The economics of a pandemic: How Indonesia is defending the Rupiah against COVID-19

(Illustration: IO/Design Team)

IO – After nearly 2 months of evading the worldwide invasion of the coronavirus (now properly known as “COVID-19”), Indonesia has finally succumbed, becoming the 66th country with inhabitants infected by the outbreak: on Monday 2 March 2020, President Jokowi announced that two Indonesian citizens had been diagnosed as suffering from COVID-19; they had been hospitalized in Jakarta. This unnerving news added to the unease of investors, who have actually been feeling alarmed since the middle of January 2020.

The Indonesian capital market immediately exhibited volatility, on the day of the announcement. This was reflected in the Composite Stock Price Index (CSPI) which dipped into the “red zone”, settling 1.68% in just one day (2/3/2020). The outflow of foreign capital that in just one day reached IDR 291.24 billion. Meanwhile, correction at the JCI since the beginning of 2020 has bopped downward to -14.89%, making Indonesia the second-worst performing stock market in the Asian region after Thailand (-15.46%). From the beginning of the year to March 2, 2020, foreign-owned “hot money” playing in the Indonesian capital market has scooted outward, totaling IDR 5 trillion. In comparison, the capital market in China itself – as the COVID-19 epicenter – has only settled by 2.60% since the beginning of 2020. Meanwhile, Hong Kong and South Korean capital markets fell 6.73% and 8.88%, respectively.

The combination of the spread of COVID-19 to Indonesia and investor panic in the capital market has inevitably infected our currency, so that over 10 consecutive days (18 February – 2 March 2020) the exchange rate of the Rupiah against the US Dollar steadily declined, by 5.48%, from IDR 13,676 (18/2/2020) to IDR 14,413 (2/3/2020). However, the next day, on Tuesday (3/3/2020), the BI middle rate or the Jakarta Interbank Spot Dollar Rate reference rate was at IDR 14,222. The Rupiah strengthened 1.33% compared to the previous day’s position, its strongest daily gain since January 7, 2019.

The weakening of the Rupiah over the past two weeks has also been driven by selling action from foreign investors in the bond market. As a result, the yield on the 10-year Government Bond (SUN) rose by 5.7 basis points to 6.58% from a previous 6.523%. During February, IDR 30.8 trillion in foreign capital drained out of the market, consisting of IDR 26.2 trillion in Government Securities (SBN) and IDR 4.7 trillion in the stock market. Since the Corona outbreak began to plague the capital market, Bank Indonesia has responded by buying up IDR 78 trillion in bonds.

The weakening of the Rupiah continues to be driven by negative sentiment about the apparently unstoppable spread of COVID-19 outside China to the US, Europe and Asia. Negative investor sentiment manifests in the aversion by investors and other market participants to risk, which in this case is quite strong. As a result, the global financial market has shown signs of weakness. In such a situation, investors tend to retreat from their portfolio investments in various countries, including Indonesia, moving funds to “safe haven” developed countries, scurrying away from fiat currencies to invest in gold; as a result, shares of companies in developed countries, along with gold prices, steadily strengthen: global gold prices surged since the beginning of the year by 7.6% as of February 21, 2020, reaching their highest level of USD 1,636.57 per troy ounce. Once again, the Rupiah has become an easy target for profit-taking, making it the most persecuted currency in Asia.

Pressure on the Rupiah and other macroeconomic instruments is closely related to concerns that the COVID-19 outbreak will disrupt global supply chains, as people and the business world become ultra-cautious. Production is also affected, with many factories closed, especially across China. Respected international institutions have projected a decline in China’s Gross Domestic Product (GDP) in a range of 0.5-1% for 2020.

China’s 2019 economic growth was reported as 6.1%. With this growth baseline, the Economist Intelligence Unit (EIU) created four scenarios of China’s economic slowdown, namely (i) an optimistic scenario, if the COVID-19 outbreak is overcome in China by the end of February 2020; in such a case China’s GDP growth would only settle to 5.7%; (ii) the baseline scenario if COVID-19 can be overcome by the end of March 2020, with Chinese GDP growth at 5.4%; (iii) a pessimistic scenario, if COVID-19 is finally overcome by the end of June 2020 – then, China’s GDP growth would only touch 4.5%; and (iv) a nightmare scenario, where COVID-19 cannot be eradicated in 2020 – then, Chinese GDP growth would settle below 4.5%.

In addition to projections from the EIU, several institutions cut China’s 2020 economic growth estimates, include Goldman Sachs (from 5.5% to 5%) and The Consultancy Oxford Economics (from 6% to 5.4%). Whatever the estimated economic decline in China results as, all parties say that the impact of COVID-19 on the global economy will be far greater than the impact of SARS in 2002-2003. When the SARS outbreak took place, the impact on China’s economic slowdown was 2%, moving from 11.1% (Q1-2003) to 9.1% (Q2-2003). At that time, China’s contribution to global output reached 8.2%, while its current share marks 19.7%. What’s more, the contribution of China to global trade in 2002-2003 was only 5%, whereas at present it has reached 13%. With these two indicators alone, it can be clearly illustrated how the economic slowdown that will occur in China will have an extraordinary impact on the global economy, including that of Indonesia.

Potential for economic infection
The negative implications of the slowdown in the Chinese economy on the Indonesian economy have been simulated by the World Bank, projecting that any decline in Chinese economic growth by 1% will potentially reduce Indonesia’s economic growth by 0.3%. That is, if the average growth of Indonesia’s economy in the last five years is only 5%, then Indonesia’s economic growth in 2020 has the potential to slow down to only 4.7%. Even then, if the Chinese economy only fell 1% and has not included the assumption of a decline in economic growth in Indonesia’s strategic trade and other investment partner countries, such as Singapore, Japan, South Korea, and the European Union.

After the Corvid-19 outbreak began in early January 2020, the sector that was first affected was tourism. Of the 16.1 million foreign tourists to Indonesia in 2019, 12.9% or 2.1 million people were Chinese, the second-largest number after that of Malaysia. The amount of foreign exchange obtained by Indonesia from foreign tourists in 2019 reached USD 16.83 billion, and foreign exchange contributions from Chinese tourists amounted to USD 2.47 billion. According to the calculation of Bappenas (2020), the closure of tourist traffic from China to Indonesia since the beginning of this year will exert a direct impact at a foreign exchange loss of USD 1.2 billion. Not only that, the indirect impact, as negative perceptions by western tourists who consider COVID-19 as an “Asian Corona Outbreak” will also have an impact on the decline in their numbers to all of Asia, including Indonesia, so that a USD 0.4 billion potential loss of foreign exchange to Indonesia is suggested.

The next route of infection is through the trade medium, where China is the main non-oil export destination country of Indonesia, reaching 16.68% (2019). Besides, Indonesia’s manufacturing industry will also be hit, because more than 25% of Indonesia’s manufacturing production input comes from China. When production in China stalls, demand for raw materials from Indonesia (mainly CPO and coal) also zooms downward, causing prices of the two main export commodities to plummet. As a result, the potential for a trade deficit will widen. In 2019, Indonesia’s trade balance deficit reached USD 3.19 billion, relatively better than the deficit in 2018 of USD 8.69 billion. However, seeing the realization of Indonesia’s non-oil and gas export growth to China, which declined from 14.3% (2018) to 5.9% (2019), it is likely that in 2020 Indonesia’s non-oil and gas exports to China will continue to stall.

The next potential effect of COVID-19 is through investment transmission, where China is the 2nd-largest country of Foreign Direct Investment (FDI) in Indonesia, with a share of 16.8% or USD 4.7 billion in 2019. COVID-19, moving from China to Indonesia, will certainly exert an impact, slowing investment from China to Indonesia. Commitments already recorded will also be affected in their realization, resulting from the prohibition of entry and exit of Chinese citizens, as well as the difficulty of raw materials or capital goods arriving from China.

Note that the Indonesian balance of payments (NPI) in 2019 recorded a surplus of 4.7 billion US dollars, improved from the previous year which saw a deficit of 7.1 billion US dollars. This development was driven by an improved current account deficit and a significant increase in the capital and financial account surplus. The current account deficit in 2019 was recorded at 30.4 billion US dollars or 2.72% of GDP, improved over the deficit in the previous year of 2.94% of GDP.

Several factors that led to the improvement in the balance of payments were the trade balance in goods that recorded a surplus, different from the previous year which experienced a deficit. Goods from trade balance which recorded a surplus were affected by the rising non-oil and gas trade balance surplus and the declining oil and gas trade balance deficit. This was influenced by the decline in oil imports, in line with import control policies such as the B20 program. The improved performance of the balance of payments was also supported by a capital and financial transaction surplus that increased significantly, to US $ 36.3 billion from US $ 25.2 billion in 2018, supported by long-term capital inflows amid continued uncertainty in global financial markets.

Given the potential for economic infection in all three of these pathways (tourism, trade, and investment) the impact on the stability of the Rupiah will certainly be ominously large, especially if you look at the acquisition of foreign exchange reserves which recorded a record high of USD 131.7 billion in January 2020; it is thus estimated that foreign exchange reserves will be optimized to hold the rate of depreciation of the Rupiah in the future. To that end, the government must continue to focus on stimulating the real sector, especially in terms of demand, so that the circulation of money in the country can be maintained properly; otherwise the economy, mainly supported by household consumption, could keel over and take a dive.

Maintaining endurance
If the Rupiah continues to “suffer a fever” with an indication of weakening, that will trigger an even bigger State Budget deficit. In the 2020 State Budget, there is a planned budget deficit of 1.76% of GDP. The government still has room to raise the deficit, because the maximum limit is still at 3% of GDP. The Minister of Finance finally acknowledged that the State Budget deficit is expected to widen from 1.76% of GDP due to additional government spending of IDR 10 trillion on incentives amid a miasma of global uncertainty. It also predicted that there would be a tax shortfall, the victim of slowing economic growth. The Fitch Institute estimates that Indonesia’s fiscal deficit will widen to 2.5% of GDP.

The widening of the fiscal deficit, adding fiscal incentives, is indeed a positive development to stimulate the economy, which ends up maintaining the stability of the Rupiah exchange rate, since this is a form of “counter-cyclical” policy. The government will reportedly spawn several incentives to ward off the impact of the coronavirus on the domestic economy, among them to increase the food card allowance from IDR 150 thousand to IDR 200 thousand. The additional budget will require IDR 4.56 trillion for the next 6 months.

Then, the government will also provide tax exemptions for hotels and restaurants in 33 districts/cities, over the next six months. Through this policy, subsidies of IDR 3.3 trillion will be disbursed to regional governments affected by the regulation. What’s more, the government also budgeted funds of IDR 298 billion in a bid to attract foreign tourists. IDR 72 billion will be given to influencers, promotional needs at IDR 103 billion, and tourism promotion at IDR 25 billion. Packages for airlines and travel agents amount to IDR 98.5 billion. In total, the government allocated IDR 10 trillion for fiscal incentives earlier this year. The policy is likely to be continued until the end of the year if the impact on the domestic economy seems significant.

Rupiah needs a vaccine
In addition to fiscal stimulus, efforts to safeguard Rupiah immunity from COVID-19 exposure must also be carried out through the monetary side. The five monetary policies that will be implemented by Bank Indonesia, to reduce the impact of the coronavirus: first, increasing the intensity of interventions in financial markets, both in spot markets, Domestic Non-Deliverable Forwards (DNDF), and government bonds or Government Securities (SBN).

Second, reduce the minimum statutory reserve requirement (GWM) of foreign currency from 8% of Third-Party Funds (DPK) to 4% of DPK, effective March 16. This reduction is expected to increase foreign exchange liquidity in the banking sector to US $ 3.2 billion, thus strengthening the stability of the Rupiah. Third, BI’s decision to reduce the Rupiah reserve requirement by 50 basis points (bps) specifically to banks that carry out large-scale imports/exports (effective from April 1 for nine months) is expected to help exporters and importers who encounter difficulty after the outbreak of COVID-19.

Fourth, BI’s steps to expand the types and scope of underlying foreign investors in hedging, including entering the Domestic Non-Delivery Forward (DNDF) market. If someone wants to access DNDF, they must have a clear underlying rationale, such as import needs, payment of a foreign debt, and so on. This means that foreign investors who sell SBN ownership and put it in Rupiah accounts in Indonesia can use it as a DNDF underlying. For foreign investors, there is no need to hedge through offshore NDF.

In the fifth step, BI invites global investors to use custodian banks, both global and domestic in conducting investment activities in Indonesia. So not only foreign banks but local banks are also able to provide custody services. The five BI policies proved to be quite effective in increasing Rupiah immunity so that the Rupiah, which was previously in the red zone, immediately turned stronger and continued to accelerate on March 3, 2020.

Besides, although Bank Indonesia has reduced the BI-7 days’ repo rate in January, there is still room for monetary policy to reduce interest rates again so that they can provide stimulus to the economy. Monetary authorities and financial services are responsible for ensuring the availability of liquidity amid negative pressure from COVID-19. Moreover, the low realization of bank credit in 2019, which only grew 6.08 percent, illustrates the slowdown in the real sector. This is because most of the liquidity needs in the real sector continue to rely on banks. The government needs to immediately provide various stimuli to the real sector to lift the pace of the economy. Besides, in order that short-term funds circulating in Indonesia do not cause exchange rate fluctuations when they return home, they must begin “detoxification” of the swift flow of hot money. Lowering the benchmark interest rate is one of the options that can be taken to maintain a stabler exchange rate. (Abra el Talattov)

Abra El Talattov is a graduate of Diponogoro University where he studied Economics. He is currently a researcher at INDEF (Institute for Development of Economics and Finance).