Indonesia Pain Threshold Looms on Rate Increases: Southeast Asia

Indonesia’s most aggressive rate-tightening in eight years has barely dented a current-account deficit, prompting calls for more increases and other measures before the Federal Reserve cuts stimulus.

Bank Indonesia has raised borrowing costs by 1.75 percentage points to 7.5 percent since early June, the quickest since 2005. Following data last week showing the country recorded its second-highest current-account shortfall on record in the three months through September, JPMorgan Chase & Co. and Standard Chartered Plc now see a further 50 basis points of increases in the first half of next year.

Foreign funds pulled $3.8 billion from Indonesian stocks and local-currency bonds in June after the Fed said it could cut stimulus, and a lack of progress on improving the current account before the U.S. does eventually taper leaves the country vulnerable to another sudden outflow. The government said this week it will raise import taxes for consumer goods, showing policy makers are looking for other bullets to slay the deficit.

“I’m afraid that when we really need to raise the reference rate, Bank Indonesia will have no ammunition left,” said Anton Gunawan, chief economist at PT Bank Danamon Indonesia in Jakarta, who is forecasting another 25 basis-point increase next quarter. “There was no urgent need to raise the rate last week.”

The rate rise on Nov. 12 came after a pause in October and was forecast by just one of 25 analysts surveyed by Bloomberg. A day later, the government reported a current-account deficit of $8.4 billion in the third quarter, compared with a record $9.9 billion in the previous three months.

Low Reserves

The trade gap and prospect of reduced U.S. stimulus have fueled a near-18 percent drop in the rupiah this year, making it the second worst-performer among 24 emerging-market currencies tracked by Bloomberg. Foreign funds have pulled $1.4 billion from Indonesia stocks so far this year.

The central bank’s foreign-currency reserves have fallen by 14 percent this year to October, according to Bank Indonesia data, giving it reduced ammunition to intervene to defend the currency. The rupiah will weaken to 12,000 per dollar in three months due to the deficit, relatively low level of reserves and risk around tapering, Barclays Plc said in a report on Nov. 14.

Bank Indonesia sees the current rupiah level as appropriate, with its weakness temporary and due to global factors, Governor Agus Martowardojo told reporters today. The central bank will manage the current-account deficit to a sustainable level that it sees as being less than 2.5 percent of gross domestic product, he said.

Bank Indonesia is likely to face further capital flight and severe rupiah depreciation when the U.S. does reduce stimulus, pressuring it to raise rates again next year, said Toru Nishihama, an economist at Dai-ichi Life Research Institute Inc. in Tokyo. Yet, lifting borrowing costs will shrink the economy and is not good from a long-term viewpoint, he said.

More Pain

The country’s GDP increased 5.6 percent in the three months through September, the weakest since the global recession, as investment slowed with the higher rates.

“Fifty to 75 basis points should be fine, but more than that, the pain will be more than the gain,” said Eric Alexander Sugandi, an economist at Standard Chartered in Jakarta. “Instead of just relying on the Bank Indonesia rate, I would suggest they would try to use other measures such as increasing bank minimum reserve requirements.”

Martowardojo told bankers on Nov. 14 that the central bank is considering raising reserve requirements for shariah lenders. The country has to accept an economic correction, and needs deeper markets and policy responses to guard economic stability, he said. The government has said it is planning more economic measures in November.

Fed officials said they might reduce their $85 billion in monthly bond purchases “in coming months” as the U.S. economy improves, minutes of their last meeting showed.

Build Refineries

Monetary policy alone will not solve the persistent imbalances in Southeast Asia’s largest economy, said David Sumual, economist at PT Bank Central Asia in Jakarta. The country’s expanding middle class is importing more goods while demand for commodity exports has weakened.

Fundamental concerns such as dependence on oil imports will instead need to be addressed by the government, by building refineries and infrastructure, liberalizing investment and increasing tariffs for some products, Sumual said.

“Bank Indonesia’s recent policy in raising the policy rate signals the government’s inability to handle the current-account deficit,” Sumual said, adding it still had room to raise it to around 8.5 percent. “More than that level, it might only trigger recession in the country as it would affect the consumption sector, the only engine of growth left.”

Still Spending

Economic indicators show that Indonesians are still spending even as the central bank and government attempt to slow the economy to tackle the trade and current-account shortfalls.

Bank Indonesia’s consumer confidence index rose to a four-month high in October, while motorcycle sales climbed 5.7 percent from the previous month. Private consumption increased 2.9 percent in the third quarter from the previous three months, when it climbed 1.5 percent, official data showed.

“When private consumption is growing much faster than the second quarter, that actually signals the slowdown isn’t enough to curb this current-account deficit,” said Enrico Tanuwidjaja, an economist at Nomura Holdings Inc. in Singapore. People are borrowing now “because they believe the interest-rate environment is bound for higher ground,” he said.

Five Years

Bank Indonesia may have to introduce more macroprudential and administrative tightening measures, including increasing primary and secondary reserve requirements for lenders, as well as possibly levying a capital gains tax on second or third properties, said Tanuwidjaja, who is forecasting two 25 basis-point rate increases in the first quarter.

Monetary tightening has failed to cool the property market, with the Indonesian Real Estate Association predicting housing sales will climb more than 50 percent this year.

Along with 50 basis points of rate increases through June 2014, restrictions on real-estate sector credit could be imposed to slow construction activity, Sin Beng Ong, an economist at JPMorgan in Singapore, wrote in a Nov. 15 research note.

To tackle the structural problems with the current account, the government needs to provide incentives for investors producing capital goods and manufacturing for overseas markets, Standard Chartered’s Sugandi said.

“In order to have the current-account return to surplus, it may take at least three to five years,” he said.

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