Analysis: Impact US Monetary Tightening on the Indonesian Economy

In the latest US Federal Reserve meeting (Federal Open Market Committee), held earlier this week, it was decided to be patient regarding raising interest rates. However, as the economy of the USA has recently been experiencing structural recovery, the market is increasingly speculating that the Federal Reserve will raise its benchmark Fed Fund Rate sooner than expected (perhaps in April 2015) despite Fed Chairwoman’s Janet Yellen earlier statement that there will remain a “considerable time” between the ending of the bond-buying program (quantitative easing which ended in November 2014) and the introduction of higher US interest rates. Since 2008, the Federal Reserve has held a historically low key interest rate of between 0 and 0.25 percent. The expected average interest rate increase at end-2015 is 1.125 percent, implying expectation of multiple US interest rate hikes in 2015, further rising to 2,500 percent and 3,625 percent in 2016 and 2017, respectively.

Amid the financial crisis and subsequent monetary easing in the late 2000s in the West, Indonesia saw the influx of considerable capital as the country’s assets were considered attractive and US dollars were ‘cheap’. In the course of 2013, Indonesia experienced the downside as capital outflows emerged after former Fed Chair Ben Bernanke (in late May 2013) started to give signs that the period of US monetary easing would be over sooner than later. Overseas investors reacted by pulling funds from emerging markets. Indonesia was particularly plagued by capital outflows as investors were concerned about the country’s wide current account deficit (implying that it is dependent on foreign funding). Although Indonesia’s benchmark stock index (Jakarta Composite Index) has recovered from the severe outflows, the Indonesia rupiah exchange rate has continued its depreciating trend against the (bullish) US dollar. In 2015, the next global shock is expected (higher US interest rates) and it is expected that Indonesia will see considerable capital outflows again.

Benchmark Stock Index of Indonesia:

US Dollar versus Indonesian Rupiah:

| Source: Bank Indonesia

Slowing economic growth in China and Japan - the world’s second and third largest economies - will also affect the economy of Indonesia. China’s economy, which had become used to a 10 percent (y/y) growth pace, will probably see GDP growth fall to 7 percent (y/y) in 2015, while Japan needs to avert falling into a deeper recession. Both countries are important trading partners of Indonesia and therefore directly affect the performance of Indonesia’s exports. Indirectly, weakening demand from China and India negatively affect Indonesia’s export performance as global commodity prices fall (Indonesia being an important commodity exporter).

Indonesia’s central bank (Bank Indonesia) is expected to raise its benchmark interest rate (BI rate) next year in an attempt to limit capital outflows and support the rupiah rate. Between June 2013 and November 2014 Bank Indonesia has raised its key rate gradually, yet aggressively, from 5.75 percent to 7.75 percent. Besides global factors, the institution also raised the BI rate to combat accelerated inflation after two subsidized fuel price hikes (in June 2013 and November 2014). These fuel price hikes were conducted by the Indonesian government to create more fiscal room for structural public investments (for economic and social development) and in a move to curb the wide current account deficit (primarily caused by costly oil imports). The Standard Chartered Bank expects that Indonesia’s central bank will raise its BI rate in the third quarter of 2015 as it expects the Federal Reserve to raise US interest rates in September 2015. Other international institutions, however, expect the Fed to raise its key rate earlier, which would mean that Bank Indonesia would also need to raise its BI rate earlier.

Bank Indonesia's BI Rate:

Financial Update Indonesia: Credit Growth, Bad Loans and Retail Sales

Indonesia's Quarterly GDP Growth 2009–2014 (annual % change):


 Year    Quarter I
   Quarter II    Quarter III    Quarter IV
 2014        5.22        5.12         5.01  
 2013        6.03        5.89         5.62         5.78
 2012        6.29        6.36         6.16         6.11
 2011        6.45        6.52         6.49         6.50
 2010        5.99        6.29         5.81         6.81
 2009        4.60         4.37         4.31         4.58

Source: Statistics Indonesia (BPS)

Gross Domestic Product of Indonesia 2006-2013:

    2006   2007   2008   2009   2010   2011   2012   2013
(in billion USD)
 285.9  364.6  432.1  510.2  539.4  706.6  846.8  878.0
(annual percent change)
   5.5    6.3    6.1    4.6    6.1    6.5    6.2    5.8
GDP per Capita
(in USD)
 1,643  1,923  2,244  2,345  2,984  3,467  3,546  3,468

Sources: World Bank, International Monetary Fund (IMF) and Statistics Indonesia (BPS)