Low Interest Rate Summaries and Indonesian Context

-The Low Rate World taken from The Economist (September 24th 2016)

Since the 2008 Global Financial Crisis, central banks around the world have been slashing their interest rate to an all time-low to boost demand and inflation to 2% target. ECB and BOJ even employ negative interest rate in desperation to stimulate growth, resulting in fall of bank’s profitability and increase of pension fund liabilities. Negative interest-rate also punishes savers along with the trend of falling real interest rate (currently -0.5%) due to the integration of China into the world economy. China is a rich country in term of saving rate, therefore increasing the supply of available funds in the world and decreases the real interest rate.

 

There are parties that blame central banks for the stagnating growth, however we must remember that central banks are also reacting to the current economic condition. Structural reforms are under progress to increase the underlying growth rates, but their results are felt only in the long-term. Fiscal policy, on the other hand, could bolster demand in short-medium term and is an appropriate tools for stimulating growth. It is suggested that infrastructure spending would be a good investment for current condition; private sector has to be involved so that pension and insurance funds have more investment options available. Other tools recommended that could also easily transmit economic policy are sales tax, income tax, and tax-free allowances on saving.

 

After 2008 GFC, Indonesian economy was able to recover more quickly compared to US and other developed countries due to the diversified demographic and economic structure. Low interest rate is perhaps not a threat currently to Indonesian economy, it may actually benefits Indonesia; as of October 2016 BI repo rate stays at 5%. The high yield is attractive to investors abroad and attracts investment inflow to Indonesian equity and bond market, especially from Europe and Japan. Inflation has also been low this year at 3% YoY and in 2015 at 3.35%, but previously in 2014 and 2013 Indonesia inflation rate is high at 8.36% YoY and 8.38% YoY. This signifies the strong demand in Indonesian economy apart from the weak consumption globally since 2009.

 

In the current slow growth condition, Bank Indonesia has also stimulate Indonesian economy by decreasing the interest rate from 7.75% in January 2015 to 6.5% in July 2016, and now 5% using repo rate. Meanwhile, the government policy is expansive as well under President Joko Widodo, focusing on infrastructure development and attracting foreign investors to participate in available projects. All these efforts are in line with the goal of expansive monetary and fiscal policy to stimulate growth in GDP. The attractiveness of yield in Indonesia compared to other countries, combined with supportive government policy will further attract capital from “low rate” countries until the Indonesian yield reach equilibrium price based on the country risk.

Published by Journeyman

A global macro analyst with over four years experience in the financial market, the author began his career as an equity analyst before transitioning to macro research focusing on Emerging Markets at a well-known independent research firm. He read voraciously, spending most of his free time following The Economist magazine and reading topics on finance and self-improvement. When off duty, he works part-time for Getty Images, taking pictures from all over the globe. To date, he has over 1200 pictures over 35 countries being sold through the company.

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