In the past three weeks, Turkey has suffered a great stress in their currency market. They have been hit by another Trump’s blow in which Turkey Lira depreciated 10,33% a week after Trump announced (8/10) that US would impose tariff on steel and aluminium Turkey for 50% and 20% respectively. Investors tried to pull out their money hence causing a tumult in emerging market stock indices and currencies, including Indonesia. All are too afraid because Trump can hit any country in a single tweet.
The Twitter Attack!
When we started this year, some said that we could be in another crisis after we suffered the great subprime mortgage crisis 10 years ago. This hypothesis is bolstered with the facts that Trump left the Trans Pacific Partnership (TPP) right on the first day he sat in white house by saying “on trade, I’m going to issue a notification of intent to withdraw from the Trans-Pacific Partnership”. He then tweeted that TPP is a potential disaster too.
After US left TPP, Trump began to review US trade deficit that he thought US trade balance should be positive. Here’s when the story of trade war begins.
In April 2017, President Trump instructed his administration to self-initiate two major investigations into steel and aluminium imports threatening US national security, especially from China. Therefore, US continued searching what kind of goods hurting US current account balance with China as the biggest contributor to US deficit. As of 2017, US deficit from China reached USD357,6 billion or approximately 40% of US deficit coming from China.
Following Trump’s instruction, US International Trade Commission found that imports of solar panels and washing machines have caused injury to those industries. On January 22, 2018, Trump then approved to impose tariff on USD8.5 billion solar panels and USD1.8 billion washing machines. Two weeks later, China self-initiated to investigate of roughly USD1 billion US exports of sorghum even though Chinese government denied the action was some kind of retaliation.
This fighting continued between US and China. The peak moment was when Trump tweeted on March 1, 2018 “trade wars are good” as he announced plans for steeper US tariffs on steel and aluminium by 25% and 10% respectively. This action was then widened to EU, NAFTA (exclude Canada & Mexico), and South Korea that Trump wanted to impose the tariff as well. From that day, emerging markets started to tumble down worried this action could hamper global trade in the future.
The Mighty China
The trade war between the two countries has started to affect China’s external trade. Their Q1–2018 current account posted a deficit for the first time since Q1–2001 because of the significant decrease in goods. The trade war also sent their stock index and currency down.
But China is no more a small country. They have guts to fight back by retaliating tariffs for some of US goods in order to hurt US. As the biggest factory in the world with investment as the main contributor of GDP, China succeeded to keep their economy stable amid the on-going trade war as seen from their stable growth in Q2- 2018 at 6,7% yoy, only 0,1% lower from previous quarter.
In fact, the depreciating CNY is maybe according to their plan, because the cheaper CNY the more goods exported. And of course, China has that comparative advantage to play the J-curve condition as their current account balance bounced back to surplus in the second quarter, so it seems like China would not surrender from this game.
Heatwave from Turkey
After playing game with China, EU, South Korea and other countries, President Trump then struck Turkey on August 10 by imposing tariff on aluminium and metal Turkey after conflicting the issue of a detained American Pastor in Ankara. This conflict worsened US-Turkey relationship after previously disputing about Syrian Civil War and a failed coup attempt in 2016.
Turkey did retaliate by imposing tariffs for US exports as well. But unlike China, Turkey could not defend the heat. The sanction from US directly blew up the market which has been overheating just before the trade war. The high GDP growth followed by high inflation, high private credit growth and increasing external debt have worsened the external stress dropped by Trump.
Turkey also has another issue in their fundamentals as they have been suffering a twin deficit for more than a decade. Moreover, their current account deficit has widened to -7,9% in Q1–2018, widest deficit since taper tantrum.
In order to stabilize the currency, Turkey central bank has increased 975 bps their policy rate from 8% to 17,75% in the last 4 months along with dropping its foreign reserves by USD16.9 billion from January 2018. When the currency was in pressure in the second week of August, the central bank allowed Turkish banks to borrow foreign short-term debt, decreased reserve requirement and allowed to use EUR (not only USD) as foreign reserve requirement.
Turkish banking authority has also played part in stabilizing Lira by limiting swap transactions and restructuring credit policy. Amidst the arising tension, Turkey has succeeded in convincing their neighbor Qatar to pledge USD15 billion investment for Turkey.
As a result, these responses managed to momentarily end the rout in Turkish Lira. But the rout could radiate to other fragile countries.
A Thin Rupiah
The two-week Asian Games event held in Jakarta and Palembang have not been so helpful in driving a stronger Rupiah, indeed its value has gradually decreased to IDR14,725/USD, matching its weakest since September 2015. And if it weakens further, it would hit the lowest point in 20 years. For now, Indonesia is the second worst performer of 2018 in terms of currency depreciation in Asia after India. To help maintain the stability, Bank Indonesia raised its interest rate policy by 25 bps to 5,50%, collecting 125 bps hike throughout 2018.
As financial market tumbled in Turkey spread through other emerging market countries, Indonesia has been in pain more than its peers in Asia. Despite a bold growth in second quarter, low-stable inflation and persistent stock market index, Turkey (and Argentina) currency has triggered the large sell-off of USD in Indonesia. But why Indonesia?
Indonesia has been targeted due to some classic issue, a twin deficit, just like Turkey. These deficits are expected to lower Rupiah even further and are worsened by the speculators action. Indonesia current account has widened in Q2–2018 reaching -3,04% of GDP, driven by high imports of infrastructure materials to endorse Government’s main program. After an extensive decline in Rupiah’s value, Jokowi’s administration has promised to halt some infrastructure projects and reduce imports for consumer goods to prevent further depreciation.
This situation are more perplexing for Indonesia due to the external behaviour. The trade war between China and US would hurt Indonesian export indirectly since China and US are the two biggest Indonesia trading partners. So the less their export, the less their import as well. Moreover, stronger US economy followed by increasing trend of FFR would enforce a sell-off in our domestic market that later would induce a rout in its financial market. Can Rupiah stand its position?
Indonesia market once hit so hard with taper tantrum and low commodity price in 2013 and 2015 respectively. But we stood firmly at that time. This time, Indonesia’s fundamental factor is better than it was. I expect that the growth would be even higher in the second semester because the Government has only realised his social budget (alokasi dana desa) by 30% along with low and stable inflation.
From the demand side, revenue of non-financial public company has been growing along with high cash flow investment. It means that the private sector is in expansion phase, expecting that demand will recover in coming months. The boost in credit growth in the last three months also confirmed the expansion phase as it is mainly driven by investment and working capital. I wish, but cannot guarantee, this recovery can persuade investor to keep their money here.
Tourism is the Main Key
Apart from what the authorities have done in the short term and the good signal from both household and corporation, they have to think about the longer term structure. As a growing country with demography bonus in 2025–2035, the current account balance should restore to surplus. But how?
We have to accept that Indonesia cannot merely rely on commodity due to its price volatility, like we felt in the last four years. We understand that our comparative advantage in the world right now is producing good commodities but it hurts the current account when the price subdues.
Unfortunately, to export authentic final goods from Indonesia is truly impossible at this time since we do not have that kind of technology, resources and structural support from the Government yet. I believe that to produce final goods that can compete in international level will at least take a longer period of time.
Indonesia can learn from Thailand that has succeeded in keeping their currency stable nowadays because of the positive services, thanks to tourists’ arrival that have doubled since 2012. In the current phenomenon where millennials go to places for taking pictures and posting photos in instagram, tourism has helped Thailand services lift the current account balance back to surplus.
In a similar tune, Indonesia has a lot of potential in tourism sector with its white-sand beaches, beautiful islands, diverse culture and deep-rooted history that not many other countries possess. Hence, the government should support the development of tourism in Indonesia through strategic initiatives on this sector.