Tale of two emerging markets: why Indonesia’s prospects look healthier than Turkey’s
These are challenging times for the world’s developing economies. Money has been pouring out of emerging markets and into the US for the past several weeks as international investors reposition their portfolios in anticipation of a faster pace of interest rate increases by the Federal Reserve. A stronger American economy, attested by an unemployment rate that has just fallen to its lowest level in 18 years amid signs that wage growth is picking up, has fuelled a rally in the dollar and driven up Treasury yields, putting emerging market currencies, bonds and equities under heavy strain.
Countries with large external debts, or which suffer from sizeable macroeconomic imbalances, have been hardest hit. In Asia, Indonesia has come under more pressure than other nations in the region, mainly because of its hefty current account deficit, currently the largest in Asia along with India’s, and the nearly 40 per cent share of local currency bonds held by foreign investors.
Between January 25 and May 23, the rupiah, Indonesia’s currency, fell nearly 7 per cent versus the dollar, the Jakarta Composite Index (the country’s main equity gauge) plunged 13 per cent, while the yield on Indonesia’s benchmark 10-year domestic bond shot up almost 150 basis points.
Yet over the past 10 days or so, investor sentiment has improved markedly, with the rupiah gaining more than 2 per cent and the 10-year yield down 60 basis points. Moreover, this comes at a time when emerging market bond and equity funds are still suffering net outflows, according to data from JPMorgan, and when the dollar index, a gauge of the greenback’s performance against a basket of other major currencies, is close to its highest level since last November.
Much of the credit for this belongs to Perry Warjiyo, Indonesia’s new central bank governor, who only took office on May 24. After an interest rate hike under his predecessor failed to reduce the selling pressure, Warjiyo, who pledged to take “pre-emptive” action to shore up the rupiah and ensure that the central bank gets “ahead of the curve”, held an unscheduled policy meeting last Wednesday, at which the main rate was lifted by a further 25 basis points, to 4.75 per cent. What is more, the new governor hinted at further tightening, depending on how market conditions evolve and how aggressive the Fed is in raising rates.
The credibility of Indonesian monetary policy is further enhanced by the fact that financial stability is being prioritised over growth just months before a presidential and parliamentary election campaign gets under way and has the backing of the country’s respected finance minister, Sri Mulyani Indrawati.
The emphasis placed on defending the rupiah will help guard against a spike in inflation, currently under control at 3.4 per cent. As a net oil importer, Indonesia is threatened by this year’s sharp recovery in oil prices which risks causing a further deterioration in the country’s trade deficit – already at its widest level since 2014 – thereby increasing the nation’s reliance on foreign capital.
Indonesia’s resolve to preserve financial stability during a period of intense pressure on emerging markets shows Southeast Asia’s largest economy has heeded the lessons of 2013 when it was singled out by Morgan Stanley as part of the “fragile five” group of developing nations that were at risk partly due to their large current account deficits. Another member of the club was Turkey which, unlike Indonesia, has failed to mend its ways over the past five years.
While Indonesia’s current account shortfall is expected to stand at some 2 per cent of GDP by the end of this year – down from more than 3 per cent in 2013 – Turkey’s will be around 5.5 per cent, according to the International Monetary Fund. More worryingly, Turkey’s central bank has fallen way behind the curve, letting inflation surge to nearly 11 per cent – more than twice the central bank’s target – and losing the confidence of markets because of vociferous opposition to higher interest rates from the country’s autocratic president, Recep Tayyip Erdogan.
While sentiment towards Indonesia is improving, investors have lost faith in Turkey. The lira, Turkey’s currency, has plunged 22 per cent against the dollar since early March while the yield on the country’s 10-year local bonds has shot up 270 basis points.
Still, Indonesia is not yet out of the woods. Pressure on the rupiah could easily resume if the rally in the dollar gains further momentum, forcing the central bank to hike rates further and endangering growth.
Yet with Warjiyo at the helm, there is little risk of a Turkish-style rout.
Nicholas Spiro is a partner at Lauressa Advisory
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