Winarno Zain, Jakarta
The economic turbulence that swept the global economy in the last quarter of 2007 will cast shadows on the Indonesian economy in 2008. Unleashed by the jump in oil prices and the sub-prime mortgage crisis in the U.S., the turbulence will test the resilience of the Indonesian economy, barely two years after it took the drastic step of hiking fuel prices by more than 100 percent.
Oil prices and the sub-prime credit crisis in the U.S. would adversely affect Indonesian economic growth in 2008, although the severity of the effect will depend on the strength and the vulnerability of the economy. The downside risk could also increase if oil prices keep rising and the sub-prime crisis in the U.S. runs deeper than forecasted.
The outbreak of the U.S. sub-prime crisis has had little impact so far. Preliminary indications suggest that direct exposure of Indonesian financial institutions to sub-prime risks are relatively limited, although the risk may increase if the global instability and tightening of credit markets associated with the crisis intensifies. The main transmission channels to Indonesia so far and to other emerging economies in the aftermath of the sub-prime crisis have been heightened uncertainty and reassessment of risk, reflected in stock price declines, the depreciation of the currencies, and the widening of sovereign bond spreads
The Indonesian economy may have acquired some strength from recent improvements in its macroeconomic fundamentals, but whether these improvements will be sufficient to weather the adverse impact of the global downturn will depend on the steps taken by the government.
A number of factors should continue to support the resilience of the economy. The balance of payments is now stronger than in the past due to robust export growth and capital inflows. Current accounts surpluses have reached a record level of US$10.8 billion and foreign reserves rose to $53 billion at end of September, also a record level. This should make the economy less vulnerable to sudden volatility in capital flows.
Domestic demand is still strong, and there are signs that investment has started to pick up. Sales and the earning growth of Indonesian companies remain strong as shown in their third quarter financial reports. Some companies have acquired plenty of cash, enough to support further investments.
The Indonesian economy has been less dependent on the U.S. economy in recent years, thanks to its buoyant trade with other Asian countries. Indonesian non-oil exports to the U.S. only rose 5 percent up to September last year, the lowest increase compared to those in other countries. Exports to the U.S. as a percentage of total exports declined to 12.5 percent last year from 14.3 percent in 2005. On the other hand, exports to some Asian countries like Singapore, Malaysia, China and South Korea have been growing at double-digit rates.
But the quality of growth in third quarter of 2007 was less solid than it appeared to be. It is true the economy grew at 6.5 percent in third quarter year-on-year, which was higher than growth in previous quarters. But the growth was largely due to unusually high growth in agriculture, which reached 9 percent. It should be noted that this spurt of growth in agriculture was a one-time phenomenon, resulting from the cyclical nature of prices and weather and will not automatically repeat itself in the subsequent periods.
Normally, agriculture grows at only 2 percent, and if it grew at this level, economic growth would have been only 6 percent. What is worrying is that the growth of core economic sectors like manufacturing and mining actually fell in the third quarter. Growth in the manufacturing sector declined from 5.5 percent in the second quarter to 4.5 percent in the third quarter, while mining growth declined to 1.8 percent from 3.4 percent in the previous quarter.
Higher oil prices will also be a drag on the Indonesian economy, as they affect corporate earning growth and government budgets. The oil price reached $99.26 per barrel in mid-November 2007, almost the same level in real terms as in 1979, the highest in history and reached during the Iranian revolution. In the short term, prices will pull back due to some temporary factors. But supplies will remain tight in the long term, and it is unrealistic to expect prices to drop[ below $70 or even $80.
Indonesian companies will not be able to pass on cost increases to consumers, curbing their ability to maintain earning growth, thus depriving them of the ability to undertake further investment. Deficits in the government budget will mount, as the government tries to avoid raising domestic fuel prices. This could undermine fiscal sustainability and market confidence and result in volatilities in capital flows and exchange rates.
The government is taking steps designed to cover the mounting deficit in the 2008 budget should oil prices hit $100 per barrel. The plan includes reprioritizing government spending, cost saving, efficiency improvement and the use of regional government surpluses. Rationing gasoline sales to private cars is being considered. But a decision to increase fuel prices has been ruled out.
The government’s plans could preserve consumer purchasing power and spending, preventing the economy from sliding further. But the risk of fuel supply disruption increases if oil prices continue to rise. As the gap between market prices and subsidized prices widen, hoarding and smuggling of subsidized fuels will become widespread, disrupting supply, and making life difficult for millions of people. It was chaotic fuel supply and distribution in 2005 that finally forced the government to raise prices substantially. If oil prices stay high for a prolonged period it is not unlikely that the drama in 2006, where the government was forced to make drastic and painful adjustments in fuel prices, will repeat itself.
The best defense against the global economic slow-down would be more incentives for investments. Since cost increases would be the main challenge for the business sector, it is imperative for the government to make doing business in this country less costly. Improving infrastructure, streamlining bureaucratic procedures, reducing taxes and duties for several sectors, combating graft and corruption, are more urgently required now than ever before. The government should address immediately complaints from the business community regarding legal uncertainties. These measures have to be taken seriously to moderate the impact of a global slow-down on the domestic economy.
So the hope is that the impact of higher oil prices and the sub-prime credit crisis in the U.S. will not be prolonged and protracted, and that a severe slow-down in global growth can be avoided. It is possible that the Federal Reserve will continue its current monetary stance to ensure enough liquidity on the market .But still, the consensus forecast envisages the weakening of the U.S.’s GDP growth this year to 1.8 percent, a full one percentage point drop from last year’s estimated GDP growth.
By looking at past U.S. economic slow-downs and their impact on the growth of emerging markets, the World Bank found that real GDP growth in emerging economies drops by 0.5 percent for each 1 percent drop in U.S. GDP growth. For Indonesia, this could translate into Rp 25 trillion in losses in GDP at current prices in 2008, should the fall out from sub-prime credit crisis remain unabated. A Rp 25 trillion loss in GDP for Indonesia is not a disaster, but it is still significant.
The writer is an economic analyst.
