Market volatility is back after a relatively subdued 2017 and emerging markets (EM) have not been spared. A resurgent U.S. dollar and higher borrowing costs have triggered a global selloff in EM bonds and currencies, with Indonesia caught in the crosshairs. The country’s two-year bond yield hit the highest level in 10 months in May and the rupiah breached the 14,000 mark. The Jakarta Composite Index, meanwhile, languished at lows not seen since August last year.
The headwinds are clear. The tightening monetary policy in the United States—as the Federal Reserve continues to normalize its balance sheet—is attracting inflows back into the U.S. With three more rate hikes by the Fed expected this year, the market declines could continue especially for countries like Indonesia where foreign investors own a large chunk of its financial assets.
Geopolitical developments also play a part, with rising trade tensions between the U.S. and China. While our base case assumes a bumpy road of U.S.-China negotiations rather than a fully-fledged trade war, trade tensions could of course escalate further. A trade conflict between these two giants would clearly be negative for many countries, including Indonesia. Meanwhile, in the Middle East, all eyes are on the outcome of the dismantling of the Iran nuclear program, which could push up oil prices and impact net oil-importing countries.
While impossible to completely negate the ill effects of macro events, Indonesia can limit the impact with a tactical approach and through longer-term planning. In the short term, managing the currency swings as a result of rising U.S. interest rates requires a concerted effort between the central bank, the banking regulator and the government. The central bank has done its part in aggressively intervening by buying sovereign bonds and selling foreign currencies, and sending a clear signal that raising interest rates to defend the rupiah is in the cards, if necessary. In parallel, banking regulator Otoritas Jasa Keuangan must ensure that all large purchases of U.S. dollars have underlying transactions and are supported with valid documentation. Simultaneously, the government might want to have policies requiring exporters to convert excess proceeds in U.S. dollars into rupiah, with assurance that they could access U.S. dollars whenever needed.
Longer term, the focus should be on cultivating an environment conducive to attracting FDI. This focus includes supporting and facilitating capital raising activities, which pulled in foreign inflows even when times are tough. A case in point—the $1.5 billion rights issue by Indonesia cigarette maker Sampoerna in October of 2015, which helped to pull the rupiah back to under the 14,000 level at a time when economic growth was at its weakest in six years. With increasing global focus on the so-called unicorns and their potential listings, it might be worth keeping an eye on our own homegrown unicorns in the ride sharing and online marketplace industries.
Despite the imminent challenges, Indonesia’s economic fundamentals remain solid, with its abundant natural resources, a young demographic, a growing middle class, large population in excess of 260 million and disciplined government fiscal policy. With proper guidance from authorities to weather the market storm, the country remains on track to achieve its aspirations as one of the world’s leading economies.