How Indonesia Responds to the Looming US Fed Funds Rate Hike
Ahead of looming higher interest rates in the USA, Indonesia's financial authorities seem confident that the impact of tightening US monetary policy on Indonesia's capital markets will be controlled as Indonesia's economic fundamentals are solid, while the nation's central bank (Bank Indonesia) and government are ready to step in to stabilize the rupiah exchange rate or the pace of capital flows, if needed.
On 14-15 March 2017 the Federal Reserve is scheduled to meet and determine the direction of its monetary policy. Nearly all analysts expect to see a Fed Funds Rate hike this month, especially after "hawkish" language expressed by Fed officials, including Chair Janet Yellen. Only disastrous US labor market data could block an interest rate hike. Key data on the US labor market that are set to be released include the ADP private employment report on Wednesday (08/03), weekly jobless claims on Thursday (09/03), and the government's monthly payrolls on Friday (10/03).
Tightening monetary policy in the world's top economy is expected to lead to capital outflows from emerging markets, including Indonesia. Bank Indonesia Governor Agus Martowardojo said market players should be ready for the possibility of capital outflows. For Bank Indonesia it means that the institution will be on its toes to safeguard the performance of the rupiah. In case of great volatility, the central bank will intervene to stabilize the currency, Martowardojo said. Also in November 2016, when markets were shocked by the surprise victory of Donald Trump in the 2016 US presidential election, Bank Indonesia used its foreign exchange reserves to support the rupiah.
During the taper tantrum in 2013 - when the Federal Reserve announced to wind down its massive quantitative easing program - Indonesia was one of the biggest victims as billions of US dollars left Southeast Asia's largest economy. Back then, Indonesia was highly vulnerable because the country's economic fundamentals were bleak: high inflation, a record current account deficit, and slowing gross domestic product. Now, however, the macroeconomic picture is different (reflected by accelerating GDP growth, low inflation and a under control current account deficit) and thus Indonesia should not be plagued by the same amount of outflows. Still, considering Indonesia depends heavily on foreign portfolio investors (who own about 40 percent of Indonesia's total government securities) authorities need to remain alert in times of global turmoil. Foreign investors usually move their funds more rapidly compared to domestic investors.
Indonesian Chief Economics Ministers Darmin Nasution also remains optimistic. He expects some short-term pressure around the days when the rate hike decision is made. But after these couple of days markets are expected to calm down and investors are expected to continue to be attracted by lucrative and stable emerging markets such as Indonesia. Considering most analysts expect to see a rate hike at the March FOMC meeting, this hike may actually already be priced in.
Meanwhile, Bank Indonesia renewed its bilateral local currency swap arrangement with the central bank of South Korea on Monday (07/03) for a three-year period (and can be extended again). The swap aims to promote trade and financial cooperation between both nations. The swap arrangement allows for the central banks of Indonesia and South Korea to exchange local currencies of up to KRW 10.7 trillion won (approx. USD $9.2 billion) or IDR 115 trillion (approx. USD $8.6 billion) to ensure the settlement of trade in times of financial turmoil and hence support regional financial stability.