Global Sky Clouding Over

AFP PHOTO/ANDREW CABALLERO-REYNOLDS

The International Monetary Fund (IMF) managing director, Christine Lagarde

"The clouds on the horizon ... are getting darker by the day," International Monetary Fund (IMF) managing director Christine Lagarde said recently to describe the global economy, currently hit by trade wars. (CNN, June 12, 2018).

Protectionism was the darkest cloud that covered the horizon of the world economy. In fact, Lagarde said, the world economy was currently headed in the right direction from 10 years ago in 2008-2009, when the subprime mortgage financial crisis in the United States shook up the global economy.

The IMF projected the global economy would grow 3.9 percent this year, the highest since 2011. However, the improving global economy has been hit by the US trade war, triggered by the large trade deficit of US$375 billion with China in 2017. US exports to China totaled only $130 billion, while imports reached $505 billion.

The US has just announced a $50 billion import tariff on China and its other major trading partners, such as the European Union, Mexico and Canada. This unfair trade practice quickly led to retaliation. A tariff war was inevitable and could spread throughout the world. The world economy will no longer be efficient because consumers will have to pay more for the goods they buy.

Lagarde said the sky over the global economy was growing darker, as US protectionism was also followed by: (1) monetary tightening, namely the US interest rate hike; (2) increased foreign debts in emerging countries; (3) the diminishing US fiscal stimulus; and (4) the continuing slowdown in China\'s economic growth (Bloomberg, May 25, 2018).

AP PHOTO/STEPHEN B. MORTON

Several ship to shore cranes work a vessel at the Georgia Ports Authority\'s Port of Savannah loading and unloading container in Savannah, Georgia, Jan. 30, 2018. On Thursday, June 14, the International Monetary Fund issues its annual assessment of the U.S. economy at a news conference with IMF Managing Director Christine Lagarde.

The strategic issue has also hit Indonesia: for example, Indonesia\'s foreign debt, which totaled $357 billion, or about Rp 5 quadrillion. Psychologically, the amount is frightening, although it is relatively safe because it is 36 percent of the gross domestic product (GDP), far below the maximum limit of 60 percent. Currently our GDP is above Rp 14 quadrillion, meaning that Indonesia is one of the 16 countries with GDPs of trillions of US dollars.

The darkest cloud for Indonesia today is the rupiah depreciation triggered by the rise in the US benchmark interest rate, currently at 2 percent. This year, the US central bank, the Federal Reserve (the Fed), plans to raise its interest rate twice to meet its target of 2.5 percent. Actually, the Fed policy is counterproductive with regard to the efforts to cut the US trade deficit. The US trade deficit of $580 billion cannot be helped by strengthening the US dollar.

Conflict of interest

A conflict of interest exists between the efforts to raise interest rates and the efforts to reduce the US trade deficit. The two are out of sync. The Fed chairman needs to evaluate this year\'s aggressive rate hike plan. What is needed is gradualism, an increase in stages. The plan to raise the reference interest rate to 2.5 percent should not be realized this year. Fed chairman Jerome Powell should delay the rate hike until next year. There is no hurry. What is it for?

AP PHOTO/JACQUELYN MARTIN

Federal Reserve Chair Jerome Powell

The latest Fed rate hike was made during Idul Fitri in Indonesia, which caused the rupiah to return to above Rp 14,000 to the dollar. Therefore, during the upcoming Board of Governors meeting (RDG) on June 27-28, Bank Indonesia (BI) will surely monitor the rupiah’s development. If the rupiah exchange rate is still weaker than its fundamental level, the central bank needs to raise its benchmark interest rate further to 5 percent.

Many fund owners (savers) are less comfortable with the current rate of 4.75 percent, because the margin between the interest rate and the inflation rate, which is expected to reach 4 percent, is too narrow.

The money market in Indonesia is not yet used to a situation in which the margin between the benchmark interest rate and the inflation rate is so narrow. Much criticism has been addressed to the central bank following the interest rate hike, because it was made when credit expansion remained weak.

The central bank seems to have prepared measures to reduce the impact of the rate hike, such as by relaxing the loan to value (LTV) ratio. This policy will basically facilitate borrowers, as they would be allowed lower down payments when raising loans for buying property and vehicles. Relaxing the LTV is expected to encourage consumers to realize their shopping plans. So, BI’s planned easing of the LTV ratio should be made to conform with the interest rate increase.

The rate hike is intended to halt the outflow of foreign funds that would cause a further decline in foreign exchange reserves (now $122 billion). This policy will definitely have a negative impact on credit expansion in the banking industry.

Kompas/Wawan H Prabowo

A. Tony Prasetiantono

The relaxation of the LTV ratio will help reduce the impacts, although it will not be very effective. The rupiah’s stability is the highest priority right now, more than anything else. The sharp depreciation of the rupiah can disrupt the market’s confidence in economic fundamentals. It would also place a greater burden on foreign debt payments and increase inflation from imported goods and services, while at the same time it will not automatically raise exports (depending on the elasticity of the demand for our export goods).

Hopefully, the cloud over the global economy will not darken as Lagarde fears. Restraint among key countries involved in the trade war, such as the US and China, and the monetary tightening will be the deciding factors. Indonesia sits within this pendulum.

A. Tony Prasetiantono, Head of Economics and Public Policy Center, Gadjah Mada University