Rupiah, Hostage of Interest Rate
When things go awry, the US dollar and gold will be the shelters of choices. Such is tradition in the financial market.
SO do not be surprised to see the price of gold and the US dollar start to drop at the time good news about vaccine for Covid-19 comes out. Perception of the situation is safe now has coaxed investors out of their shelters, convincing them to release their dollar and gold.
Analysts even predicted that the dollar’s downward trend will continue up to next year. The market, which is no longer in panic, will go back to follow more fundamental factors. Asset prices will be dependent on more rational sentiments instead of emotional anxiety.
Take the US dollar as an example. The Federal Reserve’s policy to go all-out on dollar liquidity to prevent market collapse will certainly contribute in lowering the value of dollar. So will the Fed’s intent to keep interest rates as low as possible until no one knows when. These two fundamental factors has made the US dollar loses attractiveness in stable situations, when there is no urgency for investors to seek shelter.
The slump of US dollar is reflected in the Dollar Index, which reflects the value of the US dollar against six main currencies. In mid-March, at the peak of the panic as the pandemic exploded, the Dollar Index jumped to 102.82. At the end of the week on November 20, the Dollar Index was only at 92.35, down 10.2 percent compared to its highest point in mid-March.
Even so, investors in Indonesia who are holding on to assets in rupiah must be wary. The movement of the rupiah against the US dollar since the beginning of November has not been in sync with US dollar’s decline against the main global currencies. Indeed, the rupiah appreciated at one point. But the rupiah’s appreciation is limited, and it has not reached its strongest point this year before the markets panicked, at around Rp13,600 per US dollar. The rupiah’s appreciation seemed to stop once it touched Rp14,000 per US dollar.
In fact, the rupiah dropped again after Bank Indonesia (BI) shaved off its benchmark interest rate, the BI 7-day Reverse Repo Rate, by 0.25 percent, down to 3.75 percent on Thursday, November 19. After that, the rupiah once again depreciated closer to Rp14,200 per US dollar when Jakarta market closed for the weekend on November 20.
Rupiah’s return to a weakening trend has revealed one thing: Indonesia is still being held hostage by a market that demands high interest rates. Even though fundamental conditions are ripe for lower interest rates—inflation is already so low and the current account balance for Q2 2020 saw a surplus of US$964 million—the markets are unhappy when interest rates fall.
This is the legacy of Covid-19 that will continue to burden our economy in the coming years. The explosion of deficit to overcome the pandemic, which must be directly funded by BI, makes market’s confidence in the rupiah not as strong as before. As compensation, investors are demanding higher yields for rupiah investments.
Foreign investors’ weak appetite for rupiah-denominated Indonesian government bonds indicates how that trust is still not fully restored. Before the outbreak of the pandemic, on early February, foreign investors’ possession were at Rp1,071 trillion. After the market panic, foreign capital fled in droves, and this position went down to Rp921 trillion at its lowest point on April. As of November 18, this number sits at Rp960 trillion. It is still far from recovery.
The explosion of government budget deficit will be a heavy and lasting burden. Therefore, even though markets have started calculating that the US dollar will continue declining until next year, investors in Indonesia cannot expect too much that the rupiah will be appreciated with it.
This same burden has restricted BI from implementing interest rate policies as an extra push to reinvigorate the economy. It is a classic recipe: lower interest rates will make the economy more lively. But the legacy of Covid means that lower interest rates can bring forth hard times on the rupiah. Yopie Hidayat (Contributor)