The Fate of the Rupiah
A teller counts US dollars at the head office of Bank Mandiri, Thursday (28/6/2018).
At the end of the successful 2018 Asian Games, the rupiah fell sharply. Of course, there is no connection between the two, but there are similar dynamics in play. Like the athlete\'s triumphs, the dynamics of the exchange rate are also determined by the dimensions of “physics” (fundamental factor) and "spirit" (sentiment factor), which have a reciprocal relationship.
Last weekend, on Friday (31/8/2018), the rupiah closed at Rp 14,711 per US dollar, the lowest level since three years ago (Kompas, 1/9/2018), and even approaching the level during the 1998 crisis. Is it true that our economic fundamentals are as bad as those from two decades ago? Or is it more due to negative sentiment resulting from external pressure?
The external pressure is the main determining factor in the sharp fall of the rupiah, although there is certainly a contribution from the domestic fundamental factor. However, what is clear is that the current situation is completely different than the 1998 Asian crisis.
The recent panic was triggered by the Argentine crisis, which caused investors to withdraw from almost all developing countries that are considered to have fundamental weaknesses.
Experts often liken the dynamics of a financial crisis that takes place from generation to generation to a sports competition with the Olympic motto: faster (Citius), higher (Altius) and stronger (Fortius).
The crisis is increasingly fierce and difficult to overcome. The crises in Argentina, Venezuela and Turkey have rapidly spread to all developing countries.
Broadly speaking, the most fundamental difference between the current situation and the situation in 1998 lies in the “epicenter” of the problem. If, during the 1998 financial crisis, the epicenter of the earthquake was in the Asian region and at home, this time, it is outside the region. First, the economy of the United States is undergoing a consolidation phase. Second, there is pressure from developing countries such as Argentina, Venezuela and Turkey.
The source of turmoil
The economy of the United States in the second quarter grew by up to 4.2 percent. Even though President Donald Trump claims it as a great success, many economists think otherwise, describing it as the beginning of the crisis.
Jeffrey Frankel, professor at the John F. Kennedy School of Government at Harvard University, US, said Trump\'s fiscal policy was pro-cycle, which could later trigger a crisis (Project Syndicate).
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A worker carries a batch of beach sarongs to the banks of the Solo River on Monday (9/3/2018) as lengths of colorful fabric dry under the sun in Laban village, Mojolaban district, Sukoharjo regency, Central Java. Local businesses have been impacted by the rising price of raw materials, such as fabrics and dyes, due to the weakening rupiah against the US dollar, while their profits have been shrinking from an inability to increase the selling price.
The US economic growth is supported by tax reduction policies that have resulted in the swelling of the government budget deficit. To close it, the government must issue new bonds. The economic growth actually provides the opportunity to foster fiscal strength so that the government will have enough financial buffer when there is turmoil. This basic principle is ignored by the Trump government.
Its monetary policy can no longer accommodate low interest rates. Slowly but surely, the US Federal Reserve (the Fed) must raise interest rates toward the 2.5 percent limit. The pro-cyclical fiscal policy amid rising interest rates has brought a spillover effect on global financial markets.
The Trump government is well aware of the position of the US dollar as the safest currency and is taking advantage of it excessively. Complexity is added by the lingering trade war that is accompanied by an exchange rate war between the US and China. In countering tariffs, China has allowed its currency to weaken so that its products are cheaper. The complexity of this global situation affects developing countries.
Why are Argentina, Venezuela and Turkey unable to deal with this situation? Their domestic economic fundamentals are so bad, making the sentiment factor out of control. The sentiment can hit back the fundamental factor, so the situation will get worse quickly.
That is why the Argentine government has asked for an acceleration of the disbursement of the US$50 billion loans from the International Monetary Fund (IMF).
As reported by Kompas on Saturday (1/9), citing Bank Indonesia data, at the end of last week the fall of the Argentine peso was the sharpest compared to other currencies in the world (-51.67 percent) since the end of 2017, followed by the Turkish lira (-43. 85 percent), the Brazilian real (-20.26 percent) and the South African rand (-15.98 percent). In the Asian region, rupiah depreciation was 8.01 percent worse than the Philippine peso (-6.61 percent), but better than the Indian rupee (-9.70 percent).
Why has Argentina’s currency fallen the most? According to the latest The Economist, Saturday (1/9), in the first quarter of 2018, Argentina\'s current account deficit was 4.7 percent of its gross domestic product, while Brazil’s was 1 percent, South Africa’s 3.2 percent, Turkey’s 5.9 percent, and India’s 2.4 percent. Indonesia\'s current account deficit worsened from the first quarter of 2.1 percent of the GDP to 3 percent of the GDP in the second quarter. Other countries in Latin America also experienced a significant fiscal deficit, namely Argentina at above 5 percent and Brazil at above 7 percent. The fragility of the fundamentals of the domestic economy triggered the withdrawal of investors from the country, at least temporarily.
What is the fate of the rupiah? Admittedly, the external pressure this time is quite heavy, while the domestic economic situation is not stable enough. Policy responses must be quick without showing panic. First, the interest rate has been raised five times since May to reach 5.5 percent. Second, the government introduced a new fiscal policy through the increase of the Import Income Tax rates on 900 imported products. Third, there is a mandatory use of the 20 percent blended biodiesel (B20) and strategic projects (infrastructure) that have high import components have been postponed.
If these policies are implemented, it will result in a decline in economic growth and, as a consequence, the government\'s target of 5.2 percent by 2018 will be difficult to achieve. Policy choices are indeed very limited so the consequence of having lower economic growth must be accepted.
Policies can also be directed to spur exports of manufacturing products. Therefore, this sector needs to be excluded, including from the delay in infrastructure projects. There should be a direct connection between infrastructure development and efforts to improve the competitiveness of export products so that export productivity can be improved immediately.
A. Prasetyantoko
The rupiah can still be saved. Although there are still fundamental problems, the opportunity for improvement is still wide open. Moreover, the future of our economy is very promising. We can learn from the great success of the Asian Games that just ended, where different interests can be united into strengths; all for Indonesia.
If in overcoming this heavy economic problem we could "embrace", the effect would be extraordinary. It should not just be about using the economic problem as ammunition in a rivalry that can affect the sentiment. The "Embrace the Asian Games" moment must be continued!
A. Prasetyantoko, Lecturer at Atma Jaya Catholic University Jakarta
