It probably wouldn’t be fair to say that Indonesia is at the “center” of the storm when it comes to emerging market turmoil, but it’s not a stretch to say they’re under a whole lot of pressure.
Acute, idiosyncratic flareups in Turkey and Argentina should always be viewed through the lens of broader EM vulnerability to a rollback of post-crisis accommodation by developed market central banks.
Back in May, at an IMF/SNB event, Jerome Powell insisted that emerging economies should prove to be resilient in the face of Fed tightening. Some EM policymakers beg to differ. For instance, the RBI’s Urjit Patel and Bank Indonesia’s Perry Warjiyo have both implored the Fed chair to be mindful that his actions have consequences and that some of the dynamics at play in the U.S. (e.g., Fed balance sheet rundown playing out against a supply deluge to finance the GOP tax cuts) seem to be underappreciated by the FOMC when it comes to the potential for sapping dollar liquidity at a delicate time.
Some developing economies are more vulnerable than others, but the entire EM complex benefited from the hunt for yield catalyzed by a decade of DM accommodation that pushed investors out the risk curve and down the quality ladder. Now, the tide is going out on that, which means the entire space is exposed to a greater or lesser degree.
Indonesia has hiked rates four times since May in an effort to shield the rupiah from the storm. We’ve variously begged folks not to ignore that increasingly frantic effort to stay out ahead of things (see here and here, for instance). As of July, foreign bond ownership in Indonesia was nearly 38% of outstanding.
The problem with that in an environment where the global hunt for yield is reversing on the back of Fed tightening is that it sets up a potential exodus, with serious consequences for countries that rely on external funding. Last week, Indonesia’s Finance Ministry said it’s aiming to reduce the amount of sovereign debt owned by offshore accounts by nearly half, to 20% from the 38% shown above. That’s an effort to make the country less vulnerable to episodes like what’s going on right now.
Well on Friday, the rupiah fell to its weakest against the dollar since the Asia financial crisis.
As a reminder, Bank Indonesia hiked rates earlier this month, days after saying the current-account deficit widened to 3% of GDP in Q2, versus 2.2% in Q1.
Amid the Friday slide, Warjiyo said BI was stepping up its ongoing efforts to defend the currency, intervening in both the FX and the bond market. “We’re committed to maintaining economic stability, including the rupiah,” he said in Jakarta.
But really, this isn’t as much a story about fundamentals (which aren’t terrible for Indonesia, despite the BOP risk), as it is a story about contagion, fear and souring overall sentiment.
“Fundamentals mean very little at this stage”, Mirae Asset Sekuritas Indonesia said Friday, adding that “it’s flow that matters and foreigners are taking risk off their balance sheet.”
That echoes concerns expressed weeks ago by Nomura. “In Asia, there may be some short-term BOP-related contagion in [Indonesia, India and the Philippines] but from a fundamental standpoint, we believe the bigger vulnerability for Asia in coming months stems from domestic credit stress and evaporating market liquidity, not balance of payments or currency pressures”, the bank wrote, in a note dated August 13, on the way to suggesting that a VaR shock might be just around the corner. Here’s more, for those who missed it:
A VaR shock, as experienced in previous instances of specific EM stress is possible. The concerns emanate from several fronts, including still relatively large positioning from real money in Turkey (tracking the JPM EMGBI) for which we have seen investors overweight on a geographical basis in eight of the past 12 months to June 2018. This is similar in other parts of EM, with overweights in Asia (except THB), LatAm (except COP) and EEMEA (except PLN; Figure 3). Like the Russia-led VaR shock, the contagion effect is driven by the need of real money investors to sell their holdings (even those with strong local fundamental stories) in other markets to fund redemptions, as indicated by discussions with EM real money investors, as well as by the strong historical relationship between global EM and specific EEMEA/LatAm/Asia dedicated funds’ net flow data.
BI’s efforts to mitigate a potential panic liquidation were evident on Friday as the central bank bought some 4.1 trillion rupiah worth of government debt.
On that note, here’s one last quote from the above-mentioned Mirae Asset Sekuritas, whose Taye Shim seems to be a bit exasperated with a certain binge-tweeting U.S. President:
The bottom line is that nobody wants to mess with uncertainties, especially with Trump at this time. With the U.S. economy in such good condition, at least for now, he has got no problem with continuing his rhetoric.