Indonesia Has to Focus to Offset Impact of Quantitative Easing Tapering

The Fed's decision to continue its quantitative easing program (QE3) clearly resulted in high volatility on the Indonesian stock market during these last two days. The continuation of cheap US dollars flowing to the emerging market of Indonesia is expected to translate into a rising trend, albeit volatile, of the IHSG and into a stabilizing of the Indonesian rupiah for the remainder of the year. According to Bank Indonesia's mid rate, the rupiah appreciated 1.86 percent against the US dollar on Thursday, but fell 0.66 percent today.

| Source: Bank Indonesia

The large capital outflows from emerging economies, including Indonesia, that emerged after the Fed began to speculate (in late May) about an end to the bond-buying program, can be regarded as a prelude to another round of outflows later this year or early next year. After all, there comes a day when the US economy is considered healthy enough to be able to stand on its own feet again, without the help of quantitative easing; a decision which is very much dependent on the US unemployment rate. An unemployment rate of about 6.5 percent is considered suitable to end QE3. Currently, the US unemployment figure stands at 7.3 percent and - taking into account the pace of the figure - it may take another year before the 6.5 percent mark is reached. Therefore, it is possible that the Fed starts 'tapering' at the end of 2013 or beginning of 2014. As such, funds that (re)enter Indonesia in the months ahead, may be quickly pulled out again when the tapering - or the speculation of tapering - reappears.

All emerging economies are expected to feel the impact of quantitative easing tapering. However, some will be hit harder than others. For example, countries such as Indonesia, India, South Africa, Brazil and Turkey are all emerging economies that are coping with serious current account deficits. In combination with a downgraded outlook for economic growth, investors will be more eager to pull their money out when tapering begins, and thus putting more downward pressure on local currencies.

Indonesia's current account deficit reached USD $9.8 billion, or 4.4 percent of GDP in the second quarter of 2013. This deficit is brought on by a massive trade deficit in the country's oil & gas sector. Indonesia, once an oil-exporting country, now has an oil deficit of about 340,000 barrels per day (bpd). According to Wood Mackenzie, this figure may rise to 420,000 bpd by 2018. And while the rupiah's depreciating trend in 2013 can be labeled good for exports (although due to global financial turmoil Indonesia's export revenues have been hit hard), oil imports are paid in US dollars and thus have increasingly burdened the state's budget balance.

Indonesia subsidizes a significant portion of domestic fuel prices and as the economy has been expanding robustly in the last decade, demand for subsidized fuels has surged. In late June 2013, the government did finally reduce fuel subsidies (although it is still expected to allocate IDR 230.8 trillion for fuel subsidies in 2014). The price of gasoline was raised by 44 percent to IDR 6,500 (USD $0.58) and diesel by 22 percent to IDR 5,500 (USD $0.49) per liter. Although this is a good development for the government's budget balance, it has resulted in high inflation (8.79 percent year-on-year in August), thus pressuring people's purchasing power (domestic consumption accounts for about 55 percent of Indonesia's economic growth). High inflation and the depreciating rupiah were reasons for the central bank to raise its benchmark interest rate gradually during the last three months from a historically low figure of 5.75 percent to 7.25 percent in September. A logical step, but one that comes at the expense of economic growth.

Indonesia's IHSG and rupiah will be hit (again) when the tapering of the Fed's massive bond-purchase program starts. However, it can somewhat offset the pain if the country is able to tackle its internal financial issues.

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