FOMC: Tapering of Quantitative Easing Might Start Sooner than Expected

Almost all members of the FOMC meeting agreed that economic prospects of the USA had not changed since the previous meeting and therefore the continuation of the bond-buying program was decided. However, one important note is mentioned in the latest FOMC minutes - one that can be crucial for the program's future. Previously, the Federal Reserve always said that the US unemployment rate should ease to below the 6.5 percent mark before the program can be wound down. According to the latest minutes, however, the Federal Reserve discussed the possibility of dropping that requirement.

Quantitative easing is a stimulus program through which the Federal Reserve purchases USD $85 billion worth of securities each month, thereby increasing liquidity in the US banking system and causing a lower interest rate environment. This subsequently leads to more loans being purchased by businesses and consumers and thus aims to boost the economy.

However, part of the money that is generated through quantitative easing has flown to the capital markets of emerging economies (including Indonesia). These markets are characterized by the slogan "high risk, high gain". With US dollars being cheap amid the low interest rate environment, global investors were more willing to invest in the riskier assets in these emerging markets.

For emerging markets, this "hot money" can be called a blessing in disguise because a sudden reversal of the money flow is always looming (therefore foreign direct investments are a more stable source of investments). In the case of Indonesia, there was broad-based optimism when the country's benchmark stock index (IHSG) hit its highest ever point at 5,214.98 on 20 May 2013. However, after Ben Bernanke started speculating (in late May 2013) that the end of the quantitative easing program was in sight, the IHSG plunged dramatically. Amid a long period of uncertainty about the future of the stimulus program (triggering high volatility), the IHSG fell 23.91 percent to 3,967.84 on 26 August 2013, the index's lowest point in 2013. Hereafter, the index recovered to the 4,300.00 line as investors adjusted their mindsets to ongoing market uncertainty and high volatility.

Undoubtedly, Indonesia will feel the impact when the Federal Reserve does indeed commence the tapering, particularly because Southeast Asia's largest economy is coping with a wide current account deficit (partly responsible for the sharp depreciation of the Indonesian rupiah exchange rate in 2013) as well as high inflation. The current account deficit eased to USD $8.4 billion (or 3.8 percent of the country's GDP) in the third quarter of 2013 from USD $9.8 billion (4.4 percent of GDP) in the second quarter. This large deficit is mainly caused by a huge trade deficit in the country's oil and gas sector. Inflation is expected to accelerate to 9.0 percent by the end of the year (year-on-year) after prices of subsidized fuels were raised by the government in June 2013. These issues intensified the capital outflow from Indonesia after Bernanke started speculating about an end to the quantitative easing program in May 2013 and made both the government and central bank of Indonesia decide to release programs to stabilize the country's financial markets. These programs include strategies to curtail imports, while increasing exports and foreign direct investments (FDIs) as well as the support of rupiah exchange rate stability and inflation-control mechanisms. It will take a few months before the impact of these programs can be felt but - if successful - it is expected to limit the damage done by the looming tapering of US quantitative easing.

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