Dollar Exchange Rate Mismatch
The phenomenon of 5.61% growth, low inflation, and sufficiently large foreign exchange reserves, contrasted with the continuous weakening of the Rupah exchange rate and the Jakarta Composite Index (IHSG), cannot be explained by standard macroeconomic explanations. Under standard explanations, when macroeconomic indicators strengthen, the Rupiah exchange rate should also strengthen.
This discrepancy is caused by assumptions used in standard explanations that are not met within the Indonesian economy. First, the assumption of an open economy; second, the distinction between exchange rate volatility as ‘voice’ versus ‘noise’; and third, the segmentation of the economy based on differing marginal propensity to consume (MPC), macro multiplier effects, and money circulation velocity.
Regarding the first point, Indonesia’s dependence on the global economy is significant. Edward Leamer, a professor at UCLA, uses Trade Intensity Ratios and Intra-Industry Trade Ratios in his study ‘Measures of Openness’. Similarly, the Legatum Institute utilises the Global Index of Economic Openness. By any measure, Indonesia is still far from being classified as a truly open economy.
Economic openness in Indonesia occurs through three main channels: exports-imports, foreign loans, and foreign investment. Bordo, Meissner, and Weidenmier, researchers at the National Bureau of Economic Research (NBER), explain in their study ‘Currency Mismatches, Default Risk, and Exchange Rate Depreciation’ that a currency mismatch occurs when a country’s debt is dominated by foreign currency, while its income is dominated by local currency.
Indonesia meets these criteria, as its loans are dominated by foreign currency while its revenue is dominated by the Rupiah. This results in a dollar exchange rate mismatch. Fiscal expansion and/or monetary expansion in the form of Rupiah will directly affect the Rupiah exchange rate.
On the other hand, fiscal and monetary policies must absorb global volatility through a process of sterilisation to maintain the Rupiah exchange rate. This is where the wisdom lies in maintaining the balance between the independence of central bank monetary policy and fiscal policy that drives growth.