As money pours in, Indonesia and other emerging markets fret over Fed easing
Thursday, November 4, 2010; 10:09 PM
JAKARTA, INDONESIA - The stock market here doubled last year and is headed that way again, money is pouring into Indonesian government bonds, and investment is booming.
It might seem an embarrassment of riches, but the capital flooding into Indonesia and other emerging markets could be too much of a good thing.
As the United States and other developed countries cope with what might be years of slow growth and frugality, the concern in Indonesia is - quite literally - over too much money and how to prevent it from sowing a future crisis.
Governments from Bangkok to Buenos Aires are imposing new taxes and other conditions to try curbing the flow, which can make local currencies more expensive, impede local exporters and create asset bubbles that ultimately crash.
Although capital controls had lost favor in many countries during a U.S.-led drive to open financial markets, officials in emerging markets are now looking for ways to insulate their economies from dramatic capital flows set off in large part by the United States.
The Federal Reserve's announcement Wednesday that it would pump $600 billion into the economy, aiming to energize the flagging recovery, could mean even more difficulties for these countries. The Fed action could lead to a weaker dollar and even lower interest rates, prompting global investors to look elsewhere for returns and put money into economies such as Indonesia's - in turn forcing up local currencies and asset prices again.
"There is a fundamental shift of capital flowing from developed to emerging markets," said Fauzi Ichsan, senior economist for the Standard Chartered bank in Indonesia. ". . . There is money sloshing around the world. The real economy can't fully absorb it."
The situation is likely to complicate U.S. efforts to push for an agreement on exchange rates and other financial issues when heads of the world's major economies gather in South Korea next week. An initial agreement among the finance ministers called on countries with widely used currencies to avoid decisions that would shake up world markets. U.S. officials may well be asked to explain how the Fed's actions comply with that commitment.
Fed move felt in Jakarta
The Fed's decision to pump money into the economy through massive purchases of Treasury bonds was meant to rekindle consumer and business demand and create jobs. If successful, U.S. policymakers argue, this will help the world by invigorating its largest economy.
In developing markets, however, there are concerns that the move could aggravate some of the same problems in the global economy that U.S. officials say they are trying to curb. U.S. officials have roundly criticized China's undervalued currency and large trade surplus, saying these make it hard for other nations to export more. But loose U.S. monetary policy, which has left the economy awash in dollars, is seen as the other side of the coin.
Among Jakarta's business community, "sentiment is against" any move by the Fed to add more money to the system, said Sandiago Uno, founding partner of Saratoga Capital, a local investment firm.
Indonesia has one of Southeast Asia's most open capital markets, and the local currency, the rupiah, has been rising. But the central bank has pushed back and recently began requiring investors in its short-term certificates to hold them for a minimum of 30 days - a regulation that would prevent about $30 billion invested in potentially volatile holdings from leaving the country in a rush.
Once discouraged by the International Monetary Fund, such capital controls are now seen as a potentially useful tool, though there are also concerns that the trend could expand - like other sorts of trade restrictions - to a harmful degree.
"After years in the intellectual deep freeze, capital controls have acquired a new aura of respectability," a team of HSBC analysts wrote in a recent report, "Manning the Barricades," on how emerging markets are managing the influx of capital. The trend toward open capital markets "is in danger of going into reverse," the report said.
Will things be different?
To a point, emerging markets welcome the influx of money. Indonesia is particularly trumpeting the increase in long-term foreign investment into business and other capital projects.
But there are bad memories, here and in other developing nations, of the downside. Money that flows into local markets can flow out just as fast. The financial crisis that rocked Asia in the 1990s is still felt in Indonesia - lost years when little was invested in infrastructure, commercial property values that remain below what they were 15 years ago, a corporate and government culture so biased against debt it could crimp economic growth.
The question is whether things will be different this time. Many argue that it will. At the offices of the Asian Development Bank, officials call the capital inflow "a good problem" that, if managed properly, will be useful in building the economy and allowing the government to borrow at lower rates.
Business executives, government officials and agencies such as the IMF, meanwhile, note that the country emerged from the Asian financial crisis with a solid banking system, mostly in the hands of outside investors, and a government that has kept its debt and spending modest.
With local economic growth at 6 percent, the new capital isn't just "hot money" looking for quick returns but investment in a potentially lucrative and large market. The country's population of 230 million includes an expanding middle class, and economic growth is increasingly fueled by local demand for consumer and other products.
Analysts look at the exploding sales of things such as motorcycles - up to 7 million a year, a boon for companies and the banks that finance the purchases - and see a market likely to retain the interest of investors even if there is another shock to the world system.
"The growth story in Asia is a good one," said Bejoy Das Gupta, an Asia analyst with the Institute of International Finance. "There are large economies doing well, the corporations are doing well and the region is doing well, and people are buying into that."
But the effect of U.S. policy remains a matter of concern - not just the latest Fed actions to expand the money supply but also the inevitable return to tighter conditions. It might not happen soon, but "at some point they will have to contract," said Eugene Galbraith, president commissioner of local bank BCA.
"There could be sort of an undertow that hurts smaller, open economies," he said.