Indonesian Government Succumbs to Market Forces, Raises Interest Rates

I have been pointing out that it is inherent in governments and their monetary institutional apparatus, the central bank, to see interest rates as an obstacle to their perception of a politically shaped economic nirvana. This has mostly been premised on an ideological framework justifying their political mandate and their power over society. 

Thus resisting rate increases has been intuitive for them UNLESS forced by the markets.

Well Indonesia seems like a wonderful example. The Indonesian government succumbed to market forces by raising rates anew.

From the New York Times:

The Indonesian central bank raised its interest rates on Thursday, in a desperate effort to shore up a currency that has been badly hit by the recent sell-off in emerging markets worldwide.

The Indonesian central bank’s decision, announced at a hastily called board meeting, raised the benchmark rate by half a percentage point, to 7 percent, and highlighted the increasing pressure that many of the world’s largest developing economies have faced while market sentiment has withered.

Investors have poured billions of dollars into emerging economies in recent years, as buoyant growth rates and relatively high interest rates made them attractive investments compared with the United States and Europe. Since May, however, a gradual recovery in the West and signs that the Federal Reserve would soon scale back its support of the American economy have prompted a stark shift away from emerging markets back to assets like United States Treasury securities.

That shift has dragged down stocks and currencies in emerging markets, depriving them of the cash that fueled their previous growth spurts and raising the cost of crucial imports like oil.

Hit hardest have been those countries that, like Indonesia, have trade deficits and are more risky in the eyes of investors.

Remember in 2011, Indonesia had been the darling among emerging markets, as credit rating agencies feted on her alleged 'success' story. Endorsements by credit rating agencies are really a 'kiss of death'

Yet the problem hasn’t been about trade deficits. Trade deficits are merely symptoms of a deeper underlying problem: a debt inflated political economic bubble.

Like all central banks, Indonesia’s interest rates went into the direction of Zero Bound over the past few years. 

Doing so or the implementation of the policy of negative real rates (financial repression) encouraged deficit spending by the government which ballooned her external debt position.

In 9 years Indonesia’s external debt posted a CAGR of 6.71%. This is more than the average annual GDP growth of 5.42% from 2000-2013 according to tradingeconomics.com

But the kernel of the growth in Indonesia’s debt has been during the past 3 and 1/2 years as shown by the red trend line. This means that much of the aggregate growth in debt has been acquired during this record ultra low interest rate period.

Now the mainstream used to say that Indonesia’s macro fundamentals has been allegedly sound given the declining debt-to-gdp ratio. 

Yet again we won’t be seeing today’s market turmoil if such statistical data is valid.

The reality is that ballooning debt has been camouflaged by a credit bubble in both the private and the public sector. 

And speaking of the private sector, Indonesia’s loans to the private sector has burgeoned by 48.5% or CAGR 21.88% over the last two years

All these debt financed consumption based growth story has led to the trade deficit bogeyman. 

Today's market upheavals also suggests of the culmination of the bubble cycle.

Thus in the recognition of the huge buildup in systemic leverage, the Indonesian government has struggled to resist increasing rates. They initially even used foreign reserves as shield in futility.

Nonetheless the tightening process, even without the actions of the Indonesian government, has been running in course via the dramatic selloffs in Indonesia’s financial markets, the currency the rupiah, the stock markets the JCI and the bond markets.  So the Indonesian government attempts to “save face” via raising rates.

Higher interest rates means debt service cost will rise, which should put pressure on the humongous debt acquired by both the private sector and the government. 

Higher interest rates will also depress the statistical economy, thereby we should expect the ballooning of the debt to gdp ratio and this will also unmask the mirage of the 'strong' statistical economy. 

Higher interest rates could also signify as the proverbial pin that bursts Indonesia’s homegrown bubbles, which the government has fervently tried to ensconce.

Yet if the popping up of domestic bubbles will hit the Indonesia’s banking sector hard, then we may see Asian banking currency crisis 2.0 (circa 2013).  We will know of the gravity of the damage from the recent market selloff and from the sharp hike in interest rates in a couple of months and its ramifications.

The risks of popping of bubbles wouldn’t just be an Indonesian story, but for much of her neighbors too, the Philippines included.

The illusions of a statistical boom fueled by inflationism are being exposed.

Caveat emptor