Get Ready for a High Cost Economy in 2024

Indonesia is at risk of heading towards a high-cost economy following the strengthening of the US dollar and global-domestic economic complications.

KOMPAS/PRIYOMBODO

Bank Indonesia Governor Perry Warjiyo is preparing to begin a press conference announcing the results of the Bank Indonesia Governor's Meeting (RDG) in Jakarta, Wednesday (17/01/2024).

JAKARTA, KOMPAS In the midst of the weakening of the rupiah which tends to continue, Bank Indonesia is under pressure to raise the benchmark interest rate. However, the option to increase interest rates from the 6 percent position that has been in place since October 2023 will put the brakes on economic growth.

The Governor's Board Meeting of Bank Indonesia (BI) was held on Wednesday (24/4/2024) and Thursday (25/4/2024). This regular meeting discussed once again the monetary policies that BI will take to respond to the increasingly uncertain global and domestic economic situations.

On March 19-20, 2024, the BI Governor's Council Meeting decided to maintain the benchmark interest rate at 6 percent, the deposit facility interest rate at 5.25 percent, and the lending facility interest rate at 6.75 percent.

The signal from The Fed to postpone the reduction of benchmark interest rates in the United States from the initial plan has pushed for the strengthening of the US dollar against other currencies, including the rupiah. For six consecutive trading days, the rupiah fluctuated above Rp 16,000 per US dollar.

Referring to the Jakarta Interbank Spot Dollar (Jisdor) data at the market's closing on Tuesday (23/4), the rupiah again closed weakened at the level of Rp 16,244 per US dollar or depreciated by 20 basis points compared to the previous day's closing.

KOMPAS/PRIYOMBODO

Governor of Bank Indonesia Perry Warjiyo (third from the left) and his staff prepare to hold a press conference revealing the results of the Board of Governors' Meeting (RDG) at Bank Indonesia in Jakarta on Thursday (October 19th, 2023).

Towards IDR 16,500

Citing CNBC, Wells Fargo Securities predicts that the exchange rate of the rupiah will reach Rp 16,500 per US dollar due to The Fed's delay in lowering interest rates. Strategy experts at Brown Brothers Harriman & Co even project that the rupiah's exchange rate will reach Rp 17,000 per US dollar by September 2024.

There is also an internal factor that weakens the rupiah, namely the seasonal increase in demand for foreign currency every second quarter. This seasonal demand, among other things, is for payment of principal debt, dividends, and coupons to non-residents.

Wells Fargo Securities predicts that the exchange rate of the rupiah will reach Rp 16,500 per US dollar in line with the delay of interest rate cuts by The Fed.

The strengthening of the US dollar and the weakening of the rupiah, coupled with the complications in the global economy, will directly impact the national economy. Starting with its transmission to the financial sector, this issue will increase the burden of the national economic costs.

The production costs of the real sector will soar, especially for businesses that import raw materials and auxiliary materials. The situation becomes even more complicated if the debt for production is in US dollars, but the sales of goods are for the domestic market.

KOMPAS/PRIYOMBODO

The exchange rate of the rupiah against the US dollar has continued to fluctuate above the level of Rp 16,000 throughout this week. This is happening as the US dollar index (DYX) strengthens, which this week moved 106 basis points or reached its highest level since November 9, 2023. The trend of DYX rising has been occurring since the end of March 2024.

The government budget will also be under pressure. Energy subsidies and compensations will expand. This is because a portion of domestic energy needs are fulfilled through imports that require payment in US dollars.

This can become more complicated if at any time the global crude oil prices skyrocket due to the escalation of conflicts in the Middle East, as has happened before.

Inflation risks climbing. It all comes down to high cost economics.

The cost of government and private debt, especially in US dollars, will also soar. This applies to both new debt withdrawals or interest payments on existing debt.

Inflation risks climbing. It all comes down to a high cost economy. Finally, Indonesia's economic growth rate could be even slower.

KOMPAS/TOTOK WIJAYANTO

Visitors see items displayed at the Indo Leather & Footwear Expo 2023 at JlExpo, Kemayoran, Jakarta, Thursday (3/5/2023).

Risk of slowing down

Indonesia's economic growth in 2023 is predicted to be 5.05 percent, lower than 5.31 percent in 2022. In 2024, the government is targeting 5.2 percent. The International Monetary Fund's World Economic Outlook as of April estimated that Indonesia's economic growth will be 5.0 percent in 2024 and 5.1 percent in 2025.

Bank Permata's Chief Economist, Josua Pardede, stated that uncertainty in the global financial market is still very high at present and can change drastically and quickly. The geopolitical conditions in the Middle East and anticipation of the release of several data in the US that will affect The Fed's policies become crucial topics to be discussed in BI's RDG on April 23-24, 2024.

We see increasing the BI Rate as BI's last option to maintain rupiah exchange rate stability

If the global condition tends to worsen accompanied by an increase in demand for safe investment instruments, Josua continued, there will be actions from some investors to avoid prolonged risks. This will cause the rupiah to continue to weaken even though BI intervenes.

"There is indeed room for BI to raise the BI Rate. We see the increase in the BI Rate as BI's last option to maintain the stability of the rupiah exchange rate," he said when contacted in Jakarta on Tuesday (23/4/2024).

KOMPAS/COKORDA YUDISTIRA M PUTRA

The Bank Indonesia Bali Provincial Representative Office held a webinar titled "Reshaping Bali Economic Strategy After Covid-19" as part of the dissemination of the Bali Provincial Economy Report for May 2020 on Tuesday (7/7/2020). The online seminar featured PT Bank Permata Tbk's Chief Economist Josua Pardede as a speaker along with Muhammad Firdaus, a Professor of Economics and Management at the Bogor Agricultural University.

According to Josua, Bank Indonesia (BI) can reduce pressure from external factors by raising the benchmark interest rate. This is because the yield differential between domestic financial instruments and other countries is widening, which can be attractive to investors.

However, on the other hand, the increase in benchmark interest rates by BI can cause a rise in the burden of domestic financial instrument yields and become a burden for bond issuers.

The increase in interest rates can also be transmitted to the increase in credit interest rates. This will result in increased loan costs, which in turn will hinder Indonesia's economic growth potential.

"For BI's RDG in April 2024, we see that BI is likely to still maintain the BI Rate at the level of 6 percent," said Josua.

KOMPAS/ADRYAN YOGA PARAMADWYA

Bank Indonesia Governor Perry Warjiyo listens to journalists' questions during a press conference following the Bank Indonesia Board of Governors Meeting in Jakarta, Wednesday (20/3/2024). The Bank Indonesia Board of Governors Meeting has decided to maintain the benchmark interest rate at 6 percent.

Senior economist and Associate Faculty of the Indonesian Banking Development Institute, Ryan Kiryanto, also predicts that the Bank of Indonesia will maintain its benchmark interest rate at 6 percent. The reason is that external geopolitical factors so far do not support the central bank to loosen its policy.

Moreover, Ryan emphasized that The Fed has also delayed its benchmark interest rate cut from the projected June to September 2024. It is not impossible that The Fed will only lower its benchmark interest rate next year.

Even if US inflation is still difficult to control, meaning that it remains above the target of 2 percent until the end of 2024, The Fed potentially will increase the benchmark interest rate by 25 basis points up to 5.5-5.75 percent.

"For the sake of continuing efforts in stabilizing the domestic economy and monetary system, namely controlled inflation and exchange rate stability of the rupiah, the best available option is to maintain the BI-Rate," said Ryan.

Six percent

If The Fed raises its benchmark interest rate and inflation in Indonesia tends to rise towards 3.5-4 percent, Ryan added that BI has room to increase its benchmark interest rate. However, in the short term, maintaining the BI Rate at 6 percent is a reasonable, precise, and anticipatory step.

President Director of PT Bank CIMB Niaga Tbk, Lani Darmawan, stated that the high level of interest rate could potentially slow down credit growth. He hoped that the relevant authorities and regulators would make the right decisions.

Also read: Reuters Survey: Majority of Economists Expect Fed Interest Rates to Decline by September

"We believe that the government and regulators will make the best decisions. If interest rates remain high and also if the exchange rate of the rupiah remains weak, it is predicted that credit growth will slow down. This is what must be anticipated by the banking industry," he said.

Based on the data from the Financial Services Authority (OJK), bank lending in February 2024 grew by 11.28 percent annually to Rp 7.095 trillion. Monthly, the loan distribution in February 2024 grew by 0.52 percent, which is lower compared to February 2023's growth of 1.02 percent.

KOMPAS/FERGANATA INDRA RIATMOKO

Bank officials and vehicle dealers are trying to attract potential motor vehicle buyers with credit systems during promotional activities at a mall in Solo Baru, Sukoharjo, Central Java, on Saturday (5/3/2022).

Hope it's stable

The President Director of PT Bank Central Asia (BCA) Tbk, Jahja Setiaatmadja, hopes that BI will make decisions that can maintain the stability of the rupiah exchange rate. This is important amidst the global interest rate conditions, especially the high benchmark interest rate in the United States which is expected to last longer than initially expected. "(Our hope) is that the rupiah exchange rate can be well-controlled," he said.

Meanwhile, President Director of CIMB Niaga Finance (CNAF) Ristiawan Suherman believes that the increase in interest rates to maintain the value of the rupiah can have an impact on the increase in funding costs (cost of fund). This will also cause a decline in people's buying power.

"Until now, the exchange rate movement has not yet affected car prices, so it is hoped that with a stable or fixed interest rate, it can drive economic growth, especially in the financing industry," he said.

If they follow the Fed too closely, central banks in Asia could damage price stability in their respective countries.

Quoting Reuters, the Director of the Asia Pacific Department of IMF, Krishna Srinivasan, on Friday (19/4), stated that the interest rates in the United States have a strong and rapid impact on the financial conditions and currency exchange rates of Asian countries.

He reminded that if central banks in Asia adhere too closely to The Fed, they can disrupt price stability in their respective countries. This was emphasized when several central banks in Asia faced a dilemma.

"We recommend central banks in Asia to focus on domestic inflation and avoid making policy decisions that are too dependent on anticipating movements from the Federal Reserve," he said.