The Fed and Positive Sentiment

KOMPAS/ALIF ICHWAN

A foreign exchange officer counts money at a money changer in Jakarta, Friday (1/2/2019). The rupiah exchange rate against the US dollar strengthened slightly at the close of trading on that day, when the rupiah rose in closed spot exchange trading by 25 points or 0.18 percent to Rp 13,947 per US dollar. The rupiah moved to the range of Rp 13,945 to Rp 13,985 per US dollar.

The decision of the United States central bank, the Federal Reserve (Fed), to keep its benchmark interest rate unchanged has brought a positive sentiment to the global financial market and triggered inflows of foreign funds into emerging markets.

The foreign fund inflows, which were also triggered by attractive investment returns in developing countries, including Indonesia, have contributed to a sharp increase in currency exchange rates and stock indices. The rupiah, which in October 2018 fell to 15,400 per US dollar, further strengthened to 14,000 per US dollar on Thursday. Meanwhile, the Jakarta Composite Index (JCI) of the Indonesian Stock Exchange (IDX) bounced back to the psychological level of 6,500.

In addition to the Fed‘s signals that an increase in interest rates will not as aggressive as before this year, another factor that helps bring positive sentiment in the global financial market is also the decline in oil prices amid an increase in global supply. The easing of the tension of the US-China trade war also brings a positive impact. The US policy of maintaining its interest rates is based on consideration of the gloomy projections on US domestic economic growth and the global economic slowdown.

AFP/GETTY IMAGES/ALEX WONG

Federal Reserve Board chairman Jerome Powell pauses during a news conference after a Federal Open Market Committee meeting on Jan. 30, 2019 in Washington, DC. The Fed has decided to leave interest rates unchanged.

The strengthening of the rupiah, which is currently undervalued, and also the JCI, is expected to continue with high investor confidence in the fundamentals of the domestic economy. With government bond yields of 7.27 percent for a 10-year tenor, Indonesia is also one of the most attractive investment destinations among emerging markets.

Our challenge is how to take advantage of global positive sentiment and keep domestic positive sentiment in order to spur domestic economic growth. Managing foreign funds, especially volatile short-term portfolio investment, by turning them into long-term investments through the acceleration of financial market deepening and improvement of the investment climate, is urgent.

The surge in portfolio investment since the beginning of the year has not been accompanied by an increase in direct investment, as reflected in the decline in the realization of the foreign direct investment (FDI) compared to the previous period. In the long term, the sustainability of growth will depend on three economic drivers: investment, exports and domestic consumption. Some critics see that the emergence of the positive sentiment is more due to external factors and not because of improvement in the country. One of the problems is the current account deficit, which increased to 3.37 percent of the GDP or US$8.8 billion in the third quarter of 2018.

The widening current account deficit raises vulnerability to the risk of capital flight and pressure on the exchange rate. More decisive steps to reduce the current account deficit, such as by fixing export-oriented industries that have so far been dependent on imported components, are needed.

In addition, structural reforms need to be continued, including fixing the investment climate and the ease of doing business index that slipped a little after improving sharply during this regime. We do not know how long global positive sentiment will last, so the acceleration of infrastructure development and the improvement of economic fundamentals are quite important.

Slowing global growth will be a challenge because it affects demand for Indonesian exports. We also need to be able to take advantage of the ceasefire in the US-China trade war to expand our market.