In Bitter Remembrance of 2013
Yopie Hidayat (Contributor)
INVESTORS in emerging markets need to be more vigilant. There is an important signal from the minutes of the Federal Open Market Committee meeting that was held last April. The FOMC is composed of the highest level leaders of The Federal Reserve. This committee determines the important policies of The Fed, which have widespread effect around the world.
The minutes were only made public on Wednesday, May 19. The most important part to note is that it is a higher chance of The Fed reducing liquidity injections into the market before the end of the year. The notes reveal that several Fed leaders want to start a discussion about this tapering in the FOMC meetings in the upcoming months.
Previously, The Fed Chair Jerome Powell sent out a similar signal on April. It is likely that The Fed will put off raising interest rates until 2023. However, far in advance of the higher rates, The Fed will first reduce the injection of liquidity, which is now at US$120 billion per month. The tapering will certainly done gradually so that the market does not receive too much of a shock. And it makes sense for the market to expect that the tapering will start before 2021 ends.
Some data are worthy of consideration in predicting The Fed's movements. The most important one is, of course, economic recovery trend. The outpouring of stimulus since Joe Biden took over as President on January has heated up the US economy, far more than just giving it signs of recovery. The US economy is growing much faster than Europe’s. The clearest indicator is year-on-year inflation rate in the US that has risen dramatically, from 2.6 percent at the end of March to 4.2 percent at the end of April.
This situation has brought back memories of eight years ago to the date, when the Fed started tapering to reduce the stimulus that has been put in since the global economic crisis in 2008-2009. The 2013 tapering effect caused a great shock in the financial markets of emerging economies, including in Indonesia. The rupiah fell deeply at that point and has not recovered below Rp10,000 per US dollar since.
It is not impossible that Indonesia will suffer even greater damage compared to 2013. Because of the pandemic, the government must spend much more than it earns. For the last two years, 2020 and 2021, the government took on additional debt of around Rp1,000 trillion per year. Bank Indonesia shouldered part of the burden by printing money to cover for the government deficit.
Foreign investors can still tolerate the policy which can erode the credibility of the rupiah. Abundant liquidity with low interest makes foreign investors think that investing in rupiah is still interesting. This calculation will change once the Fed starts tapering. When liquidity is no longer in abundance, the appetite of foreign investors to make investments in rupiah will also be lower.
The signal of tapering did not come only from the United States. Most likely, the European Central Bank (ECB) Board of Governors meeting next month will also discuss plans to reduce liquidity injections into the market. The ECB has never before started tapering before The Fed. But, if The Fed is considered too slow in responding to the rapid economic recovery and rising inflation, it is quite possible for the ECB to create a new precedent this year.
A shock that can soon happen in the global market due to tapering should receive serious attention from the Indonesian government too. More prudent fiscal policy should be the choice to bolster the government position against the shock. The plans to borrow up to Rp1,060 trillion this year, for example will not be easily realized when the market is teetering with uncertainty due to investment reallocations around the world.
It is very possible that the shock will also affect the rupiah exchange rate. The government’s spending for foreign debt servicing can rise drastically if the rupiah depreciates. And that will reduce the government’s fiscal capacity significantly.