While the IDR is amongst the best performing currencies quarter-to-date and year-to-date in Asia thanks to its trade surplus, improving growth and benign inflation, the pressure cooker is on as fiscal space runs out and inflation is expected to rise.
As expected, the Fed raised rates by 75bps to 3.25% for the upper bound target, but it was its promise for more by year-end until inflation drops to target that has rattled markets.
The most impacted in ASEAN has been the Philippines, not just following the Fed but also quarter-to-date and year-to-date, falling -6% and -13% in FX, respectively. We have long argued that the Philippine peso is the most vulnerable in ASEAN as it is exposed to the three shocks acutely, especially because of its fuel and food trade deficits of -5% of GDP, worst in ASEAN (Chart 2).
Furthermore, the Philippines has more limited room to move than others on the fiscal side. As such, today, the central bank hiked rates by 50bps to 4.25%, as widely expected by us and markets.
The big surprise came from Bank Indonesia, which increased rate by 50bps to 4.25%, more than 25bps expected by consensus but in line with Natixis’ expectation. While the IDR is amongst the best performing currencies quarter-to-date and year-to-date in Asia thanks to its trade surplus, improving growth and benign inflation, the pressure cooker is on as fiscal space runs out and inflation is expected to rise.
For one, the key reason for its relatively muted inflation, although increasing, stems from its very generous electricity and fuel subsidies. But as the government keeps the lid on prices through subsidies, demand remains firm and adds further to costs that increased three times and ultimately led it to raise pricesto limit the fall-out.
We have long argued that there is a ceiling to Asia’s fiscal-led effort to suppress the rise of inflation, especially for countries such as Indonesia with funding constraints and revenue ratios still too weak to support run-away fiscal expenditure even though growth is improving.
More importantly, if Indonesia wants to consolidate the budget and increase investment, then it needs to reign in its widening subsidy hole. With the specter of higher inflation looming from higher costs of fuels, which we argue is the right call, monetary policy becomes even more key to fight inflation to avoid a much more depreciated rupiah.
We expect other central banks to follow soon – with Bank of Thailand (BOT) likely to hike next week at its 28 September meeting by 50bps or even earlier. The Reserve Bank of India (RBI) will also hike by 50bps at its upcoming 30 September meeting as inflation remains elevated and the INR is under pressure, although less so than others. The next Bank of Korea (BOK) meeting is not until 14 October, and we think more hikes are warranted even though exports are weakening as the KRW has weakened sharply on a more hawkish Fed and Korea’s deteriorated terms of trade.
With interest rates rising, economic momentum is likely to sag slowly into year-end as tightened financial conditions bite, both via higher rates, still elevated inflation, and portfolio outflows. Still, it is key to remember that FDI inflows are still resilient, providing a key buffer for EM Asia ex China as its short-term and expected long-term growth outperforms aging Asia.
Elevated geopolitical tensions between the West and China add another tailwind to investment inflows, especially as firms are pushed to diversify both demand and supply chain risks.
Source: Natixis Global Markets Research