Fed rate outlook brings relief to Indonesia

JAKARTA. Policy makers in emerging-market economies may breathe a sigh of relief after the US Federal Reserve ended the uncertainty over its monthly bond-buying policy, as well as announcing it would keep its benchmark interest rate low for an extended period.

For Indonesia, the most important takeaway from the US central bank’s meeting this month was not the fate of the bond-buying program but rather a statement by the central bank’s governor, Ben Bernanke, that the Fed funds rate would remain low, even if US unemployment continued on its downward trend.

“In our view, the latest statement from Bernanke was quite comforting,” Bank Mandiri chief economist Destry Damayanti said. “The tapering was already priced in by the market, but our major concern is more the possibility that the Fed may act too fast in hiking its interest rate.”

At the moment, the Fed’s benchmark interest rate stands at 0-0.25 percent, with the near-zero rate already unchanged for five years, as the US central bank pursued an ultra-loose monetary stance to resuscitate the country’s economy, which was hit by the 2008 financial crisis.

The low interest rate in the US has encouraged global fund managers to switch their investment preference to high-yield environments within emerging economies, such as Indonesia, in search for more attractive returns.

However, fears that the US would gradually increase its interest rates had triggered capital reversal from emerging economies back to the developed world.

Bernanke took time to calm such concerns in his latest press briefing, saying that the low interest rate policy remained “appropriate” for the time being, adding that he would pursue an “accommodative” monetary stance for the foreseeable future.

“Bernanke’s forward-guidance statement signals that the interest rate in the US will be steady at
least until 2015,” argued Jeffrosenberg Tan, a Jakarta-based portfolio manager with Sinarmas Asset
Management.

“It gives some ‘breathing space’ to emerging markets to strengthen their financial fundamentals; especially Indonesia in its efforts to narrow the current-account deficit,” he said.

Indonesia was particularly sensitive to any changes in the Fed funds rate as the country’s high current-account deficit has made the country vulnerable to capital outflows. At the same time, foreign ownership in the country’s stocks and bonds market is among the highest in the region.

Indonesian bonds and the rupiah stood out as Asia’s worst-performers in 2013, after the Fed first signaled its intention to implement a tighter monetary policy in June. The rupiah has depreciated by more than 20 percent in 2013, while the return for foreign ownership holding rupiah-denominated bonds is around minus 15 percent year-to-date

Every 1 percent increase of the Fed funds rate could lead to a potential deviation of Indonesia’s economic output to minus 1.25 percent within the next two years in a worst-case scenario, resulting in one of the steepest falls in the world, according to Bank Indonesia (BI) data.

Moreover, every 1 percent increase in the rate for US treasury bonds — seen as the future proxy for movement in the Fed funds rate — would increase the bond yield in Indonesia by 1.3 percent, driving up the government’s borrowing costs, according to estimates from Mandiri Sekuritas.

“We are hugely affected by the US treasury yields because foreign ownership in our government bonds is currently at 32.5 percent, which is very high,” Mandiri Sekuritas’ fixed-income analyst, Handy Yunianto, said. “If there are more attractive investment alternatives overseas, then the foreign funds may be taken out of the country.” (Satria Sambijantoro)