Threshold Impacts of Exchange Rate on the Current Account Sustainability

Abstract

The issue of current account sustainability has been the subject of intense research and heated debate in the last two decades. This study examines the sustainability of current accounts in the case of Indonesia over the period 2004(4)-2021(6). We find that exchange rate plays an important role. While the symmetric impact of the exchange rate on the current account performance holds, the effect of foreign reserves on exchange rate appreciation is greater than that on exchange rate depreciation. Allowing the domestic currency to appreciate no more than 2.5 percent, central bank intervention in the foreign exchange market could improve the current account balance. Cointegrating regression robustness tests confirm that the current account balance is weakly sustainable or even unsustainable, which suggest that the country has to reduce exchange rate fluctuation to restore the current account balance. Further research to treat the changes in exchange rate as a continuous variable is advisable.