T

he Indonesia Stock Exchange (IDX) closed 2017 with a big bang. On Dec. 29, the last day of trading, the Jakarta Composite Index (JCI) reached a record high of 6355.65.

It was higher than in China (6.6 percent), Singapore (18.1 percent), Malaysia (9.5 percent) and Thailand (13.7 percent). Out of that gain, a 6.8 percentage point increase was recorded in December alone.

This was unprecedented since it occurred amid concern over the negative impact of the rise of the United States Federal Reserve benchmark rate and after Bank Indonesia (BI) decided to maintain its policy rate.

The situation was very different from 2013, when the Fed announced possibilities of ending its quantitative easing policy, which meant it would start tightening its monetary policy.

This tapering talk had a significant impact on emerging market countries (EMC) including Indonesia. The taper tantrum — as it was then generally called — had caused the exchange rate to weaken dramatically in EMCs, their stocks and bonds were hit hard, triggering capital outflows to advanced countries.

In Indonesia, the rupiah depreciated 25 percent between May 2013 and February 2014. The JCI dropped 23 percent. Foreign direct investment plunged to a trickle at only US$0.5 billion in the fourth quarter 2013 from $5.8 billion in the third quarter.

Current account deficit soared to 4.4 percent of gross domestic product (GDP).

The government took several steps to respond to this situation including rate hikes and currency intervention by BI, curbing energy subsidies and relaxation of import restriction by the government.

The policies lent some credibility to the market, but it took some eight months before the exchange rate, stock index, bond yield and capital flows recovered to their pre-taper tantrum levels.

After cutting its benchmark rates several times, BI on Dec. 14, decided to maintain its policy rate at 5 percent, while maintaining the 7-day repo rate and the FASBI rate at 4.25 percent and 3.50 percent respectively.

Apparently BI perceived that the previous monetary easing had been sufficient to continue driving economic growth and decided that there was no room for further easing and that a threshold has been reached whereby further rate cuts could pose a risk of further weakening the rupiah and increasing capital outflows.

For some time, BI has been frustrated that its monetary easing policy still has little impact on bank lending growth as well as on the growth of the economy.

One day earlier, the Fed raised its benchmark rate by 25 basis points to 1.25 percent.

The Fed viewed that the strong US economic recovery warranted tightening its monetary policy, in anticipation of the expectation of higher inflation.

In response to the US interest rate rise, several central banks in other countries have also raised their interest rates. Bank of England raised its interest rate for the first time in a decade.

The European Central Bank, People’s Bank of China and some central banks in Asia, have also done the same.

These actions were taken to stem capital outflows that could be attracted to the US.

But the external risk to the Indonesian economy has yet to be tested by the impact of the Fed’s plan to raise its benchmark rate three more times in 2018.

And also by the impact of US President Donald Trump’s tax reform, which was approved by the US Congress and the Senate last Christmas.
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Cutting the rate for Indonesia at this time would be bad news [...]

President Trump’s tax bill drastically cuts the US corporate tax rate from 35 percent to 21 percent. The US is no longer the country with the highest tax rate in the world. At 21 percent, the US tax rate is now lower
than Indonesia’s (25 percent on average).

It is understandable that the Finance Ministry is already concerned with sudden changes in the tax rate differential between Indonesia and the US. It is reported that the Finance Ministry is drafting changes in tax regulation that would respond to the effect of Trump’s tax reform.

The main issue is whether the government should cut the tax rate to match the new US rate. Cutting the rate for Indonesia at this time would be bad news, because of weak revenue collection and the need to maintain the budget deficit at its current level.

The immediate effect of Trump’s tax reform would be a significant increase in profit enjoyed by American companies.

This would have an impact on the pattern of global capital flows, but how great the impact is, depends on how American companies use the windfall gain from lower tax: whether this extra profit will be used to pay out more in dividends, to increase wages and salaries, to buy back shares or to invest for expansion. And it depends on whether the tax cut is big enough to lure American companies operating offshore back to the US, and whether foreign companies are attracted to relocate their manufacturing and plants from other countries to the US.

But higher budget deficits created by the tax cut could undermine US economic growth, which could trigger global financial volatilities. But for now, some positive developments have created a positive sentiment for Indonesia. Commodity prices including oil prices have been on the rise for some time.

Exports have grown strongly in 2017. And although the budget has been under strain, the government is committed to prudent macroeconomic policies.

The decision by Fitch Ratings to raise its rating on Indonesian sovereign debt to BBB from BBB- has also had a positive impact on the market.

Fitch cited the Indonesian economy’s resilience against external shocks, consistent macroeconomic policy geared toward stability, flexible exchange rate policy, and discipline in the monetary and fiscal policies, as reasons for the rating upgrade.

Now it is up to the government to maintain the economic resilience and to turn the positive market sentiment into investor confidence.
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The writer is a commissioner in a publicly listed oil and gas service company.