Economic Turmoil

KOMPAS/PRIYOMBODO

A foreign exchange outlet is seen on Jl. H. Agus Salim, Central Jakarta, Wednesday (3/7/2018). The US dollar has continued to strengthen against the rupiah.

Like an airplane, our economy is facing turbulence and strong headwind. As a result, the journey is thrilling and it is difficult to accelerate. That is the situation we are facing with the sharp fluctuation in the rupiah exchange rate, which has recently plunged to Rp 14,400 per US dollar, and with the difficulty in achieving economic growth of more than 5.1 percent.

Not many policy options are available to cope with the turmoil. As expected, Bank Indonesia last week raised its 7-Day Reverse Repo Rate (7DRRR) by 50 basis points (bps) to 5.25 percent, the third rate hike in six weeks. There was not much to question about the rate increase. But many parties did not expect the central bank would increase its benchmark interest rate so high. Some people thought BI’s move was excessive. Is this the case?

Actually, BI Governor Perry Warjiyo has been very clear about his stance since his appointment. He has mentions on several occasions that he wants to introduce a preemptive, front-loading and ahead-of-the-curve policy. It is a policy that, although some consider excessive, has been taken by design, and not in a panic.

The question is, how great is the urgency for this "progressive monetary policy"? The rupiah weakened a few days before the announcement of the BI rate hike. In addition to anticipating a rise in the US central bank’s interest rate, the rupiah also fell as a result of market reaction to the plan of the People’s Bank of China to relax its monetary policy, to cope with increasing market pressures and to ease the impact of its trade war with the US.

A leaked report of the Chinese government-backed think tank, the National Institution for Finance & Development (NIFD), has warned of a potential “financial panic” in the world’s second largest economy (Bloomberg, 27/6/2018).

The looming trade war, followed by the exchange rate war between China and the US, the rise in global oil prices and global uncertainties have made the financial markets in developing countries sensitive. For a country that depends highly on foreign liquidity, the turmoil could be worse.

Fundamental issues

The rupiah has depreciated about 5 percent since the beginning of the year. Many other currencies in the world have fallen more steeply, such as the Indian rupee (7 percent), the Turkish lira (17 percent) and the Argentine peso (33 percent). However, the currencies of some of our neighbor did not fare as badly as the rupiah. The Thai baht has depreciated less than 2 percent, while the Malaysian ringgit has risen 0.1 percent since the start of the year.

Although they face the same global uncertainties, Thailand and Malaysia has not experienced turmoil like we have. Generally, it can be said that a country with a larger current account deficit will experience sharper exchange rate fluctuations. In the first quarter of 2018, our current account deficit was equivalent to 2.2 percent of gross domestic product (GDP) and Argentina\'s current account deficit was 5.3 percent of GDP. Meanwhile, Thailand and Malaysia respectively posted a current account surplus of 10.2 percent and 3.2 percent of GDP in the same period (The Economist, 2/6/2018).

Current account transactions include a country’s foreign obligations, ranging from import financing, payment for foreign services, debt and interest payments and to dividends transferred to investors’ countries of origin. The current account deficit shows the extent of our dependence on foreign capital. With this high dependence on foreign capital, any global uncertainty would pose a risk for capital outflows. In a situation like this, the decision to raise the reference rate by 0.5 percent seems acceptable.

The impact of the interest rate hike was seen immediately: The rupiah strengthened by 0.6 percent against the US dollar, while the Jakarta Composite Stock (JCI), the main price indicator for the Indonesian Stock Exchange (IDX), rose 1.5 percent following the central bank’s rate hike announcement (Bloomberg, 29/6/2018). Is this policy sufficient? Definitely not. The policy to raise the benchmark interest rate is a pro-stability measure and has the potencial to impede economic growth.

One of approaches that can compensate for the interest rate hike is to ease the mortgage and housing loan regulation by revising the loan-to-asset ratio (LTV) rules that will come into effect on Aug. 1. In easing the LTV requirement, it is expected that the potential rise in lending rates will not affect the property market.

KOMPAS/HERU SRI KUMORO

Bank Indonesia decided to raise its benchmark interest rate by 50 basis points to 5.25 percent, its Deposit Facility (DF) by 50 bps to 4.50 percent and Lending Facility (LF) by 50 bps to 6 percent on Friday (29/6/2018).

Global stability

As regards the recent global situation, Nouriel Roubini, an economics professor at Stern Business School of New York University, writes in Economic Crisis (2010): “... far from being the exception, crises are the norm, not only in emerging but in advanced economies”.

The situation was normal in the 1980s to 2000s, when economic turmoil occurred only occasionally, while from post-2008 to the present, it has been quite the opposite: it is sometimes stable and generally volatile (in crisis).

The context that must be understood is that global economic turbulence is consistent and can occur at any time. The only difference is in its scale, so we don’t need to be panic whenever there is turmoil. We should instead prepare ourselves. When faced with uncertainties, we don’t have many options other than to introduce a pro-stability policy. The more appropriate question is “have we done our housework by the time the situation begins to subside and it is relatively calm?”

Naturally, policy innovations often emerge in times of crisis. In times of calm, everything returns to normal. On the other hand, when turmoil occurs, we need to understand that the monetary policy must be tightened. But what measures will be taken when the situation has subsided? Progressive policies also need to be applied at such times to prepare for uncertainties.

BI\'s obligations, as set out in the law, focus on exchange rate stability and inflation. However, many structural factors affect the stability of the exchange rate and inflation within the BI’s scope. Therefore, when the situation is secure, progressive policies need to be taken in order to prepare for future turbulence that could be stronger.

The journey ahead will be full of turbulence. In addition to the fact that crisis will become the new norm, instability also exists in "ourselves". As Hyman Minsky (1986) puts it, the old non-conventional thinking has been forgotten: "Instability is a normal result of modern financial capitalism".

A. Prasetyantoko, Lecturer, Atma Jaya Catholic University