
We’re at a 20-year historical low now. Rupiah has never been this weak since the 1998 Asian financial crisis. Our worse ever was 17 Jun 1998, when USD:IDR was 1:16,090. Of course, drawing a direct parallel to 1998 isn’t fair – our banking sector was very fragile, and back then we had just gone out of a managed float FX system – but we can’t let Rupiah weaken anymore.
The depreciating trend needs to be contained. With elections on the horizon, people have started to politicize exchange rates, and use them as a medium to criticize the sitting president. Our economic technocrats – let’s call them Sri Mulyani & Co – should look beyond this realm. They shouldn’t subject themselves to the political pressure.
The higher loyalty, and the higher order, for Sri Mulyani & Co is to protect Indonesians, by protecting the Rupiah.
We need this not so that we could bolster Jokowi’s electability rates, but because our workers’ jobs depend on the strength and stability of our currency. A portion of Indonesian companies’ debt is dollar-denominated. This wasn’t simply because our firms had chosen to, but because they had to: our local market wasn’t deep enough for our conglomerates, and even our SMEs, to always borrow in Rupiah. Persistent depreciation means a lower ability to service dollar-denominated debt, and a higher probability of default, especially if our firms sell their goods and services in Rupiah. The impact won’t be as severe as 1997/98 – firms are not highly-leveraged, banks are better-capitalized. Years after 1998, we also managed to weather through a global financial crisis and a taper tantrum. However, our firms’ lower ability to pay back debt still means that Sidoarjo workers’ jobs are at the edge.
Our rates should be stable not so that we would have the firepower to respond to egocentric political tweets. They need to be stable as we need to protect our workers’ ability to fulfill their basic daily needs. Weak Rupiah means more expensive raw materials imports for us – oil, being one of them. As of today, we’re a net importer of oil, and our firms have been adjusting their product prices based on cost of inputs. We’ve also been importing from overseas a substantial amount of raw materials used to produce BPJS-approved generic medicine. We can’t afford any significant inflationary pressure on basic goods. Not today, not ever. It is not the time to witness oil-dependent products or drugs getting costlier faster than workers’ wages getting higher.
There’s three things we could do to address the situation. Sri Mulyani & Co should lead these efforts.
Import Less, Export More
The associated economic jargon is to tighten our current account deficit, but in simpler terms, it means to export more and import less. Econ 101 is loud and clear. For years, Indonesia hasn’t had enough foreign-denominated currency to purchase foreign-denominated goods – not enough from our exports proceeds and net financial inflows combined. This makes USD expensive simply by the law of supply and demand: we’re asking for more USD goods when our USD supply isn’t readily available, thus appreciating the USD. Sri Mulyani & Co’s job is to figure out how to mitigate this from happening further. The following are options we could consider taking:
- Figure out what we could import less. We’re not recommending a protectionist approach here – we’re asking if we’ve really been importing goods that’s not our competitive advantage to produce. To start with, we could deep-dive on government infrastructure and defense projects which involve importing capital goods from abroad. Look for ways to substitute oil with palm oil bio-diesels, whose raw materials are of abundance – we’re already dominating the world on palm oil production together with Malaysia. Consider targeted import tariffs on leisure / non-core goods. A quick Google search shows that Sri Mulyani is already doing this, but not to a level that’s as aggressive as her approach to her relatively-successful tax amnesty program. However, if, upon reviews, we do need to import more, we must continue re-checking that these imports would benefit Indonesia in the medium-to-long term.
- Keep our bilateral trade deals air-tight. This is more of Trade Minister Lukita’s job. Our country should remain level-headed despite all the commotion surrounding the U.S.-China / U.S.-Canada trade discussions. We shouldn’t make unnecessary statements that could work against our advantage. So far we’re doing okay – U.S. Secretary of Commerce Ross was briefed earlier in July in relation to an effort for Indonesia to keep its low import tariffs privilege (Generalized System of Preferences set by the WTO). While it’s difficult to negotiate bilateral trades in the current environment, one thing is clear: we must not let low-tariff privileges imposed on us slip away.
- Join the CPTPP. Subject to keeping our second point above robust, we should seriously consider opening ourselves up to markets which could allow us to export more. The CPTPP – Comprehensive and Progressive Agreement for Trans-Pacific Partnership – is one of them. The framework isn’t in full-force yet (we need 3 more signatories to ratify it), but there’s no apparent downside to declaring our intention to join early. The slightest benefit we get is incrementally restoring investors’ confidence in Indonesia as an active participant in international trade.
Attract Foreign Capital (at Least Don’t Let It Flee)
First off – we don’t want investors to keep selling their Indonesian assets, be it debt or equity, liquid or illiquid. The more they do this, the weaker Rupiah gets.
The easiest way to have portfolio managers, sovereign wealth funds, and institutional investors return to Indonesia is by having Bank Indonesia taking a more hawkish stance on rates. Introduce more rate hikes, thus reducing the rate of return spread between Indonesia and more developed markets.
This would work especialy as foreigners own >35% of our bond market. Additionally – and unfortunately – our deficit isn’t mostly financed by productive foreign direct investment. We’re a member of the Fragile Five, whereby portfolio financing accounts for a significant portion of net capital inflows. A higher rate thus sounds appealing. We still have room to increase it anyways: around 75 basis points max to reverse the easing Bank Indonesia has done over the past few years (200 bps).
But continuously introducing rate hikes – especially beyond the pace of the U.S. Fed – isn’t sustainable.
First, making Rupiah-denominated debt more expensive in times when we’re not in our near-peak recovery stage may backfire on economic growth. Relative returns may be attractive, but absolute returns would be under pressure. Second, yes, capital may flow to Indonesia following a series of monetary policy tightening, but history shows that the impact can be temporary. We could have rates as high as Argentina’s (a whopping 60%), but with a weak economic backbone, capital will flee. Third, we should keep Bank Indonesia as an institution fully independent from domestic political affairs. We shouldn’t breach this ‘sanctity’ with the government – including Sri Mulyani & Co – directly influencing Bank Indonesia’s decisions. We must respect the independence of our institutions.
The good news is that Sri Mulyani & Co does have a say, from fiscal and regulatory standpoints:
- Make investing less bureaucratic. We’re on our way there. When foreign companies or investors contemplate on investing in Indonesia, we should strive towards having the term “regulatory risk” removed from their investment committee approval decks / write-ups. BKPM and the government have been relatively proactive on this over the past few years, but we need to hit another octave. Launching the Online Single Submission (“OSS”) system, allowing for local/foreign investors to obtain permits through a single channel, was a commendable move, but execution on the ground hasn’t been very smooth. In short, make foreign direct investment execution processes as frictionless as possible.
- Re-evaluate our negative investments list. In other words, selectively let foreign investors own more of Indonesian companies. This is a sensitive issue, as it relates to our sovereignty as a nation. I’m a strong proponent of having resources and sectors of national interest kept in our hands. Under no circumstances should we ever yield more than 49% of our agriculture, land, and hospitals to foreigners, for example. However, that doesn’t mean we shouldn’t re-evaluate sectors that could benefit from greater foreign ownership, simply on the merits of having larger investment check sizes, and of obtaining the value-adds foreign investors can bring to the table if they were to gain greater control. This isn’t a new concept. In 2016, we opened up our passenger land transport industry to foreigners, allowing 49% of foreign ownership. Internet services is now open to 67%, and even our crumb rubber industry is up for grabs up to 100%. There is no time more auspicious to conduct another in-depth review of our negative list than now.
- Maintain our investment grade status. This will allay our debt investors’ concerns. So far we’re on track. We should keep engaging S&P, Moody’s and Fitch, and continue making foreign investors take note. No one should rest until the messaging to all economic agents is bold and clear: we’re taking the necessary steps to handle the situation.
- Reform. Lets turbo charge our initiatives in infrastructure / human capital development, governance improvement, and economic deregulation. Lets also send more corrupt economic agents to Lapas Sukamiskin. Let investors know we’re doing this.
Learn from Thailand
The Baht hasn’t moved an inch vis-à-vis USD, if we compare rates in Sep 2018 and Jan 2018. In fact, it’s appreciated c.9% compared to 3 years ago. This is a strike contrast to Indonesia.
We can learn from our neighbour, whose track record on forex management has been close to impressive in the past year.
The interesting thing is that Thailand has been able to do this even when it doesn’t benefit much from the structural composition of its households. The Thais are older – its median age is close to 40, vs. 30 in Indonesia. The Thais have weaker debt capacity: household debt as a percentage of GDP is c.79%, vs 17% for Indonesians. In very rough terms, if Indonesian younger cohorts continue to increase their disposable income as they grow wealthier, and if they fuel their purchases with more debt just like a majority of the Thais, Indonesia could grow even faster, its FX rates more stable. Sri Mulyani & Co wouldn’t need to be cautious at all when making statements on expected real GDP growth.
What makes Thai Baht resilient has been its healthy external condition. Yes, the Bank of Thailand has been aggressive lately, propping up the Baht, but Thailand has: (i) a current account surplus of c.10% (vs. a deficit in Indonesia), ii) USD reserves of >US$200bn, covering nearly 10x of its imports (vs. <US$120bn in Indonesia, covering 7x of our imports), and iii) external debt / export ratio of <50% (vs. >160% in Indonesia).
Looking at Thailand as our ASEAN peer, it’s clear that we need more backup of our reserves to withstand FX volatility. We’ve outlined the core strategies – tightening our current account deficit and keeping investors interested in Indonesia – but we could do more than that. Elongate our external debt profile. Repatriate cash: I’m not entirely sure to what extent Indonesian firms keep their cash overseas, but regardless of the amount, we could incentivize firms to repatriate their cash back to Indonesia. Understand that there’s no strict correlation between private and public FX reserves. Regardless, domestic market liquidity would improve, reducing frictions of USD:IDR trades.
Unfortunately, there are things beyond Sri Mulyani & Co’s control.
Portfolio managers exiting Indonesia aiming to rebalance ‘bundled’ exposure to emerging markets (given recent volatility in Turkey, Malaysia, etc) is an example. Thus, anything negative impacting the emerging markets will eventually spillover to us – to some degree. This is why FX and equity strategists say that FX depreciation in our region is broad-based – Malaysia, Vietnam are also experiencing currency depreciation issues we’re facing.
Additionally, information transmission isn’t always speedy, and information will be assymmetric. Rational expectations among market players may not form even with constant communication of our efforts to them. In other words, a portfolio manager out there will sell off his or her Indonesian equities or bonds just because his or her sentiment is negative despite all the steps we’ve taken. “Might as well spend the money on Amazon and Alibaba than dealing with this emerging market fuss.”
It is what it is, but it doesn’t mean we should stand still. In dire cases whereby the shocks faced aren’t exogenous, protecting the currency might be a futile effort. Letting the currency freefall is perhaps the wisest move (despite how painful it could be). But this isn’t the case for us now – our capital flight was more of a result of an external regional shock. There’s no clear local asset bubbles to be worried of. Our banks are stronger. We’re far more resilient than the Asia financial crises days: Debt/GDP > 100% (most in USD) sounds very foreign and archaic to us now. Letting Rupiah weaken on the basis of gaining greater exports thus seems imprudent.
The set of recommendations above isn’t a panacea, and implementing them isn’t without the expense of others. It’s also worth noting that, of course, depreciation isn’t always a curse – we can slowly gain from cheaper exports. The depreciation we’re facing is also not as bad as 2013. The sell-off is even shallower. Nevertheless, the core tenet Sri Mulyani & Co must adopt shouldn’t change. While politics and economics are tightly intertwined, politics shouldn’t be the main ingredient of their policy packages. At moments like this, we shouldn’t do what’s expedient. We should do what’s right to protect Indonesians, by protecting the Rupiah.
A final note: as nationalistic as this post might sound, draconian measures, such as introducing extreme capital controls, should be left off the table.