Global Recession Antibodies

KOMPAS/KARINA ISNA IRAWAN

A discussion with the theme "Indonesia in the era of trade war: its impact on business, global trade and investment" in Jakarta, Thursday (1/31/2019). Present as panelists included former Minister of Finance M. Chatib Basri, Ministry of Trade\'s Lead Advisor Lili Yan In, and Professor of Economics at Lee Kuan Yew School of Public Policy, Danny Quah.

We often hear the saying "life is like a wagon wheel, sometimes above, sometimes below". In business circles this refers to the business cycle, which describes the ups and downs or fluctuations in the global economy.

This is natural as there are times when the economy is at its peak, before decreasing to its lowest point. However, economic activity starts to rise again at a certain time. The basic question is, how many years is a business cycle? How often does a global recession occur? There are those who estimate 8 to10 years. This means that since the United States experienced a recession in 2008/2009, it will experience another in 2019. It seems too early and premature to say the US will have a recession this year. Mathematical figures are too simplistic and simplify the problem. Perhaps it would be more appropriate to say that the US is showing increasing signs of an approaching recession.

No one can be sure when there will be a recession in the US and how much it will affect the global economy. A recession comes like a thief in the night, with nobody knowing when it will strike. Therefore, we must remain vigilant and wise in responding to global and domestic economic conditions. Excessive worry could cause panic and undue reaction and accelerate a recession.

Increasingly difficult to predict and solve

In recent years, the scientific method of projecting macroeconomic variables such as econometrics has been rendered useless because it fails to accurately capture the dynamical behavior of the global economy. In other words, the element of error that originates from global economy uncertainty tends to dominate various predictions.

Since 2018, several countries have started to fall into recession, such as Venezuela, Turkey, Argentina and Italy. Meanwhile, other developed and developing countries are in a slowing trend and struggling to avoid an economic crisis. Seeing this condition, it is only natural that there are concerns about the possibility of a recession like 10 years ago. It would be better to look back at the situation of the 2008/2009 global economic recession, which had a large impact and took the world by surprise. The recession began in the US and spread to Japan, the European Union, Russia and other regions. The 2008/2009 global recession could have been worse and deeper, but fortunately there was still China, which at that time was a buffer for the global economy.

There is one interesting thing to note, and that is how developed countries found solutions for their economic recovery. The US, the European Union and Japan introduced very low interest rates and non-conventional monetary policies, namely Quantitative Easing (QE), whereby central banks bought financial assets of commercial banks and other private institutions, thereby increasing money supply in the economy. Why was this a remedy? In recovering the US economy, the Fed (US central bank) was forced to reduce its benchmark interest rate aggressively from 5.25 percent to 0.25 percent in just 16 months. With reducing the benchmark interest not proving to be enough, the Fed also used QE so that the assets of the Fed increased significantly from US$890 billion in 2007 to $4.5 trillion US in 2014. This means there was an additional supply of US dollars in the economy, namely $3.61 trillion (400 percent more).

KOMPAS/ALIF ICHWAN

Bank Indonesia Governor Perry Warjiyo (right) with BI Senior Deputy Governor Destry Damayanti, held a press conference at the BI Building, Jakarta, Thursday (9/19/2019). The conference explained the results of the Bank Indonesia Board of Governors Meeting decided to reduce the benchmark interest rate by 25 basis points to 5.25 percent this month.

The same measures were followed by Europe and Japan. Europe reduced its benchmark interest rate from 4 percent in 2007 to zero percent until now, plus QE of 3.1 trillion euros (up 200 percent). Meanwhile, Japan\'s benchmark interest rate was negative 0.011 percent as of October 2019 from 0.459 percent in 2007, coupled with QE of 458.5 trillion yen (up 412 percent). In the future, it is quite possible that the US and European central banks will follow Japan with negative interest rates. Complementing their monetary policy, these developed countries also introduced expansive fiscal policies to encourage economic growth.

However, the US experience demonstrates that its economic growth was not sustainable and reached its peak in 2018. The condition of Europe and Japan is also not as good as the US and tends to remain in a difficult zone. Low interest rates and QE prompted the economies of developed countries to grow not on their own accord and showed that the remedies could be destructive in the long run. So it is not surprising that developed countries are experiencing a slowdown once again and fears of a recession have increased.

Signs of a recession in the US are beginning to be seen from the inverted yield curve, whereby long-term bond yields are lower than those of short-term bonds. The US bond market (UST) is already abnormal because the UST yields over three months is higher than those of 10-, five- and two-year bonds, and it is slightly different from the very long tenor of 30 years. Experience shows that when the UST inverted yield curve occurred during the 1980-2009 period, the likelihood of a US recession was 80 percent (four times out of five). Surprisingly, each time the Fed lowered its benchmark interest rate during the 1970-2009 period, there was a recession probability of 83 percent (five times out of six events).

Judging from these events and according to business cycle theory, a global recession is expected to occur again. One thing to watch out for is that if the US experiences another recession, so too will Europe and Japan. This time around a recession will be more difficult to overcome because the monetary and fiscal policy space is very limited. The Fed\'s interest rate was 2.00 percent as of September 2019, potentially going down again this October to 1.75 percent. This means that the Fed\'s benchmark interest rate reduction will remain at 2.00 percent at the maximum, half of that during the 2008/2009 US recession, which was 5 percent. The limitation of monetary policy space is even narrower in Europe because the benchmark interest rate is zero percent and Japan is even negative.

Indonesia’s response

The world is increasingly exposed to the possibility of a recession, with the probability of a US recession increasing significantly to 35 percent in October 2019 from 20 percent last year. Likewise in Germany, where it is 35 percent from 10 percent. Japan is even higher from 32 percent to 40 percent as of October 2019. With global economic conditions like this, what should be the response of Indonesia in facing global economic pressures? Indonesia must fix its structural economic problems and anticipate and adapt to external shocks that leave it increasingly exposed.

Indonesia has already begun to feel the impact of the global economic slowdown. National economic activity is beginning to slow. This is reflected in the slowing down of state revenues as of 31 August 2019. Finance Ministry data shows that tax revenue grew only 1.4 percent, down significantly from 2018, when it grew 16.5 percent. Likewise, non-tax state revenue only grew 11.6 percent from 24.3 percent in the previous year.

When the domestic economy comes under pressure, we need a counter cyclical fiscal policy so that growth remains robust despite external shocks. Fiscal space is indeed limited because state income grew only 3.2 percent in the first eight months of 2019. As a result, the fiscal deficit widened slightly to 1.24 percent of GDP compared to 1.02 percent in 2018. This has become a challenge for the government so that the fiscal function remains powerful to encourage economic growth.

Moreover, BI eased the loan-to-value ratio for property loans by 5 percent and the motor vehicle down payment requirement to a range of 5 to 10 percent, plus another 5 percent for environmentally friendly motor vehicles.

On the monetary side, Bank Indonesia (BI) has taken early anticipation measures to maintain economic growth. The BI benchmark interest rate was reduced three times in July-September 2019 to 5.25 percent from 6.00 percent. It is estimated that reductions in the BI benchmark interest rate will continue as long as the stability of rupiah can be maintained, coupled with low inflation. BI has also relaxed macro-prudential policies to encourage bank lending and increase business credit demand through the regulation of the Macro-prudential Intermediation Ratio (RIM). Moreover, BI eased the loan-to-value ratio for property loans by 5 percent and the motor vehicle down payment requirement to a range of 5 to 10 percent, plus another 5 percent for environmentally friendly motor vehicles.

Expansive fiscal policy and eased monetary policy are necessary conditions to maintain economic momentum. However, there is a bigger and more important target, namely how to increase people\'s welfare, and encourage exports and investment, which in turn drive people\'s purchasing power and ability to save at a higher level, so that there is an acceleration in Indonesia\'s economic growth. Indonesia needs a remedy that creates immunity to external shocks.

I believe that one day Indonesia will be more immune to external shocks and could be a savior of the global economy if and when a recession occurs.

Structural changes in the economy must be carried out continuously and consistently. Infrastructure development, which has increased significantly, must be carried out effectively so that the multiplier effect is immediately felt in the "joints" of the economy. Labor productivity must be further encouraged through vocational education launched by the government, in collaboration with the private sector. Bureaucracy, regulation and legal affairs must be able to encourage investment, as well as attractive fiscal policy incentives. I can truly understand the rage of President Jokowi over the 33 investments that came out of China without any of them entering Indonesia. Limited infrastructure is a major obstacle, but the main problem is the harmonization of regulations, legal affairs and institutions between the central and regional governments, which needs to be resolved immediately. If we can overcome this immediately and comprehensively, the Indonesian economy will naturally become immune to external shocks. I believe that one day Indonesia will be more immune to external shocks and could be a savior of the global economy if and when a recession occurs.

Anton Hendranata, Economist of PT Bank Rakyat Indonesia, Tbk