Issue Background

International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in you having to pay less for your new shoes.

Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries. Almost every kind of product can be found on the international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water. Services are also traded: tourism, banking, consulting and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country’s current account in the balance of payments.

Discussion

After Donald Trump’s shocking presidential win, the US and the world are trying to grasp what it will mean. Some have dubbed the event a bigger shock than Brexit. Aside from the elevated risks to the US economy, what does it mean for Indonesia?

The US stock market rebounded after the initial sell-off on the news that Trump had won. The winners were banks and pharmaceuticals. Banks will thrive on a friendlier White House. Pharmaceutical companies are happy to be rid of pressures of price-fixing from the Democrats. Defense stocks soared on planned larger armed forces spending. Meanwhile, the treasury market also rose from the earlier sharp decline. The pattern of sell-off then rebound also took place after the June 2016 Brexit decision. But does it mean all is well?

Trump’s acceptance speech appears to have calmed frayed nerves, and governing is usually less poetic than campaigning. The recent precedent of an inexperienced president guided by senior statesmen can appear under control. Remember George W. Bush? If you think his leadership was fine, think again. His eight years in office saw the Iraq invasion and the global financial crisis. Lax financial regulations and rising deficit were the bases of the 2008 meltdown.

Trump’s campaign platform is scary, despite being vague. His fiscal proposal promises tax cuts with more spending. The tax cuts will amount to a revenue fall of US$6.2 trillion over the next decade. Combined with his spending plan, government debt will rise from 77 percent of gross domestic product (GDP) today to 105 percent in the next 10 years. No wonder the 30-year US bond price plunged and yields went up around 0.2 percent in one day. This will be a big game shifter in global finance. Rising long-term interest will raise the cost of borrowing, not just in the US but globally as well.

In monetary policy, Trump has commented that the current US Federal Reserve governor is too dovish. This amounts to public intrusion into what should be an independent monetary authority. Independence is its main basis for credibility. Many governments have tried to steer monetary policy, but usually behind closed doors. Being overt about it creates problems between the executive branch and the central bank.

For the Fed’s move to raise rates in December, the fundamentals are in place. These are improving GDP growth, lowering unemployment and rising inflation. But, if market turbulence remains worrying, it might delay the hike.

The most concerning aspect of Trump’s platform is trade and globalization in general. It is likely that he will revisit several trade agreements. This signals a rise in protectionism. Closing the US economy as the largest global market means even lower global trade and growth. This could be the straw that breaks the camel’s back, plunging the world into recession within a year.

Trump’s campaign also looks to reduce the US military presence worldwide. That would allow Russian President Vladimir Putin and China more room to maneuver in Europe and Asia. The instability this would cause is anathema to trade and investment in Asia.

What does it mean for emerging markets and Indonesia?

Trade has been the engine of growth for emerging markets. A trade slowdown is bad news for exporters such as China and South Korea. The same applies to commodity producers, like Indonesia and Brazil. The US’ plan to raise its oil production is an extra blow, which could lower the global oil price further and other commodities with it.

What happens in the US will affect us through financial market contagion. The already expensive Indonesian equity market could face downward pressure. Rising US interest rates mean emerging market bonds are not attractive at present yields. Both will put pressure on the currency.

Only later, when things have settled down, can we expect investors to adopt a risk-on strategy. Then they will become more discriminatory about which emerging economies to bet on. Indonesia and India could be safe bets. Both are embarking on the overhaul of staid bureaucracy and massive infrastructure buildup. Both have large domestic markets with a young population. These factors bode well for longer-term growth potential.

The surprise Trump victory resulted in sudden negative moves in the market, which then changed direction, as is its wont, but the longer term trends are worrying. First is the potential rise in US deficits. The resulting rise in interest rates means a great deal on global finance.

More worrying is the likely US pullback from world trade. Add this to Brexit and you have more fire in the anti-globalization movement.

For Indonesia, the immediate impact is on direct exports to the US, like edible oil. Another impact channel is through the currency and financial markets. With already expensive equity valuation and low bond yields, the risk is a correction. Still, long-term investors in both markets appear confident in Indonesia’s prospects.

Domestic Effect

We can see now day panic hit domestic financial markets on Friday as investors showed concern over the anticipated policies of US president-elect Donald Trump that may negatively affect Indonesia’s economy.

The Jakarta Composite Index (JCI)  the benchmark of the Indonesia Stock Exchange (IDX) – ended in the red on Friday after falling 4 percent to 5,231.97 points, its lowest level in the past two months.

Almost all sectors ended in negative territory, as investors sold a net of Rp 2.46 trillion (US$184.27 million) worth of securities throughout the trading day. Net sales jumped more than eightfold from the previous day, when investors ditched less than Rp 300 billion worth of securities.

The situation was just as bad in the foreign exchange (forex) market, with the rupiah sinking as low as Rp 13,865 per US dollar, the lowest point since June 24. Market intervention by Bank Indonesia (BI) propped up the currency, enabling it to end at Rp 13,383 to the greenback.

Friday’s development sent the government, financial authorities and analysts rushing to calm panicked investors. They attributed the market rout to speculation that Trump might push up fiscal spending after taking office. Higher spending may translate into higher inflation and interest rates in the US, which is not good news for Indonesia and other emerging markets that rely heavily on foreign funds, as some of those funds would return to the US. “It is natural to see that every decision made in the US, as the world’s largest economy, even in the form of a statement, can have a significant impact.” She said investors, including those holding government debt papers (SUN), did not have to be worried, as Indonesia had a low debt risk with a relatively long maturity profile and a relatively small state budget deficit.

Moreover, with various fiscal measures to control the state budget deficit, spending and tax revenues, government debt papers had a very low risk profile. The IDX and the Financial Services Authority (OJK) also tried to calm investors, saying any impact of Trump’s policies would be temporary. BI senior Deputy Governor Mirza Adityaswara admitted the central bank had intervened in local forex and sovereign bond markets to stabilize the rupiah. Selling by forex traders, particularly in non-deliverable forward (NDF) derivative contracts, he went on, had triggered the market volatility. NDF contracts, unlike forex forwards, are settled in dollars determined by reference to a daily fixing, which in some jurisdictions is set by a survey of lenders.

“The NDF market weakened and affected traders without considering Indonesia’s economic fundamentals. That’s why the rupiah was traded at Rp 13,400 [per US dollar] during opening, because the market followed what occurred in Mexico, Brazil and other places,” he said. Mirza emphasized that the country’s fundamentals remained strong, with economic growth of 5.02 percent in the third quarter, higher than in most of Indonesia’s Southeast Asian peers.

Meanwhile, stock market analysts deemed investors’ reaction exaggerated and urged a more cautious manner. They said the market should actually have priced in the expectation of a December rate increase in the US, with further increases in 2017 and 2018.

Separately, Trade Minister Enggartiasto Lukita said investors should wait until Trump formed his team. He expressed optimism that economic relations between the two countries would remain positive, despite Trump’s seemingly protectionist stance. Compared to its regional peers, Indonesia is unlikely to be affected by a possible protectionist movement from Donald Trump’s US presidency as trade is no longer a main source of growth, Singaporean based bank UOB has said.

UOB economist Jimmy Koh said a Trump administration was likely to affect US-Asia trade with higher import tariffs and even the cancellation of trade agreements such as the Trans Pacific Partnership (TPP). In ASEAN, Vietnam, Malaysia and Thailand are the most vulnerable given a high trade dependency on the US.

“The US is the third-largest export market to Indonesia, accounting for 11 percent of Indonesia’s exports in 2015. However, with one of the lowest shares of exports of goods and services to (gross domestic product) GDP among Asian countries, Indonesia will be less affected than its peers in the event of trade restriction measures,” Koh said on Thursday.

According to the Central Statistics Agency’s (BPS) latest data, export shares to GDP are getting lower. In the third quarter, exports were only 19.5 percent of GDP while in the same period of 2015 and 2014 the figures were 21.84 and 23.01 percent, respectively.