One thing that we can learn from previous rounds of monetary tightening in the USA - i.e. the winding down of the US quantitative easing program in late 2013 and the Federal Reserve's interest rate hike in December 2015 - is that capital outflows from Indonesia are particularly severe in the period leading up to the official decision of the Fed to implement a tighter monetary policy stance when - amid a high degree of uncertainty in global markets - investors become nervous, or even anxiously longing for clarity from the Fed. However, once the decision has been made public, there occurs a rapid recovery.

For example, when in late May 2013 former Fed Chairman Ben Bernanke started to hint at the winding down of the US QE program, it led to six months of uncertainty and speculation on international markets before the Fed finally provided clarity by announcing to taper its asset purchases in December 2015. However, during these six months of uncertainty and speculation Indonesia's benchmark Jakarta Composite Index fell from a high of 5,155.09 points on 20 May 2013 to a low of 4,174.83 on 9 December 2013, losing nearly one-fifth of its value. After the Fed's taper decision was made in December 2013, however, the Jakarta Composite Index rapidly rebounded and would hit a new record high some three months later.

A similar phenomenon was seen leading up to the US interest rate hike in December 2015 (the first FFR hike in nearly a decade). In the months ahead of this decision emerging markets fell prone to capital outflows. However, besides concern about further US monetary tightening, capital outflows from emerging markets were exacerbated by severe worries about China's 'hard landing'. However, after the Federal Reserve confirmed in December 2015 that the FFR would be raised it soon led to capital inflows into Indonesia's stock market as investors were pleased by the more certain economic context, while Indonesian stocks had become 'cheap' after the decline.

However, over the past couple of weeks speculation has been heightening again about another FFR hike and therefore we expect to see another round of capital outflows from Indonesia's stock market ahead of the official Fed decision (possibly in July).

Jakarta Composite Index' Reaction to US Monetary Policy Changes:

The Indonesian rupiah, however, is a different story as there is a clear long-term depreciating trend against the US dollar ever since Bernanke hinted at QE tapering in May 2013. There are two brief periods characterized by marked rupiah appreciation (i.e. February 2014 and October 2015). However, such temporary rupiah strengthening was related to domestic factors (Joko Widodo joining the presidential race in early 2014 and Indonesia's improving macroeconomic context in late 2015), not so much the result of the rupiah's response to changing monetary policy of the Federal Reserve.

After the Fed decided to raise its FFR in mid-December 2015 there emerged high depreciating pressures on the rupiah for a couple of days. Soon, however, the currency started to appreciate and stabilize at around IDR 13,500 per US dollar. This was a much better response to US monetary tightening compared to the sharp rupiah depreciation that occurred after Bernanke hinted at QE tapering in May 2013. This is most likely related to the fact that Indonesia's financial system is in a better condition with inflation having eased below five percent (y/y) from nearly double-digit figures in 2013-2014. Meanwhile, Indonesia's current account deficit - which has been a major concern of foreign investors - improved as well.

Indonesian Rupiah versus US dollar (Bloomberg Dollar Index):

The current account balance is the broadest measure of a country’s international trade. When a country - such as Indonesia - is plagued by a current account deficit it implies that the country is a net borrower from the rest of the world and thus needs capital or financial inflows from abroad to finance this deficit. However, the dependence of the country to plug the deficit by foreign inflows is what makes investors nervous and therefore countries that have a (wide) current account deficit are highly vulnerable to capital outflows in times of global economic shocks (such as a change to US monetary policy).

In the first quarter of 2016 Indonesia's current account deficit was recorded at 2.14 percent of the nation's gross domestic product (GDP), improving from the 2.37 percent of GDP deficit in Q4-2015 but slightly worse than the 1.94 percent of GDP deficit in Q1-2015. Bank Indonesia expects the full-year 2016 CAD to reach between 2.2 and 2.5 percent of GDP, a level that is considered sustainable. Although it remains not far from the level that separates a sustainable from an unsustainable deficit it is an improvement from the 3.3 percent and 3.1 percent deficits in 2013 and 2014, respectively.

As such, we expect the rupiah to remain stable in the range of IDR 13,500 - 13,700 per US dollar in the coming months, while there should emerge outflows from Indonesia's Jakarta Composite Index ahead of the next FFR hike (but soon after this rate hike there should occur a rebound in the performance of the Jakarta Composite Index).

Potential Risks to Indonesia's Financial System Stability
• Interest rate hike in the USA
• Low commodity prices & Indonesia's reliance on commodity exports
• Sluggish global economic growth
• Sluggish economic growth in China
• Indonesia's widening gap between the rich and poor
• Sluggish household consumption in Indonesia
• Easing credit growth in Indonesia


lugano |

Beautiful example currency risk:
an American who has invested since 2013 in Rupiah investment must create an overall efficiency of at least 40% over three recent years to have no loss - currency risk hedging is an (expensive) option ..