IMF and Adaptive and Balanced Policy

The International Monetary Fund (IMF) has again issued a warning about the possibility of a global recession in 2023. The IMF recently lowered its 2023 global economic growth forecast to 2.7 percent, from its previous forecast of 2.9 percent made in July. One of the interesting things about the warning is how the IMF tries to maintain a balance in controlling inflation expectations without sacrificing growth potential too much.

In addition, the IMF is also trying to reduce impacts of its announcement by balancing gloomy prospects with expectations and solutions. This is an alternative approach to the orthodoxy of the United States Federal Reserve (Fed), which has a tight target of bringing inflation back to around 2 percent, regardless of the risks.

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The IMF taking the middle ground is in line with the prediction that policymakers prefer to avoid risk during times of high uncertainty (Arrow, 1965 and Holcombe, 1989). This is an adaptive policy to cope with the impacts of the Covid-19 pandemic and the energy and food crisis caused by the Russia-Ukraine war.

This is in contrast to the orthodoxy of the US Fed, which is trying to restore its credibility as a monetary authority as it continues to raise its benchmark interest rate several more times in 2022 and 2023. Moreover, annual US inflation in September 2022 was 8.2 percent, only slightly down from 8.3 percent the previous month.

The IMF's middle ground policy is an alternative that is expected to ease world recession in 2023, because not all countries will be trapped by orthodox policy. This position is important, considering that 28 countries are already experiencing financial difficulties in meeting the IMF’s requirements for assistance. The consequences of policies that are too drastic regardless of external developments can be seen in the collapse of the British currency some time ago. To stimulate its economy, the United Kingdom planned to lower the rate for the 45 percent tax bracket, which means increasing the budget deficit.

This adds to inflationary pressures through food and energy imports (imported inflation).

In accordance with the predictions of the models by Fleming (1963) and Mundell (1962), if the budget deficit is financed by selling government bonds in the money market, the local currency will appreciate. Meanwhile, if the bonds are purchased by the central bank, the country's currency will depreciate. However, in the case of the UK, none of these scenarios are relevant because the rise in international interest rates due to the Fed hike has caused the value of the US dollar to increase. As a result, the pound sterling fell to almost reach parity with the US dollar. This adds to inflationary pressures through food and energy imports (imported inflation).

Economic dualism

The IMF mentions Indonesia as one of the world’s bright spots, along with India. The two countries share similar characteristics, namely in the spread and size of their middle class populations, as well as the large portion of the nontrade (nonexport) sector in their economies, although they still have export-oriented segments or a mix of export and domestic trade.

Indonesia's annual growth of 5.44 percent in the second quarter of 2022 was partly supported by growth in nontrade sectors, such as transportation and warehousing (21.27 percent), accommodation and food and beverage (9.76 percent), and information communication (8.05 percent). This growth also boosted trade (4.42 percent) and manufacturing (4.01 percent). The unidirectional growth between the nontrade and the information and communication sectors is a legacy from the pandemic, when domestic demand was fulfilled online. After the pandemic subsided, there has been synergy between online and offline trade.

Amid US dollar appreciation, Indonesia's trade balance has recorded a surplus for 28 consecutive months, helping to insulate the domestic economy, exchange rate pass-through, and global inflation. As a result, it could slow the rupiah’s depreciation against the US dollar so it does not stray too far from its natural balance.

Several non-oil manufacturing products, such as iron, steel, electrical machinery and equipment, as well as vehicles and automotive parts, have recorded the highest growth. This indicates that Indonesia still has room to expand into the international manufacturing supply chain. The complexity is that Indonesia's trading partners could potentially become divided into different blocs amid the current escalation of geopolitical tensions, especially between China and the US, Indonesia's two largest export destinations.

Only a few G20 countries have lower inflation rates, for example China (2.8 percent), Japan (3 percent), and South Korea (5.6 percent).

Indonesia, which has a foreign trade sector (trade goods) and a domestically oriented (nontrade) sector, can reduce its exposure to the gloomy global economic outlook in 2022 and 2023, in terms of both maintaining growth and controlling inflation. Statistics Indonesia (BPS) reported annual inflation of 5.95 percent in September, below the average inflation in G20 countries and territories, including the eurozone (10 percent), Australia (6.1 percent), Brazil (7.17 percent), India (7 .41 percent), the US (8.2 percent), and the UK (9.9 percent). Only a few G20 countries have lower inflation rates, for example China (2.8 percent), Japan (3 percent), and South Korea (5.6 percent).

In addition to the pandemic, the geopolitical crisis in Europe has brought the world closer towards deglobalization. Indonesia’s free and active foreign policy offers an opportunity to implement a balanced policy. At present, the most favorable policy for Indonesia is to take the advantage of the G20 to improve its position in the world supply chain. The dualism of its economy has left Indonesia unable to turn away from the global economy, because the pandemic has provided an opportunity to take a bigger role in the international supply chain (exports).

At the same time however, Indonesia must maintain growth and control inflation by further strengthening domestic production by prioritizing agriculture and derivative industries. The global agenda of the transition to renewable energy is a good opportunity for Indonesia to transform its national economy.

KOMPAS/HERU SRI KUMORO

Ari Kuncoro

ARI KUNCORO,Rector of the University of Indonesia.

(This article was translated by Hendarsyah Tarmizi)