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Timing the next taper and its effect on RI
The global economy started to gradually recover in the first half of 2021 from the COVID-19 pandemic-led recession in 2020 as vaccinations began to be distributed across the world, albeit unevenly.
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he global economy started to gradually recover in the first half of 2021 from the COVID-19 pandemic-led recession in 2020 as vaccinations began to be distributed across the world. However, the pace of economic recovery tends to be uneven among countries depending on the state of the pandemic, the availability of vaccines and the amount of stimulus of each country.
Countries with fast, widespread vaccinations (i.e., China, the United States and the European Union) have experienced faster recovery and rising inflation, which then raises questions on when the best and most appropriate time is to unwind the massive stimulus policy that has been deployed since the onset of the pandemic.
Debate on the timing of the great stimulus unwind has been dominating market sentiment this year, especially the talk of the tapering policy in the US. Tapering means to unwind and reduce the amount of bond buying that is currently being done to inject liquidity into the economy.
The minutes of July’s United States Federal Open Market Committee (FOMC) meeting showed the US Federal Reserve System's (Fed) members’ inclinations to start the tapering by the end of this year, as the economic indicators showed strong recovery. Yet, the Fed’s official policy stance so far remains dovish, as reflected in Jeremy Powell’s Jackson Hole speech. This week, the market will monitor the FOMC meeting that will be held on Tuesday and Wednesday to look for signals of possible timing of the Fed’s tapering.
The European Central Bank (ECB) is also considering the timing for tapering. The ECB has announced it will trim emergency bond purchases over the coming quarter, a small step toward unwinding the emergency aid that has supported the euro zone economy during the pandemic.
Some other central banks, mostly those of emerging market (EM) countries, have even moved further by raising interest rates due to the rising inflation pressure. Brazil, Russia and Chile are among the countries that have already raised interest rates this year each by 325 basis points (bps), 250 bps and 100 bps.
Thus, the talk of timing the stimulus exit is highly relevant now.
However, a stimulus exit needs to be done gradually and carefully, due to the still uncertain economic conditions, especially with the recent outbreak of the Delta variant of COVID-19.
The Delta outbreak has raised concerns that the current economic recovery may stall, thus, reducing the expectations of faster policy normalization or tapering.
Economic indicators showed moderation in the US. In August, the inflation rate grew softer at 5.3 percent from previously 5.4 percent. The US Purchasing Managers’ Index showed a slowdown in expansion both for manufacturing (from 63.4 to 61.1) and non-manufacturing (from 64.1 to 61.7).
In China, concern is rising over the potential default of one of its biggest property developers, Evergrande, which may threaten China’s recovery and could have a spillover effect on other EM countries.
Nonetheless, the global exit policy, especially the Fed’s tapering, will remain the most anticipated risk in the next quarters.
Even so, we think the impact, especially on EM countries, will be milder than the 2013 tapering episode due to a few reasons: (i) The global economy is currently flooded with massive liquidity, which may reduce the degree of capital flight from EM countries. (ii) Emerging markets (especially Asian EM countries) generally have better fundamentals now (i.e., stronger current account balance, low inflation and high foreign exchange reserves) despite being hit by the pandemic. (iii) The central banks, such as the Fed, appear to communicate better with the market, which may reduce the possibility of a negative announcement effect. However, EM countries also differ in the stages of recovery and vulnerability. We cannot ignore the risk of a contagion effect if a more vulnerable EM country got hit harder than the others.
For Indonesia, it is important that the economy can regain growth momentum and re-accelerate recovery so that we will be in a better position to weather any negative impact should there be any global shock situation.
The public activity restrictions (PPKM) and faster vaccination rollout have suppressed daily COVID-19 cases from a record high in July to 1,932 daily cases on Monday.
These achievements are encouraging and need to be maintained to pave the way for a sustainable economic recovery.
Currently, policy response is still very accommodative. Fiscal policy remains expansionary this year with the government increasing the allocation for the National Economic Recovery budget to Rp 745 trillion (US$53.40 billion) amid the Delta variant wave.
On the monetary side, Bank Indonesia has kept the interest rate low for some time and maintains ample liquidity in the financial market to support the economy.
Yet, the risk of a global policy shift, from loosening to tightening, needs to be closely watched, especially its impact on the financial market.
For Indonesia, the timing of this policy shift needs to be considered carefully, not too early as it may be counterproductive for the economy, and not too late as it may disturb the external balance condition.
***
Economist at Bank Mandiri
