Economic Vulnerability
The recent shock from the sharp depreciation of the rupiah against foreign currencies requires the government’s serious attention to prevent a severe economic crisis such as those of 1997-1998 and 2008-2009.
The recent shock from the sharp depreciation of the rupiah against foreign currencies requires the government’s serious attention to prevent a severe economic crisis such as those of 1997-1998 and 2008-2009.
The turmoil needs attention because since August 2013, Morgan Stanley has included Indonesia in the group of fragile five economies along with Turkey, South Africa, India and Brazil. Because of their poor balance of payments, the five countries’ currencies are highly vulnerable and sensitive to global economic shocks.
According to Rudiger Dornbusch, the late and prominent economics professor at the Massachusetts Institute of Technology (MIT), economic crises take a much longer time coming than we think, and then happen much faster than we would have thought.
Immediate government action is needed in handling the problem, because we cannot rely only on Bank Indonesia (BI). BI\'s ability to intervene in the foreign exchange market is highly limited, given its small volume of foreign reserves, totaling only about US$120 billion. This year, BI has used about $7 billion of its foreign reserves to halt the fast depreciation of the rupiah exchange rate.
Limited amount
BI can borrow a limited amount of funds under the Chiang Mai Initiative, a multilateral currency swap arrangement, from Japan, South Korea and China. Traumatized by the strict lending conditions the International Monetary Fund (IMF) imposed during the 1997 crisis, BI still avoids borrowing from that institution.
The attempt to lure foreign capital inflows by raising BI\'s benchmark interest rate also has limited impact. The interest rate hike makes it difficult for credit recipients to pay off their debts.
The low interest rate and the fall in stock prices and securities, including government bonds, encouraged foreign fund outflows from Indonesia.
By the end of March, foreign investors had sold $2.3 billion in government bonds and $1.6 billion of shares and transferred the sales funds abroad. The capital outflows severely hit the balance of payments.
Source of the problem
Indonesia\'s economic turmoil stems from changes in the economic policies of developed countries, especially the United States, the European Union, Britain and Japan. As a result of the increase in economic growth and inflation rate, the countries changed their monetary policy, which previously injected liquidity and lowered interest rates. Like Indonesia, all developed countries use inflation targeting in setting their monetary policies.
Under that policy, the central bank\'s benchmark interest rate was raised, as the inflation rate was approaching its target and the economic growth rate was reaching its growth potential.
The interest rate hikes in major countries caused an increase in the cost of international borrowing and reduced capital flows to developing countries, including the fragile five. The drop in US income tax rates attracted private capital investment to that country, including from developing countries.
As in 1997-1998, the combination of the interest rate rise in foreign loans and the fall of the rupiah exchange rate led to an increased burden in repaying foreign loans.
The interest rate hike and the rupiah depreciating by more than seven times since mid-1997 to early 1998 had led to all foreign debt recipients (government, banking, corporate and private) declaring bankruptcy.
The current problem is much more vulnerable than during the New Order era because today, a number of state-owned ministries and agencies, without coordinating, are being encouraged to tap into foreign debts to increase capital and to finance the construction of infrastructure projects.
What must be done
During the 32 years of the New Order (1966-1998), Indonesia\'s foreign borrowing was primarily sourced from official, long-term soft loans from donor countries grouped in the Inter-Governmental Group on Indonesia (IGGI). There was no export credit, let alone commercial credit.
Our ties with the IGGI was only controlled by a single person, Wijoyo Nitisastro, the chairman of the National Development Planning Agency (Bappenas). All IGGI loans and financial assistance were included in the State Budget (APBN) and were referred to as “development revenue”.
The IGGI loans and assistance were used only for development projects and were tightly overseen by Bappenas, which controlled the development budget. Through the State Budget, the House of Representatives (DPR) and the people could control the amount, terms or direction of foreign loans. This system no longer exists in the Reformasi era, because the DPR and the people no longer have full rights to the budget.
The government can take various actions to help BI curb the economic problems. The first action is to increase exports in order to boost foreign exchange earnings.
Indonesia sends the largest number of pilgrims to Mecca because the country has the largest Muslim population in the world. The hajj pilgrimage can be used to promote exports, as the trip requires air transportation to the Holy Land and land transportation during their stay there. The pilgrims, both men and women, also need special clothing to observe the pilgrimage, as well as food, lodgings and shopping for souvenirs.
During annual hajj pilgrimage and the minor pilgrimage (umrah), the pilgrims need special ihram clothing, abaya clothing, waist sashes, hoods, peci and turban to withstand the heat of the sun, as well as prayer beads and prayer rugs.
Until now, all Indonesian pilgrims don the special clothes made in China. In fact, the two-piece ihram clothing, veils, prayer robes and turbans can be produced in Indonesia, even by unskilled workers or elementary school dropouts, to raise exports and create jobs. It is therefore necessary to issue a regulation requiring hajj and umrah pilgrims to use domestic products.
By modifying colors and motifs, the same veil product can be sold to Catholic women in Europe who also wear veils to church.
Except for small stalls, no restaurants in the Holy Land sell Padang food (the cuisine of the Minang people in West Sumatra) or soto banjar (a type of soup) to serve Indonesian pilgrims.
Learning from Thailand, China and Malaysia, the Indonesian government needs to sponsor the expansion of Indonesian restaurants in the Holy Land. Dodol garut (fudge-like sweet) and jenang kudus (a type of porridge) should be sold there to compete with Turkish delight.
State-owned enterprises (SOEs) should be encouraged to increase exports. Palm oil exports can also be expanded to China and India, whose markets are more open. Why can the state-owned Padalarang paper factory, Leces, and the Aceh Kraft plant not compete with the Sinar Mas Group, which has already exported their paper products to foreign countries? Why can Indonesian fishery companies not compete with Thai companies that dominate the world canned tuna market? In fact, Indonesia is one of the largest sources of tuna in the world.
The second action the government needs to take is to increase domestic savings to reduce dependence on grants and foreign loans. In this regard, tax revenues need to be improved.
Indonesia has been independent for 73 years, but its tax revenue remains one of the lowest in the world, only 11 percent of the gross domestic product (GDP). As a consequence, the government has to print money and raise foreign loans to cover the budget deficit.
The people do not believe in state debts because in the past, they were often not paid off and eaten up by high inflation. The average tax-to-GDP ratio in developed countries is 35 percent, and 20 percent in developing countries. According to worldwide practices, the tax ratio can only be increased through law enforcement and not through a tax amnesty.
Domestic savings
The third action the government should take is to increase domestic savings by modernizing non-bank financial institutions, especially Bank Tabungan Pos (BTP), the bank owned by the state postal company PT Pos, as well as insurance, pension funds and securities firms. These non-bank institutions should be able to absorb long-term government bonds (SUN). Today, most of the assets and branch offices of financial institutions in Indonesia are dominated by the banking industry. The main players in the Indonesian banking sector are the four state banks – Mandiri, Bank Negara Indonesia (BNI), Bank Rakyat Indonesia (BRI) and Bank Tabungan Negara (BTN) – and a number of BPDs (local government-owned banks), all of which are unproductive and inefficient, and require government protection.
Local governments need to be encouraged to sell bonds to develop traditional markets, drinking water plants and other infrastructure facilities. The function and role of Bank Tabungan Pos (BTP, or postal savings) needs to be restored. PT Post, which has offices almost in all parts of the country, is no longer used to mobilize savings from the people and teach them to use modern financial technology.
These days, the BTP has turned into a state commercial bank and mortgage lender. In the European Union (such as the Netherlands and Germany) and Japan, the branch offices and the assets of their postal services are larger than commercial banks.
Postal savings in Japan is the country\'s largest buyer of government bonds and a major funder for small and medium enterprises (SMEs), as well as provides funds to finance strategic government projects. In Japan, postal savings funds are dubbed the “second state budget”.
The establishment of a social insurance company is also needed. The easiest way to establish a social insurance company is through a vehicle accident insurance company. Such accident insurance could reduce conflicts and fights from car and motorcycle accidents.
It should be realized that a monetary policy based on inflation targeting can work well only if it is supported by a conservative fiscal policy and the existence of healthy financial institutions with sufficient capital. Centralized control over foreign borrowings and their use needs to be restored. In order to restore the budgetary rights of the House and public disclosure, all information on the amount, source, terms and purposes of the loans’ use must be accountable and stipulated in the State Budget.
Anwar Nasution, Professor Emeritus, Economics and Business School, University of Indonesia