Pressure on Rupiah Continues

The pressure on the rupiah exchange rate has not subsided. The Fed’s plan to increase its interest rate increases pressure on the rupiah, and Bank Indonesia was forced to raise its benchmark interest rate again to 5.5 percent this month.

ANTARA FOTO/WAHYU PUTRO A

A teller counts US dollars at the head office of Bank Mandiri, Thursday (28/6/2018). Bank Indonesia’s Jakarta Interbank Spot Dollar Rate (Jisdor) showed the rupiah weakening to Rp 14.271 per US dollar, the lowest level in more than three years, amid negative market sentiment and unsupportive fundamentals.

The pressure on the rupiah exchange rate has not subsided. The Indonesian currency remains weak at about Rp 14,600 per US dollar. While the chairman of the United States Federal Reserve (the Fed), Jerome Powell, still insists on again raising the benchmark interest rate to 2.50 percent this year and then to 3.25 percent next year, President Donald Trump opposes the plan.

The Fed’s plan to increase its interest rate increases pressure on the rupiah, and Bank Indonesia (BI) was forced to raise its benchmark interest rate again to 5.5 percent this month. The currency problem had not been resolved when another complication arose with the Turkish economy was hit by a crisis that reverberated negatively around the globe.

Economist Paul Krugman said the Turkey crisis was similar to the economic crisis in Indonesia 20 years ago in 1998 ("Partying Like It\'s 1998", The New York Times, 11/8/2018).

In fact, Turkey is to be a reference for the rupiah redenomination. Turkey dropped six zeros from its currency on Jan. 1, 2005, and 1 million old lira was redenominated into 1 new lira. Before that, the Turkish lira was one of the weakest world currencies in history.

In 2001, US$1 was equivalent to 1.65 million old Turkish lira! There was even a 20 million lira bank note! Inflation was very high as seen in the price of a bottle of mineral water, which cost 300,000 lira, cinema tickets cost 7.5 million lira and the Toyota Corolla 33 billion lira!

Redenominating the Turkish lira by eliminating six zeros has not been the most dramatic redenomination. Brazil has erased 18 total zeros from its currency in four redenomination measures, Argentina 13 zeros in four measures, Israel nine zeros in four measures, Bolivia nine zeros in two measures, and Peru six zeros in two measures. While redenomination which eliminates fewer zeros is Ukraine (five zeros), Poland (four zeroes), Mexico (three zeroes), Russia (three zeroes) and Iceland (two zeroes).

Initially, Turkey was successful in controlling the lira exchange rate. After redenomination, 1 US dollar was equivalent to 1.34 lira (2005), but it rose to 1.50 lira (2010), then to 2.72 lira (2015), 3.02 lira (2016), 3.65 lira (2017) and 7.23 lira, before rising to 6 lira per US dollar (2018).

Why did the lira depreciate so steeply? The answer is the distrust resulting from the economy’s poor performance and reputation. The current account deficit reached 5.5 percent of gross domestic product (GDP), exceeding the 3 percent of GDP maximum threshold, while the government debt was 60 percent of GDP.

The Turkish economy was also highly dependent on foreign funding. Its foreign debt was 53 percent of GDP, of which the private sector owed 70 percent. The debt situation, according to Krugman, was similar to Indonesia in 1998.

Interestingly, the Turkish lira fell last year, just after the economy grew 7.4 percent. How can this be explained? Harvard economist and Turkish nation Dani Rodrik said President Recep Tayyip Erdogan also contributed to the currency’s fall. The Turkish economy was basically driven by a loose credit policy, and high economic growth driven by disproportionate debts would end in a big problem. Turkey was now experiencing the problem, said Rodrik ("The Economic Costs of Erdogan", Project Syndicate, 24/8/2018).

Comparison

Several statistics compares the similarities between Turkey and Indonesia. Economists agree that Turkey suffered a crisis because of the foreign debt accumulation, which currently stands at about $453 billion. Indonesia currently has $387 billion in foreign debt.

Turkey\'s foreign exchange reserves ($124 billion) are slightly better than Indonesia’s ($118 billion) and reached as high as $142 billion in October 2017, while Indonesia’s reached $132 billion (February 2018). Other statistics show that the Turkish GDP is worth $900 billion, slightly below Indonesia’s $1 trillion GDP.

So, what conclusion and lesson can we draw from Turkey’s problems?

First, Turkey’s foreign debt-to-GDP ration (50 percent) is much worse than Indonesia’s (38 percent). Second, although the lira redenomination was successful, it failed to maintain price stability, with the new lira depreciating.

Kompas/Heru Sri Kumoro

A. Tony Prasetiantono

Third, even though Indonesia\'s debt is better than Turkey’s, vigilance is needed on the debt position. Government efforts to reduce the budget deficit to below 2 percent of GDP are relevant and necessary. This means that the government must step on the brakes on infrastructure development. Unfortunately, such a measure is not evident in the 2019 state budget’s infrastructure spending of Rp 420 trillion, higher than the Rp 410 trillion of this year\'s state budget.

Fourth, we need to listen to Krugman\'s view that a temporary foreign exchange control policy should be applied. Indonesia has so far only urged business players to place their foreign exchange in the country. More binding measures are still needed to counteract the continuing rupiah depreciation.

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