Indonesia’s experiment to borrow money for free from the central bank has excited proponents of modern monetary theory and raised concerns about its effects on inflation and the rupiah.
The “burden-sharing” agreement unveiled last week involves Bank Indonesia (BI) effectively buying about $28 billion worth of bonds the government plans to issue to finance its COVID-19 stimulus spending, while relinquishing interest payments.
The final plan, announced after months of tough negotiations between BI and the government, limits the central bank’s debt-monetisation to this year.
Still, the lack of clarity on the tenor of bonds the BI will buy and how it will subsequently get rid of these bond holdings have analysts worried.
The rupiah IDR=, historically prone to volatile swings caused by inflationary pressures, has fallen more than 3% against the dollar in about three weeks.
Deutsche Bank strategists said their main concern was that significant debt monetisation would expand the monetary base, eventually feeding into faster credit growth, inflation, imports and a weaker rupiah.
“The risk is that, in conducting these operations in such large size, that people start to question what the exit policy to this will be,” said Siddharth Mathur, head of APAC emerging markets research at BNP Paribas in Singapore.
As investors await details, Mathur expects “they will raise slightly the risk premium that they associate with Indonesia as a compensation for the uncertainty of what happens down the road”.
It is a rare case of a government borrowing without paying interest to the central bank, which must then print money to ensure that borrowing is free and the budget deficit doesn’t blow out.
Yields on rupiah bonds, more than 30% of which are held by foreigners, have so far held steady.
Analysts at Nomura Singapore said they remain neutral on Indonesian bonds after the announcement, and Deutsche said it would stay long bonds but shift to the five-year tenor.
The biggest investor concerns are however around the likely pressure on BI to cut interest rates to limit losses and whether that would compromise its policy responses to inflation.
June annual inflation was at a 20-year low of 1.96% as the virus outbreak suppressed demand. BI Governor Perry Warjiyo has said it would likely remain muted this year, while signalling there was space for lower rates even after the three cuts to 4.25% this year.
A BI document presented to parliament last week showed the central bank expected a 3.35% inflation rate this year as a result of debt monetisation, up from an initial forecast of 2.49%, and a further increase to between 4.88% and 6.69% in 2021.
Citi Indonesia economist Helmi Arman said he had expected one more 25 basis point cut before the scheme was announced, but there could be more as policymakers “may be more inclined to lower monetary policy costs”.
Former Indonesian finance minister Chatib Basri told us it was heartening that BI’s participation in government financing was limited.
“If BI doesn’t have a strong enough capital, it may be reluctant to raise rates even when the economic conditions warrant, for example, when inflation shoots.”