A Bitter Lesson or A Sweet Victory
Yopie Hidayat (Contributor)
THE prospect of the world’s economy grows increasingly bleaker. Latest projections from the International Monetary Fund predict that at the end of the year, income per capita of 170 countries will be lower compared to the end of last year. On average, 90 percent of the global population will become poorer. Market analysts even predict that this income decline will last until the end of 2021.
Indonesia is also struggling to overcome this problem. The pandemic is worsening while the economy keeps suffering. According to the official government projections, at the end of Q2 2020 Indonesia’s economy will shrink by 3.8 percent annually. The government has came up with various initiatives to salvage the economy and prevented further decline.
As a result, the budget deficit has inflated to Rp1,039 trillion. Bank Indonesia (BI) is shouldering part of it by directly buying Rp397 trillion government bonds in the primary market. BI will also become the standby buyer for Rp177 trillion worth of bonds, which will become stimulus for small businesses and corporations. In other words, BI is covering some parts of government’s deficit by creating rupiah liquidity.
This is a quite risky experiment. The government and Bank Indonesia are crossing a line that has been considered taboo in fiscal and monetary policies for emerging economies: the central bank directly shouldering government debt without going through the market. This policy also means the loss of central bank independence—an important factor for foreign investors when they consider investing here.
The eyes of the world are on Indonesia. If she succeeds and survives, Indonesia will become a model for many other emerging economies. But whether the policy succeeds or fails, it will be an important case study in macroeconomic and monetary textbooks. History will record it either as a bitter lesson or a sweet victory.
The possibility of investors turning away from Indonesia is one of the biggest risks of the policy. According to calculations by Bloomberg analysts, if the policy is implemented, the injection of rupiah liquidity from BI will reduce the ratio of foreign reserves to money in circulation (M2) from about 30 percent (now) to 27 percent. For emerging economies, a ratio of 30 percent is the safety limit. Below that, foreign reserves will be deemed insufficient to anticipate market shock.
Even so, there are other factors that might convince investors to tolerate the risk. First, the interest on Indonesian government bonds is still very high. Everywhere else, the interest rate is at zero percent. This is the ideal situation for carry trades, where investors borrow zero interest dollars from abroad to invest in rupiah-denominated government bonds that gives high returns. Second, Indonesia’s inflation rate has been highly stable so far, which reduces the risk of carry trades.
The negative side of this situation is Indonesia will hold a hostage to the high interest regime. To make foreign moneys stay in Indonesia, the interest of rupiah must remain high. This high interest rate is also functioning as a brake for economic growth and recovery. This situation will ignore government’s effort to push the economy through massive spending. With high interest, the cost for business capital becomes more expensive, and businesses will not be moving quickly.
The other problems that make market is hard to convince is the effectiveness of this BI injection to help the economy of the country. Bear in mind that the money will not go directly to the economy, but rather go through government programs. Meanwhile, the effectiveness of bureaucracy in planning executing programs is still questioned. President Joko Widodo himself had repeatedly showed his displeasure publicly because of the government’s sluggish works.
The worst-case scenario: the government issues the bonds, BI creates liquidity, but the money is stuck in the state’s coffer. It will be very worrying if this actually happens when the policy being implemented.