Jakarta. Indonesia's central bank said the rupiah still remains undervalued and will continue to strengthen to its pre-pandemic levels supported by a low inflation, narrowing current account deficit and increasing foreign capital inflow. 

Bank Indonesia (BI) Governor Perry Warjiyo said the rupiah might soon strengthen to Rp 13,600–Rp 14,000 against the US dollar. 

"We believe the rupiah is still undervalued and has the potential to get back to its fundamental level," Perry said in a teleconference on Thursday.

The rupiah traded at Rp 14,769 against the greenback on Thursday, dropping by one basis point (bps) from a day earlier according to the Jakarta interbank dollar spot rate compiled by Bank Indonesia.

The currency has appreciated by 11 percent from its lowest level ever on March 23, when it traded at Rp 16,603 against the US dollar. 

Meanwhile, Indonesia's current account deficit has narrowed to $3.9 billion or 1.4 percent of its gross domestic product (GDP) in the first quarter of this year from $8.1 billion or 2.8 percent of the GDP in the last quarter of 2019.

Perry said he took confidence from the declining spread of credit default swap (CDS) – a contract for investors to eliminate possible loss from a sovereign's default.

A high CDS spread indicates high investment risks.

"[CDS] is a premium for global investors when they hold bonds issued by the Indonesian government. To mitigate risks, they make CDS transactions, and for now [the CDS spread] is at 160 basis points," Perry said.

During the peak of the Covid-19 panic in the global market – in the second and third weeks of March – the CDS reached as high as 245 bps.

Before the pandemic, Indonesia's CDS spread was at 66 bps.

Support for Optimism

Perry's optimistic view has found some support among foreign investors. A study from global investment bank Morgan Stanley showed Indonesia could be among the first countries in Asia outside China and Japan to return to their pre-pandemic economic level. 

Morgan Stanley said China's "first-in, first-out of Covid-19, domestic demand-oriented economy and policy easing" would help its economy to return to pre-Covid-19 levels by the third quarter of this year. 

Indonesia, India and the Philippines would follow close behind, thanks to their "lower exposure to global recession impact and relatively high structural growth," Morgan Stanley said. 

"The risk is if the Covid-19 pandemic does not peak by the second quarter, as per our assumption. If that happens, they would fall behind [Korea and Taiwan] on the timing of their recovery," Morgan Stanley said. 

Export-oriented economies like Thailand, Malaysia, Hong Kong and Singapore would recover slower, possibly by the first quarter next year, the investment bank said. 

Low Ramadan Inflation

Bank Indonesia also estimated the country's annual inflation rate would likely be at 2.21 percent this month based on a preliminary survey from 43 branch offices across Indonesia until the fourth week of May.

The country recorded a 2.67 percent inflation last month, its lowest in the past 12 months. The Central Statistics Agency will announce May's inflation figure on Monday.  

Perry said inflation in May was lower than the corresponding figures in previous Ramadans. The estimated month-to-month rate of 0.09 percent is significantly lower than in 2019 (0.68 percent and 0.55 percent before and after Idul Fitri, respectively), in 2018 (0.59 percent) and in 2017 (0.69 percent).

Low demand for goods and services as a result of restricted activities during the Covid-19 pandemic was one factor for the low inflation, along with low prices of imported goods.

Foreign Capital Inflow on the Up

Bank Indonesia data also show that foreign capital continues to come in to Indonesia, particularly from investors interested in buying government bonds.

There was Rp 2.97 trillion in foreign capital inflow in the first week of May before doubling to  Rp 6.15 trillion on May 18–20, Perry said. 

The yield on Indonesia's 10-year government bonds has declined from 8 percent in the second week of April to 7.22 percent on Wednesday, Perry said.

The spread between Indonesian government bonds and US Treasury bonds now stands at 6.7 percent, still an attractive opportunity for investors, Perry said.