Toward A Low Interest Rate Era
Speaking about reference interest rates, almost all countries will follow or refer to the monetary policy of the US central bank, the Federal Reserve.
Any action of the Federal Reserve (The Fed) is always anticipated by market players and investors because they often have a very significant negative impact on the movements and fluctuations in foreign exchange and global financial markets, especially countries that are held hostage by current account deficit problems. Countries with a lack of US dollar supply from the real sector are almost certain to lose their exchange rates when the Fed raises interest unexpectedly and aggressively.
Last year was still fresh in our memory, the only country whose accelerated economic growth was very impressive was the US, growing 2.9 percent from 2.2 percent in 2017. Conversely, developing countries, some developed countries (European Union and Japan), and the world\'s second-largest economy (China), their economic growth tends to continue to experience pressure, stagnation and decline.
This imbalance and uneven economic growth is responded to by different or divergent monetary policies by each country. The US chose a tight monetary policy and was very confident in raising its benchmark interest rate from 1.50 percent to 2.50 percent (up four times) in 2018, even though the previous year it had gone up three times (0.75 percent), and respectively once in 2015 and 2016. Meanwhile, other countries (European Union and Japan) are more comfortable implementing loose monetary policies, namely low interest rates, to stimulate and support economic growth that is in a difficult zone.
As a consequence of the Fed\'s rate hike, emerging market countries that are usually spoiled and flooded by inflows of foreign capital through portfolio investments (bonds and stocks) experience significant pressure on their currencies. Most world currencies (including the rupiah) weakened against the US dollar, due to the reversal of foreign capital flows to the US and triggered by a gradual reduction in the financial assets of the Fed. At that time, US dollar liquidity was greatly reduced in the global economy so that the US dollar was very powerful and strengthened against almost all currencies in the world.
The US trade balance deficit is widening, especially against China. The trade war initiated by President Donald Trump against China is not a surefire solution, it has even hampered and threatened the restoration of global economy.
This condition not only makes other countries very uncomfortable because of the significant weakening and turmoil of their currencies. The US is also very disadvantaged because the export of goods and services has become very uncompetitive. The US trade balance deficit is widening, especially against China. The trade war initiated by President Donald Trump against China is not a surefire solution, it has even hampered and threatened the restoration of global economy.
Direction change
Pressure on the US economy began to be felt in late 2018 and was expected to continue going forward. Therefore, it is only natural that the reaction of the Fed leaders has started to change direction. This indication can be seen from the statement of US Central Bank Governor Jerome Powell, who changed from optimistic (hawkish) to neutral on 26 November 2018 and continues to be pessimistic (dovish) at this time.
This confirms the fact that interest rate increases are already irrelevant and irrational to be talked about at the moment. So are the fixed interest rates. Now it shifts to how fast and how big is the Fed\'s benchmark interest rate going down this year and the next?
The US economy this year was not as powerful as last year\'s and was unstable. According to the International Monetary Fund (IMF), the US economy is expected to grow only 2.6 percent this year, slowing from 2.9 percent in 2018. The slowdown is expected to continue and is estimated to stand at 1.9 percent in 2020. Meanwhile, the European Union, Japan and China also faced a similar situation and it would be very difficult to get out of the zone of economic slowdown.
Pressure on the global economic slowdown is even higher because of the US-China trade wars that are on/off and there are no clear signs of abating. Moreover, at present there is no country that can be expected to be a supporter and a driving force for the world economy so that it does not sink even deeper.
Therefore, the era of low interest rates will again color the world economy and we have begun to feel it. Some countries have already lowered their benchmark interest rates, preceding the Fed\'s rate cuts.
Just look at India, which has an economic structure similar to Indonesia and which has a current account deficit, had already lowered interest rates three times (0.75 percent) from 6.50 percent to 5.75 percent since February 2019. In line with India the benchmark interest rates in the Philippines and Malaysia have each decreased once, while Indonesia has dropped twice from 6.00 percent to 5.50 percent.
The trend in the decline of world interest rates is getting stronger when the Fed lowers its interest rate to 2.25 percent from 2.50 percent as of 31 July 2019. Opportunities for further interest rate cuts are still wide open because of the vulnerability from the slowing world economic growth.
Fresh breeze
The downward trend in the benchmark rate of the world\'s central bank will certainly be a breath of fresh air and a breath for the domestic economy in 2019 unlike in 2018, when the rupiah weakened to Rp 15,238 per US dollar in October due to massive and massive foreign capital outflows. Fortunately, Indonesia\'s economy proved to be resilient and flexible enough to reverse this situation. The rupiah slowly strengthened again and closed at Rp 14,390 per US dollar at the end of 2018.
Sure enough, the flow of foreign capital returned to Indonesia and was supported by changes in the direction of the Fed\'s increasingly loose monetary policy.
Economic growth is also relatively very good, namely 5.17 percent in 2018, when the global negative sentiment was so strong gripping the Indonesian stock and bond markets. It must be admitted, in 2018 a lot of energy was spent to maintain the stabilization of the rupiah. Bank Indonesia was forced to aggressively raise interest rates from 4.25 percent to 6.00 percent so that Indonesia\'s financial assets would be very attractive. Sure enough, the flow of foreign capital returned to Indonesia and was supported by changes in the direction of the Fed\'s increasingly loose monetary policy.
Foreign investors believe strongly in the Indonesian economy in 2019 and in the future despite a major political event, the presidential election. International ratings agency, Standard & Poor\'s (S&P), upgraded the government debt rating (Sovereign Credit Rating) from BBB- to BBB on 31 May 2019. This means that Indonesia has obtained investment grade status equally from three world\'s top ratings agencies, namely S&P, Moody\'s and Fitch.
The influx of foreign capital that is so swift becomes a very soft cushion for the rupiah. With inflation expected to be relatively low and maintained, and the rupiah moving normally, we estimate BI still has enough room to cut its benchmark interest rate faster and bigger.
From the BI press release, it is quite clear that BI will not hesitate to slash interest rates again to encourage economic growth, in addition to the stabilization of the rupiah. Moreover, several central banks in developed and developing countries have responded to the dynamics of the slowing global economy by adopting a loose monetary policy through lower interest rates.
A decrease in lending rates is indeed needed, but not necessarily strong enough to encourage credit growth if banking liquidity is still tight and domestic demand is relatively limited.
The era of low interest rates is already in front of us, the opportunity for the domestic economy to be more powerful becomes more open. The domestic economy requires lower lending rates even though there is no guarantee that credit growth will expand immediately. A decrease in lending rates is indeed needed, but not necessarily strong enough to encourage credit growth if banking liquidity is still tight and domestic demand is relatively limited.
It seems that Indonesia still needs relaxation of macroprudential policies that are able to instantly and effectively increase banking liquidity, such as reducing the mandatory reserve requirement (GWM). In addition, more expansive government spending is needed in the second half of 2019 to further stimulate domestic demand.
Anton Hendranata, Economist at PT Bank Rakyat Indonesia