In Indonesia, relaxing the monetary and banking regulations was made possible from the issuance of a regulation in lieu of law (Perppu), which was later enacted as Law No. 2/2020.
By
BY MIRZA ADITYASWARA
·6 minutes read
As a country that relies heavily on capital inflows, Indonesia must pay attention to any changes in the economic and monetary policies of major countries, especially the United States and China.
We are just 10 days into 2022 so it is still too early to observe a trend, as many global financial market players have just returned from their holidays. However, within the past week, the performance at global financial markets sent a fairly uniform signal, namely concern about the expected increase in the benchmark interest rate of the United States Federal Reserve (Fed). The US stock index for the technology sector, Nasdaq, fell 5.7 percent while the Standard and Poor's 500 (S&P 500) declined 2.5 percent. Meanwhile, the Financial Times Stock Exchange 100 Index (FTSE 100) in London dipped 0.3 percent and the Shanghai Stock Exchange (SSE) Composite Index was down 1.8 percent.
As the US economy has begun to recover from the Covid-19 crisis, the Fed needs to reduce monetary stimulus and raise interest rates, because if this is left unchecked, inflation will only grow further. US treasury yields have already begun to increase. For example, the yield for 10-year notes climbed sharply from 1.52 percent to 1.77 percent. However, if the pace of the Fed rate’s increase is too fast, it is feared that this would effect a slowdown in economic recovery to result in a fall in the country’s stock prices. If public mobility returns to normal and people start working at the office again, the use of technology for meetings and shopping will decline and as a result, the prices of techno stocks will also fall. The value of crypto assets will also fall sharply. The price of bitcoin, for example, skyrocketed 44 percent in October-November 2021, but then slumped 54 percent over November 2021-January 2022, possibly due to expectations that the US dollar exchange rate would rise.
The US dollar also strengthened 0.7 percent against the rupiah.
Expectations of a Fed rate hike and rising US treasury yields have resulted in increased purchases of the US dollar. In early January, the US dollar rose 1 percent against the Korean won, the Russian ruble as well as the Brazilian real. The US dollar also strengthened 0.7 percent against the rupiah.
The world is moving from abnormality to normalization. We remembered that during the peak of the Covid-19 pandemic in 2020-2021, the state budget was under tremendous pressure as state revenues fell sharply while subsidy spending increased significantly to save the people. As a result, the budget deficit drastically increased and had to be covered by debt. The government debt ratio therefore increased sharply during the pandemic because state funding was increased to mitigate the impacts of the pandemic on its citizens.
In handling the global Covid-19 crisis, the monetary authorities of several countries had to save their economies by loosening liquidity in an extraordinary manner, significantly lowering interest rates, and even financing their government budgets, which should be avoided under normal circumstances.
Supervisory authorities in some countries, such as the Financial Services Authority (OJK) in Indonesia, also had to ease “prudential" rules by relaxing the rules on non-performing loans so that banks and financial institutions would not suffer losses. In Indonesia, relaxing the monetary and banking regulations was made possible from the issuance of a regulation in lieu of law (Perppu), which was later enacted as Law No. 2/2020. However, this special law is in place only during an emergency, and normal macroeconomic management principles must resume after three years.
The pandemic has not ended, especially since the more contagious virus variant, Omicron, has emerged, but economists are confident that the number of new Covid-19 cases will continue to decline. With the increased pace of the vaccination program and other efforts to cope with the pandemic, the economy began to show signs of recovery in the fourth quarter of 2021. Thus, several countries have also begun to square off their fiscal and monetary policies as well as policies on banking reserves towards normalization, meaning a return to prudent policies.
It is important that developing countries, especially those that have a structural deficit in the balance of trade balance in goods and services, or current account deficit (CAD), follow prudent policies These countries should prepare in a coordinated manner in anticipation of a hike in the Fed interest rate and an increase in US treasury yields in 2022-2024. During periods of financial turmoil, like in 2013 that was caused by rising US interest rates, our fiscal deficit and current account deficit are very high. We have to prevent such high deficits form occurring again.
We are currently enjoying macroeconomic stability thanks to a number of factors. First, the government has succeeded in showing the international community that it has been able to reduce the fiscal deficit, from 6.1 percent of gross domestic product (GDP) in 2020 to 4.65 percent of GDP in 2021. In 2022-2024, the government must show that one of its priorities is to reduce the budget deficit to below 3 percent of GDP.
Indonesia should therefore quickly shift to exporting manufactured goods, encourage export-oriented foreign direct investment and save foreign exchange.
The second reason is that the balance of trade in goods and services recorded a surplus, which is something of a rarity in Indonesia. The current account surplus means that Indonesia has an excess in its foreign exchange reserves. The current account surplus was driven by the sharp increase in commodity prices. However, if commodity prices decline in 2022-2024, our current account will record a deficit again. Indonesia should therefore quickly shift to exporting manufactured goods, encourage export-oriented foreign direct investment and save foreign exchange.
The third reason is relatively low inflation, recording only 1.9 percent in 2021. Due to low inflation, Indonesia's real interest rate still remains positive at around 1.6 percent (Bank Indonesia’s 3.5 percent benchmark interest rate minus 1.9 percent inflation). To compare, the US’s real interest rate remains negative at present. So, in order to maintain the stability of the rupiah exchange rate with the Fed rate set to rise from 0.25 percent to 1 percent this year, Indonesia must maintain a positive real interest rate that is higher than that of the US, by controlling inflation so it does not rise beyond 2.5 percent while gradually raising the interest rate.
MIRZA ADITYASWARA is an economist and chairman of the Indonesian Fintech Society (IFSoc)
(This article was translated byHendarsyah Tarmizi).