Indonesia to hike rates again as emerging markets tremble
- Patrick Commins
- Angus Grigg
Indonesia's central bank is poised on Wednesday to lift rates for the second time this month as policymakers move aggressively to fend off further capital flight and prevent another potentially destabilising bout of currency depreciation.
With the ghosts of the Asian currency crisis of the late 1990s continuing to hang over the region, investors are wondering whether more vulnerable economies such as Indonesia may be pulled into the turmoil that threatens financial crises in countries such as Turkey and Argentina, where central banks have been stepping in to combat currency routs caused by a stronger US dollar and c limbing US bond yields.
"Within our region Indonesia always seems to be the one that is hardest hit" during such periods of volatility, Bank of America-Merrill Lynch foreign exchange strategist Rohit Garg said.
"As soon as we saw movement in Russia in April and then in Turkey and Argentina, it was just a matter of time before Indonesia was impacted," the Singapore-based Mr Garg said.
Reflecting concern among policymakers, and a day after the inauguration of new governor Perry Warjiyo on May 24, Bank Indonesia made the surprise announcement that the monetary policy board would meet again this Wednesday â" a month before its next scheduled meeting.Advertisement
On May 17, Bank Indonesia raised rates for the first time since 2014 â" to 4.5 per cent from 4.25 per cent â" in a move explicitly designed to support the rupiah. In a statement accompanying the policy decision, the bank made i ts commitment to further intervention clear, saying it would "continue to monitor developments and be prepared to take stronger measures to ensure macroeconomic stability".
BI's primary mandate is currency stability and analysts, including Mr Garg, now expect BI to hike again this week.
Higher dollar causes pain
The country's current account deficit explains some of its vulnerability to moves in US dollar rates, particularly in a region that now runs a current account surplus in aggregate. More acute, however, is the fact that about 40 per cent of the country's bond market is in the hands of offshore investors, Mr Garg said, making the currency vulnerable to rapid turnarounds in sentiment, usually linked to moves in US yields and the dollar. Both have climbed steeply in recent weeks, before stabilising more recently.
"The higher US dollar real rates are what caused the pain," Mr Garg said.
The rupiah has dropped 3 per cent against the US dollar this year, and by more than 7 per cent since its recent peak in January. A US dollar last fetched just under 14,000 rupiah, according to Bloomberg.
Since the start of April, foreigners have pulled $2 billion from Indonesia's bond market, on BAML numbers. Money has also been pouring out of the country's equity market, with $2.9 billion fleeing in 2018. The Jakarta Composite Index is down nearly 10 per cent from its February peak.
But it is the "chunky" withdrawals from the bond markets in recent weeks that have caused consternation among investors, Mr Garg said. Nonetheless, the recent selling accounts for only about 3 per cent of the $60 billion of Indonesian bonds in the hands of offshore investors, he said. Previous periods of extreme capital flight have involved drawdowns of more like 7-7.5 per cent.
"If you look at the last eight to nine years and compare the current outflows, I am not worried," Mr Garg said.
"Indonesia's buffers are actually pretty strong," he said, pointing out that the country's current account deficit was much improved from five years ago and now "manageable". Core inflation at 2.5 per cent was within the central bank's target range.
"Indonesia will be able to weather this storm."
Lack of reform
Indonesia analyst Kevin O'Rourke, publisher of the Reformasi newsletter, said the current problems reflected a lack of economic reform over recent years.
"Indonesia would be better insulated from global trends if it had been more assertive in economic reforms, which would have helped bring in the long-term capital the country requires," he said via phone.
"It's unfortunate the central bank has to raise rates just at the time when it appeared investment was picking up. It should provide some short-term stability, but the price will be longer-term pa in."
For now, the more acute stresses in emerging markets appear to have eased alongside assertive central bank action and as the US dollar yields and the price of oil retrace.
"My main worry would come if we have dollar yields going to 3.5 per cent, oil going to $US90 and $US100 and the Fed not being bothered about emerging markets," Mr Garg said.
"If all these things happen at the same time, and, more importantly, if China slows down as well, then I would be really worried."
ANZ's head of research in Asia, Khoon Goh, sees scope for the rupiah to rebound, deeming it undervalued following this month's sell-off. Foreign portfolio outflows are at $US5.9 billion since February, more than the 2013 taper tantrum and the November 2016 US presidential elections.
The central bank is tipped to raise rates this week and again in June, taking the key rate to 5 per cent, on ANZ's forecasts.
"Getting ahead of the curve bodes well for Indonesia's financial markets. Although higher interest rates will have an impact on economic growth, this will be offset by stabilising the rupiah," Mr Goh wrote on Monday. Other policy measures will be considered to support growth, he added.
"Given the large portfolio outflows seen this year, there is scope for inflows to resume. The recent pullback in US 10-year bond yields below 3 per cent and the retreat in oil prices, if sustained, will also improve appetite for EM assets." With Indonesia's inflation "well contained", any further rate increases will make real rates more attractive to investors.Source: Google News | Berita 24 English