IMF: Don't Follow The Fed, Central Bank Should Focus On Domestic Inflation

Expectations regarding The Fed's policy easing have fluctuated in recent months, driven by factors unrelated to the need for price stability in Asia.

QuotingReuters, Director of the Asia and Pacific Department of the IMF, Krishna Srinivasan, Thursday (18/4/2024) or Friday (19/4/2024) Indonesian time, stated that US interest rates have a strong and fast impact on the financial conditions and currency exchange rates of Asian countries.

"The expectation regarding the relaxation of The Fed's policies has fluctuated in recent months, driven by factors unrelated to the need for price stability in Asia," he said in explaining the economic prospects of the region.

If central banks in Asia follow The Fed too closely, Krishna continues, they can damage price stability in their own countries. This was emphasized when several central banks in Asia faced a dilemma. Recent currency market changes triggered by changes in The Fed's expectations have made their policy path more complicated.

"We recommend central banks in Asia to focus on domestic inflation and avoid making policy decisions that are too dependent on anticipating movements from the Federal Reserve," he said.

If they follow the Fed too closely, central banks in Asia could damage price stability in their respective countries.

The Governor of the Bank of South Korea, Rhee Chang-yong, stated during a seminar at the IMF-World Bank Meeting in Washington on Wednesday (17/4/2024), that the fading possibility of The Fed lowering interest rates has caused obstacles for the won and made it difficult for the bank to decide when to start cutting loan costs.

In its World Economic Outlook, the IMF predicts that Asia's economy will grow by 4.5 percent this year, down from 5 percent in 2023. By 2025, the IMF projects that Asia's economic growth will slow to 4.3 percent.

Meanwhile, The Fed's signal of extending high interest rates and tensions in the Middle East following Israel's alleged retaliation attack further depreciated the rupiah and increased global crude oil prices.

The rupiah exchange rate against the US dollar on Friday (19/4/2024) morning depreciated. Throughout the day, the rupiah moved in the range of Rp. 16,255-Rp. 16,288 per US dollar with a trimming loss pattern towards the close of the day.

The further weakening of the rupiah occurred after several Fed officials reaffirmed their commitment to maintaining high interest rate policies for a longer period of time.

Also read: Israel Allegedly Responding to Iran, JCI Almost Touches 7,000

The Rupiah also weakened following the re-escalation of geopolitical tensions in the Middle East early Friday morning due to alleged retaliatory attacks from Israel on Iran. The weakening of the rupiah occurred in tandem with the depreciation of almost all countries' currencies due to the strengthening risk-off sentiment in the market and the increasing demand for safe haven assets such as the US dollar.

The development of conflict in the Middle East following Israel's attack on Iran also briefly raised the price of Brent crude oil to $90.14 per barrel on Friday morning and the price of West Texas Intermediate (WTI) to $85.80 per barrel.

Coordinating Minister for Economic Affairs Airlangga Hartarto emphasized that Indonesia's economic conditions are still under control. The government will not yet issue a worst-case scenario policy because it still hopes that the conflict can still be de-escalated.

"We don't need to be reactive because regarding Iran itself, they deny it and their foreign minister says the attack was not from Israel. So, we just monitor and don't need to react," said Airlangga at the Coordinating Ministry for Economic Affairs office in Jakarta on Friday.

We'll cover the worst case scenario, but for now we're not playing that far.

He acknowledges that due to the heating up of geopolitical tensions on early Friday, there was turmoil in the financial market. However, Indonesia's economic condition is still under control because the turmoil was only a market reaction to the tension of conflicts in the Middle East, not because of domestic economic problems.

"The impact (of the conflict), isn't it, not for one day? We can see, even though the market reacted negatively and in many countries it did (the currency fell), not only in Indonesia. So, we'll just keep monitoring it," he said.

Airlangga had a dialogue with the former Prime Minister of England from 1997-2007, Tony Blair, on Friday afternoon, to ask for input regarding the current global economic and geopolitical conditions. From the meeting, Airlangga said that everyone currently does not need to be reactive because the push for de-escalation of conflicts has already emerged in various forums.

"The current situation in politics is tit for tat. It's limited to saving each other's face. This means that there will indeed be retaliation, but it will be on a small scale and it is hoped that it will not have any further effects on world economic conditions. "We have enough problems due to the unfinished war in Ukraine," he said after meeting with Blair.

Also read: Market is worried that supply will be disrupted, oil prices will rise again

Deputy for Coordination of International Economic Cooperation at the Coordinating Ministry for the Economy, Edi Prio Pambudi, added that currently no country wants the conflict to escalate. "There is a term called brinkmanship (preventing conflict from going to the brink of destruction). "That is what is currently being pursued in various forums," said Edi.

Therefore, he continued, Indonesia's economic policy in responding to the spillover effects of the Middle East conflict will remain measured in order to maintain market and public confidence. Although worst-case scenarios have been calculated, the government still chooses to monitor the situation.

"We are protecting the worst case scenario, but for now we are not playing that far," he said.

One of the worst-case scenarios in question is the government's plan to recalibrate the budget policy energy subsidies if world crude oil prices soar due to the escalation of the Middle East conflict.

Earlier this week, the government announced plans to re-evaluate energy subsidy policies, but is still waiting for developments in the situation in the Middle East.

Based on calculations by the Ministry of Energy and Mineral Resources, the worst-case scenario could occur if conflicts in the Middle East drive Indonesia's crude oil price (ICP) to reach 100-110 US dollars per barrel or far above the 2024 APBN assumption of 82 US dollars per barrel.

If this happens, energy subsidies will swell to IDR 356.14 trillion-IDR 404.21 trillion from the current energy subsidy budget of IDR 244.18 trillion.

The Head of Bank Permata's Economist, Josua Pardede, predicts that the global economic uncertainty caused by the conflict in the Middle East will continue until next week due to the reaction of uncertainties in financial and commodity markets. He predicts that next week, the rupiah still has the potential to move in the range of Rp 16,100-Rp 16,350 per US dollar.

The continuous depreciation of the rupiah and the volatile global oil prices can have an impact on oil-importing countries like Indonesia. The fiscal situation may be pressed considering that the state budget acts as a shock absorber domestically through energy subsidies and compensations.

However, Josua also assessed that Indonesia's economic fundamentals currently tend to be stable despite temporary turmoil in the financial markets.

"Considering that the current situation is external turmoil and taking into account that Indonesia's economic fundamentals tend to be solid, the government does not need to reactively respond to the escalating geopolitical tensions in the Middle East," said Josua.