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Burden sharing needs to be limited
Bond market instability is a price that must be addressed in the burden sharing.
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Monetary talks: President Joko “Jokowi” Widodo (left) shares a light moment with Bank Indonesia (BI) Governor Perry Warjiyo on the sidelines of the BI annual meeting in Jakarta on Nov. 28, 2019. (Antara/Aditya Pradana Putra)
T
he government and Bank Indonesia (BI) agreed again last week to share the financing burdens of health care and social assistance for the 2021-2022 fiscal year. Under the agreement BI will buy from the primary market government bonds (SBN) amounting to Rp 215 trillion (US$15.03 billion) in 2021 and Rp 224 trillion in 2022. BI will bear the interest on Rp 90 trillion of the total amount while the government will pay the interest on the remaining Rp 349 trillion at the BI seven-day reverse repo rate, which is much lower than the market rate.
In many other countries, central banks also contributed to the financing of fiscal deficits that have risen sharply during the COVID-19 pandemic. The United States, for example, bought government bonds to fund fiscal stimulus.
Up to this point, the side effects of the burden sharing scheme seem to be within the control of BI and the government. However, BI's direct support in the burden sharing scheme still needs extra caution. The large volume of SBN absorption by BI will disrupt the market equilibrium. The burden sharing will decrease SBN issuance through regular auctions from Rp 632 trillion to around Rp 417 trillion in the second half of this year, thereby causing tight market competition.
The purchase of SBN by BI in the primary market will be immediately monetized. This is because the rupiah SBN is a new issuance and has a long tenor (five to eight years), and is tradable in the market. As a result, bond market instability is a price that must be addressed in the burden sharing. The type of SBN purchased by BI can indeed be used as an instrument for monetary operations. However, the commitment to buying SBN when the monetary situation does not require it will have an impact on the effectiveness of the monetary instrument itself.
The accumulated tension of financial market instability will increase when the taper tantrum (money tightening) policy is imposed by the US central bank. The taper tantrum, estimated to start later this year, will increase the US benchmark interest rate and this would trigger capital outflows from emerging economies such as Indonesia.
Such conditions would prompt foreign investors to unload their rupiah bonds and BI would again have to buy SBN in the secondary market. Certainly, the rupiah sterilization policy must also be pursued through intervention in the spot market. The foreign exchange market intervention and the purchase of SBN in the midst of uncertainty are very expensive. The BI's foreign exchange reserves and equity could be eroded.
The above concern seems to be reasonable. The burden sharing scheme series I and II in 2020 have reduced 8.64 percent of BI's capital ratio. The third volume of the burden sharing scheme is projected to shrink BI's equity by 8.9 percent in the current year and is likely to shrink again by 4 or 5 percent for the next year.
