Rupiah Vaccination

HERYUNANTO

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The global economy does not seem to be easygoing right now, and it is even more difficult to predict. The cloud of uncertainty is quite thick and is affecting the global economic condition.

Problems have emerged, one after another, both in developed and developing countries, like the waves of the sea. Every country tends to protect itself. The global monetary and fiscal policies tend to be more inconsistent and inharmonious. The economic policy divergence has occurred and will probably continue.

As a result, the supply of American dollars tends to be unbalanced and never reaches a reasonable equilibrium level. The supply of dollars can be very excessive in the market at certain times, but then declines instantly. The global currencies tend to weaken against the dollar and it is difficult to stabilize them in the medium and long term. The world is busy with short-term solutions that are often quite temporary. It sounds very naive, but that\'s the reality of the situation.

The condition has caused a lack of economic growth. Just look at world economic growth. The US is recovering alone, while China has tended to slow down, and other developed countries are still in the consolidation stage and even tend to weaken as well.

Then, in the emerging markets, economic growth is still relatively limited, although the opportunity to grow further is still widely open as the potential output is still high. Therefore, it is time to vaccinate the rupiah so that it will be immune from the global financial and economic turmoil. The rupiah must be supported by monetary, fiscal and real sector policies that should be gradually and consistently issued. The rupiah must be protected with a bulletproof vest in facing the external shocks.

For that, we can start with the basic macroeconomic theory through identity and equality: Export (X) -Import (M) = Saving (S) -Investment (I). With this simple equation, we can answer why the rupiah is under pressure when external shocks occur. On paper, strengthening and stabilizing the rupiah may look easy. We don\'t need to use advanced macroeconomic theory.

This country only requires synchronous policies and can be implemented by all institutions (government, Bank Indonesia, the real sector and society) to increase the confidence of domestic and foreign investors toward the rupiah.

Defense

The main structural problem of the Indonesian economy is the current account deficit, which has become an old disease. Indonesia suffers a shortage of dollar supply from the real sector, which is usually covered by the inflow of foreign direct investment (FDI) and portfolio investment (stocks and bonds). The country’s real sector is very dependent on the dollar. Moreover, the bonanza era of primary export commodities has ended.

The manufacturing industry sector also faces difficulties in competing with foreign products. Domestic products cannot compete with imported products because of low productivity and lack of innovation. As a result, the pressure on the rupiah increases due to the high demand for the dollar.

So what should we do? This country should be much stronger and healthier than 20 years ago. It has already been accustomed and tested to face difficult situations. The key is very simple; the government, Bank Indonesia (BI), the Financial Services Authority (OJK), businesses, and the public must have the same spirit and are willing to work together to strengthen the rupiah antibodies, instead of blaming each other.

At present, Indonesia\'s economic fundamentals should be far better than during the 1998 economic and monetary crisis. However, these economic fundamentals are still unable to dampen the sharp depreciation of the rupiah. So, a positive story and a short term policy are needed to convince economic players and the public that the rupiah will return to normal immediately and to reverse abnormal condition to be normal and predictable.

BI has made many efforts in dealing with the depreciation of the rupiah. Raising  BI\'s benchmark interest rate (BI-7DRR) significantly, intervening in the foreign exchange market, buying government bonds, and providing monetary instruments to strengthen the mechanism in the absorption of foreign exchange earnings from exports. However, apparently, the positive impact is relatively limited and temporary. Rupiah only rises briefly, then weakens again.

There are three choices of BI instruments to absorb foreign exchange (FX) earnings  from exports for the domestic economy, namely: (1) selling  FX (through spot, swap, forward) to domestic commercial banks, (2) placement in Bank Indonesia Foreign Currency Deposits/ Securities Deposits (Foreign Currency Term Deposit/ Foreign Currency SBBI notes), and (3) placement on a Special Deposit Account (SDA).

Exporters will definitely take advantage of this facility if the FX swap hedging fees are cheap enough. The FX Term Deposits or FX SBBI notes should be also attractive with high interest rates.  So, the chance of rupiah to further fall can be curbed and the drop will be temporarily.

It should be acknowledged that it is impossible for BI to fight alone to maintain the stability of the rupiah because external pressure is very strong (the US dollar tends to strengthen against other countries\' currencies). The main problem is the current account deficit must be resolved immediately because this is the culprit why the rupiah is often under pressure.

Back to the equation: Export (X) - Import (M) = Saving (S) -Investment (I). At present, when the current account deficit is high, the rupiah tends to weaken significantly. By halting the economic growth through the increase in BI\'s benchmark interest rate, and with the assumption that imports of consumer goods, capital goods and raw materials will drop significantly, the trade balance (X-M) will consequently record a surplus, which will in turn ease the pressure on the balance of payments. As the result, the deficit will decreases, even there is a possibility, there will be a surplus.

So far, the government has implemented a number of measures to reduce imports, namely: (1) import restrictions with an increase in Income Tax (PPh) 22 on imports of consumer goods, (2) delaying government infrastructure projects with high import content, (3) increasing the domestic components (TKDN) in infrastructure projects, and (4) B20 Biodiesel policy (a mixture of 20 percent palm oil-based biofuel in regular diesel fuel) as import substitution. In addition, the government tries to increase the supply of US dollars by promoting the tourism sector and providing incentives to export-oriented industries.

Structural reform

All of the above policies are good, but not enough to make the Indonesian economy strong in coping with the external turmoil in the long run. Indonesia needs structural reforms which are massive, consistent and on the right target.

Monetary and fiscal policies must attack like a striker in a soccer game. It can be defensive but only occasionally. The medium and long term solution in coping with the structural problem of the current account deficit, which can make Indonesia to become a developed country, should be carried out through the increase in public savings and encouraging industries to export. This is not easy because it relates to labor productivity, technology and innovation. When labor productivity increases significantly and more efficiently, people\'s income increases.

Our industry should be more competitive and its products can be exported abroad and can increase the supply of dollars. I think the government has been quite aware of the low productivity of the country’s workforce for a long time.

The mismatch between the industrial needs and the workforce education is an old problem that has never been resolved. The vocational education proclaimed by the government of Joko Widodo-Jusuf Kalla, I think, should be fully supported in order to help cover the gap in the supply of quality labor.

The large education budget, which is 20 percent of total government expenditure, is a fantastic amount. It can make the education system more competitive at the global level, if it is used effectively in building the human resources, not just the physical facilities.

Infrastructure development, with the right priorities, will increase investment significantly. If this can be implemented in stages, consistently and disciplined, I am quite sure that the rupiah will have strong antibodies in facing any global economic pressure. The right rupiah vaccination makes Indonesia\'s economy immune so that domestic economic growth can reach its sustainable balance.

With such an achievement, Indonesia won’t certainly need to be burdened with debts in financing its development. There will be no more a shortage of US dollar supply and current account deficit again. In fact, Indonesia can be a blessing for other nations because it has become a creditor (not a debtor anymore).

Anton Hendranata, Economist at Bank Rakyat Indonesia