Well, you can’t say Bank Indonesia isn’t trying.
On Thursday, BI hiked rates for a fifth time since May, the latest in a series of increasingly frantic efforts to shore up the rupiah in the face of the Fed’s tightening cycle.
Simply put, these hikes aren’t working:
(Bloomberg)
Although acute crises in Turkey and Argentina have grabbed all the headlines this year, the Indonesia story is important.
Ostensibly, the central bank is doing the “right” thing and Governor Perry Warjiyo is clearly attune to the dangers inherent in sitting on one’s hands while the Fed hikes rates. But five rate hikes since May and round after round of intervention have been insufficient to stabilize the rupiah, which is still hovering near its weakest levels since 1998.
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Indonesia is vulnerable in a classic sense. They’re running a current account deficit at a time when the dynamics that pushed investors out the risk curve and into emerging market assets are reversing. The tide is going out and countries that rely on external funding will need to work hard to ensure their markets remain attractive to foreign investors when things like, for instance, short-dated USD fixed income, are offering some semblance of “attractive” yield again.
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. Last month, 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.
In addition to the multiple measures BI has rolled out in an effort to stem currency weakness, the central bank is launching NDFs, providing companies with a hopefully useful hedging tool for their dollar exposure.
“While there are some benefits of having such an instrument, we believe its introduction is unlikely to have a significant impact on Rupiah”, BofAML wrote, in a note dated Wednesday, adding that in their mind, “it is more important for policymakers to persuade exporters to convert their USDs to Rupiah as this is likely to have a much bigger impact.”
Right. But that kind of begs the question, doesn’t it?
Anyway, Thursday’s rate hike is (another) step in the right direction but at the end of the day, emerging market policymakers are trying to outrun a thunderstorm in a car. No amount of rate hikes is sufficient to completely mute the impact of a Fed tightening cycle, especially not in an environment where so many EMs have borrowed heavily in foreign currency.
“Unless and until the external backdrop changes and oil comes off, we doubt Indonesia can witness a substantial and sustainable rally”, BofAML said, in the same note cited above, before warning that “trade balance numbers for July (-2bn USD) and August (-1bn USD) suggest that downside risks to Q3 current account deficit has increased and we could be potentially staring another 3% deficit number if not more.”
Finally, it’s important to note that these rate hikes come at the risk of undercutting domestic growth. That’s the dilemma for EM policymakers. They can hike to protect the currency, but in doing so, they contribute to the very same tightening of global financial conditions which caused the problem in the first place.
“We believe BI and the Ministry of Finance will continue to take steps to reduce risks to the currency, but these will likely result in weaker growth”, Barclays cautioned on Thursday, after the latest hike.
For what it’s worth, Barclays thinks BI will follow the Fed on the way to delivering another 50bp worth of hikes by next March.
