Monday, December 22, 2008 Vincent Lingga, The Jakarta Post, Jakarta
Government and private sector analysts have a consensus prognosis: Indonesia's economic growth will markedly slow down next year because of the international credit crunch and the deep recession in the United States, Europe and Japan.
However, with the news on the global economy getting worse every week, they differ on the extent of the downturn. The government, the central bank, the World Bank, the International Monetary Fund and the Asian Development Bank still expect the gross domestic product (GDP) to grow by between 4.5 and 5 percent, while private sector analysts forecast an expansion ranging from 2.5 to 4.5 percent.
Depressed demand in the world's economic powerhouses has begun to hit Indonesian exports, pushing down commodity prices and forcing manufacturing companies to reduce employment. In the third quarter the economy grew 6.1 percent -- the slowest in the past six quarters -- as declining prices for palm oil, rubber and coal slashed the value of exports.
Growth in the last quarter could be less than 6 percent with the second round impact of the global economic downturn hitting all sectors of the economy harder.
Although overall growth for the whole year could still hover at 6 percent thanks to robust expansion in the first half, the economic landscape next year will be bumpy and jagged.
Private consumption, which accounts for 65 percent of growth, will slacken because of steep falls in commodity prices and the erosion of consumer purchasing power by the estimated 11.30 percent inflation this year and the 20 percent depreciation of the rupiah over the past two months alone.
Exports, already hurt by depressed demand in the developed world, will further be hindered by the tighter credit markets, making it more difficult for companies to secure working capital and payments for international shipments.
This is different from the 1997-1998 economic crisis when export-oriented businesses continued to do very well. Companies depending largely on export markets will suffer because of the recession in the developed economies.
In fact, manufacturers have begun feeling the pinch, as evidenced by the wave of employee layoffs that started last month and which, it is feared, will escalate next year as the full impact of the global crisis makes itself felt.
Political spending during the parliamentary elections in April and the following presidential election will be an additional boost to private consumption but surely not as strong as in the 2004 elections because of the negative impact of massive wealth destruction on the Jakarta stock market in October.
According to the Central Statistics Agency, between July and September, the contribution of foreign trade (exports and imports) to economic growth was virtually negligible.
Even though the country is not largely dependent on foreign trade (which contributes only about 20 percent of GDP), given the size of the economy ($400 billion), it will still feel the brunt of the global downturn via the financial channels -- both from higher risk aversion on the part of investors as well as extremely tight liquidity conditions (due to the credit crunch).
The crash of the Jakarta stock market in October, which shaved off almost 60 percent of market capitalization as the composite index collapsed from 2,800 early this year to as low as 1,100, reflected the withdrawal of foreign portfolio capital and at the same time spelled the end of the investment boom.
This also means that the nearly 400 listed companies can no longer rely on the stock market for long-term funds. Consequently, they will slash capital expenditure, thereby reducing the possibilities for investment and job creation.
The only good news is moderate inflation, probably controlled at 6 percent for the whole of next year.
But even though inflationary pressures have eased because of the falling prices of food and fuel, there is not much leeway for Bank Indonesia (BI) to ease its monetary policy substantially.
So don't expect a significant lowering of the BI rate from its current level of 9.25 percent because of the international financial volatility and the vulnerability of the rupiah to speculative attacks.
The high interest rates will further hit consumer spending and new investment.
Weaker domestic demand and an expected slowdown in manufacturing exports will reduce imports, but the risk of imported inflation will remain high if the rupiah remains highly vulnerable to speculative attacks.
The biggest challenge for both the government and the central bank, therefore, is maintaining public confidence in the rupiah. With an 8.25 percentage-point differential with the U.S. funds rate, rupiah financial assets are still attractive for depositors and investors.
But given all the volatility and the uncertainty in the international financial market and the risk of the crisis taking a sudden turn for the worse, the rupiah could be severely hit as people may lose confidence in it.
In such circumstances, the interest rate differential would become less meaningful as depositors and investors may simply move their money to safer places (flight to safety).
Here lies the issue of the government guarantee for bank deposits, which is still limited to Rp 2 billion ($165,000) per account compared with the blanket 100 percent guarantee available in Hong Kong, Singapore and Malaysia.
But this issue is also directly related to the condition of the banking industry.
The Finance Ministry, which oversees the Deposit Insurance Corporation, seems not fully comfortable yet with the quality of the central bank's supervision of the 125 city-based banks and hundreds of secondary (rural) banks.
Introducing a blanket guarantee without strong supervision of the banking industry could put taxpayers at risk of having to pay out for another huge bailout as they did after the 1997-1998 banking crisis.
Banks will also have to brace for a new wave of nonperforming loans (NPLs), especially in areas such as plantations and mining, due to the steep fall in commodity prices between August and October.
This risk could slow down the pace of new bank lending, but not to the point of a severe credit crunch.
Given the grim prospects for private consumption and investment, government spending should take up the role of the locomotive of growth. An aggressive fiscal stimulus package must take up the slack, or the economy will plunge into the worst-case scenario of growth below 4 percent.
Fortunately, the government has fully understood the urgent need for pump priming to offset the anticipated sharp decrease in the growth of private consumption and investment.
The Finance Ministry has been accelerating the implementation of its investment program in labor-intensive projects such as infrastructure (for example, highways and rural infrastructure), with total spending expected to reach Rp 200 trillion within the next two months alone.
Most analysts agree that with a government debt-to-GDP ratio of less than 30 percent -- compared with more than 100 percent at the height of the crisis in 1998 -- and with a fiscal deficit of just around 1 percent of GDP, the government has a lot of leeway to increase its deficit spending next year.
Larger budget spending is needed not only for the construction of infrastructure but also for expanding the social safety net into public-employment works and providing assistance to financially distressed businesses in anticipation of a sharp economic downturn.
The problem is that almost half of the country's population of 227 million still lives on less than US$2 per day (the international poverty line). They live on the edge of the absolute poverty line, so that even a slight downturn in the economy could plunge a hundred million poor into abject poverty.
Given the tight international and domestic liquidity conditions, which make borrowing costs punitively high, the government made the right move in approaching the World Bank, Asian
Development Bank and bilateral sovereign creditors such as Japan and Australia for larger standby loans.
All in all, the economy will muddle through at a much slower pace next year. Growth could still hover at more than 4 percent if the government succeeds in implementing its pump priming measures and takes forceful and credible steps to maintain stability in the banking industry and the rupiah exchange rate.
