Paul Donovan, London
After several years of running above trend growth, the world economy in 2008 is expected to slow. What is important is that the nature of the slowdown is likely to change, and this change does have implications for the Indonesian economy.
For the first nine months of 2007, the slowdown of world growth was quite narrowly focused. The chain of events was: U.S. house prices fall; U.S. mortgage refinancing falls (less credit to the consumer); U.S. consumption weakens; U.S. growth weakens. The consumer, who had been growing at 3.9 percent (annualized) at the start of the year, had slowed to 2.7 percent by the fourth quarter.
For Indonesia, and indeed much of Asia, this sort of U.S. slowdown was not a major problem. Mortgage refinancing was the critical link in the chain, and mortgage refinancing is generally used to raise funds for specific sorts of purchases. Cars and home improvements are impacted, and some other expensive items (what economists call “big ticket” items). A consumer is unlikely to refinance their mortgage to purchase a mobile phone (for example). Many of the goods that Asia exports to America, and which Indonesia exports directly or indirectly, were unaffected.
However, the crisis of confidence in credit markets has changed things in two ways. First, this is no longer about American cars and home improvements. Credit standards have been tightened across a range of credit forms.
In spite of official, policy interest rate cuts there have been rising interest rates on several forms of consumer debt. Households are starting to retrench their spending on a wider range of items (in the critical holiday sales weekend that follows the Thanksgiving holiday, spending per person actually fell).
Second, the crisis of confidence in credit markets has expanded the geographical reach of the economic slowdown. Higher credit market interest rates are starting to reduce consumer sentiment in Europe — for instance, both Spanish mortgage rates and German small business borrowing rates are linked to money market interest rates, not to the ECB’s policy interest rate. As European sentiment slows so demand for exports from Asia will slow.
One of the questions most asked of economists in recent months is “can Asia decouple?” In one sense, the answer is a clear and unambiguous “no”. The economic slowdown in 2008 is a broader slowdown. More sectors of the U.S. economy are affected as the credit tightening becomes more general. More economies among the OECD countries are affected as credit tightening starts to affect them for the first time.
It is simply implausible to suggest that the exports of Indonesia, or the wider Asian region, can remain unaffected in the face of slowing demand. Of course, demand growth is still positive — this is not about declining exports. Nevertheless, as the OECD dips below trend we have to expect that Indonesian exporters will feel the negative consequences.
However, there are compensations. Exports are not the only source of growth in an economy, and domestic factors can help to offset the softening global environment. To date, this has not been much of a help for Indonesia.
In recent years the attempts by policy makers to keep inflation under control have resulted in domestic demand being a drag on growth, not a positive contribution. Indonesian domestic demand in 2008 is likely to run at around the same pace of growth as it did in 2007. This is not bad news, of course, but it does suggest that the domestic economy is unlikely to power growth higher in 2008.
An additional offset for Indonesian growth is the fact that 53 percent of Indonesian exports in the last 12 months have been commodity related. This means that commodity, not final consumer demand is what matters for Indonesia. While the OECD economies are slowing to below trend rates of growth, these are not the commodity intensive countries of the world economy. It takes (for instance) more oil to generate one percent of economic growth in China than it does to generate one percent of economic growth in the United States.
Thus, China’s economic growth is likely to be more important in determining commodity prices than is the growth of the United States. Non-OECD demand is also likely to slow in 2008, and 47 percent of Indonesian exports are not commodities, so decoupling is not likely to be total. However, the level of commodity demand is unlikely to fall as much as is the demand for consumer goods.
While the commodity story will help to limit the damage of a slowing economy for Indonesia, it is important to recognize that even commodity demand will slow. This can help Indonesia, however, inasmuch as the slowing commodity demand suggests that the world oil price will fall in 2008.
Indonesia, as a net oil importer, therefore gets a benefit (a higher oil price transfers money away from net oil consumers like Indonesia, and gives it to net oil producers like Saudi Arabia). We are expecting oil to average US$75 per barrel in 2008.
The world therefore provides a somewhat complex backdrop for Indonesia in 2008. The global growth slowdown is broadening in scope, from the relatively narrow and parochial slowdown of U.S. consumption that was the hallmark of the first nine months of 2007. Growth is slowing below trend in the OECD and to trend in the rest of the world. The range of products that will be affected are broadening, as the effects of the credit slowdown similarly broaden.
Balancing these different forces is likely to require a delicate approach from Indonesian policy markers, with interest rates being held unchanged (even as the U.S., Europe and the UK all cut interest rates). UBS expects Indonesian growth will average 6.5 percent in 2008 — little changed from the 6.3 percent of 2007.
However, steady growth at a time of a global economic slowdown is a notable achievement. Similar relative stability is seen for the rupiah, with the end year forecast of 8,800 against the U.S. dollar likely to be of little concern to Indonesian businesses (especially as the dollar is likely to weaken against other Asian currencies over the course of the year).
The writer is Managing Director of Global Economics, UBS Investment Bank. This is a personal view. He can be reached at paul.donovan@ubs.com.
