Indonesia's central bank cuts policy rates to overcome corona-ravaged economy
In Indonesia, the spread of the new coronavirus has led to growing speculation of an economic slowdown, and Bank Indonesia, after cutting its policy rate from 4.5% to 4.25% in June, decided to cut it further to 4% on July 16.
In times of recession, cutting the rate to make it easier for companies to borrow money and motivate them to invest in capital equipment is a common monetary policy of central banks to stimulate the economy.
In the case of Indonesia, real GDP growth will remain around 5% until 2019, inflation is over 3%, and even though the value of goods has increased by 8% of nominal GDP (nominal GDP growth + inflation), the minimum wage has almost quadrupled in the last 10 years, so the public's willingness to buy is high, and when interest rates fall, companies will invest in capital equipment to produce more, leading to a move to produce more.
In the case of Japan, however, the real GDP growth rate is 0.8% but the inflation rate is -0.6% (deflation), so the nominal GDP growth rate is only 0.2%, which means that the value of goods rarely rises, and because of the deflationary recession, goods cannot be sold at a high price even if they are made, so companies' capital investment as a result of the lack of enthusiasm and further decline in interest rates, the interest rate is now negative.
Well, negative interest rates do not mean that the interest rate is actually deducted from my account balance at Sumitomo Mitsui Banking Corporation and SMBC Trust Bank in Japan, but rather that the interest rate on the checking account balance held by private banks at the Bank of Japan is negative, so rather than having the interest rate taken away by the Bank of Japan, it is better to lend money to companies and invest in them, which will stimulate the economy and end deflation.
Why were interest rates so high during the financial crisis of 1998?
Indonesia has had several major recessions in the past, but the financial crisis triggered by the Asian currency crisis between October 1997, when I came to Indonesia, and May 1998, when the Suharto administration left office (Kris Moneter for short) led to a series of corporate bankruptcies and a rise in unemployment.
During the economic crisis that followed, policy rates rose and interest rates on time deposits rose to nearly 30% per annum, and interest rates on loans from banks to businesses exceeded 30%.
The rupiah exchange rate at that time was a managed basket system linked to the dollar (dollar-pegged system), which was essentially a fixed exchange rate system that prevented the difference between the value of the dollar and the rupiah from deviating too far from the value of the rupiah through the intervention of the central bank.
Bank Indonesia, and the U.S. at that time denied the competition for a weaker currency and the U.S. Treasury bonds from abroad in order to attract demand, Indonesia had to adopt a policy of raising interest rates to strengthen the dollar and increase the value of the U.S. Treasuries, even if this had a negative impact on exports, but Indonesia also had to adopt a policy of high interest rates in order to keep the rupiah's appreciation in line with the dollar, and the rupiah was overvalued compared to the real economy at the time.
When interest rates are high, the attractiveness of the currency increases and the number of foreign buyers increases, which attracts money and causes the currency to appreciate, but at that time, if you exchanged 10,000 yen bills, it would be about 600,000 rupiah.
At that time, nasi goreng at Kaki Lima (hand-pressed food stall) cost Rp.1,500, and domestic prices were very cheap, and I think we could afford more luxuries than today, when a 10,000 yen bill costs 1.4 juta, which is more than double the current price.
Hedge funds, led by George Soros, believed that Indonesia did not have enough foreign exchange reserves to support the currency's collapse, and in anticipation of future rupiah depreciation, they launched an offensive of shorting the rupiah while it was still high (i.e., entering into a no-positive sell contract), and Indonesia's central bank was forced to switch to a floating exchange rate system when its foreign exchange reserves were exhausted and its ability to support purchases became ineffective, and the rupiah collapsed.
In 2016, domestic companies were effectively restricted from borrowing dollar-denominated funds from abroad, but domestic companies that had dollar-denominated debt at the time were unable to repay their dollar-denominated debts due to the rupiah crash, and the cost of importing dollar-denominated oil was too high for them to borrow money from domestic banks due to the interest rate The rise caused domestic fuel BBM (Bahan Bakar Minyak) prices to soar, and in a chain reaction, the price of nine daily necessities Sumbako (Sembilan Bahan Pokok) also rose, and banks also raised their deposit rates to collect the cash that was liquidated in the market.
In other words, the reason for Indonesia's high interest rates from the 1997 currency crisis to around 2000 was a combination of factors: the country originally adopted a high interest rate policy under the Suharto regime in order to link the interest rate to the dollar's exchange rate; interest rates were raised to prevent the rupiah from falling due to short-selling by hedge funds; and even after the country came under the control of the IMF after the transition to a floating exchange rate system, austerity measures and the promise of high interest rates continued to be high.