The current account was also in surplus during that period. A significant part of the gross financial inflows surplus was driven by the ‘easy money’ coming from the quantitative easing measures by the US Federal Reserve, the Bank of England and the Bank of Japan involving bond buying that resulted in near-zero policy rates and sharp declines in yields that started in the second quarter of 2009.
While FDI inflows have remained strong since 2009, portfolio investment inflows have been volatile. Coincidentally, when the gross financial inflows slumped below zero in the third quarter of 2011, the current account turned negative, reaching its rock-bottom in the second quarter of 2013 at 4.4 per cent of GDP. In other words, just when financial inflows were most needed to finance the current account deficit, the financial accounts went into the red. The rupiah slumped and policy interest rates climbed in reaction.
After some economic turbulence in the third quarter of last year, today, Indonesia seems to have reached ‘a new equilibrium’ with a lower value of the rupiah at around Rp.12,000/USD from Rp.8600/USD in the second quarter of 2011, and a higher policy interest rate at 7.5 per cent from 5.75 per cent in May 2013. Inflation has also increased from around 4 per cent in January 2013 to 8.2 per cent a year later (although this is expected to be temporary due to the rise in administered subsidised fuel prices in 2013).
Indonesia’s macroeconomic strategy has had to adjust, to safeguard macroeconomic stability at the expense of some degree of growth slowdown. The adjustment in the macroeconomic policy mix and a slowdown in growth have occurred not only in Indonesia but also in Argentina, India, Turkey, South Africa and other emerging economies too. While domestic factors played a role in the required adjustment, sudden changes in capital flows triggered by changes in US monetary policy were equally important.
It is no surprise that Indonesia’s minister of finance, Dr Chatib Basri, has been calling for more coordinated monetary policy in his recent interviews. The issue has also been discussed at G20 meetings. In fact, since the St Petersburg Finance Ministers and Central Bank Governors Meeting, there has been a call for more coordination and better communication of monetary policy so there will not be ‘shocks and bumps’ to the EMEs.
The Fed was clear about its ‘strategy’ of tapering, and as soon as it saw better macroeconomic conditions it started to reduce its bond buying by US$10 billion, down to US$75 billion per month. Subsequently, on 29 January 2014, it again announced further tapering by another US$10 billion. However, the strategy is a contingent plan of action, dependent on US labour market prospects that have been quite unpredictable in recent years. Meanwhile, the adjustment that needs to be made by EMEs is a long-term structural adjustment, including export competitiveness and investment climate.
The question is how the G20 finance ministers and central bank governors really define and put in practice more coordination and better communication of monetary policy?
The question remains unanswered. Coordinated monetary policy is almost like a chimera. But there are some possible strategies that the G20 countries could envisage to push for more coordination, especially among major AEs and EMEs.
First, rather than the G20 attempting to implement an ‘early alert’ system, mainly through the (‘augmented’) Mutual Assessment Process, the interaction between the IMF/Financial Stability Board (FSB) Surveillance and the G20 must be prioritised.
The existing IMF and FSB Surveillances (and other independent regional surveillances, such as the ASEAN+3 Macroeconomic Research Office Surveillance) must remain the central internal mechanisms for monetary coordination. Regional surveillances should be able to provide more timely assessment than the IMF and FSB Surveillances. To reach the full potential of such internal coordination mechanisms, member governments must provide timely, consistent and honest performance indicators and information, and place more importance on regional and global policy objectives, which may not always be aligned with individual national interests. This may be unavoidable given that sovereign monetary policies have crossed borders.
Second, the G20 Finance Ministers and Central Bank Governors Meeting currently has too many ‘backbenchers’ — those who sit behind the ministers and central bank governors — and other viewers, which makes it difficult for highly sensitive information and anticipated policies to be discussed at the meeting.
In contrast, the highest-level FSB meetings, especially on vulnerabilities issues, and some of the lower-level FSB meetings, do not allow ‘backbenchers’. Therefore, the FSB meetings, with more limited attendance of central bankers, and also probably the Basel Committee on Banking Supervision, could feasibly serve as a forum for monetary coordination. Capable central bank governors must then be able to translate highly sensitive information and anticipated policies to domestic policies without leaking them to the market. Whether discussion will be more candid when ‘backbenchers’ are not present is uncertain, but at least it will more easily facilitate the sharing of highly sensitive information and anticipated policies. The G8 apparently has had some success on such monetary coordination in closed-door meetings.
Third, there is currently no facility for liquidity swaps from AEs to EMEs. There is also no incentive mechanism to internalise spillovers by AEs that conduct unorthodox monetary policies that cause spillover. Hence, establishing a liquidity swap agreement between AEs and EMEs could probably be a way to incentivise AEs to internalise spillovers. Outside the IMF’s traditional Stand-by-Arrangements, Flexible Credit Line, Precautionary Liquidity Line and High Access Precautionary Arrangement conditionality, the G20 could probably support discussions on bilateral and multilateral liquidity swap agreements that include the US and other AEs.
Fourth, deepening of capital markets in EMEs, especially bond markets, could be a ‘new source’ of financial safety net, as it could better channel capital inflows into more productive investments that stay longer in the country, and so are less volatile. Azis argues that of all asset classes, bonds are the most relevant asset to support financial safety nets. Deepening of the capital market has to come with better legal infrastructure for the financial market and strengthened legal systems in general. It can also be risky without compatible and effective macroprudential policy. Policy and regulatory reform to support the development of a domestic investor base is also a key to a more robust capital market.
If a person is hit by a small stone once, she may not feel the impact. But if she is hit 10 times, she will get hurt. Similarly, EMEs have felt the impact of ‘little surprises’ that are hurting many EMEs due to their frequency. Something has to be done. The fourth solution seems to be the most realistic solution because it targets domestic policies.
But we must not give up chasing the apparent chimera. The solution must be a balanced one — putting one’s own house in order and collectively managing external spillovers that are outside the control of a sovereign country.
Maria Monica Wihardja is an economist for the World Bank country office in Jakarta, and an Associate Editor at the East Asia Forum. The views expressed here are personal and do not reflect those of the World Bank and its board of directors.