The rupiah exchange rate will continue to face hard pressure until the end of the year as US central bank The Federal Reserve (The Fed) is likely to raise its benchmark interest rate in the remaining four months of this year. Limited foreign exchange reserves and economic risks have hindered Bank Indonesia’s efforts to raise the rupiah by hoisting its benchmark interest rate and intervening in the market.
On Thursday and Friday next week (27-28 September 2018), BI will hold an annual board of governors meeting to make a decision about its benchmark interest rate. It is planned for after the meeting of the Fed’s board of governors, known as the Federal Open Market Committee (FOMC), at the beginning of next week.
“We are waiting for the Fed announcement, so we set our the meeting to be held in the fourth week of September. Hopefully, at that time, we will already know the position of the US central bank’s interest rate,” said Bank Indonesia (BI) Deputy Governor Dody Budi Waluyo.
The Fed had raised its benchmark interest rate, the Federal Funds Rate (FFR), twice this year. The market estimates the US central bank will raise the FFR – now at 1.74 percent-2 percent – twice in the remaining four months of this year. It is predicted to be done at the end of September and in December.
The Fed’s move is part of the normalisation of the US monetary policy and also anticipation to offset rising economic growth. The problem is that the Fed rate hike will increase US interest rates. As a result, banking products and financial investment instruments in the US will be more attractive, causing capital outflows from developing countries, including Indonesia, to the US.
This means the rupiah will face two big waves of pressure from the Fed’s interest rate policy, even though BI has raised its benchmark interest rate four times since the beginning of this year. BI raised the seven-day reserve repo rate (7-DRRR) for the last time in August from 5.25 percent to 5.5 percent to maintain the margin of its benchmark interest rate over the FFR so the rupiah would not be further depressed by the strengthening of the US dollar.
On Thursday (20/9), the rupiah exchange rate hit Rp 14,840 per USD, weaker than Rp 13,416 per USD at the beginning of January, a 10.6 percent drop this year.
From the beginning of the year to 13 September, foreign net sell in the capital market reached Rp 54.07 trillion, while foreign net sell in the government bond market was Rp 20.54 trillion.
Pressure is also coming from the Fed’s policy to streamline its balance sheet. Since the 2007-2008 financial crisis, it has implemented a quantitative easing program - buying bonds on the US financial market to inject liquidity into the economy.
At the peak of the program, the Fed purchased government and private bonds of up to US$ 85 billion per month. Part of this was then invested in emerging markets, including Indonesia.
Looking at the US economic recovery, the Fed decided to stop the quantitative easing program in 2013, and began to gradually release the bonds back into the market, which is commonly known as tapering off.
As of 3 September, bond assets owned by the Fed were US$ 4.208 trillion, from US$ 4.449 trillion at the end of 2017. This means the Fed had released bonds to the market for eight months this year worth US$ 241 billion, around US$ 30.12 billion per month.
According to BlackRock Investment Institute Head of Research Elga Bartsch, the US financial market will be more attractive with the raising of benchmark interest rate and the availability of bonds to be purchased. Consequently, foreign capital will flow back to the US from emerging markets, including Indonesia.
Due to the continuing threat, Moody's Investors Service believes the biggest risk to the Indonesian economy will come from the weakening of the rupiah. Although Indonesia’s credit rating is currently at investment grade level with a stable outlook, a prolonged weakening in the rupiah exchange rate will have a major impact on the economy because of the high dependence of the government and private sector on foreign funding.
Moody’s Vice President and Senior Analyst Joy Rankothge said the government, BI and the Financial Services Authority (OJK) as the fiscal and monetary policy makers for macro and micro sides have properly carried out their duties to stabilize the exchange rate and minimize the impact of rupiah fluctuations on the financial sector.
However, policies through interest rates and interventions as well as economic resilience also have their own limits. If the weakening of the rupiah prolongs, it will eventually increase government and private debt costs and inflation. These conditions have serious implications in the form of deteriorating credit profiles channelled by banks.