Bank of Indonesia
Indonesia’s central bank has cut its benchmark interest rate (targeting seven-day repurchase rate) at 3.75 percent for two consecutive months. Indonesian bank has reduced its policy rate by 125bp in just 2020 after pandemic hits. Indonesia has chosen untraditional way of monetary policy in the use of tactics of directly financing the government’s fiscal deficit. This is unlike other central banks since they buy the bonds form secondary markets such as commercial banks or financial institutions (for example: Blackrock or PIMCO in U.S.) The direct government bond buying from central bank was possible after a panel of people in parliament recommended a revision to the central bank law.
Investors concern whether the government will have a larger role in the central bank’s policy decision. In the 1999 Central Bank Act, BI have mandates to maintain currency stability and manage inflation by supporting economic growths and jobs. However, as government takes most of the part in central bank’s decision-making, central bank won’t have full right in setting interest rates and issuing new monetary policy.
Rupiah
The rupiah has declined almost two percent this month and more than 6.5 percent in just 2020. The performance of Rupiah was the worst in Asia. I can think of two factors that make Indonesian currency weaken this year: fear of pandemic and BI’s super-dovish stance.
A surge in pandemic in Jakarta has added pressure on depreciation. As foreign investors worry about the fundamental of Indonesian market, they had to cash their assets and exit from there. In the process of exit, investors need to exchange Indonesian Rupiah to their native currency. If demand falls, then the value falls which made Rupiah into devaluation. BI is prompting intervention in the currency market to prevent the outflow of their own currency.
BI has pledged to buy $27 billion of government bonds in the primary market in the condition of relinquishing interest payments as one-off purchase in the reason of $40 billion fiscal expenditure for countermeasure against pandemic in 2020. The yield on 10-year Indonesian government bonds was 7.2%, but BI promised to buy it in higher price exempting interest payment to 0%. This means central bank is printing more money than its actual value. This will lead to more liquidity environment which is vulnerable to their currency value.
Slow Recovery
Recent economic indicators are sending risk signals on the pace of recovery in Southeast Asia's largest economy. Manufacturing and consumer confidence and retail sales data were falling, and exports and imports declined more than expected in August. Dis-inflationary circumstances were caused by sluggish domestic demand in both July and August. Inflation rate has shown a little uptick from last year which is 1.32%. (BI’s target is 2%-4%)
“Finance Minister Sri Mulyani Indrawati said Tuesday the economy could suffer a more severe contraction in the third quarter than previously forecast due to the renewed social curbs in the capital. For the full year, she expects economic growth at the lower end of the government’s outlook, which ranges from 0.2% growth to a 1.1% contraction”, Bloomberg reports.
Central banks in emerging market
Covid-19 has hit worldwide economy; global trade has begun slowing, great lockdowns interfered outdoor travels, corporates had no choice but to furlough workers which led to the rise of unemployment rate. Financial market has also been in a fearful strike as investors worry about their plunging assets. At least, expectation of strong economic growth from advanced countries is good news as many believed that the worst had passed. Their stock market quickly recovered from the bottom point recorded in March.
However, emerging market has different story with the advanced countries. Countries like Indonesia, Philippines, India, Russia, Brazil, and Turkey are in economic crisis as pandemic has been spreading rapidly. Central banks like India, Indonesia, or Philippines have eased their monetary policy which can lead to downwards on their credit ratings. For example, Bangko Sentral ng Pilipinas, the central bank of the Philippines announced that it would implement 300 billion Philippine peso (about $6.2 billion) government bond repurchase agreement with the country's Treasury Bureau for six months at most. Excessive stimulus programs like sovereign debt purchases in response of pandemic recession, can damage central bank’s future cuts and tapering and monetary authorities can lose credibility.
S&P Global concerned that the purchase program does not only result to an inflation problem but also lead to debt issuance surge and currency depreciation. "Sovereigns with less credible public institutions and less monetary, exchange rate and fiscal flexibility have less capacity to monetise fiscal deficits without running the risk of higher inflation”, says the analysts. "This may trigger large capital outflows, devaluing the currency and prompting domestic interest rates to rise, as seen in Argentina over parts of the past decade." S&P has downgraded more than 50 government ratings as level of debt is are set to continue of spiral.
Source: Bank of Indonesia, Bloomberg, The Economist
https://www.bloombergquint.com/onweb/bank-indonesia-seen-on-hold-as-rupiah-pressured-decision-guide
Global Monitor
