Creating a New Growth Model

The Kompas daily held a panel discussion on the economy titled "Anticipating and Facing Volatile Economic Conditions" on June 6, 2018 at its editorial offices. The panelists comprised Bank Indonesia (BI) senior deputy governor Mirza Adityaswara, Indonesian Food and Beverage Association chairman, (GAPMMI) Adhi S Lukman; the chairman of the Indonesian Hotel & Restaurant Association (IHRI) Hariyadi B Sukamdani, Kalbe Farma president director Vidjongtius, Citi Indonesia economist Helmi Arman, and University of Indonesia economics lecturer Faisal Basri as moderator. Following is an excerpt from reports of the discussion, prepared by Ninuk M Pambudy, Dewi Indriastuti, Andreas Maryoto and FX Laksana AS. Related articles appear on print edition pages 24 and 25.

KOMPAS/PRIYOMBODO

A teller counts out 100- dollar US bank notes on Friday (2/3/2018) at the Bank Mandiri cash center in Jakarta. The rupiah continues to weaken against the US dollar.

Prior to the Kompas economic panel discussion, the central bank twice raised its benchmark interest rate, the 7-day reverse repo rate (7DRRR). The first hike of 0.25 percentage points (pp) was on May 17 and another hike of 0.25 pp was imposed on May 30. BI again raised the 7DRRR by 0.5 pp on June 30. BI\'s move was surprising, yet necessary, to stabilize the domestic financial market.

The rupiah has been under pressure since April 20 amid the strengthening US dollar. The Indonesian currency, which was then worth Rp 13,770 per US dollar, has continued to decline. According to the Jakarta Interbank Spot Dollar Rate (Jisdor) on Tuesday, the rupiah fell to Rp 14,418 per US dollar from Rp 14,331 per dollar the previous day.

BI’s move on June 30 to raise the benchmark interest rate by 0.5 pp strengthened the rupiah only slightly from Rp 14,404 on June 29. After that, the Indonesian currency weakened again. This raises a disturbing question as to whether the rupiah depreciation is short term, or if it points to a structural problem.

External factors will definitely not end in the short term. It might last even longer if American President Donald Trump sticks to his policy to impose import tariffs on goods from countries with which the US has a trade deficit.

The trade war has begun to affect the global economy. The People’s Bank of China plans to reduce the reserve requirement ratio imposed on state and public banks to ease the impact of the US trade restriction. This has caused a fall in the renmimbi. China\'s economic growth is expected to fall from 6.8 percent to 6.5 percent.

The rupiah pressures increased partly due to the normalization of the US and EU economies through hikes in their respective benchmark interest rates. This year, the US Fed is expected to raise its benchmark interest rate twice more to 3 percent, with an inflation target of 2 percent. Currently, the Fed rate is in the 1.75-2 percent range, compared to 1.5-1.75 percent previously.

AFP PHOTO/NICHOLAS KAMM

US President Donald Trump waves after speaking about taxes in the White House’s East Room in Washington, DC, on June 29, 2018 on the occasion of the six-month anniversary of his tax cuts.

Structural

A number of global currencies have fallen more steeply than the rupiah. The challenge for Indonesia is in how to reverse the situation so it can benefit from the ongoing global economic transformation.

Many economic observers share the opinion that Indonesia has a structural problem, as indicated by the current account deficit it has suffered since 2012. There are several causes for the deficit.

In the last 15 years, Indonesia has seen two major cycles of economic growth. The country’s economic growth fell to its lowest level in 2009 following the 2008 global financial crisis. The second cycle was in 2014, from the impact of the sharp drop in commodity prices on the world market in 2013.

The consumption sector has been the main driver of economic growth since 1998, despite the budget deficit. About 60 percent of the deficit is financed by foreign investment, including foreign direct investment (FDI) in the industrial sector.

However, due to the absence of a high-tech industry and the lack of intermediate and supporting industries, the country’s manufacturing industry still relies heavily on imported raw materials.

The need for foreign exchange is increasing as foreign investors repatriate their dividends, while manufacturing products are intended for the domestic market. The condition has led to an increase in foreign debts. The need for foreign exchange reserves continues to increase from year to year, either to pay off debts or to pay dividends.

It must be remembered that economic growth in China – a major export destination for Indonesian commodities – has fallen to 6.5 percent from about 10 percent at the beginning of the decade.

The 2016-2017 increased commodity prices are unlikely to reach pre-2013 prices, so it is difficult to rely on commodity exports to cover the shortage in foreign exchange reserves.

Industrialization and exports

The weakness in the real sector, especially the manufacturing industry, has caused the rupiah to be more vulnerable to global uncertainties. Indonesia does not have many options but to change its development model to diversify its industrial goods exports.

If the economy is projected to grow annually by 5 percent over the next five years, exports must grow by more than US$10 billion a year (including spending on raw material imports). If the economy targets 7 percent growth, exports must grow more than $20 billion a year on average.

The lack of foreign exchange reserves cannot be covered only by revenues from the tourism sector, which is estimated at only $1 billion a year, or from the base metal industry. A paradigm shift in the economic policy requires a strategy.

REUTERS/BRENDAN MCDERMID

A trader stands in front of a monitor broadcasting the Fed Rate hike on June 13, 2018 at the New York Stock Exchange (NYSE) in New York City.

First, it is necessary to understand the global supply chain so that local industries are able to more effectively increase their foreign exchange earnings from exports.

China, for example, has relocated its labor-intensive industry to other countries. South Korea and Japan have also relocated their industries from China upon the fears that China might “steal” their technology. Unfortunately, it is Vietnam, followed by Thailand and Myanmar, that has seized the opportunities from the move.

To open new markets, Indonesia urgently needs to establish free trade agreements in products which Indonesia, as a tropical country, has a better competitive advantage, such as agricultural and fisheries products, as well as those produced in the plantation, mining, creative economy and tourism sectors.

However, wage and labor issues remain a major challenge. Indonesian wages, according to surveys among foreign investors, are higher than those in neighboring countries.

In addition, legal uncertainties also remain a problem for investors, as regulations change frequently. The government\'s measure to introduce tax incentives for export-oriented industries should be appreciated. However, they are yet to be implemented.

With the upcoming 2019 election year, the people hope that the government will continue to focus on driving the economy, especially through immediate and concrete measures. If its response is slow, the current account deficit will only continue to grow.