
exception, as external factors, which are not included into the
model, are influencing it.
Thus, our analysis confirms the hypothesis that we stated in the
quantitive part of the research and all the variables in the equation
have impact on the behavior of the IDR/USD exchange rate.

18. Thank you for your
attention!