Indonesia’s central bank takes away the punch bowl

September 28, 2018

By William Pesek

If you think you are having a frenetic year, spare a thought for Perry Warjiyo. In four months as Indonesia’s central bank governor, he has hiked interest rates four times — roughly once every 32 days.

With his nation’s currency down 10% this year against the U.S. dollar and investors fleeing its markets, Warjiyo has come out monetary guns blazing. In Manila, Nestor Espenilla, the same. Warjiyo’s Philippines counterpart also pulled the trigger on Thursday — raising his benchmark rate to its highest since March 2009.

Both policymakers are on the front lines of a frenetic monetary policy transition: Asia is having a Paul Volcker moment, and it is about time.

Volcker was the heavy-handed chairman of the Federal Reserve from 1979 to 1987. He moved quickly to get ahead of runaway inflation and curb violent volatility in debt markets. His aggressive moves to yank away the proverbial punchbowl tamed the world’s biggest economy, resulting in what historians term the “Volcker transition.” That is when financial bedlam gives way to stable and productive growth.

Warjiyo seemed to channel Volcker following Wednesday’s 25 basis-point boost to 5.75% when he said: our “stance remains hawkish, pre-emptive and ahead of the curve.” In recent weeks, as an air of a 1998-like contagion coursed through markets, Warjiyo pledged a “front-loaded” assault on pessimism toward Jakarta’s policies. And with five tightening moves in the last six meetings, Bank Indonesia appears to be delivering.

The Volcker reference here is not random. In January 1998, the institution Warjiyo heads invited Volcker to Jakarta in an advisory capacity. While there, Volcker met with then-President Suharto to discuss Indonesia’s imbalances. Volcker’s pitch: rely less on loose monetary policy, more on modernizing a rigid economy.

Twenty years on, this is still, in some ways, Jakarta’s challenge as the rupiah returns to its 1998 depths. Thankfully, Warjiyo is using his 30 years of experience working in central bank circles to address it with assertive measures.

While painful in the short-run, it is a necessary precondition to Asia regaining the reformist momentum. What we are seeing in Jakarta and Manila are pivots toward trying to lead the markets, not following and enabling their whims. That, in turn, puts the onus on elected officials to upgrade economies so that growth comes from private sector innovation, not easy-money policies.

The proximate cause of Indonesia’s latest reckoning is U.S. President Donald Trump’s trade war and Fed tightening.

Since May, Trump has waged a tariffs arms race of sorts. First, it was levies of 25% on steel and 10% on aluminum. Next, taxes on $250 billion of Chinese goods on the way to proposed 25% tariffs on cars and auto parts. This assault on Asian supply chains put investors into a spin. Many are pulling capital out of riskier economies.

Fed tightening, meantime, is upending credit markets and adding to the uncertainty factor. On Wednesday, the Fed raised its benchmark another 25 basis points to the 2% to 2.25% range and signaled more steps to come.


Yet Indonesia must own the causes of its vulnerabilities. One is a chronic current-account deficit that has investors lumping Indonesia together with the Philippines and India as weak links in the global emerging markets chain. Even if Jakarta meets its pledge to narrow the gap to 2.5% of gross domestic product by 2019 from 3% now, the rupiah would still be vulnerable to speculators and Fed austerity.

Another danger: dollar-denominated debt. Dollar loans — both bank IOUs and bonds in circulation — stand at about $106 billion for Indonesian companies excluding financial services. This burden saw a 12% jump since 2016 alone, an increase that looks increasingly risky as Trump’s trade conflicts hit Asian economic growth. Cumulatively, about $21 billion of this dollar debt will mature between now and the end of 2020.

The rupiah’s plunge will heighten inflation risks, a difficult prospect for President Joko Widodo ahead of next year’s election.

But while an Indonesian inflation surge reflects an economy that it getting a bit warm, the Philippines is really beginning to overheat.

Bank Indonesia is trying to keep inflation where it is currently — within the target range of 2.5% to 4.5% in 2018. That is a band of which Espenilla’s Bangko Sentral ng Pilipinas can only dream. Espenilla’s team is grappling with a 6.4% inflation rate, the highest in almost a decade, just as the peso is down 8.6% this year. And, unfortunately, just as the Philippine government is distracted by other pursuits.

One, of course, is President Rodrigo Duterte’s deadly war on drugs. Another: political chaos in Manila that last week saw the arrest of Antonio Trillanes, the Senate’s most vocal Duterte critic, on questionable grounds. The biggest worry for global investors is Duterte’s neglect of structural reforms.

The president’s “Build, Build, Build” infrastructure gambit is having a dangerous side effect: throwing Manila’s trade balance further out of whack. The trade deficit has jumped 72% in the last year alone to $22.5 billion and 3% of GDP. The policy also features less accountability than that of Duterte’s predecessor Benigno Aquino. It means that a short-term GDP sugar high could be followed by higher public debt and political controversy.

Hence Espenilla’s challenge. In his first several months after grabbing the reins in July 2017, he was slow to tap the breaks.

Espenilla is now playing catch up. Question is, can he?

With Thursday’s 50 basis-point hike to 4.5%, the BSP has now clamped down to the tune of 150 basis points in 2018. The problem, though, is that inflation is running nearly 2 percentage points above borrowing costs. That disconnect collides with a cratering peso and the economically disruptive effects of Trump’s tariffs on steel, aluminum, $250 billion of Chinese goods and threats of more penalties to come.

The Fed’s rate hike trajectory, meantime, appears more aggressive than Asian policymakers expected. Today’s Chairman Jerome Powell is no Volcker — at least not yet — but he is telegraphing more hikes to come. The more U.S. policymakers drain the punchbowl, the more emerging markets could be at risk heading into the last quarter of 2018.

India’s rupee, for example, is down an eye-popping 13% this year. Even central banks much higher up the development league are grappling with Fed tightening moves. Count the Bank of Korea among them. With a benchmark at 1.5%, Governor Lee Ju-yeol’s team is struggling to bridge the gap with rising U.S. rates.

That also goes for Hong Kong, whose currency is pegged to a rising U.S. dollar. And Beijing, of course, where the People’s Bank of China is scrambling to offset the liquidity Powell’s team is siphoning from global markets.

This circles back to Volcker’s advice to Jakarta two decades ago. There is a common thread between the fallout from the 1998 Asian crisis and the Lehman Brothers crisis of 2008: national leaders abdicated their responsibilities to compliant central banks. Signals from Jakarta suggest those days are ending, and Asia will be better off for it.


William Pesek is an award-winning Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia, for his work for the Nikkei Asian Review.

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