Indonesia's Policy Framework Weakens after Perry's Exit

TEMPO.CO, Jakarta - Perry Warjiyo’s resignation as Governor of Bank Indonesia (BI) came as a shock. For investors, however, the more important question is no longer why he stepped down or who will eventually replace him. What matters is whether Indonesia’s macroeconomic policy framework is beginning to deteriorate. That is the issue increasingly weighing on financial markets.

The concern is well founded. Over recent months, investors have watched an increasingly visible clash between two competing policy priorities. On one side stands President Prabowo Subianto’s unwavering determination to pursue an ambitious package of flagship programs, despite fiscal resources that appear insufficient to match the scale of those ambitions. For markets, the widening gap between political aspirations and fiscal capacity represents a growing macroeconomic risk. It is one of the reasons the rupiah has fallen 10.2 percent against the United States dollar over the past year.

Whatever the political backdrop, Bank Indonesia was obliged to fulfill its statutory mandate by responding to the currency’s weakness. The playbook is familiar to central banks everywhere. One of the most effective ways to defend a depreciating currency is to tighten monetary conditions by withdrawing liquidity from the financial system.

BI therefore turned the Bank Indonesia Rupiah Securities (SRBI) into its principal liquidity-absorbing instrument. By the end of June, the central bank had withdrawn a net Rp965.5 trillion from the financial system through SRBI. Foreign investors accounted for Rp293 trillion of that total, while the remainder represented liquidity absorbed from domestic banks and other financial institutions.