Allaying the Specter of Recession
The United States is approaching recession. However, we must wait for economic growth data for the third quarter of 2019 to confirm this. Economic growth in the second quarter of 2019 slowed significantly to 2.1 percent.
The United States is approaching recession. However, we must wait for economic growth data for the third quarter of 2019 to confirm this.
Economic growth in the second quarter of 2019 slowed significantly to 2.1 percent year-on-year (yoy) from 3.1 percent in the first quarter.
A recession is defined as a significant decline in growth over two consecutive quarters. Data from the financial sector and the real sector are showing convincing signs that the US appears to be in a heading towards imminent recession. The interest rates for short-term US government bonds have been higher than long-term bonds since mid-year (inverted yield curve). The declining trend is appearing in several other indicators aside from economic growth, including the purchasing managers’ index (PMI), the Cass Freight Index (on the trucking industry) and the business confidence index (BCI).
China is also starting to show signs of slowing. Growth declined from 6.4 percent in Q1 I to 6.2 percent in Q1 2019, the lowest in three decades. Exports have dropped 1.3 percent yoy. Some studies predict that China will enter the below 6 percent growth rate of around 5.6 percent yoy in the next quarter. China also allowed the exchange rate to depreciate below 7 yuan per US dollar. It is currently 7.15 yuan per US dollar. This weakening compensates for the decline in the competitiveness of Chinese exports to the US due to the tariff hikes.
What is important is that some macroeconomic indicators remain unconvincing in pointing to an imminent recession. The US still created 164,000 jobs in July, which maintained unemployment at 3.7 percent. In China, the government began encouraging domestic consumption as a counter-cyclical policy to withstand the slowdown in the world economy. Retail spending, including motor vehicle sales, grew 9.8 percent yoy in July from 8.6 percent yoy in June, although it must be admitted that this was due to a massive discount program. Nevertheless, people began to reduce their spending on travel, dining and other leisure activities and divert them to consumption goods.
Spending on infrastructure projects increased from 2 trillion yuan to 4 trillion yuan to compensate for the decline in exports, which has been the engine of Chinese growth. The term “specter of recession” shows that expectations lean towards a global recession, especially as a result of the ongoing US-China trade war, which shows no signs of ending. This affects exports and investment behavior throughout the world.
The impact of the world economic slowdown on Indonesia is most noticeable in the balance of trade.
US consumption and unemployment data convinced Trump to continue with the trade war to gain concessions from China, especially for intellectual property rights and capital market access. He seems confident that the US economy will remain resilient until the presidential election in November 2020, when he plans to be reelected to a second term. On the other hand, China is holding its position, believing that the US economy will slow and thus, Trump will not be reelected. Trump\'s successor is expected to resume trade negotiations.
The situation is in a deadlock, like the children’s game of “chicken”, an age-old staring contest in which the one who blinks first loses. There is a glimmer of hope that an initial agreement will be reached at the upcoming US-China meeting in October. However, it seems that the business community remains pessimistic about the possibility of a positive outcome, so the recession could arrive earlier in 2020 and last until 2021.
Mitigation
The impact of the world economic slowdown on Indonesia is most noticeable in the balance of trade. In the years following the commodities bonanza, the trade balance usually remained in surplus, even though the current account remained in deficit due to a weak balance on services. However, the 2018 trade balance recorded a deficit of US$438 million compared to the $18.81 billion surplus recorded in 2017 as a result of slowing global trade, the narrow export base, falling commodity prices and Indonesian industry’s high dependence on imported inputs. This situation is exacerbating the current account deficit.
The deficit was then closed with short-term capital inflows, so that the balance of payments edged into the positive. The World Bank’s proposal to cover the current account deficit with foreign direct investment (FDI) is an ideal solution, but it also oversimplifies the problem. Long-term solutions like FDI are not as easy as turning the page. The World Bank said as much when it cited that most of the 33 companies that left China had chosen Vietnam and none had chosen Indonesia because of its high-cost economy.
Capital inflow though portfolio investments is still needed in the short term to maintain liquidity.
It must be recalled that Vietnam is a socialist country that cannot be compared to Indonesia\'s democratic system. FDIs also have varying characteristics. Attracting FDIs that utilizes only the domestic market and is highly dependent on imported inputs will also cause future disruptions to the current account.
The ideal solution should be differentiated among the short, medium and long terms. Capital inflow though portfolio investments is still needed in the short term to maintain liquidity. In order to achieve this, prudent macroeconomic policies are needed to safeguard Indonesia’s macroeconomic fundamentals so that the country appears on the FDI radar. Nevertheless, portfolio investments must be reduced in the long run to stabilize the rupiah. In the medium term, the services balance can be improved to reduce the current account deficit.
There are two potential transactions, namely the travel balance that involves the tourism industry and the secondary income account, which includes remittances. The travel balance recorded consecutive surpluses of $3.639 billion, $4.85 billion and $5.33 billion, respectively in 2016, 2017 and 2018. Meanwhile, the secondary income balance recorded a surplus of $4.46 billion, $4.5 billion and $6.89 billion over the same period. Improving the quality of vocational education could potentially increase the surplus in secondary income by shifting the remittance structure from informal workers to professionals like cooks, sailors, nurses and factory workers.
In the long run, the government has been making efforts to reduce the high-cost economy, such as by developing the backbone of infrastructure for continuing with the development of other supporting infrastructure. It has made serious efforts and will continue to make serious efforts to address licensing, which remains a problem at both the central and regional levels. To improve the trade deficit through means aside from attracting export-oriented FDI, it has also readied tax incentives for intermediate goods producers that are part of the export-oriented and non-export oriented supply chain, such as automotive manufacturers, pure exporters and non-exporters.
Because Indonesia is unable to produce all raw materials, industry inputs and capital goods domestically, some imports are still needed to encourage export and national production, while others are needed for consumption.
The demand side of the economy also needs to be encouraged to anticipate a decline in exports and slowing consumption in a more conservative society. The economy is like a cycle of public consumption, investment and public expenditure that flow into society and imports as an outflow. Because Indonesia is unable to produce all raw materials, industry inputs and capital goods domestically, some imports are still needed to encourage export and national production, while others are needed for consumption.
The faster this cycle rotates, or if new currents flow in, it grows larger like a typhoon or a hurricane. On the other hand, leaks in then cyclical flow and slowdown in rotation will lead to slowdown. Therefore, a balance between inflow, outflows and rotational speed are needed to maintain the current can be sustained. The rotational speed is influenced by public expectations: The more positive they are, the stronger the current of national production/income will be.
”Pump-priming”
In this cyclical concept, what is good for the individual is not necessarily good for the national economy. If the saying “hemat pangkal kaya” (more savings means more wealth) is applied to the above cycle, the national income can flow towards preventing recession. In order to avoid recession, savings must be returned into the flow as investment or for future consumption.
Taxes must be returned to the government as an expense. Taxes are reformed to reduce the tax burdens of the private sector and to improve innovation and the supply chain. The fear of recession will make people delay spending, especially on durable goods. Investors may delay investments. Overseas customers may delay their orders. Foreign tourists postpone their visits.
The government’s task is to implement the spending policy and improve the supply side of the economy to make the income cycle flow smoothly and to maintain positive expectations among consumers and businesses. If a global recession continues through 2020, even 2021, it is necessary to implement a pump-priming policy in the style of US President Franklin D. Roosevelt during the Great Depression of the 1930s. Infrastructure projects such as irrigation, rural roads, markets and fish auctions can proceed.
Regardless of the pros and cons, the plan to relocate the capital city can be used as an instrument for countering recession. The construction sector has backward and forward linkages with other sectors, so it can function as counter-cyclical tool through the multiplier-accelerator process.
Ari Kuncoro, Professor, Economics and Business School, University of Indonesia