SEACEN High Level Seminar on Integrating Monetary Policies with Macroprudential Framework Opening Remarks by Dr. Perry Warjiyo Deputy Governor of Bank Indonesia Bali, November7 th 2013 Distinguished Speakers, Participants, Ladies and Gentlement. 1. Good morning. Let me start by welcoming all of you to SEACEN High Level Seminar on Integrating Monetary Policies with Macroprudential Framework, at this beautiful island Bali. I am very delighted to provide opening remarks to this seminar today. The topic of the seminar is both timely and essential. Global crisis gave us a valuable lesson that fostering financial system stability plays a key role beyond price stability as the mandate of the central bank. Macroprudential policy becomes an increasingly important new policy tool kit of the central bank to complement the already established monetary policy and microprudential supervision. Yet, we still need to rethink and design the current framework for monetary policy to include macroprudential in order to achieve both price stability as well as financial stability. 2. I will speak these issues along with the following two broad aspects. First, I will discuss the changing nature of central bank challenges since the global crisis and why we need to complement and integrate the current monetary policy with macroprudential policy.then, I will share the experience of Indonesia in formulating and implementing monetary and macroprudential policy mix in facing the unprecedented challenges for maintaining price and financial system stability since the global crisis. 3. Global crisis taught us a number of lessons and brought up new challenges to the central bank. First, there is a need to expand the mandate of central bank from price stability to encompass also a role in promoting financial system stability. The success of sound monetary policy in delivering low inflation and then low interest rate in the period preceeding global crisis was construed as giving rise to the boom and risks in the financial sector that lead to the global crisis. Certainly, strengthening regulation and supervision in the financial sector, both in the micro aspect to mitigate individual risk as well as in the 1
macro aspect to manage systemic risk, are needed to secure financial system stability. But it is clearly that monetary policy to achieve price stability need to be closely coordinated with macroprudential policy to foster financial system stability. 4. Second, we also need to put stability objective, whether it relates to price or financial system stability, into a new prospective. We need to think of stability not in static sense, i.e. year by year, but in a more dynamic and forward looking sense. This is especially true since financial activities exhibit procyclicality along with the boom and bursts in the economic cycle. Bank lending, for instance, tends to be more excessive in the boom period but restrictive when the economy slumps. Interest rate policy alone would not be effective to address this financial acceleration fenomenon in the economy. Macroprudential policy for securing financial system stability must also able to manage these procyclicality nature and allocative distribution of bank lending among sectors so as to help manage (and not accentuate) the boom and bursts cycle in the economy. Likewise, apart from investors' preference in the global financial market, capital inflows are usually high when our economy is on the rise but they will reverse when risks in the economy emerge. Some forms of capital flow management are needed to complement exchange rate policy to maintain external stability from the impacts of the volatility of capital flows. 5. Third, market mechanism does not always work efficiently in developing countries like South-East Asia. The invisible hand of Adam Smith may not always be prevailed. Inflation, for example, may be caused by non-monetary factors such as production, distribution, or market structure, and thus would not be effectively responded by interest rate alone. Likewise, financial imperfections often inhibit rigidities of interest rate and exchange rate in transmitting monetary policy to the economy. Interest rate response to monetary policy tends to be with a long lag and bank's lending tends to be less elastic to interest rate setting. Exchange rate overshooting often happen because of price rigidity in the real sector and under developed financial market. Under such circumstances, we could not only rely on standard monetary or banking policy for achieving price and financial system stability. In a number of cases, some forms of intervention policy may be needed when market failure exists. 6. The preceeding discussion leads to the need for formulating a monetary and macroprudential policy mix to achieve price and financial system stability to promote sustainable economic growth. Monetary policy to achieve price stability must also take into account non-monetary factors of inflation and the impact of financial imperfections to monetary transmission mechanism. Likewise, macroprudential policy needs to balance the objective of maintaining financial system stability with the promotion of a sustainable intermediation function and efficiency of the financial sectors for stimulating the economic 2
growth. The question is then how to formulate and integrate monetary and macroprudential policy mix. 7. Let me share with you Indonesia experience in this regard. Indonesia, as a small open economy, faces a number of challenges over the past years. First, capital inflows were substantively large over the period of 2009 to 2011 from the quantitive easing of monetary policy in the advanced counties, but then they reverse because of Greek crisis in the end of 2011 and recent market over reaction to the planned tapering of Fed quantitative easing. Second, inflation was under controlled and relatively low up to 2012 but it has been under pressures since then because of increased of domestic fuel price and supply shocks on food prices. Third, current account was in relatively large surplus up to 2011 induced by strong external demand and high global commodity price, but it then turn into large deficit when the global economic condition reverse. These three challenges depict a more complex environment faced by Bank Indonesia to formulate and implement its policies to maintain price and financial system stability to promote economic growth. 8. Faced with these more complex problems, Bank Indonesia no longer just rely on one instrument, particularly, the interest rate policy. Since mid of 2010, Bank Indonesia has adopted a new approach of monetary and macroprudential policy mix, implemented through the following five instruments. 9. First, the policy interest rate is always the main instrument of monetary policy, directed to anchor future inflation to remain under controlled within the target range. Thus, when inflation declined and relatively low during 2010-2012, policy interest rate was lower 100 basis point from 6.75% to 5.75%. But the recent increased inflation pressures, coupled with relatively high current account deficit occurring when pressures on capital reversals are mounting in respond to Fed's planned tapering, the policy rate has been increased 150 basis point to 7.25%. We will continue monitor the pressures on inflation and current account deficit and readjust our policy repond to ensure price and external stability are maintained. 10. Second, Bank Indonesia continues to maintain exchange rate stability in accordance with economic fundamentals. Thus, maintaining the path and stability of exchange rate is an integral part of the efforts to achieve the inflation target based on the forward looking macroeconomic projection exercise. Thus, when inflation was low, current account was in surplus and capital inflows were large in ghe period of 2009-2011, we let exchange rate to appreciate from about Rp12.000 per USD when the global crisis erupted in 2008 to about 3
Rp9.700 per USD in 2010 and even to Rp8.500 per USD in the mid of 2011. The Rupiah was under strains because of global financial market pressures emanated from the European crisis in the end of 2011 and recent Fed's planned tapering. Rupiah is now stabilizing at around Rp11.400 per USD and we view this consistent with the economic fundamental. 11. Third, Bank Indonesia has pursued a number of measures to manage capital flows so as not to induce extreme volatility in the exchange rate and endanger the risks to financial stability. We welcome those capital flows that are long-term and benefits to financing the economy, especially FDI and to some extent portfolio inflows to government bond and equity. We targeted the measures to "put sand in the wheel" those capital inflows that are short-term and speculative. Thus, we introduced 1 month and then lengthend to 6 monthholding-period for Bank Indonesia Certificates (SBI) in 2010-2011 as we regarded capital inflows were excessive during that time, but it was shortened to 1 month recently as a part of policy mix to withstand from the impact of Fed's planned tapering. We also introduced maximum of 30% capital to the short-term offshore borrowing of the banks in 2011, but it was relaxed recently with exluding divestment of equity portfolio flows and capital participation from parent companies. We also continue to deepen domestic financial market with introducing a number of new products such as negotiable securities and hedging instruments. 12. Fourth, Bank Indonesia also introduced a number of macroprudential policies to manage ovesll lending and the allocation of bank credit to various sectors to be more balanced and support the economy. The measures are also geared toward dampening the procyclicality nature of bank lending in the economy. In the past, we rely very much the instruments for managing liquidity and lending of the banks through a number of reserve requirements. We strengthened our macroprudential policies last year with introduction of Loan-to-Value (LTV) ratio on lending to automotive and property sectors. Recentley, we amended the LTV regulation due to excessive credit growth in the property sector, particularly for houses and high-rises (flats and apartments). On the other hand, accommodative macroprudential measures are deployed to stimulate lending to a number of sectors which are supporting sustainable and equitable economic growth. For example, Bank Indonesia has issued a policy requiring lending to MSMEs by each bank a minimum of 20% of their total lending within the next five year. 13. Fifth, Bank Indonesia continues to strengthen policy coordination with the Government at central and local levels to manage inflalion, macroeconomic and financial system stability for promoting economic growth. To curb inflation pressures especially from volatile foods prices because of production, distribution and market structure, we established Inflation Control Team (ICT) at the national, as well as in all of the 33 provinces and 76 4
cities/counties. Coordination on monetary - fiscal - and structural policies are conducted through Bank Indonesia involvement in the government budget process as well as regular coordination meering between Bank Indonesia, Ministry of Finance, and other related line ministries. For maintaining financial system stability, a forum called Financial System Stability Coordination Forum (FKSSK) involving Ministry of Finance, Bank Indonesia, Financial Service Authority (FSA), and Indonesian Deposit Insurance Company (IDIC) has been formed and meet regularly to discuss overall financial system condition and coordinated policy responses that are needed. 14. Our experience over the past three years shows that this new framework has been more effective in maintaining price and financial system stability for promoting exonomic growth. The policy mix, however, is not always easy to design and implement, and it needs to be appropriately and continuously calibrated according to the evolving dynamics of the global and domestic economic environment. Communicating the policy mix is also a challenge. We need to be clear which instrument is directed to which specific objective, and we must avoid substituting the interest rate policy for other instruments in the mix. Even when we are successful in these aims, there is always a risk that the market may perceive the policy mix differently, given that the monetary policy response is generally (and often only) associated with interest rate adjustments. 15. In closing, once again, I am delighted to give opening remarks to this important seminar today. I am particularly hopeful that the next two-day seminar will provide ample opportunities for all of us to enrich our understanding and able to give inputs to improve the integration of monetary policies and macroprudential framework for policy making in our respective central bank. We appreciate it very much to the SEACEN Centre for organizing this Seminar and commend this important topic will be further enriched and deepened in the future. With that, I declare this seminar officially opened. Thank You. 5