Indonesia will use unprecedented quantitative easing and other emergency monetary and fiscal policies for as long as it takes to recover from the coronavirus pandemic, according to the country’s finance minister.
With the private sector in retreat after weeks of lockdown, massive state spending was needed to shore up the economy, Sri Mulyani Indrawati said. This was despite concerns among investors about the country relaxing hard-won constitutional limits on fiscal deficits.
“Today the government is the only player in town,” she told the Financial Times in an interview.
South-east Asia’s largest economy has become one of the biggest emerging markets to experiment with QE, under which the country’s central bank is buying government bonds to help fund an economic relief programme for the pandemic and to counter market turmoil.
QE was heavily used by central banks in developed markets to deal with the global financial crisis of 2008-09 after traditional measures such as cutting interest rates failed to revive their economies.
The pandemic represents the first time large emerging markets have wholeheartedly adopted the policy.
Ms Indrawati said the pandemic triggered a “perfect storm” of falling government revenue, rising fiscal spending and volatile financial markets.
“In this very extraordinary situation when the reliability of the market is in question and capacity to absorb [an] increasing deficit [is needed], then the central bank can play as a standby buyer,” said Ms Indrawati, adding that Indonesia would not rely on central bank financing in the long run. “That is not good policy practice,” she said.
Indonesia suffered Rp125tn ($8.83bn) of capital outflows in the first quarter as the pandemic struck. The yield on 10-year, rupiah-denominated government bonds jumped from a low of 6.5 per cent in February to 8.3 per cent in late March, while the currency fell from about Rp13,500 to Rp16,500 against the US dollar in the same time period.
“Nothing [had] changed in Indonesia . . . but the market was just totally panicked from this pandemic,” said Ms Indrawati.
In response, authorities this year gave the central bank, Bank Indonesia, permission to buy government bonds in the primary market for the first time. Indonesia’s QE also allows for central bank purchases of government bonds in the secondary market.
The Indonesian government is forecasting a fiscal deficit this year of 6.34 per cent of gross domestic product, more than double the constitutional 3 per cent cap, which has been waived until 2023.
Bank Indonesia has also used QE to stem outflows of foreign capital. The economy is vulnerable to capital outflows and currency depreciation during crises thanks to large foreign holdings of rupiah-denominated government bonds, which stood at about 40 per cent pre-pandemic.
Critics say emerging markets could face risks from QE including inflation or a collapse in foreign exchange rates. Deflationary pressures caused by the pandemic, however, make a jump in prices less likely.
Changyong Rhee, director of the Asia Pacific department at the IMF, said Indonesia had made it clear QE would only be used as a last resort. He said Jakarta was committed to maintaining the good reputation and independence of its central bank. “We believe there is good intention,” he said.
Asked whether there was a stigma attached to emerging markets using unconventional monetary policy, Ms Indrawati said the government would not sacrifice its achievements in building policy credibility. “We will judge policies and instruments on their own merit,” she said. “There is no ideology here.”
Indonesia’s QE has had some success. Foreign capital inflows totalled Rp7tn in the first week of June. This month, the yield on 10-year rupiah-denominated government bonds fell to just below 7 per cent while the currency appreciated to Rp13,800 against the US dollar. But at 30 per cent, foreign holdings of government bonds have yet to fully recover.
“There are some encouraging signs in the latest auctions . . . but still they [foreign investors] haven’t returned in a big way,” said Joseph Incalcaterra, chief Asean economist at HSBC. “That’s the key litmus test.”
The government could also face challenges in ensuring good governance while managing the planned huge growth in public spending in a country that scores poorly in corruption indices, analysts said.
“The opportunities for rent-seeking are pretty immense with the size of the fiscal deficit,” said Peter Mumford, head of south-east and south Asia at Eurasia Group. “Recently governance mechanisms have been weakened in Indonesia as a result of reducing the powers of the anti-corruption body. That will be a concern.”
Beyond fiscal and monetary measures, the fight against the virus remains the “root of the issue”, said Wellian Wiranto, economist at OCBC. He said Indonesia was easing its lockdown even though infections were still rising, potentially threatening future economic growth.