Indonesia and Trade War

KOMPAS/FERGANATA INDRA RIATMOKO

Vehicles pass along the Salatiga-Solo section of the Trans Java toll road at dusk in Boyolali Regency, Central Java, on Friday (31/5/2019).

”Uncertainty is an uncomfortable position, but certainty is an absurd one.” The sentence was said by Voltaire, the French philosopher, who liked to ridicule on anything. He is right, uncertainty is indeed disturbing. However, there is no single answer to this anxious life.

Amid the hopes of ending a trade war between the United States (US) and China, a few weeks ago US President Donald Trump said he would increase import duties for Chinese products.

China does not remain silent. They reply. The people\'s daily in China replied: We want to work together, but do not hesitate to fight until the end. Escalation of trade war increases.

Two pathways of impact

What is the impact on Indonesia? To answer this question, we need to look at the impact on two pathways: the trade path and the financial path. Trade path: the trade war will reduce the volume of global trade. Exports will decline, but the impact will vary in each country. Countries whose economic growth is heavily dependent on exports, such as Singapore, will be hit. However, Indonesia is fortunate because the source of its economic growth is more driven domestically.

KOMPAS/BAHANA PATRIA GUPTA

Passengers disembark form KM Dharma Ferry VII from Balikpapan, East Kalimantan, at Gapura Surya Nusantara Pier, Tanjung Perak Port, Surabaya, East Java, Thursday (30/5/2019). According to state port management company Pelindo III data, the number of Mudik travel passenger in 2019 on the route was estimated to increase by around 3 percent to around 467,730 people, compared to 454,059 people in 2018.

The data shows that the ratio of international trade in the portion of our gross domestic product (GDP) is only around 30 percent, far lower than Singapore\'s 200 percent of GDP. In such a condition, the impact of the decline in the volume of global trade will be limited on us. This is one of the factor that explains why Indonesia can still grow 4.6 percent -- the second highest among G-20 members -- when the global financial crisis hit the volume of world trade in 2008.

However, we need to be careful. The dreaded impact is its indirect impact. China is one of the centers of production networks in Asia. Many countries in ASEAN, including Indonesia, export semi-finished goods and raw materials to China. About 40 percent of Indonesia\'s exports to China are palm oil and coal. The slowdown in China\'s economic growth will reduce palm oil and coal.

Its implication: purchasing power, especially for regions were commodities and mining materials are produced such as Sumatra and Kalimantan, will decline. The impact: household consumption slows down. We had faced a similar situation in 2014-2015. Nevertheless, my guess is that this time the decline in commodity prices and energy will not be as bad as that time.

The decline in exports and consumption will result in the fall in investment. As a result, company profits will decline. Its implication: State revenues will also decrease. We have already begun to see these symptoms in the April 2019 state budget revenue. It could be predicted: The budget deficit will increase. Unfortunately, this increase in deficit is not due to fiscal expansion, but rather due to declining revenues. As a result, the impact on economic growth does not occur.

KOMPAS/RADITYA HELABUMI

Vehicles queue at the Cikampek main toll gate in the Jakarta-Cikampek toll road, Thursday (30/5/2019), at around 3:00 p.m. A one-way traffic control system began was applied starting from the Cikampek toll gate to Kilometer Market (KM)263 in West Brebes.

In short, we need to anticipate a slowdown in household consumption, government expenditure, investment and exports. Fortunately, the portion of international trade in our GDP is relatively small. Therefore, I think the Indonesian economy can still grow 5 percent or slightly below 5 percent.

Financial path: We see how financial markets and exchange rates have been shaken in the last three weeks. The thing to pay attention is the contagious effect. It is true that the US and Chinese financial exposure here is relatively small. However, don\'t forget, many investors are investing in the US, Europe, Asia, and China, who also invest in Indonesia.

When they experience losses in the US or European or Chinese markets, they will make portfolio adjustments by withdrawing a part of their money from Indonesia. As a result, the rupiah will weaken, financial markets will be hit. Carmen Reinhart from Harvard University called this contagious effect is caused by common creditors.

Other risks? What if China sells its US Treasury bonds in retaliation to the US? The amount is more than US$1 trillion. If this happens, interest rates in the US will skyrocket due to rising bond yields. The US dollar will strengthen, while US exports will be hit. As a result, the US economy will be hit. The world financial market will collapse. Will China choose this path?

AP PHOTO/ERIC RISBERG

A Cosco Shipping container ship passes the Golden Gate Bridge Tuesday, May 14, 2019, in San Francisco bound for the Port of Oakland. The United States and China are raising tariffs on tens of billions of dollars\' worth of each other\'s imports, escalating a trade war, spooking financial markets and casting gloom over the prospects for the world economy.

During a meeting at the Astana Economic Forum, at Khazakstan last week, which was attended by many world leaders and economists, we discussed this scenario. Justin Lin, a Chinese economist, former World Bank chief economist, said China would not do that because China knew about its impact on the global financial market. However, Stanley Fischer, the former deputy of the Fed, and Maurice Obstfeld, former chief economist of the International Monetary Fund (IMF), said it was too early to conclude whether China would not do that.

In a state of urgency, everything can happen. However, I tend to agree with Lin -- even though due to other reasons. In my opinion, China will not release all of its US Treasury bonds because it will drop the price of the bonds they have and cause huge losses for China itself. However, Fischer is right, we never know China\'s reaction.

For me, China\'s more realistic response will be to carry out monetary expansion to weaken its exchange rate. The goal is to maintain export competitiveness. If this happens, I suspect that the emerging market currencies, including the rupiah, will be under pressure, and so is the financial market. If later the Fed responds with the same policy, the risk of exchange rate war (currency war) will increase.

Several steps

Then what can be done? The ideal answer is to strengthen our economic structure by increasing productivity. However, this requires outside lag. With time constraints, what policies might be implemented immediately?

AFP/FREDERIC J BROWN

Shoppers at an outlet mall exit a Nike store on May 21, 2019 in Los Angeles. - More than 170 shoe companies and retailers, including Adidas, Nike, Skechers and Under Armour, have warned US President Donald Trump against a trade war with China, warning of the "catastrophic" effects his proposed 25 percent tariffs will have on the US economy, consumers and companies.

First, do a contra-cycle policy. In a difficult external condition, the domestic economy must be encouraged. We know fiscal space is limited because of declining state revenues. Therefore, the focus of fiscal stimulus is for people who have high marginal propensity to consume (MPC) and marginal propensity to import. What is that? Family Hope Program (PKH), cash-intensive work, direct assistance, labor intensive training (cash for training or pre-employment cards).

Increased consumption will drive production in the short term. As a result, investment also increases. Another thing is to take advantage of tourism potential. Tourism has a high multiplier effect.

Second, I do not see much room for monetary policy. If BI raises interest, to maintain rupiah stability, the economy will get worse. It would be better for us to accept a slightly weaker rupiah to maintain the competitiveness of our exports.

However, other countries\' currencies, including China, have also depreciated against the US dollar. What needs to be maintained is excessive volatility, not keeping the level of the exchange rate (pegging the level).

CHINATOPIX VIA AP

In this Tuesday, May 14, 2019, photo, a worker prepares exercise clothes for export at a clothing factory in Quanzhou in southeastern China\'s Fujian Province. China\'s factory output and consumer spending weakened in April as a tariff war with Washington intensified, stepping up pressure on Beijing to shore up economic growth.

Is there room to lower interest? It depends on the condition of our current account deficit, inflation, and the Fed\'s interest rate. Fischer, in Astana, doubted that the Fed will reduce interest this year because the economic situation in the US is still relatively strong.

The same thing was also expressed by Janet Yellen, a former element of the leadership of the Fed, when meeting to discuss the global economic situation, last April in Washington DC. If Yellen and Fischer are right, there is not much room for Bank Indonesia (BI) to reduce interest rates. Moreover, Indonesia\'s trade deficit is still relatively large.

Nevertheless, in my opinion, if the US economy deteriorates due to the trade war, there is room for the Fed to lower interest rates. In this condition there is room for BI to reduce interest rates.

Third, crisis is an opportunity. A trade war will force investors to relocate investments from China to other countries in order to access the US market. Just look at foreign investment (PMA) in Vietnam which is increasing for electronic products. Likewise, Thailand in terms of automotive and Bangladesh for apparel.

KOMPAS/RIZA FATHONI

President Joko Widodo, accompanied by Industry Minister Airlangga Hartarto (second right), tries a light truck produced by PT Kiat Mahesa Wintor during the Indonesia International Motor Show 2018 at JI Expo, Kemayoran, in Jakarta, on Thursday (19/4/2018). During the opening of “Your Infinite Automotive Experience” motor show, the president said Industry 4.0 could lead the auto industry to technology development and open more opportunities.

Indonesia must use this by attracting foreign investment into Indonesia. Accelerate the revision of the negative investment list, accelerating the revision of the Manpower Law regarding severance pay. Simplify regulations and maintain consistency among government institutions and between the central and regional governments in terms of licensing.

Fourth, I suspect, the tension between the US and China is more than just a matter of trade. It will spread to other problems, including competition about digital technology. This is a matter of rivalry between two world economic giants.

Therefore, it will last a long time. That is why short-term policies must be combined with medium-term policies, such as product diversification and export destination countries and increasing productivity. Take advantage of the intra-industry trade of ASEAN and East Asia. This will not be able to replace the volume of global trade. However, the volume is quite significant.

In a situation like this, open regionalism must be emphasized.

This is indeed not an easy period. We don\'t know exactly how the world must be written today. Changes are so fast. Uncertainty is so certain. We are restless because we are unable to tame ignorance. Uncertainty is indeed annoying. However, we know: there is no single answer to this anxious life.