Can an Emerging Market Become a Policy Pioneer?
Can an Emerging Market Become a Policy Pioneer?
Even by the dramatic standards of economic stimulus in the age of coronavirus, Indonesia stands out.
Jakarta is unabashedly monetizing state debt — an idea once considered heretical in polite circles because of concerns it would stoke inflation, weaken the currency and erode central-bank independence. But this concept has been slowly making its way toward the light. The central bank said Tuesday it will purchase 574.4 trillion rupiah ($40 billion) in bonds from the government, most of it directly through private placements. The experiment is laudable, and a measure of how far things have come globally that it isn’t condemned. It could even show the way for other emerging markets.
Bank Indonesia now finds itself underwriting muscular budgets that aim to steer the world's fourth-most populous nation from its deepest recession in decades, and help prevent tens of millions of citizens from plunging further into poverty. It certainly isn’t alone. Around the globe, officials have cut rates to zero, engaged in quantitative easing and propped up markets. Finance ministries have unleashed massive supplementary budgets to alleviate Covid-19's catastrophic impact.
But few, if any, have gone this far. It may only be a question of time: India’s economy has been crippled and faces a gaping budget deficit, while Malaysia has fired four fiscal cannons and interest rates are at a record low. If Indonesia doesn’t pay too steep a price — much less no penalty — they will be tempted to follow. The Philippines central bank has bought much smaller parcels of debt in the secondary market and has expressed interest in going a bit further.
Jakarta is trying to bust out of its longstanding constraints. The rupiah isn't a reserve currency, unlike the dollar or euro, and the nation has a nagging deficit in its current account, the broadest measure of trade. That means an avalanche of bond sales to more traditional investors, including international buyers, would tend to weaken the rupiah. This isn't theoretical; Indonesia descended into political chaos and communal violence in the late 1990s when the currency collapsed during the Asian financial crisis.
Investors are giving policy makers the benefit of the doubt, for now at least. Though markets faltered last week when word of monetization began to leak, bonds rallied after Tuesday’s announcement. Perhaps that's because Finance Minister Sri Mulyani Indrawati assured us that the deal is a one-off — and many took heart that the amount wasn’t even bigger. Credit-rating companies don’t sound perturbed, either, being largely agnostic about who owns this debt. The rupiah rose 14% last quarter, reflecting a broad rally in emerging-market currencies after a drubbing in the preceding three months.
Central banks have long balked at direct monetization because it challenges the idea that monetary policy should be independent from politics. Another reason why it has been taboo is the risk that rampant spending will spur inflation. It’s worth noting that BI isn't giving the finance ministry a free pass; the government will have to pay the benchmark rate — now 4.25% — rather than zero, as some had feared. Central bank Governor Perry Warjiyo said inflation is under control and that if prices do spike, he can stop them.
Warjiyo is a lucky soldier in this revolution. Deflation is a bigger threat than inflation, which was in retreat around the world for years before Covid-19 came along. Indonesia is no exception; the pace of annual increases in the consumer price index have fallen to the bottom of BI’s 2% to 4% target range.
If anything, Indonesia's steps have exposed the limitations of inflation targeting as the key pillar of central banking architecture. Emerging markets borrowed this framework from the West to buy credibility with investors. In time, forward guidance, public forecasting and press conferences followed.
These models were never quite set in stone. Indonesia and the world now have broader priorities. As a result, fiscal and monetary teams have begun working closely to combat a once-in-a-lifetime crisis, and boundaries have been blurred. In Jakarta, the politically correct term for the monetization is “burden sharing.”
This boldness may not last. An investor panic at the prospect of stimulus withdrawal in big economies — like the “taper tantrum” of 2013 — or a medical breakthrough could see Indonesia return to the traditional model.
Officials have been clear about their intentions and Sri Mulyani, a former top executive at the World Bank in Washington, is a tremendous asset as de facto head of investor relations for President Joko Widodo. She will need to be alert for the slightest whiff of a shift in sentiment that could put emerging markets back under strain. BI is a more lenient lender than the International Monetary Fund was two decades ago. If this gambit doesn’t work, the IMF may again be on the horizon. If successful, however, Indonesia’s policy experiment will be the subject of textbooks and finance seminars for years to come.