The Risk of Losing Monetary Policy Independence
Yopie Hidayat (Contributor)
WHEN the Federal Reserve holds its annual symposium at Jackson Hole, Wyoming, the financial market definitely will pay attention very closely. The same goes with this year, even though the Covid-19 pandemic made it had to be done virtually. On Thursday, August 27, the presentation delivered by Federal Reserve Chairman Jerome Powell at the forum shook markets everywhere.
There, Powell presented the Fed’s new strategy. The Fed will no longer set an exact 2 percent annual inflation target but rather an average of 2 percent. Powell did not specify over what time the inflation would be averaged.
The signal is clear. The Fed will keep the interest rate low even once in a while there is an inflation overshoot. This is an inevitable decision for the United States economy to recover from the crisis. The Fed wants to stay flexible in executing accommodative monetary policy.
Investors certainly quick enough to make calculations how this latest change will affect yields on investment. The Fed’s new strategy creates the possibility of a low interest rate at the same time as rising inflation. This is the combination that makes investing in US dollars less attractive. As a result, the US dollar has lost its value against various other currencies one day after Powell’s speech.
Usually, the emerging markets, including Indonesia, would welcome these news with enthusiasm. Low interest rates in the US will also push portfolio investment funds to seek other places with higher yields. So far, emerging markets have been the go-to alternative for investors with an appetite for higher risk and higher returns.
Unfortunately, until the market closed in Jakarta on Friday, August 28, there are no signs of significant rupiah’s strengthening. The rupiah is relatively stagnant at Rp14,660 per US dollar. The guarantee of low interest from the Fed seems insufficient to turn Indonesia into a more favorable investment destination.
It looks like investors have other considerations that make them overlook Indonesia. Since June, the rupiah has been in a consistent weakening trend against the US dollar, even though the US dollar has been weakening against nearly every other currency during the same period. This is not unrelated to the perception of higher risk in rupiah investments.
For one, the Indonesian government and monetary authorities must take extraordinary policy measures to close the hole in the national budget through debt monetization. In layman terms, Bank Indonesia (BI) is directly printing new money to fund the government deficit that has ballooned to Rp1,039 trillion this year.
BI has committed to printing Rp397 trillion in new money. Besides that, there is the possibility of an additional Rp177 trillion. The consequence of the new injection of liquidity is clear: the rupiah will depreciate.
That is why BI has reaffirmed that the extreme measure will only be done this year. However, the budget for next year shows that the government is still shouldering a deficit of Rp971.2 trillion. Without direct financing from the central bank, it seems impossible that the government will be able to cover that massive deficit. Markets have judged that there are no guarantees that Indonesia’s debt monetization will be limited to this year only.
Furthermore, word is going around in the market that the government plans to restructure the power of monetary authorities. If this plan is realized, there will be no borders of independence that can protect monetary and banking authorities from government intervention. If the government requests that the central bank prints money to fund the deficit, for example, BI will be unable to refuse.
The trouble is, Indonesia is a very open economy. Investment funds can enter and exit freely. If investors are worried about the effects of an overly aggressive monetary policy, Indonesia’s attractiveness as investment target will suffer. The risk to invest here will be far too great compared to its return.