Recession and Economic Vulnerability
Recessions are always debated long before they occur. This is why it is usually too late to anticipate a recession, because no immediate action is taken.
Recessions are always debated long before they occur. This is why it is usually too late to anticipate a recession, because no immediate action is taken.
A recession generally has two dimensions: economic vulnerability as a fundamental factor and panic as a trigger of economic turmoil. Severe recessions are usually caused by fundamental weaknesses accompanied by widespread panic. The two have a mutually negative influence to cause a spiraling down of the economy to the brink of deep recession.
One of the keys to alleviating economic vulnerability is to reduce panic. Even though the economy may be vulnerable, if it is properly mitigated and panic is avoided, the economy can emerge from recession without any significant shocks (soft landing). Conversely, although the economy may not be in a state of high vulnerability, if panic inevitably occurs to cause economic turmoil, it could prompt either a hard landing, even a crash landing, that could claim many victims.
Be careful, lest in casting out your demon you exorcise the best thing in you.
Panicky behavior often causes economic vulnerability to become a disaster. It is not wrong for John Maynard Keynes to believe that the economy is driven by “animal spirits” that can turn ferocious in a situation of panic. In a similar vein, German philosopher Friedrich Nietzsche once cautioned: “Be careful, lest in casting out your demon you exorcise the best thing in you.”
Managing market expectations so they do not cause panic is one of the keys to addressing a potential recession. In the face of global risks, the domestic economy must be maintained to avoid any vulnerabilities that could cause panic. Adequate anticipatory steps are needed.
Global vulnerability
The World Bank’s International Debt Statistics 2020 shows increased financial risk among low- and middle-income countries over the last few years. If this risk is not mitigated, it could lead to a wave of defaults that will worsen the global economy.
Since the 2008 global financial crisis, these groups of countries have received large liquidity injections due to the low interest policies in developed countries. Over the last 10-year period, debt has at least doubled in many countries. Several countries, including Indonesia, have seen an abundance of liquidity as a result of the commodity boom.
In general, these groups of countries are experiencing increased risk because their debt burden is increasing on the one hand while on the other, their ability to pay off debt has decreased due to the economic slowdown.
The default risk has also increased as a result of higher interest rates in developed countries, followed by lower capital inflows to developing countries. On the other hand, the commodity boom has ended and the prospective economic growth has declined as a result of the trade war. In general, these groups of countries are experiencing increased risk because their debt burden is increasing on the one hand while on the other, their ability to pay off debt has decreased due to the economic slowdown.
In 2008, Indonesia had US$159.9 million of foreign debt and the figure had grown to $369.8 million by 2018, nearly doubling over 10 years. Similarly, Thailand saw its debt increase from $66.6 million in 2008 to $169.2 million in 2018, a 250 percent increase. India’s debt increased from $227.1 million to $521.3 million, while Vietnam’s debt drastically increased fourfold, from $26.4 million to $108 million.
Debt cannot be judged merely by value. Since the debt is an obligation, it must be viewed in terms of a country’s ability to pay it off: first, foreign debt as a percentage of gross national income (external debt stocks) and second, debt as a percentage of export revenue (value of external debt).
Indonesia had external debt stocks of 37 percent in 2018, higher than Thailand\'s 35 percent and India\'s 19 percent, but better than Vietnam’s external debt stocks of 47 percent. However, Vietnam has better economic prospects than ours, so it has a better ability to repay its foreign obligations.
When viewed as a percentage of export revenue, Indonesia had an external debt value of 170 percent in 2018, while Thailand had only 49 percent, India 93 percent, and Vietnam 42 percent. It is obvious here that when compared to other countries, we have a very serious problem of export revenue that is lower than our foreign debt.
One step that must be taken to address this situation is to proportionally reduce any new debt to prevent economic vulnerability.
The risk of a global recession in 2020 will be a second blow for our economy, following the first blow of falling commodity prices. The end of the commodity boom has prevented Indonesia\'s economic growth from surpassing the 5 percent range. A global recession in 2020 could potentially reduce Indonesia\'s economic growth to below 5 percent. One step that must be taken to address this situation is to proportionally reduce any new debt to prevent economic vulnerability.
Corporate risks
If we are facing a macroeconomic risk of increased debt due to a diminished ability to pay off debt, the same holds true in for microeconomics. Moody\'s investment agency has just published a report in which it cautions Indonesia and India as two of 13 Asia-Pacific countries with the highest risk of corporate default, the other 11 being Australia, China, Hong Kong, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Taiwan and Thailand.
The report, "Asia-Pacific Banks Are Facing Growing Risks From Highly Leveraged Companies As Macroeconomic Conditions Worsen" (30 Sept. 2019), explains that the generally low interest rates over a long period has caused high corporate debt in the Asia-Pacific. Amidst increasing private sector debt, the world is facing the risk of a recession that has caused many corporations to be potentially unable to repay their obligations. The prolonged trade war between the US and China has caused an economic slowdown, a cycle that has certainly had an impact on the corporate sector, which has seen a general decline in revenues, with many suffering losses or going bankrupt and thereby being unable to meet their obligations.
Indonesia does not actually have a large corporate debt ratio. Hong Kong has the highest corporate debt ratio at more than 200 percent of gross domestic product (GDP), followed by China with more than 150 percent and Singapore more than 100 percent, while Japan and Korea both have private foreign debts of around 100 percent of GDP. Meanwhile, Indonesia\'s corporate debt-to GDP ratio is the lowest at below 20 percent, much lower than India’s 45 percent and Thailand‘s 50 percent.
Then why is Indonesia – along with India – among the most vulnerable? First, although its corporate debt-to GDP ratio is low, the distribution of debt is insecure, given that many companies are carrying very high debt. Second, a stress test has shown a 25 percent decrease in pre-tax revenues (EBITDA), indicating a dramatic decrease in corporate ability to pay off debt. Indonesian corporations that are highly dependent on commodity prices have experienced a sharp decline in revenues, so companies that fall within this group have the highest default risk. The potential risk of the corporate sector will cause a systemic impact when many companies have default potential and involve large credit in the banking sector. So far, this is a relatively small possibility, considering that corporations’ foreign currency debt comprised only 18 percent of total bank loans to May 2019.
Nevertheless, we must not be careless because basically transparency cannot be guaranteed in corporate balance sheets. The default case of textile company Duniatex has burdened our banking balance sheet. State-owned bank shares have been dragged into major non-performing loan cases as well as in the efforts to save Jiwasraya Insurance (Kontan, 3/10/2019).
The global recession risk poses an important occasion for introspection. Do not allow global risks come into contact with domestic vulnerability, especially if the vulnerability is caused by panic on both the economic and political fronts. Do not allow Keynes’ "wild animal spirits", let alone Nietzsche’s "casting out the devil", come to haunt the economic and political dynamics of our nation.
A. Prasetyantoko, Rector and economist, Atma Jaya Catholic University