Rate normalization in the pause?
The meltdown of three banks in the US directly or indirectly caused by the Fed’s aggressive rate hikes prompts a further question as to whether the US central bank will carry on with its normalization policy. We will figure this out during the first Federal Open Market Committee (FOMC) meeting on March 21-22. The Fed’s chief monetary policymaking body will be one of the most watched-for events around the globe, as it will set a future direction of the Fed’s monetary policy – which will have global ramifications.
Given that the inflation rate in the US is still high – at 6 percent in February – while the desired target is 2 percent, many experts predict the rate hike will continue. However, the recent bank collapses due to their difficulties in adapting to the high interest rate may force the Fed to evaluate its hawkish monetary policy during the FOMC meeting. At least the size of next interest rate hike will not be as dramatic.
It is estimated that the Fed will continue to raise the FFR, at a moderate level of 0.25 percent. This will send a signal to the market that inflation is under control – an important move – while at the same time not piling more pressure on the still fragile global financial sector. There is also a likelihood that the Fed will retain its benchmark interest at 4.75 percent, because of the pressure from the banking sector in the two weeks leading up to the meeting. However, amid the still acutely high inflation in the US, this decision risks being perceived by the market that the problems in the US banking sector could be deeper than thought.
Regardless of the Fed’s decision, it seems the option to aggressively raise FFR is a tough call. On top of increasing the risk in US efforts to restore its banking sector stability and credibility, the measure could also undermine market confidence in the Fed’s ability in dealing with failing banks. What’s more, the impact of SVB, Signature Bank and First Republic Bank collapses have also spread to Europe, with the struggling Credit Suisse now acquired by UBS, the largest bank in Switzerland.
Rupiah to strengthen?
The pause or reduction in the size of a US rate hike could present an opportunity for the Rupiah to strengthen against the US Dollar. Of course, this will not happen automatically; it takes efforts. Indonesia should not regard the Fed’s rate hike moderation as a mere “blessing in disguise”, but instead prepare itself to optimize the current situation.
The Rupiah has undergone significant fluctuations since a FFR hike was enacted in March 2022, compounded by the impact of the Russia-Ukraine war. The Rupiah exchange rate in Budget 2022 macroeconomic assumptions was set at Rp14,350 per US Dollar but by the end of the year it touched Rp15,731 (averaging Rp14,871 against the greenback in 2022).
In the 2023 Budget, the Rupiah was set at Rp14,800 per US Dollar. Given that as of March 20 it has reached Rp15,372, the Fed’s slowdown must be capitalized to the greatest extent to strengthen Rupiah. This is crucial because if Rupiah is stable, an economic growth target of 5.3 percent in 2023 is more likely to be achieved.
So far, Indonesia has been able to dispel the negative sentiment sparked by US bank collapses. A slew of indicators show that the fundamentals of Indonesian banks are quite strong. Liquidity-wise, data from the Financial Services Authority (OJK) shows that the ratio of Liquid Assets to Non-Core Deposits of banks in Indonesia as of January stood at 129.64 percent and Liquid Assets to Third Party Funds ratio was 29.13 percent, still safely above the regulatory threshold of 50 percent and 10 percent, respectively. The Capital Adequacy Ratio (CAR) of 25.93 percent is also way above the 8 percent guidance while the gross Non-Performing Loans (NPL) – at 2.59 percent – is also at a safe level (the tolerable benchmark set by BI and OJK is 5 percent).