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Working Paper Series

Does Indian financial market nosedive by COVID-19 outbreak in comparison to post-implementation of demonetisation and GST?

Alok Kumar Mishra, Badri Narayan Rath, Aruna Kumar Dash


This paper investigates the impact of COVID-19 on Indian financial market and compared with the outcomes of two recent major structural changes of the Indian economy such as demonetisation and implementation of GST. By using daily data on stock returns, net Foreign Institutional Investment and exchange rate volatility over the period from 3 January 2003 to 20 April 2020, the study finds the stock returns of all the indices turned out to be negative during COVID-19, which was not the scenario during post demonetization and post GST phases. The volatility of the benchmark stock price is 2.77 as compared to 0.51 and 0.59 in post demonetisation and post GST phases, respectively. Finally, by employing Markov-Switching VAR model, the results reveal that the impact of COVID-19 is severe on stock returns in comparison to the impact of demonetisation and GST. Our findings propose that RBI should intervene in the forward contracts policy along with determining the trading limits for the commercial banks to arrest the speculative forces to stop the precipitous fall of rupee against the dollar. 


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Bitcoin Price Growth and Indonesia’s Monetary System

Paresh Kumar Narayan, Seema Narayan, R. Eki Rahman, Iwan Setia
ABSTRACT
Concerned by the volatility of Bitcoin price growth (BPG), Bank Indonesia—Indonesia’s central bank—discourages trading cryptocurrencies. We examine the relationship between Bitcoin price growth (BPG) and Indonesia’s monetary aggregates (inflation, real exchange rate, and money velocity). In doing so, we develop the conceptual link between Bitcoin and monetary aggregates. We find strong and robust evidence that BPG leads to inflation growth, currency appreciation, and a reduction in money velocity. Our results have policy implications for other central banks in terms of achieving stability of the monetary system if BPG is indeed a concern for those countries.

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Understanding the role of trade agreements in Indonesia’s FDI

Paresh Kumar Narayan, Badri Narayan Rath, Ferry Syarifuddin
Abstract
In this paper, we develop the hypothesis that trade agreements influence foreign direct investment (FDI). We extend the conventional model of FDI determinants to accommodate the role of trade agreements. Fitting Indonesian data to this model, we discover strong evidence that, while both bilateral and multilateral trade agreements positively influence Indonesia’s FDI, multilateral agreements have a larger effect. We further distinguish FDI by sector and find sector-specific trade agreements to play an active role: these agreements positively influence FDI in the primary and service sectors, but not in the manufacturing sector. We also find that trade agreements positively influence FDI through the export and total factor productivity channels, and less so through the economic growth channel.

Role of Islamic Banks in Indonesian Banking Industry – An Empirical Exploration

Syed Aun R. Rizvi, Paresh Kumar Narayan, Ali Sakti, Ferry Syrafuddin
Abstract
Islamic Banks have been gaining traction in Indonesia, which is the world’s largest Muslim population. Although the share of Islamic banking is small, the growth potential poses challenges and questions that need an inquiry. Our paper is a response to this. We investigate whether more competition from Islamic banks adds to the financial stability and profitability. We then test the source of any such stability/instability. We find, consistent with the competition-stability theory, that the presence of Islamic banks has not impacted profitability but has made the banking industry more stable. We show that Islamic banks have improved both lending and deposit growth of the banking system, suggesting that Islamic banks have contributed to stability through both asset and liability channels. 


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Understanding Indonesia’s Macroeconomic Data: What do we know and what are the implications?

Susan Sunila Sharma, Lutzardo Tobing, Prayudhi Azwar
ABSTRACT
Unit root properties of macroeconomic data are important for both econometric modelling specifications and policy making. The form of variables (whether they are a unit root process) helps determine the correct econometric modelling. Equally, the form of variables helps explain how they react to shocks (both internal and external). Macroeconomic time-series data are often at the forefront of shock analysis and econometric modelling. There is a growing emphasis on research on Indonesia using time-series data; yet, there is limited understanding of data characteristics and shock response of these data. Using an extensive dataset comprising 33 macroeconomic time-series variables, we provide an informative empirical analysis of unit root properties of data. We find that regardless of data frequencies the empirical evidence of unit roots is mixed, some series respond quickly to shocks others do take time, and almost every macroeconomic data suffers from structural breaks. We draw implications of these findings.

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Determinants of Indonesia’s Income Velocity of Money

Susan Sunila Sharma, Ferry Syarifuddin,
Abstract
Using monthly time-series data and both short- and long-run models, our paper examines the determinants of Indonesia’s income velocity of money. Our findings suggest that in the long-run, tax revenue, short-term interest rate, industrial production and, in the short-run, money demand, significantly determine income velocity of money. Our analysis suggests that the effect on income velocity is mostly over the long-run as most determinants are dormant in the short-run. The implication from a policy perspective is that shocks are unlikely to burden income velocity over short time horizons.

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Does Information and Communication Technologies Foster Economic Growth in Indonesia?

Badri Narayan Rath and Danny Hermawan
Abstract
This paper investigates, using annual data from 1980 to 2014, whether adoption of information and communication technologies (ICT) fosters economic growth in Indonesia. We employ an Autoregressive Distributed Lag cointegration technique using an augmented neoclassical growth model. The empirical results indicate a positive effect of ICT development on economic growth in both the long-run and short-run. The other regressors, such as total factor productivity, human capital, and capital per worker, also positively affect economic growth. From a policy perspective, the Indonesian government should promote ICT development through greater investment.

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Do financial technology firms influence bank performance?

Dinh Phan, Paresh Kumar Narayan, R. Eki Rahman, Akhis R. Hutabarat
ABSTRACT
We develop a hypothesis that the growth of financial technology (FinTech) negatively influences bank performance. We study the Indonesia market, where FinTech growth has been impressive. Using a sample of 41 banks and data on FinTech firms, we show that the growth of FinTech firms negatively influences bank performance. We test our hypothesis through multiple additional tests and robustness tests, such as sensitivity to bank characteristics, effects of the Global Financial Crisis, and the use of alternative estimators. Our main conclusion that FinTech negatively predicts bank performance holds.

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Can economic policy uncertainty predict exchange rate and its volatility? Evidence from ASEAN countries

Solikin M. Juhro and Dinh Hoang Bach Phan
ABSTRACT
This paper examines whether global economic policy uncertainty (EPU) predicts exchange rates and their volatility in ten ASEAN countries using monthly data from January 1997 to December 2017. Applying the predictive regression model of Westerlund and Narayan (2012, 2015), we find that EPU positively and statistically significantly predicts the exchange rates of six out of ten currencies. A one standard deviation increase in the EPU index leads to a depreciation of between 0.050% and 2.047% in these currencies. Moreover, EPU predicts exchange rate volatility for all ten ASEAN countries. Their exchange rate volatilities increase by between 0.107% and 0.645% as a result of a one standard deviation increase in the EPU index. These results are robust to different forecasting horizons and subsample periods, and after controlling for the Global Financial Crisis.

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Economic Policy Uncertainty and the Financial Stability—Is there a Relation?

Dinh Hoang Bach Phan, Bernard Njindan Iyke, Susan Sunila Sharma, Yoga Affandi
ABSTRACT
This paper investigates the influence of economic policy uncertainty (EPU) on financial stability. Using data for 23 countries from 1996 to 2016, we show that the impact is negative and statistically significant. Economically, a unit standard deviation increase in uncertainty decreases financial stability by 2.66–7.26% of its sample mean. In terms of financial system characteristics, the negative influence of EPU on financial stability is stronger for countries with a financial system with more competition, less regulatory capital, and a smaller size. We show that our finding is robust, using bank-level data and different constructions of global panels and controlling for Z-score skewness, the global financial crisis, and endogeneity.


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Is there a role for Islamic finance and R&D in endogenous growth models in the case of Indonesia?

Solikin M. Juhro, Paresh Kumar Narayan, Bernard Njindan Iyke, Budi Trisnanto
ABSTRACT
The validity of growth models is debatable, more so in developing than in developed economies. We contribute to this debate by testing the relevance of semi-endogenous growth models in explaining Indonesia’s economic growth transformation. Using historical time series data (1968 to 2018), we test growth models from a unique perspective by examining the roles of the Islamic financial market, the conventional financial system, and structural changes. We show that Indonesia’s growth experience is best characterized by a semi-endogenous growth model driven by research activity and access to the financial system, particularly the Islamic financial market. We conclude that while linear models fail to support semi-endogenous growth models, nonlinear models do support them.

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Forecasting Indonesian Inflation within an Inflation-Targeting Framework: Do Large-Scale Models Pay Off?

Solikin M. Juhro, Bernard Njindan Iyke
Abstract
We examine the usefulness of large-scale inflation forecasting models in Indonesia within an inflation-targeting framework. Using a dynamic model averaging approach to address three issues the policymaker faces when forecasting inflation, namely, parameter, predictor, and model uncertainties, we show that large-scale models have significant payoffs. Our in-sample forecasts suggest that 60% of 15 exogenous predictors significantly forecast inflation, given a posterior inclusion probability cut-off of approximately 50%. We show that nearly 87% of the predictors can forecast inflation if we lower the cut-off to approximately 40%. Our out-of-sample forecasts suggest that large-scale inflation forecasting models have substantial forecasting power relative to simple models of inflation persistence at longer horizons.

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Consumer confidence and consumption expenditure in Indonesia

Solikin M. Juhro, Bernard Njindan Iyke
ABSTRACT
We estimate several competing regressions and find that confidence predicts consumption expenditure in Indonesia. Our estimations employ data on two measures of confidence, namely consumer and business confidence indexes, consumption and three standard predictors of consumption, namely labour income, stock price, and interest rate. We show that there are economic and statistical gains from consumption growth frameworks that account for consumer and business sentiments. Specifically, we show that policymakers can improve their forecast accuracy by between 4% to 13% by incorporating consumer and business sentiments into their forecasting frameworks.

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Monetary Policy and Financial Conditions in Indonesia

Solikin M. Juhro, Bernard Njindan Iyke
ABSTRACT
We develop a financial condition index (FCI) and examine the effects of monetary policy on financial conditions in Indonesia. We show that our FCI tracks financial conditions quite well because it captures key financial events (the Asian financial crisis of 1997–1998, the Indonesian banking crisis, and the global financial crisis and its aftermath). A unique feature of our FCI is that it is quarterly and thus offers near real-time development in financial conditions. We also show that monetary policy shapes the FCI. A contractionary monetary policy leads to unfavourable financial conditions during the first two quarters, followed by favourable financial conditions for nearly three quarters. This finding is robust to an alternative identification strategy. Our findings highlight the critical role of the monetary authority in shaping financial conditions in Indonesia.

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The Dynamics of Global Financial Cycle and Domestic Economic Cycles: Evidence from India and Indonesia

K.P. Prabheesh, Reza Anglingkusumo and Solikin M. Juhro
Abstract
This paper analyses the role of the global financial cycle in determining domestic economic cycles, defined as business and credit cycle, of India and Indonesia, two key open lower-middle income emerging economies in Asia. The paper particularly examines to what extend the global financial cycle can explain the variation in domestic economic cycles in the two countries and analyses the differences. Using quarterly data from 2000 – 2018, and employing various econometric techniques such as concordance index, DCC-GARCH model and standard SVAR, the study finds: (i) the domestic credit cycle is highly synchronized with global financial cycle for India, whereas in the case of Indonesia the synchronization is muted and indirect, (ii) exchange rate appreciation leads to credit boom in India, indicating risk taking behaviour through the financial channel; while in Indonesia, credit boom is driven mainly by the indirect impact of global financial cycle through the domestic real economy, (iii) the Reserve Bank of India responds to output gap strongly, suggesting an adherence to inflation targeting framework, and (iv) Bank Indonesia also responds to exchange rate volatility and credit cycle as an approach to mitigate the risks associated with large and often volatile capital flows. These differences in monetary policy approach may explain the differences in transmission of spill-over effects of global financial cycle on domestic economic cycles in the two countries.

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Monetary Policy Transmission and Credit Cards: Evidence from Indonesia

K.P. Prabheesh , R. Eki Rahman
This paper empirically tests the dynamics of credit cards and monetary policy in the context of Indonesia. Using monthly data from 2006 to 2018, and structural vector autoregressive model, our findings indicate that the credit card usage is mainly driven by Indonesia’s high economic growth over the last decade, which indeed signifies the role of credit cards on consumption smoothing. The study also found that the monetary policy transmission through the lending channel is weak. However, the role of the exchange rate and global oil price in the transmission process being more prevalent.
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A study of Indonesia's stock market: How predictable is it?

Dinh Hoang Bach Phan, Thi Thao Nguyen Nguyen, Dat Thanh Nguyen 
Abstract
Using monthly data from January 1995 to December 2017, this paper tests whether Indonesian stock index returns are predictable. In particular, we use eight macro variables to predict the Indonesia composite and six sectoral index returns using the FGLS estimator of Westerlund and Narayan (2012, 2015). Our results suggest that the Indonesian stock index returns are predictable. However, the predictability depends not only on the macro predictor used but also on the indexes examined. Second, we find that the most popular predictor is the exchange rate and followed by the interest rate. Finally, our main findings survive a number of robustness tests.

Terrorist attacks and oil prices: hypothesis and empirical evidence

Dinh Hoang Bach Phan, Qiang Gong 
Abstract
Using a unique dataset that merges terrorism activity with oil prices, this paper develops and tests the hypothesis that terrorist attacks predict oil prices. We develop three insights. First, we show that terrorist attacks have a positive effect on oil prices, but it is attacks originating from oil producer countries that most influence oil prices. Second, we devise trading strategies based on terrorist attacks and show that attacks, by signaling buying and selling in the market, beat a buy-and-hold strategy. We also show that a mean–variance investor who utilizes our terrorism-based forecasting model makes economically meaningful profits. Our analysis also shows that the effect of terrorism on oil prices operates via both the oil production and oil investment channels.

Are Oil Prices Efficient? A Time-Varying Analysis on the Weak-Form Efficiency of Crude Oil Prices

Shaista Arshad, Syed Aun R. Rizvi 
Abstract
This paper attempts to analyse the weak form efficiency of Brent oil prices to evaluate the efficiency of oil markets. With limited research on this novel area, we conduct a time-varying and multi-scale analysis on crude oil market benchmarks using Multifractal-Detrended Fluctuation Analysis (MFDFA) over the period of twenty years. The objective is to investigate whether the crude oil markets are efficient in the weak form during different economic regimes over multi-scales. The results from different sub-samples provides evidence that in the shorter horizon component, there is a tendency towards improving efficiency across every expansion post recession and this trend in the longer term component is violated in the recent global recovery of post 2010. We find that the benchmark Brent crude oil prices is weak-form efficient implying low predictability levels of prices. As a robustness check, we reassess the data in five different ways. (1) as stated above, the data is divided into periods of expansions and recessions, (2) a multi-scale analysis is integrated to include short and long-term analysis, (3) the data is reanalysed under a different order q, where results hold, (4) the analysis is repeated for weekly data, and results conform, and lastly (5) seven other oil prices benchmarks are used, and the general results conform to those for Brent crude oil.

An Exploration of Recent Indonesian Literature: Economics, Finance and Islamic Banking

Dinh Hoang Bach Phan, Syed Aun R. Rizvi, Badri Narayan Rath, 
Abstract
In this paper, we provide a comprehensive review of recent research on Indonesian economic, finance, and Islamic banking literature. Indonesia has attracted substantial research due to key unique features of its economic and finance systems. Therefore, it is important to understand what has been done in the existing Indonesian literature, what are the main findings and lessons learned, and what are the potential future directions for research in these areas. Using nearly 150 papers published in respected journals, we contribute to the literature by providing the first attempt to respond to those questions.

A financial system–led endogenous growth model for Indonesia

Solikin M. Juhro, Paresh Kumar Narayan, Bernard Njindan Iyke, Budi Trisnanto, 

Abstract
The validity of growth models is debatable, more so in developing than in developed economies. We contribute to this debate by testing the relevance of semi-endogenous growth models in explaining Indonesia’s economic growth transformation. Using historical time series data (1968 to 2016), we test growth models from a unique perspective by examining the roles of structural changes and the Islamic financial market in addition to testing the importance of the conventional financial system. Our main finding is that while linear models fail to support semi-endogenous growth models, nonlinear models do support them. We show that Indonesia’s growth experience is best characterized by a semi-endogenous growth model driven by research activity and access to the financial system, particularly the Islamic financial market.