Indonesia adds a pinch of chili against the US dollar with rate hike

INDONESIA has bolstered its credentials as an emerging market leader – at some potential cost. The country took a surprising step to shore up its faltering currency by raising interest rates, and foreshadowed the tough choices confronting Asian economies in coming weeks.

officials had hoped that hikes were well behind them, but the US dollar hegemon in foreign-exchange markets had other ideas.

Policymakers can attempt to tough out this difficult moment and allow their exchange rates to deteriorate, perhaps significantly, or try to limit the decline and jeopardise some amount of growth.

Jakarta voted for the latter on Wednesday, pushing borrowing costs higher, a move forecast by only a small number of economists. Central banks are caricatured as communicating in vague or opaque language.

There was zero ambiguity from Bank Indonesia (BI). This was about foreign exchange (forex). domestic conditions were secondary.

For all its abundant resources, huge population and hype as a comer in global economics, the strategically important South-east Asian nation lives in a financial world dominated by the greenback and the US Federal Reserve (Fed).

Bank Indonesia is ever-mindful of the rupiah’s vulnerability; its dramatic collapse in the late 1990s was an iconic chapter in Asia’s modern economic history.

Pronounced as the recent slide has been, there’s no similar upheaval beckoning. And the central bank wants to keep it that way. The quarter-point increase in the benchmark rate to a record 6.25% was seen as a one-time step.

Scepticism is warranted. Should Fed chair Jerome Powell adopt hawkish language at next week’s Federal open Market Committee meeting and traders further trim bets on US easing, life could become even less comfortable for officials beyond American shores. At least we know where Indonesia stands.

There’s an element of theater in how BI goes about announcing its decisions. Rather than publish a brief statement and follow with a media conference to flesh out concerns and offer perspective, as the Fed, European Central Bank and Bank of Japan (BOJ) do, Indonesia does the reverse.

It took governor Perry Warjiyo almost 30 minutes to get to the point. But from the outset, his choice of words signalled intent.

Like a detective building his case, Warjiyo began by walking his audience through a landscape that had become significantly less favourable.

A strong response was required. The Fed would keep its own stance restrictive for longer, and Indonesian policy would be directed toward the stability of the rupiah.

With the currency down about 5% this year and 2% since the start of April, that could only mean a lift in rates. By that reasoning, extended weakness will require a similar response. That’s when the dangers begin to multiply.

not that Indonesia loves having to do this. Far from it.

Rates are a blunt tool. They can wound as much as cure. Capital Economics, one of the many firms wrongfooted in its expectations on Wednesday, acknowledged the primacy of the currency in BI’S thinking, but doubts this is the start of a new phase.

“With inflation very low and growth struggling, the central bank will be wary about tightening policy too aggressively,” wrote Gareth Leather, senior Asia economist.

Tamara Mast Henderson of Bloomberg Economics was in the minority that called it right. She also doubts Indonesia wants to go down that route.

There may be short-term relief for the rupiah, but its trajectory is driven by events beyond the nation’s control. Will Prabowo Subianto, who won Indonesia’s presidential election, inherit a slowdown?

As the bank put the finishing touches on its communique, one of his aides told Bloomberg News that a hike would be wrong. “We set a fairly high growth target, there needs to be support from monetary policy,” said dradjad Wibowo, an economics adviser to the incoming leader.

The new team aspires to economic growth of as much as 8%.

That’s very ambitious. Incumbent Joko Widodo, who hands over the keys of the palace in october, talked about turbocharging the expansion to 7% when he came to power a decade ago.

In reality, improvements in gross domestic product have hovered at around 5%. If Prabowo is to have a prayer, he too needs priorities.

Letting the rupiah go risks tougher medicine down the track. Campaigning is one thing. The complications of governing are another. There’s a good argument for letting the bank do its job.

BI takes its role seriously. It has teams of experts who, together with provincial officials, comb the archipelago for evidence that prices are behaving themselves. The cost of food gets special attention, including chili, a staple for dishes at breakfast, lunch and dinner.

Bank inspectors have gone so far as joining police in smashing chili racketeering. Beef, poultry and garlic have also been probed for price manipulation.

Indonesia just spiced up the global interest-rate debate.

neighbours will take notice. The Bank of Thailand is resisting government assertions that it must reduce rates immediately.

The Philippines is inclined to cut, but frets about the peso. South Korea has warned speculators not to push the won too far down.

Japan has threatened intervention to support the yen, and the BOJ may be preparing investors for the next rate hike.

Jakarta ought to get credit for forthrightness. Wednesday’s decision, in isolation, won’t retard growth in any meaningful way. More such shocks will start to sting. — Bloomberg

Officials had hoped that hikes were well behind them, but the US dollar hegemon in foreign-exchange markets had other ideas.