Monetary policy restricted by foreign debt as foreign investors benefit

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Anthony Budiawan Managing Director of Political Economy and Policy Studies (PEPS)

IO – The Bank Indonesia Meeting of the Board of Governors held on 16-17 September 2020 decided to hold reference interest rates at 4%. One of the reasons stated for this decision was “…in consideration of the need to maintain the stability of the Rupiah exchange rate amid a projected continued low rate”.

How funny. A reference interest rate of 4% is quite high – so much so that it may jeopardize the recovery of the national economy. The monetary policy that we should set amid an economic recession would feature lowering both reference interest rates and credit interest rates, in order to stimulate demand, consumption, and investment. These are what will revive the national economy.

What an odd reason given for maintaining reference interest rates at 4%! Projected inflation is low, but interest rates are not brought down because they want to maintain the stability of our exchange rate? That means that Bank Indonesia’s monetary policy prioritizes the “stability” of the Rupiah higher than economic recovery! Economic recovery is essential for average people, because it means more employment and business opportunities – thus less poverty. In whose interest is it to maintain “Rupiah exchange rate stability” then?

BI’s monetary policy is truly dilemmatic. With lower interest rates, economic recovery will be realized faster. This is what the people want: policies that support their interest.

However, a reduction of reference interest rates means lowered credit interest rates, including Government bond and national securities interest rates. This will in turn cause investors, especially offshore ones, to pull away. Our national securities will fall out of favor – foreign investors might prefer to buy securities from countries like Vietnam, Thailand, Singapore, or Malaysia instead.

The potential departure of such foreign investors will shrink the supply of USD (foreign currency) flowing into Indonesia. This would not a good phenomenon, as Indonesia has the following needs for USD reserves: First, to cover current transaction deficit. Second, to repay matured foreign debts (whether incurred by the Government or private businesses). Third, to repay foreign debts (whether incurred by the Government or private businesses) that haven’t matured, but that an investor is liquidating through the securities market.

Current transaction deficit in 2019 was about USD 30 billion, having slipped downward during the 2020 pandemic. As imports sharply dried up, the trade balance showed a great surplus. Current transaction deficit in Semester I of 2020 was USD 6.6 billion. If the deficit continues throughout Semester II of 2020, we project the need for at least USD 5 billion available in our reserves by the end of the year. Total foreign debts per 31 December 2019 expected to mature in 2020 total USD 63.3 billion. This amount is comprised of both USD 11.25 billion in Government debt (and that of Bank Indonesia) and USD 52.06 billion in non-Government debt (both incurred by State-Owned Enterprises and privately owned businesses). And that does not include interest payment.

The third group is the most dangerous one because it cannot be measured. When foreign creditors are no longer interested in providing loans to Indonesia, for example because they think interest rates are too low, and decide to dump their securities, the Rupiah exchange rate suffers. For example, at the end of March 2020, the Rupiah exchange rate in the pasar spot sank to IDR 17,000.00 per USD. In order to maintain investors’ interest and keep them giving loans to Indonesia, in order to cover our great need of dollars, Bank Indonesia is forced to maintain high interest rates.

Meanwhile, it is clear that high interest rates will impede economic recovery, and it will be detrimental to both corporate and individual debtors with debts in Rupiah. Total credit in Rupiah (including in financing companies) is currently over IDR 5,000 trillion. Of this amount, consumer credit is IDR 1,600 trillion. Potential losses sustained by borrowers in this case total IDR 250 trillion a year. These Rupiah debtors suffer a lot from the monetary policy of maintaining high interest rates that only benefit foreign investors.

Each reduction of 1% in credit interest rates will swell Rupiah debtors’ liquidity by IDR 50 trillion a year. An ideal reduction of credit interest during this recession era would be 5% from current rates. The detriment of maintaining reference interest rates far exceeds the amount the Government sets aside for fiscal stimulus, slowing down the recovery of our national economy. Our current monetary policy is limited by our weak economic condition: this signifies acute current transaction deficit and huge foreign debts. BI prefers to maintain a Rupiah stability that benefits foreign investors, even though it will delay the recovery of our national economy and cause massive losses to domestic Rupiah debtors.