Indonesia came out of the 2008–09 global
financial crisis fairly unscathed; its banks only had to deleverage themselves
from a small portion of debt
But now its strong position is in danger: government
meddling could cause a good economy to go bad. The government should eschew
populism and fix Indonesia’s structural issues, including burgeoning fiscal
subsidies and inward-looking trade policies, which pose a big threat to the
country’s financial and monetary stability.
Rising oil demand in Indonesia due to a growing middle class
has made Indonesia a net importer of oil for some years now. For years, the
government responded by subsidising fuel and electricity. The problem is that
this expenditure will take up as much as 25.1 per cent of the 2013 central
government budget. This is far too much. Only 6.7 per cent of the central
government budget goes to social programs; and capital expenditures, which are
mostly spent on infrastructure, constitute only 15.7 per cent of central
government spending. Having a large fuel subsidy restricts Indonesia’s capacity
to spend in these growth-enhancing areas since Indonesia is bound by the terms
of the Maastricht Treaty, a fiscal rule that caps the government deficit at
three percent and the debt-to-GDP ratio at 60 per cent.
And ballooning oil subsidies are not just a fiscal problem.
Giving away fossil fuels to all the population increases inequality, degrades
the environment, discourages innovation in renewable energy and is a drain on Indonesia’s
balance of payments.
What’s more, Indonesia’s dependence on oil and gas imports
has made its trade deficit worse. Indonesia’s current account went into a 2.7
per cent deficit in 2012. Through mid-2012 most of the decline came from the
rapidly shrinking volume of exports in the non-oil and gas sector, followed in
more recent months by a widening of the oil deficit. The resultant annual trade
deficit in 2012 was Indonesia’s first since at least 1998.
In addition to the weaker external demand, the decrease in
export growth across the economy is also due in part to government policy.
Indonesia recently banned raw and semi-processed rattan exports, put an export
tax on 65 minerals and enacted some inward-looking import policies. The more restrictive
import policies, especially those that restrict imports of intermediate goods,
may have contributed to weak performance of exports. This is because one
ninth of total imports consist of intermediate goods that are
re-exported. Although the bulk of overall exports consist of domestic
value-added due to the high share of commodities, a significant share of manufactured exports consists
of imported value-added components.
Trade policies have also contributed to skyrocketing prices
on basic food items. In the spirit of ‘self-sufficiency’, since 2010 the
government has gradually re-introduced import quotas on a range of agricultural
products. The new licensing system and port-entry restrictions led food prices
to soar. For example, the prices of shallots climbed from US$1.20 a kilogram to
$7 in March alone, while the price of garlic tripled from around Rp.20,000 per
kilogram in January to Rp.60,000 in March. The garlic price increase shows just
how distortionary government policies are. Because almost 90 per cent of
Indonesia’s garlic comes from overseas, a domestic quota was always going to
cause a supply shortage and inflation.
Protectionist policies are especially unwise given weak
external demand. In 2012, exports to China alone declined by 5.6 per cent from
2011 levels — a huge turnaround, since China’s demand for Indonesian products
had been growing significantly for a long period of time. One reason could be
that China recently put restrictions on imports of low-quality coal, which
makes up about one-third of Indonesia’s coal export to China. In the context of
this restriction and China’s new growth model, Indonesia’s weak export
performance could be a structural problem.
These policy decisions have already had broader social and
economic effects. The across-the-board increase in food prices led the poverty
basket inflation rate to increase from its near three-year low of 5.3 per cent
in November 2012 to reach 6.1 per cent in February 2013. And Standard and Poor downgraded its outlook on Indonesia’s credit
rating based on the continuing pressures on the fiscal budget from fuel
subsidies, the threat of inflation and the widening current account deficit.
As a reaction to threats to macroeconomic stability —
including downgraded growth, which the World Bank projects will be less than 6
per cent in July 2013 — some government agencies and the central bank have
begun to reverse some of their policies. But merely backing away from
protectionism is not enough. Indonesia needs to bring systemic change to its
economy.
Structural, rather than cyclical, fiscal and trade issues
have complicated monetary management, including inflation, exchange rate,
Balance of Payment, and interest rates, and have led to ineffective and
costly monetary policies. China’s new lower growth norm and its trade
restrictions on low-quality coal, as well as forecasted lower prices for
commodities, may make it necessary for Indonesia to make structural changes so
as not to rely too much on exporting raw commodities to big emerging markets,
like China, anymore. Higher quality fiscal spending and good monetary
management, including finding the right balance between higher inflation,
higher interest rates, a depreciating Rupiah and lower growth will be keys to a
smooth structural transition while maintaining monetary stability. The
most recent portfolio outflow as a result of the Fed winding down its
quantitative easing measures and fiscal stimulus, as well as increasing its
interest rate, has reminded us of the integrated global banking and financial
system we have and its many transmission channels of monetary policies from one
country to others. Not only will the Central Bank play a crucial role, but
the new Financial Services Authority in charge of prudential banking
supervision will also play a key role in financial stability. Foreign
direct investment has also shown signs of weakening prompting a better
investment climate, including revising the rigid labor laws.
Indonesia’s economy remained insulated from the 2008–09
crisis, which was partly helped by high commodity prices and capital inflows
driven by monetary expansion in some developed countries, but whether that was
good economic management or pure luck is uncertain. Now, Indonesia’s economy is
exposed to the destabilising effects of populist domestic politics and a lack
of leadership. A bad economy is said to cause political instability. But
Indonesia shows that causation goes both ways: bad politics can lead to
economic instability.
Maria Monica Wihardja is a lecturer at the Department
of Economics, University of Indonesia, and a former
researcher at the Centre for Strategic and International Studies,
Jakarta. She is also Associate Editor at the East Asia Forum Indonesia desk.
This article is based on the Think Tank 20 Report to be
published by Brookings Institution and other Research Institutions in late
August 2013.
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