Covid-19 and debt monetisation: will Indonesia blaze a trail for other emerging markets?

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To assist the government’s financial response to the coronavirus pandemic, Indonesia’s central bank is set to purchase $40bn in sovereign bonds as part of a debt monetisation programme – a strategy seldom used by emerging markets that could have wider implications for the region.

On June 6 the Ministry of Finance announced that Bank Indonesia (BI) would buy Rp397.6trn ($27.2bn) in bonds directly from the government, to be allocated for spending on health care, social safety nets and food security.

The bonds will be purchased at the seven-day reverse repurchase rate, which was 4.25% at the time of the agreement, with BI to return the interest earned to the government.

In addition, the central bank will bear the costs of the government’s Rp123.5trn ($8.4bn) stimulus package for micro-, small and medium-sized enterprises, as well as its Rp53.4trn ($3.6bn) support fund for larger businesses.

The government plans to sell the bonds to the market with BI as a standby buyer. The central bank will also contribute to the costs, which will be determined as the difference between the market rate and BI’s three-month reverse repo rate, minus 1%. 

The debt monetisation programme, labelled “burden sharing” by Indonesian officials, will help fund the government’s additional debt financing of Rp903.5trn ($61.8bn). BI will account for Rp574.4trn ($39.3bn), or 64%, of the debt.

As a result of Covid-19-related spending, this year’s budget deficit in Indonesia is expected to increase from the initial forecast of 1.8% of GDP to 6.3%, with the government expecting a 10% drop in revenue. Meanwhile, the IMF estimates that the economy will contract by 0.3% this year before recovering with growth of 6.1% in 2021.

Merits and risks of bonds

Although Perry Warjiyo, the governor of BI, has stressed that the decision to finance public services through bond purchases is a one-off policy, the strategy has been viewed as a particularly bold one.

While the absorption of government debt from the secondary market is not uncommon, and developed economies such as Japan, the US and the EU have monetised debt in the past decade, central banks – particularly in emerging markets – have traditionally sought to avoid direct bond purchases.

Critics say that the approach could trigger higher levels of inflation, weaken the value of the currency and erode the independence of the central bank, in addition to the risks associated with the BI holding a more substantial percentage of national debt.

However, there is an argument that Indonesia is implementing this policy at the right time, with inflation at its lowest level in 20 years – below 2% – on the back of weak demand.

Although not falling as dramatically as during the initial outbreak of the virus, the rupiah lost about 4% of its value against the dollar between mid-June and mid-July.

Credit agencies Moody’s and Standard & Poor’s noted that, while the unconventional strategy would reduce government borrowing costs and was unlikely to affect credit ratings in the short term, the long-term implications of the debt monetisation programme were unclear, particularly given the uncertainty surrounding BI’s exit strategy, and the implications the scheme has for money supply and prices.

Setting a precedent?

Aside from providing financing for additional Covid-19-related expenditure, Indonesia’s strategy could also emerge as a blueprint for other emerging markets looking to fund their coronavirus-affected budgets and spending commitments.

In the Asia-Pacific region a number of central banks have followed a somewhat similar, albeit more restrained, path.

The Reserve Bank of India has been increasingly buying bonds in the secondary market, while the Philippines’ central bank has done the same, with suggestions in some quarters that it could expand its approach.

The strategy has not been restricted to emerging markets, with the central banks of Australia and New Zealand both buying up a considerable amount of bonds on the secondary market.

If Indonesia is successful in managing inflation and the value of the rupiah, while at the same time stimulating growth in the economy, more countries may adopt the debt monetisation approach in order to fund their ongoing stimulus measures.

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