U.S. Secretary of State Mike Pompeo and President Donald Trump listen during a cabinet meeting at the White House in Washington, U.S., July 18, 2018.
There are new developments in the high interest rate policy of the United States. President Donald Trump has publicly expressed his displeasure against the policy of the Federal Reserve (the Fed) to continue to increase the interest rate.
Trump said that the rapid increase in interest rates could disrupt the US economic growth. However, he acknowledged that he could not intervene in the US central bank because it has the independence to do so.
The Fed also responded that they were independent in determining interest rates (BBC News, 7/19/2018).
Furthermore Trump stated that the increase in interest rates would hurt the US because at the same time, Europe and Japan still maintain a low interest rate regime. Trump also complained China had deliberately weakened its currency, yuan.
In fact, last year, China enjoyed a high trade surplus of US$375 billion, which triggered Trump to start a trade war (CNN Money, 19/7).
The difference of opinion between President Trump and Fed Governor Jerome Powell is interesting because Trump earlier wanted US interest rates to be raised. The low interest rate policy which had taken place for seven years in the era of Fed governors Ben S Bernanke and Janet Yellen was considered unfair to depositors.
This logic is increasingly relevant as the inflation in the US has reached 2.9 percent or exceeding the target of "around 2 percent", whereas the benchmark interest rate is only 2 percent. The current ideal interest rate should be above the inflation rate, which ranges from 3.25 percent to 3.50 percent.
It is therefore quite logical if the Fed plans to raise interest rates twice more this year and three more next year. With the five-fold increase, the benchmark interest rate will reach 3.25 percent. This level is enough to "compensate" for the 2.9 percent inflation.
The problem is that every time the interest rate is raised, global markets respond it with an increase in the US dollar exchange rate. It has caused the US products more expensive. The efforts to reduce the US current account deficit which reached $462 billion will be more difficult. The US suffers the biggest deficit in the world, far surpassing the second-ranked UK, which suffers a deficit of “only” $91 billion. Meanwhile, the region and country with the largest surplus are the European Union with $387 billion and China with $162 billion.
This dilemma could be the reason why the Fed held its benchmark interest rate in the range of 1.75-2.00 percent at its last meeting on Aug. 1, 2018. However, the market still expects interest rates to be raised to 2.00-2.25 percent in September, 2018. It means that the US dollar exchange rate will continue to strengthen. This scenario can only be mitigated if inflation can be quickly lowered to the level of "around 2 percent". However, can it happen soon? It\'s hard to confirm.
With such a background, we must begin to change the way of thinking. Rupiah cannot be expected to return to the previous level, for example, to below Rp 14,000 per US dollar.
Even though the current drop in the rupiah exchange rate looks similar to that 20 years ago (1998) when the Indonesian currency plunged to a range of between Rp 15,000 and Rp 17,000 per US dollar. However, the situation is different. The current exchange rate of Rp 14,400 per US dollar was a depreciation from Rp 13,700 per US dollar. While the exchange rate of Rp 15,000 per US dollar in 1998 was a sharp depreciation from Rp 2,300 per US dollar in 1997.
Therefore, it is methodologically very wrong if people compare the two. Not to mention other indicators: inflation of 3.18 percent (2018) versus 78 percent (1998); 5 percent economic growth (2018) versus minus 13.7 percent (1998). The condition of the banking industry is also very different. Almost all banks lost money and collapsed in 1998, with negative capital. Now banks have a capital adequacy ratio that even exceeds 20 percent for large banks.
However, many adjustments must be made to protect the rupiah. With current inflation of 3.18 percent, the benchmark interest rate is now sufficient (5.25 percent). However, the problem is that the hike in the US interest rate will likely continue.
On the other hand, the government needs to halt to spend foreign exchange expenditures in large quantities. The current account deficit is an internal factor that has a large influence on the weakening of the rupiah. The President’s plan to delay some infrastructure projects is a good idea.
This year, the government has allocated Rp.44 trillion in the state budget to build infrastructure. On the one hand, the big spending will boost the economic growth, as suggested by the growth theory of Ragnar Nurkse (1907-1959). However, on the other hand, the infrastructure development had dried up the foreign exchange, which contributed to the widening of the current account deficit and reduced foreign exchange reserves.
Our long-term strategy is correct, namely building massive infrastructure. However, when obstacles arise, we need short-term adjustments. Like driving a car, we don\'t have to continue to press the gas pedal. Sometimes it is also necessary to step on the brake pedal when passing a steep and rocky road with sharp turns. (A TONY PRASETIANTONO, Head of the Center for Economic and Public Policy Studies at Gadjah Mada University)
