Strategy to Face Global Crisis
The increase in international interest rates is the result of major countries ending their liquidity-pumping policy, or Quantitative Easing, to recover from the 2008-2009 global financial crisis. The central banks bought state bonds and high-quality private securities through QE.
Five recent issues have the potential to cause new international economic turmoil.
They are: 1) increase in international interest rates; 2) increase in world inflation; 3) high debts among businesses, individuals and governments in several countries; 4) President Donald Trump\'s unilateral and protectionist trade policy that goes against WTO rules; and 5) reduced US income tax.
The increase in international interest rates is the result of major countries (especially the US, Japan, the European Union and Britain) ending their liquidity-pumping policy, or Quantitative Easing (QE), to recover from the 2008-2009 global financial crisis. The central banks bought state bonds and high-quality private securities through QE. The US government also strengthened the capital of financial institutions, insurance companies and General Motors (GM), the car manufacturer that was bailed out after filing for bankruptcy during the crisis.
As for the US trade policy, the US is no longer the driving force for world economic liberalization under the Trump administration, as reflected in its cancellation of the Trans-Pacific Partnership (TPP), its modified North American trade agreements with Canada and Mexico and its protectionist stance. The increased US tariffs on steel and aluminum imports has triggered a trade war with its partners, which has worsened the situation.
Meanwhile, the reduced US income tax will suck up investment and cause capital flight from the rest of the world to the US. Initially, capital flowed out of the US because of its comparatively low interest rates. Basically, the US has become more attractive to world investors because aside from having the most stable political and social conditions, its money and capital markets are also the largest and deepest. In contrast, capital outflows among countries will cause foreign exchange rates to fluctuate.
To deal with these various international uncertainties, Indonesia needs to improve the resilience of the domestic economy while expanding exports to non-traditional trade destinations.
End of QE
There has been a flood of liquidity because QE has lowered lending rates to nearly zero percent, even reaching negative figures in countries such as Japan and Norway. This means that depositors no longer receive interest on their bank deposits, and must instead pay to store their money. The lower interest rates in developed countries have caused capital flight from those countries. One of the causes of global capital flight is the difference in effective interest rates.
The objective of QE through lowering the interest on loans and deposits is to strengthen the capital of financial institutions, including banks, and to stimulate public spending for both consumption and investment. Low interest rates increase public lending for both businesses and individuals, as do state loans. Another objective of expanding liquidity is to increase the inflation rate to provide incentives for producers of goods and services.
As the financial health of financial institutions and the business world improve, developed countries gradually end QE.
Companies that have borrowed capital start paying off their government debts, and central banks start reselling state bonds and corporate shares they have purchased. The central banks reduce banking credit while increasing the interest rates on bank loans. The central banks\' balance sheets are expected to normalize within four years, with greatly reduced portfolios in government bonds as well as corporate stocks and bonds.
The tightening liquidity and selling state and corporate bonds has started to increase interest rates. Interest rates first start increasing in developed countries that have stopped QE and then spread throughout the world. In turn, the increased interest rates make it difficult for debtors because it raises the debt burden for individuals, businesses and governments.
Global capital flows affect foreign exchange (forex) rates, which in turn affect prices, labor wages and effective interest rates. The latter is the amount of nominal interest rates and the percentage of change in currency exchange rates.
We have felt the impact of global capital flight in Indonesia due to the difference in interest rates after QE ended. The combination of QE, capital inflow and the reduced US income tax continues to strengthen the US dollar. As a result, the rupiah and the currencies of other countries continue to weaken. On the one hand, the increase in interest rates abroad and the weakening rupiah will be a burden for those who have foreign currency debts. For example, the rupiah declining more than seven times in 1997 led to widespread bankruptcy in the private sector and the government carrying huge foreign currency debt.
The burden is even heavier if the foreign currency debts are short-term loans used for long-term infrastructure development projects such as telecommunications, electricity, toll roads and property development offering long-term, rupiah-denominated installments. Economists refer to this as a foreign exchange risk in the currencies between the credit terms and returns.
On the other hand, if it can be utilized, the weakening rupiah should offer incentives in increasing exports and tourism and in reducing imports. Exporters and producers earn more rupiah from each foreign currency unit they generate. Hotel rates, transportation and food and beverage services are becoming cheaper when measured in foreign currency. In contrast, imported goods priced in a foreign currency will become more expensive in rupiah. The cost of umrah (minor pilgrimage) and overseas travel also becomes more expensive in rupiah.
What must be done?
Several things can be done to strengthen Indonesia\'s economic fundamentals to overcome the various uncertainties above. First, monitor the health of financial institutions, companies and the government more carefully. In particular, the Financial Services Authority (OJK) needs to be more observant and strict in implementing prudent rules for banks, insurance and other financial institutions to prevent the recurrence of a financial crisis as in 1997-1998.
The government no longer provides assistance to improve the financial condition of financial institutions (bail out). Under the new rules, the financial institutions are responsible for improving their own financial conditions (bail in).
Meanwhile, Bank Indonesia (BI) needs to monitor corporate loans. The government also needs to refrain from making foreign loans to build lighthouse projects. An example of a lighthouse project is the construction of a train with a speed of 500 kilometers per hour spanning 180 kilometers from Jakarta to Bandung.
Second, the government needs to restore state financial institutions to their original functions and modernize them. Economic science believes that fair market competition is the best way to stimulate efficiency and modernization in state-owned enterprises, and not through overprotective measures such as market protection and privileges.
In terms of their assets and number of branch offices, Indonesia\'s financial industry relies today on four state banks (Mandiri, BNI, BRI and BTN) and Regional Development Banks (BPD) that depend entirely on government protection to exist. The state banks are inefficient and unable to compete with private banks, especially foreign banks, including Maybank and CIMB Niaga from Malaysia and the Development Bank of Singapore (DBS). Foreign companies control the national insurance industry while state insurance companies are increasingly marginalized.
Third, for business and income equality, BRI\'s function needs to be restored as a public bank serving small-and-medium business owners, cooperatives, farmers and fishermen to combat moneylenders. The Tabungan Pos Bank (postal savings bank; BTP) needs to be restructured to mobilize community savings and teach people to use modern financial institutions. Post offices are widely available throughout the country and at a much greater number than bank branches. Postal banks in Japan and Western Europe have greater assets than the largest private banks in those countries. Postal banks remain important in Singapore within its modern and advanced financial system. Japan funds government project and SMEs from funds mobilized by postal banks.
Fourth, increase tax revenues through enforcing taxation rules. Only by increasing the national income, including from tax revenues, can Indonesia emerge from its current status as a debtor country, despite its 73 years of independence. Government tax programs that are merely cosmetic have not produced the expected results, such as the tax amnesty, open banking and the international tax cooperation.
These programs are only for gathering information on taxpayers, their wealth and incomes. They will not increase tax revenues unless they are audited and compliance is enforced.
In terms of expenditure, the reform government has replaced the New Order discipline of a balanced fiscal budget with a discipline that applies on a fiscal basis as outlined in the 2003 State Finance Law. During the 32 years of the New Order government, all State Budget (APBN) deficits were closed with grants and loans from Western donor countries that were members of the Inter-Governmental Group on Indonesia (IGGI), which was later replaced by the Consultative Group on Indonesia (CGI).
Uner the Maastricht rules, government deficit is limited to a maximum 3 percent of gross domestic product (GDP) while maximum government debt is 60 percent of GDP.
Economic development strategy
Fifth, shift the economic development strategy towards an export-oriented development strategy. This strategy aims to achieve two dual objectives: increasing foreign exchange earnings from exports and generating employment and incomes for a dense population, especially in Java. This strategy needs a set of policies for improving economic efficiency and competitiveness in the global market: One, increase the rupiah’s real effective exchange rate (REER); two, draft a fiscal policy that is not distorted; three, draft structural policies that improve economic efficiency and productivity. These three policies will stimulate a production shift from the inefficient, non-traded goods (NTG) to the more productive and efficient traded goods (TG). NTG are oriented only towards meeting domestic needs; TG produce goods and services for the global market.
Export-oriented economic policies will encourage increased production and exports among industries that manufacture and process natural resource products that utilize labor-intensive technology that absorb surplus Indonesian workers that possess low education and skills. Increasing the efficiency and productivity of workers will increase incomes for export commodity producers. Export-oriented industries include textiles and garments, wood furniture, footwear, raw material processing for cooking oil and palm oil products, and automotive and electronics components and spare parts.
Foreign investment needs to be stimulated to develop exports because in addition to bringing capital and technology, foreign companies also open overseas markets. Why can the Salim Group and Sinar Mas export cooking oil, paper products and instant noodles, when SOEs are still unable to develop exports? Foreign capital inflows and increasing exports reduce foreign borrowing needs for Indonesia and instead, increase its ability to repay foreign loans.
To expand the export market, the Religious Affairs Ministry needs to oblige all umrah and haj pilgrims to wear locally made clothing, from ihram attire to veils, belts, skullcaps, prayer beads, sandals, and to eating and drinking implements. Using other colors and embroidery, the same veils can be sold to Catholic women in Europe for attending church. Indonesians also need to be encouraged to create partnerships with Saudi Arabian investors to establish land transportation companies, haj dormitories, inns and Indonesian hotels and restaurants in Saudi Arabia. Cakes from Garut and Kudus must be able to compete with the famous Turkish delight. National banks can also form partnerships with financial institutions in Saudi Arabia, Kuwait and other recipient countries of Indonesian migrant workers (TKI) to manage the pilgrims’ finances and help TKI transfer their money home.
Indonesian textiles, batik, handicrafts, bath soaps and laundry detergents are also highly popular in many African countries.
Logistics must be improved to reduce unnecessary production costs. It is necessary to control illegal road levies and facilitate processing at airports and seaports. Smoother logistics also provides shipping certainty.
Anwar Nasution, Professor Emeritus, Economics and Business School, University of Indonesia