Anticipating the Impact of The Fed’s Decision on Indonesia’s Foreign Exchange Reserves in 2024

Alvin Karunia By Alvin Karunia
7 Min Read
Menanti Dampak Keputusan The Fed terhadap Cadangan Devisa Indonesia di Tahun 2024
Menanti Dampak Keputusan The Fed terhadap Cadangan Devisa Indonesia di Tahun 2024

jlk – Bank Indonesia (BI) recorded Indonesia’s foreign exchange reserves at the end of December 2023 reaching US$146.4 billion, the highest since September 2021.

However, the performance of foreign exchange reserves this year will be influenced by various factors, including the interest rate policies of the United States Federal Reserve (The Fed).

Indonesia’s foreign exchange reserves in December 2023 increased by US$8.3 billion from the end of November 2023, which stood at US$138.1 billion.

This increase is influenced, among other factors, by tax and service revenues, as well as the withdrawal of foreign loans by the government.

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According to BI’s Head of Communication Department, Erwin Haryono, the foreign exchange reserves are equivalent to financing for 6.7 months of imports or 6.5 months of imports and payments of the government’s foreign debt. The reserves also exceed the international adequacy standard of around 3 months of imports.

“BI assesses that the foreign exchange reserves are able to support the resilience of the external sector and maintain macroeconomic and financial system stability,” Erwin said in a press release on Monday (8/1/2024).

Erwin added that BI also believes the foreign exchange reserves will remain adequate, supported by maintained stability and economic prospects, in line with the policy mix undertaken by BI and the government to maintain macroeconomic and financial system stability to support sustainable economic growth.

This is in line with various monetary instruments issued by BI last year to support external resilience and the stability of the rupiah. Some of these instruments include Foreign Exchange State Bonds (SBN Valas), Foreign Exchange Treasury Bills (SPN Valas), and Foreign Exchange State Debt Papers (SUN Valas).

So, what is the projection for foreign exchange reserves this year? According to some economists, Indonesia’s foreign exchange reserves will heavily depend on global economic developments and the actions taken by The Fed.

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The Fed, as the central bank of the United States, has a significant influence on global capital flows, including to Indonesia. The Fed has a mandate to maintain price stability and economic growth in the U.S., one of which is done by setting the benchmark interest rate.

The Fed’s benchmark interest rate affects inflation expectations, the exchange rate of the U.S. dollar, and the yield of U.S. bonds. These three factors impact the interest of foreign investors in investing their capital in developing countries, including Indonesia.

In 2022 and early 2023, The Fed aggressively raised its benchmark interest rate to curb inflation, which had reached its highest level in 40 years. However, since July 2023, The Fed has maintained the interest rate in the range of 5.25%-5.5%.

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Fed policymakers in December 2023 signaled that they had seen enough progress in inflation, which could be achieved through an interest rate hike and a switch to a rate cut this year.

However, it is not clear when and how much The Fed will cut interest rates. This creates uncertainty in the global financial markets, which could potentially cause volatility for the currencies and foreign exchange reserves of developing countries.

Teuku Riefky, Macro Economic and Financial Market Economist at LPEM FEB UI, said that the rupiah, like many other currencies in developing countries, has many potential sources of volatility this year.

“The stability of the rupiah and foreign exchange reserves will depend heavily on global economic developments and the actions taken by The Fed. Looking at the current foreign exchange reserves, we have a significant cushion to intervene if needed to stabilize the rupiah,” he told Bisnis on Monday (8/1/2024).

According to him, the various instruments issued by BI to support the rupiah throughout 2023 were able to support the rupiah, making it more resilient than other peer countries. The exchange rate of the rupiah against the U.S. dollar closed weaker at Rp15,525 per U.S. dollar in early-week trading on Monday (8/1/2024).

“Overall, we estimate that foreign exchange reserves in 2024 will reach around US$150-US$155 billion, surpassing our previous estimate of US$148 billion,” he explained.

Meanwhile, Piter Abdullah, Executive Director of Segara Research Institute, estimates that the rupiah will be more stable and have the opportunity to strengthen, provided that The Fed cuts interest rates.

“If The Fed cuts interest rates, there will be an inflow of capital into developing countries, including Indonesia. This will boost foreign exchange reserves and strengthen the rupiah,” he said.

Piter explained that historically, foreign exchange reserves are more influenced by the size of disbursements and payments of foreign debt, as well as intervention policies when there is pressure on the rupiah.

“With these considerations, foreign exchange reserves are not expected to change much when pressure on the weakening of the rupiah is not significant,” he said.

Piter projects Indonesia’s foreign exchange reserves in 2024 to be in the range of US$145-US$150 billion, assuming The Fed cuts interest rates by 0.25% in the second half of this year.”

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