AFTER President Joko Widodo’s show of anger in a cabinet meeting, financial markets seemed to follow suit, taking out their anger on the rupiah. Within a week after the meeting video circulated, the rupiah exchange rate against the US dollar dropped 2.31 percent.
It is opposite to the global situation where a positive aura is permeating global financial markets. There are signs that the US economy will continue recovering despite 50,000 new Covid-19 cases per day.
The rupiah’s fall is an ominous signal. This is not unrelated to the lattest government budget which was revised on June 25. There is a deficit which has inflated to over one quadrillion rupiah—or more than Rp 1,309 trillion. This deficit has forced the government to seek new debt from various sources. There are loans from multilateral institutions, sales of bonds denominated in foreign currency, and domestic sales of rupiah-denominated bonds, which make up the bulk of the debt. For this last component, a target of Rp914 trillion has been set.
These spectacular numbers have spurred the market to recalculate the risk of rupiah denominated financial assets. Investors would not be able to absorb all the bonds on offer. The market is then focusing on how big of the role of Bank Indonesia (BI) will play in buying bonds in the primary market.
Until this article went to print, there were several possible scenarios going around in the market. First, BI will buy Rp397 trillion of government bonds with no interest. Another scenario, BI will buy Rp504 trillion in bonds with interest of one percent below the benchmark interest rate. Officially, there is still no consensus. But the market has started moving in anticipation.
That policy does have massive consequences. Selling government bonds to BI in the primary market is no different than printing money. BI is creating rupiah liquidity that will be used by the government to finance all its needs. An injection of such vast amounts of rupiah can dilute its value relative to other currencies. That is what happened in the market for the past week: the rupiah losing its value.
On Friday, July 3, the value of the rupiah fell against every major currencies as well as the currency of its neighbors, from the US dollar, the Korean won, up to the Thai baht. It was quite a significant fall as well, with all exchange rates dropping by one percent in just a day. The weakening trend persisted until markets closed in Jakarta.
No one can say for sure how far the market will push rupiah. However, the weakening of rupiah can pose new problems if it goes long and deep. Not only the exchange rate is at risk, Indonesia’s sovereign credit rating can also take a hit due to market pressure from the government’s ballooning debt.
We know that the root of the problem is a budget deficit that has grown too large in the fight against the Covid-19 pandemic. In response, the government is taking on massive debt to the point that BI has to step in and buy bonds in the primary market—in other words, bailing out the government deficit.
The Indonesian government is indeed following the same recipe as many developed countries, creating new debt without limit and pumping the economy to maintain growth. However, Indonesia’s economic and monetary fundamentals are very different from developed countries. The same recipe does not guarantee the same results in very different circumstances.
The low capacity of Indonesian bureaucracy to formulate and execute stimuli programs must also be taken into account. There is no certainty that government’s willingness to take such a big risk, shouldering such massive deficit and hence new debts, would result a V-shaped economic recovery.
The evidence is obvious. Even the President himself must display his disappoinment after seeing how low the budget disbursements are. By creating massive debts, instead of solving a problem, the government might just create a much bigger one.