Delayed Recession in the US and the Indonesian Economy

KOMPAS/AGUS SUSANTO

Ari Kuncoro

Whether a recession will or will not happen in the US: that is the question. This may seem like a mere play on words based on William Shakespeare’s famous line, “To be or not to be: that is the question”. However, it is an apt metaphor about the confusion among renowned American economists in interpreting the country’s economic data.

On Dec. 3, 2018, for the first time, short-term bond yields were higher than long-term bond yields, creating a situation known as an inverted yield curve. In the past, an inverted yield curve marked the coming of a recession. The last such situation occurred in 2007, one year before the 2008 global financial crisis.

Economists are now asking whether a recession is about to come in the US in 2019. They are divided. Nobel laureate Paul Krugman represents the more pessimistic group, saying that several factors could trigger recession in the US, including China’s weakened economy, the recession in Europe and bubbles in the US stock and property markets.

A recession could occur in the stock market if the technology bubble burst. Uncertainty has also increased in relation to the open dispute between Trump and the Federal Reserve (the Fed) chair, which the public has found out through the White House’s public outreach via social media.

It seems that Trump is still angry about the hasty hike in the US interest rates. He recently said that America’s gross domestic product would skyrocket if the Fed lowered its reference rates. Earlier, former Fed chair Janet Yellen that lowering the interest rate was necessary. Afterwards, the Fed seemed more dovish, and decided not to increase its reference rates on March 19. The stock market responded to this decision euphorically: The Dow Jones Industrial Average (DJIA) and S&P 500 indices increased three times in a row and almost reached record highs on April 18, before a correction.

In contrast to the pessimism of an incoming recession, the US’ real sector has proven resilient. Economic growth in the first quarter was 3.2 percent above the market consensus of 2.2 percent. The unemployment rate decreased from 4 percent in January to 3.8 percent in February and March. Consumer spending in March grew 0.9 percent from the previous month for the first time in 10 years. At the same time, annual core inflation has remained at 1.6 percent for the first time since September 2017. The US’ strong macroeconomics have made a majority of the American public optimistic that at least a recession was not going to happen any time soon. A survey of US chief financial officers showed that 84 percent predicted that a recession would begin only in the first quarter of 2021.

Transmission to global economy

When the Fed decided not to change its reference rate in March, many issued a textbook prediction that the US dollar exchange rate would drop. However, through the growth effect, the policy actually strengthened quarterly macroeconomics. As a bonus, the prospect of peace in Sino-American trade also strengthened the macroeconomics of both countries.

Once again, international investors saw the US as a safe haven and, consequently, rebalanced their investment portfolio. This was reflected in the increasing US stock prices. The US dollar became favored once again, and its exchange rate appreciated 1.5 percent against other currencies.

For American multinationals, however, the dollar appreciation was actually harmful, as it meant that their products would cost more in the local currency. American company 3M (MMM) made Wall Street history when its stock price fell 13 percent in one day after it revised its annual profit estimate. Several other companies, including vehicle spare parts producer Rockwell, suffered from the same fate on a smaller scale to bring the S&P 500 index for the industrial sector down 2 percent. On the other hand, the stronger US dollar boosted the export potential of other countries. China, for instance, recorded growth of 6.4 percent in the first quarter of, above the projected 6.0 percent.

Oil price

The oil price is a two-edged sword for economic growth, both in the US and globally. A too-high oil price would cause real household income and expenditure to decline and the economy to weaken in net oil importers. A too-low oil price would cause revenue loss in oil-exporting countries and put their oil companies out of business.

The CEO of British Petroleum (BP) once warned that US$50-62 per barrel would be a reasonable price for West Texas Intermediate (WTI). Prices were as low as $42 for WTI and $52 for Brent in December 2018, following the news of China’s economic slowdown.

The OPEC decision on Dec. 7, 2018 to decrease its supply and Russia’s move to decrease production sent oil prices up to $62 per barrel for Brent and $51 per barrel for WTI. However, in the end, strong economic growth in the US and the prospects US Sino-American trade peace sustained the high oil price. The economic sanctions on Venezuela and the US’ decision not to extend its waiver for partner countries that were still importing oil from Iran prompted the oil price to climb higher. The WTI price increased to a little above $66 per barrel but still below $67 per barrel on April 23, due to correction.

Ironically, the oil price could also cause an economic slowdown and recession in the US. For Trump, the oil price should be in the proper range for healthy US economic growth. Therefore, he asked Saudi Arabia and other Gulf OPEC members to fill the void in the oil market left by Venezuela and Iran.

As in all oligopolistic collusions, there is always the temptation for OPEC members to grab their market share by selling at a lower price (undercutting). In addition, the high oil price presented an opportunity for US shale oil producers to grab the market share from OPEC. As a result, the WTI price dropped again to around $63 in late April 2018, and hence the global oil price fluctuated sharply within a short period.

Implications for Indonesia

Transmission of recession from the US almost always happens through the balance of trade, the current account and the capital account. From observations throughout 2018, in contrast to the standard economic model, interest rates and growth of world powers affected the capital account. The Sino-

American trade war resulted in the migration of short-term capital in search of a safe haven in the US, which weakened Indonesia’s export growth. As a result, the rupiah weakened to Rp 15,200 per US dollar.

The potential for a recession in the US prompted international investors to reallocate their portfolios to prospective countries, including Indonesia, which helped strengthen the rupiah to around Rp 14,000 per US dollar. Afterwards, the strong US macroeconomics and the prospect of trade peace caused international investors to reallocate their portfolios to the US and the US dollar again became a favorite reserve currency among many; and the rupiah again weakened to Rp 14,200 per US dollar.

The positive aspect is that improved US and global economic prospects also boosted Indonesia’s export prospects. What is interesting about Indonesia’s trade surplus in March 2019 is that both exports and imports grew. This was in contrast to the surplus in February, when exports and imports declined, but exports remained higher than imports. Mining exports grew 31.08 percent and manufacturing exports grew 9.48 percent in March. As usual, increased exports in these sectors were accompanied by increased imports of raw/supporting materials, at 12.34 percent.

Surely, such a high surplus is not enough to counter Indonesia’s current account deficit caused by shortcomings in the service balance. However, this was still something fresh amid the decline in exports since the final quarter of 2017. Substitution between improving net exports and net capital inflows shows that Indonesia still needs to work hard to free itself from the cycle of global and American recession by committing to upgrading exports, strengthening industries that produce inputs for downstream industries, and strengthening the service sector to gain foreign exchange. In terms of the capital account, deepening domestic financial markets through increased domestic savings will help reduce excessive dependency on short-term capital flows.

Ari Kuncoro, Professor and Dean, School of Economy, University of Indonesia