The Jakarta Post
The great disconnect between the market and the real economy is growing in Indonesia as recent capital market gains come at a time when the economy is likely to contract.
Around the world, people are losing jobs and falling into poverty, businesses are closing or teetering on the brink of collapse against the backdrop of COVID-19 risks. Public health measures to contain the pandemic are restricting social movement and hitting hard the global economy, which is set to contract by 5.2 percent, according to the World Bank, the worst performance in 80 years.
In the US, the contrast is especially stark. As an antiracism uprising flared up in the wake of the death of Afro-American George Floyd, Wall Street soared, with the S&P 500 index having recovered a full 40 percent from its March lows.
The situation in Indonesia is also raising many questions. The gross domestic product is set to contract in the second quarter, with May trade data pointing to a deep deterioration in the manufacturing industry and consumer spending, both of which account for a sizeable contribution to the economy.
COVID-19 infections and deaths continue to see record increases and hospitals are overwhelmed, but capital city Jakarta has begun transitioning to the “new normal”. People will soon be allowed to go out in crowds, including to malls, albeit adhering to strict health protocol, such as physical distancing, wearing masks and maintaining personal hygiene.
Against this backdrop, the domestic stock market had risen nearly 30 percent from its March low by June 8. The benchmark 10-year bond yields, which move in the opposite direction to prices, dropped from a March high of 8.32 percent to 7.24 percent recently.
Capital inflows have pushed up Indonesian asset prices. Foreign investors bought a net Rp 11.85 trillion (US$841 million) worth of stocks in the past month and Rp 18 trillion in tradable government bonds. This has also buttressed the rupiah, which appreciated by 17 percent to Rp 14,115 against the US dollar.
Funds from around the world pumped money into global stock and bond markets after policymakers ramped up stimulus spending in response to the COVID-19 pandemic.
At home, Bank Indonesia (BI) injected billions of dollars of liquidity into the financial system by buying government bonds at auctions and in the secondary market and by conducting monetary operations and intervening in bond and foreign exchange markets. The central bank also freed up idle funds in the banking system through a lower reserve requirement ratio and other measures.
The idea of central bank intervention to stimulate growth is simple: The funds that flow into the markets are expected to create a so-called trickledown effect on the wealth of companies and individuals that would be spent to get the economy going.
The reality, however, has been that bond-buying programs are inflating prices in mature markets—thereby lowering yields—and creating returns that turn investors to emerging markets for higher gains.
As many studies suggest, few of these funds flow directly into the real economy, or the main street.
In Indonesia’s case, the central bank’s multibillion liquidity pushed into the banking system has resulted in banks buying more government bonds with the excess fresh funds they have, rather than being funneled to the real sector, as businesses grind to a halt. This is evident in banks’ ownership in government bonds, which rose to 32.37 percent on June 12 versus 25 to 27 percent earlier in the year.
Meanwhile, BI’s monetary operations and bond market intervention have jacked up the central bank’s ownership in government bonds to 7.3 percent in June 12 from around 4 percent earlier in the year.
Since the market is controlled by foreign investors and banks, which collectively account for 63 percent of government bonds, the gains in the market have largely benefited them. It is similar with the stock market, as foreign investors hold 51 percent of stocks traded on the Indonesian Stock Exchange.
Hopes are high that Indonesia’s stimulus funding model, which allows BI to directly buy government bonds in the primary market, can address the disconnect, as the debt papers are being used by the Finance Ministry to fund the nation’s battle against COVID-19.
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This, however, comes with budget credibility risks, especially in the face of foreign investors. It is imperative that the government immediately turn around the widening state budget deficit, which swelled to 6.34 percent of the GDP—after decades of imposing a deficit cap of 3 percent—after spending the state budget to contain COVID-19.
In the stock market, investors have the option to buy shares of companies they see as helping the country in a time of crisis through good practices. Social responsibility, sustainable business models and good corporate governance should add to the fundamental values that encourage investors to buy a company’s stocks. By doing so, stockholders and publicly listed companies help minimize the disconnect between the market and the economy.
In the meantime, targeted and accelerated budget spending to contain COVID-19 should be prioritized as the government is likely to be the main spender in the economy this year. Revving up COVID-19 containment measures, especially on public health to ensure a steady decrease in infections and deaths, can create a healthy society that can push up the economy and accelerate the recovery. Meanwhile, social safety nets and aid for businesses should soften the shocks.
The government’s efforts to contain the pandemic and its stimulus packages should support economic recovery and be the short-term fundamental factor in the markets that could make investors stay and be the low-hanging fruit to narrow the gap between the real economy and the market.
Bridging the disconnect between the two has been a major issue in global economy and finance, but Indonesia’s less mature financial system can be a blessing in disguise in global efforts to address the issue in the longer term.