ECB's Negative Rates in the Eurozone Means Capital Inflows into Indonesia?
The central bank of Indonesia (Bank Indonesia) expects further monetary easing in the Eurozone to cause more capital inflows into emerging markets (including Indonesia). The European Central Bank (ECB) surprised financial markets last week by cutting interest rates to zero percent, expand its money printing program (quantitative easing) and reduce a key deposit rate further into negative territory (per 16 March 2016). These moves are done in an effort to revive the economy of the Eurozone and combat deflation.
Mirza Adityaswara, Deputy Governor of Bank Indonesia, said the monetary policy of the ECB will definitely impact on emerging markets, including Indonesia, as investors seek higher yielding assets. Previously, Bank Indonesia announced that capital inflows into Indonesian bonds and equities this year reached IDR 35 trillion (approx. USD $2.7 billion) up to the fourth week of February 2016. Earlier, Japan had introduced negative interest rates in a bid to boost credit growth and combat deflation. Deflation is a major problem for any economy as consumers will postpone consumption (expecting prices of goods and services to be lower the next day). Meanwhile, it causes businesses to produce less (hence needing no or less credit from banks for business expansion).
Meanwhile, Adityaswara stated markets do not expect to see a US interest rate hike anytime soon. This reduces demand for US dollars and therefore gives rise to a strengthening rupiah. On Friday (11/03) the Indonesian rupiah slightly depreciated against the US dollar (0.17 percent) to IDR 13,075 (Bloomberg Dollar Index). However, so far this year, the rupiah is still up 5.17 percent against the green back, thus being one of the best-performing emerging market currencies so far in 2016.
Besides negative interest rates in the Eurozone and Japan, higher crude oil prices also encourage improving risk sentiment across the globe. Both Brent and West Texas Intermediate are now hovering near the USD $40 per barrel level, particularly on reports of lower oil production in the USA. Improving risk sentiment implies that investor appetite for emerging market assets (including Indonesia) rises. But Indonesia also benefits of higher crude oil prices because it should lead to higher prices of other commodities, such as crude palm oil (CPO) and coal. Indonesia is one of the world's largest producers and exporters of CPO and coal.
However, rising capital inflows into Indonesia also give rise to some concern. Firstly, so-called 'hot money' can exit the country as quickly as it came. Particularly those emerging economies that show some financial weaknesses are vulnerable to a sudden reversal. Although improving, Indonesia's current account deficit is still wide at 2.39 percent of the country's gross domestic product (GDP), or USD $5.1 billion, in the fourth quarter of 2015. Secondly, a significantly stronger rupiah can have a negative impact on Indonesia's export performance as Indonesian goods become more expensive. The country's export performance has already been in a state of decline for 16 straight months. A stronger rupiah will make it more difficult to see a rebound, especially if global economic growth remains sluggish.
Indonesian Rupiah versus US Dollar (JISDOR):
| Source: Bank Indonesia