U.S. election good for RI economy

U.S. election good for RI economy

Riyadi Suparno, Staff Writer, The Jakarta Post, Birmingham, UK

Macroeconomic stability normally weakens in most election
years, but not this year in Indonesia. Three main indicators, the
rupiah, interest rates and the inflation rate, will likely stay
at their targeted levels.

At least two major factors are propping up Indonesian economic
stability this election year -- the presidential election in the
United States and the independence of Bank Indonesia, the central
bank.

What does the U.S. presidential election have to do with the
Indonesian economy? The election itself does not affect the
Indonesian economy directly, but U.S. macroeconomic policies
pursued this election year do.

Last week, the U.S. Federal Reserve defied market expectations
and maintained short-term interest rates at a 46-year low of 1
percent per annum, making the country's monetary policy its
loosest in 30 years.

Raising interest rates during an election year could be
provocative, though. Some economists now predict the Fed's rates
will be kept at current levels until after the presidential
election later this year.

This super-low interest rate makes investment in the U.S.
currency less attractive, compared to, say, the euro, pound
sterling, or equities. As a comparison, the European Central Bank
refinancing rate currently stands at 2 percent per annum, the
Bank of England repo rate of interest at 4 percent. Consequently,
the dollar has depreciated sharply against these two major
currencies in the past year.

And the U.S. has gained the benefits it wants from this
deliberate weak dollar policy. U.S. exports have expanded --
although its current account deficit remains huge -- unemployment
has dropped and the economy has grown handsomely. And
surprisingly, all this has been achieved without sacrificing
inflation, which remains low.

These developments in the U.S. to some extent affect
Indonesia's macroeconomic performance. The weakening dollar helps
make the rupiah look stronger, at least against the dollar.

The rupiah did gain a little against the dollar in the past
year, dropping from the high to the low Rp 8,000s but lost ground
by some 20 percent against other major currencies, notably the
euro, pound, Singapore dollar and Australian dollar.

The low interest rates in the U.S. also give room for Bank
Indonesia to continue cutting its benchmark rates without fear of
weakening the rupiah. Bank Indonesia's benchmark rate of one-
month certificates hit its lowest level in history at 7.42
percent on March 10, 2004, from 13 percent at the beginning of
last year.

At current levels, Bank Indonesia still has space to cut
interest rates, considering the low inflation level of 5.06
percent last year, 0.57 percent in January and deflation of 0.02
percent in February.

However, a further cut in the benchmark rate -- if the central
bank is still considering it -- must be pursued prudently, at a
much slower pace, consistent with its medium-term inflation
targets.

Maintaining low interest rates and a loose monetary policy
normally creates inflation. However, as proven in the United
States, low rates and a loose monetary policy does not
necessarily lead to inflation, especially when job growth is
sluggish and people's purchasing power remains weak.

Now, with the independence of the central bank, the fate of
inflation lies in the hands of Bank Indonesia. This legally-
established independence makes the central bank's inflation
target more achievable through its Inflation Targeting Framework
(ITF) even in an election year.

Unlike in election years in the past, this year the government
cannot ask the central bank to pump money into the economy -- in
the form of micro credits to small and medium enterprises
affiliated to the ruling party, or fund other quasi-fiscal
spending -- all inflationary pressures.

This time, the central bank has all monetary policy
instruments at its disposal to maintain economic stability,
without having to worry about the possibility of government
intervention, especially from the President.

This independent central bank, complemented with a prudent
finance minister, should assure the public -- especially
investors -- that Indonesia's economy will not slide unless the
legislative and presidential elections go badly wrong. The
central bank as well as the public and investors should be
prepared for this eventuality.

They should also be prepared for any unforeseen possibilities
from the international side -- an increase in U.S. interest
rates, which will eventually drive up the value of the greenback.
The chances, however, are quite slim that any central bank,
however independent, would take a drastic measure that would
adversely affect the incumbent government, unless there was a
very good reason to do so.

The writer is currently studying for a master in public
economic management and finance at the University of Birmingham,
UK.