Sabtu, 29 September 2012

How monetary stimulus in the US and Europe will affect RI economy


How monetary stimulus in the US and Europe
will affect RI economy
Winarno Zain ;  An Economist
JAKARTA POST, 28 September 2012



The world will be awash with dollar liquidity when the US Federal Reserve start implementing the monetary stimulus, commonly referred to as quantity easing (QE) as a means to stimulate further economic growth and reduce unemployment in the US. 

This is the third time the Fed has implemented quantitative easing (QE3). The Fed plans to inject US$40 billion a month to the economy by buying treasury notes and corporate bonds. In one year, the money injected through QE3 will amount to $480 billion, a modest amount compared with around $1.7 trillion in QE1 that started in November 2008, and $600 billion in QE2 that ended in June 2011. 

The money will be lent to banks, and the Fed charges very low interest rate, between 0–0.25 percent, so that the banks will be able to lend the money to their clients at low interest rates. As banks increase their lending, the economy is expected to grow more rapidly. 

When an economy is awash with so much liquidity, there will be some risks. Too much liquidity will depreciate the dollar exchange rate, and fuel inflation. Commodity prices, which are priced in US dollars, will rise, increasing inflationary risk, not only in the US but also in other countries. 

According to the Asian Development Bank (ADB) the Fed QE1 and QE2 in 2009 and 2010 resulted in massive capital inflow to Asia totaling $66 billion and $96 billion respectively. Indonesia benefited from the spillover of QE1 and QE2. In 2009 and 2010, portfolio capital inflow to Indonesia surged to $10.3 billion and $13.2 billion respectively. This compared with a tiny $ 1.8 billion in 2008. 

Over the same period foreign direct investment (FDI) flow rose from $2.6 billion to $11.1 billion. Although current account surplus dropped by half to $5.1 billion, the Indonesian balance of payments enjoyed its biggest surplus in history. In those two years, the surplus hit $42.8 billion. 

Last year, the euro debt crisis and market turmoil resulted in a reversal of capital flow, and there was a significant drop in the current account surplus from weakening export growth. Fortunately, the FDI flow maintained its high level, and acted as a buffer for the fall in the current account surplus and portfolio capital inflow, resulting in the overall balance of payment surplus of $11.9 billion. 

What are the prospects for the Indonesian balance of payments in 2012? In the first half of 2012, the balance of payments has suffered a deficit of $3.9 billion mainly due to a current account deficit of $10.1 billion. As the prospect of debt settlement improved in Europe, portfolio capital started coming back to Indonesia. The inflow reached $6.5 billion in the first half of the year, already higher than the whole 2011. 

The spillover of the Fed QE3 combined with market confidence on the Indonesian economic growth will drive more portfolio capital inflow into the country. 

It is likely that its amount will bounce back to 2010 level or even higher. And the FDI flow seems to be maintaining its strength as in previous years.

 Higher commodity prices resulting from the impact of monetary loosening in the US and in Europe will improve Indonesian export performance in the second half of the year. The overall result will be positive, as the Indonesian balance of payments will bounce back into surplus. 

The flux of capital inflow is welcome, but it should be noted that the higher we receive portfolio capital inflow, the higher is the risk of market volatility. As happened in the past, speculative capital exits as fast as it comes in. In the past Bank Indonesia (BI), has issued longer maturity for BI notes (SBI) where investors could park their speculative money here for a longer period, thus reducing volatility. But this time around, with possible higher capital inflows, BI should come up with bolder measures to make the presence of higher capital less volatile. 

Higher liquidity from higher capital inflows will raise the risk of higher inflation, something that BI has not had to deal with up to now. BI is comfortable in keeping its benchmark rate at 5.75 percent where is has been for the last eight months. But it is likely that BI will not maintain its current rate at present level when the full impact of latest monetary stimulus by the Federal Reserve and the European Central Bank (ECB) on capital flows to Indonesia start to bear on domestic prices. 

BI and the government have expressed their concern on the high growth of bank loans. Last year, bank lending grew 26 percent. Too high, according to BI and the government who would like to see this lending growth down to 20 percent. But with more liquidity coming to the country, pressure for an escalation in bank lending will be stronger. 

One sector that needs to be watched carefully is property. This area could easily accommodate the spillover of capital inflows as banks feel that it is the most attractive and the most secure asset for bank collateral. 

In Jakarta, property developers have been enjoying strong growth in sales and profits as prices for residential and commercial buildings keep rising. In Jakarta, empty land is getting scarcer as developers scramble for land for their expansion. 

But just like balloon that cannot keep expanding, property prices cannot keep raising. History teaches us that at one point this bubble will burst. And when this happens, the effect will be painful for the 
economy. 

The Asian Development Bank (ADB) has warned that higher capital inflows resulting from higher liquidity in the US and Europe could risk an asset bubble in Hong Kong, Singapore and Indonesia. 

BI has tightened the down payment requirement for housing loans in order to stem the excessive growth in bank lending to property sector. But it seems BI needs to act more, if it wants to prevent escalating property prices from turning into bubble.
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