The Effect of Global Economic Crisis Towards The Indonesia Economy

“THE EFFECT OF GLOBAL ECONOMIC CRISIS TOWARDS THE INDONESIA ECONOMY”

INTRODUCTION / BACKGROUND

Global economic crisis and Indonesia

The financial crisis that first emerged in the US in August 2007 has transformed into a global economic and job crisis. The latest projections from multilateral agencies suggest that the world economy will contract in 2009 for the first time since the Second World War.

According to the World Bank, the spreading global economic crisis is set to trap up to 53 million more people in poverty in developing countries this year on top of the 130-155 million driven into poverty in 2008 by soaring food and fuel prices.

This will bring the total of those living on less than US$2 a day to over 1.5 billion.

The World Bank also estimates that developing countries face a financing gap of $270-$700 billion depending on the severity of the economic and financial crisis and the strength and timing of policy responses.

Developing countries are likely to face higher spreads, and lower capital flows than over the past 7-8 years, leading to weaker investment and slower growth in the future.

What is the likely impact of the most severe global recession since the Second World War on the Indonesian economy?

At the beginning of 2008, there was considerable optimism that the Indonesian economy, unlike the 1997 financial crisis, would largely escape the effects of a looming global economic downturn.

By 2007, growth had reached 6.3 percent, the highest in the post-crisis period. The economy was poised to post a similar growth rate in 2008.

The stock market was booming and reached the highest level in its history in January 2008.

Indeed, in a January 2008 paper that assessed the medium-term economic outlook for Indonesia, Bank Indonesia observed:

The overall forecast is for further improvement in the Indonesian economy in the coming five years with growth in the range of 7.4-8.0 percent. This projection assumes that world economic growth and volume of world trade remain strong alongside sustained high prices for oil and natural gas and non-oil commodities, relative stability in world and Indonesian monetary policy, robust fiscal conditions in Indonesia and rising inflows of FDI in Indonesia.

The major sources of this growth will be significant inflows of FDI stimulated by improvements in the investment climate with FDI reaching 1.5 percent of GDP in 2012, bringing the share of investment to about 30 percent of GDP that year."

Throughout much of 2008, the monetary authorities seemed concerned with containing inflationary pressures stemming from the dual food and energy shocks. The official interest rate was increased from 8.0 percent in January 2008 to 9.5 percent in November 2008.

Since then, the mood of policy-makers has shifted. In its report on monetary policy in the final quarter of 2008, Bank Indonesia noted that *In Q4/2008, Indonesia's economic performance began to show signs of impact from the global economic downturn'.

The stock market plummeted reversing all the gains that took place between 2005 and 2008. The exchange rate depreciated significantly.

Official projections are that growth will be around 4 to 5 percent in 2009, but private sector forecasts suggest a *worst-case' scenario of 2.5 percent growth in 2009.

A recent World Bank policy note classifies Indonesia as a *high exposure' country that faces significant crisis-induced deceleration of growth and a significant increase in poverty.

How has the Indonesian government responded to the rapidly deteriorating international economic environment?

The Indonesian government has responded to the rapidly evolving global economic crisis with a combination of financial, monetary and fiscal policies. The deposit guarantee scheme for the banking system has been substantially increased to encourage continued lending to the real economy.

Monetary policy has been eased. The interest rate (as of March 4, 2009) stands at 7.75 percent, the lowest level since July 2005.

The Governor of the Bank of Indonesia, during a speech given at the 2009 Banker's Dinner, noted that the official interest rate is likely to be in the 5 to 7 percent range. A fiscal stimulus package has been enacted (effective from March 1, 2009) amounting to 1.4 percent of GDP.

It is doubtful whether these responses are going to be effective in dealing with the *worst-case' consequences of the global recession on Indonesia. Ross McLeod, a well known Indonesia specialist, notes that although the deposit guarantee scheme has been *increased by a factor of 20 . it still covers only about 50 percent of the total value of assets.

If conditions deteriorate, there is every possibility of a run on banks by large depositors'. While the reductions in the official interest rate are welcome, one wonders whether the rate was held too high for too long.

Given that monetary policy operates with a long and variable lag, it is difficult to assess the extent which the current easing of monetary policy can offset the effects of a phase of tightening that was sustained between January and November 2008.

The fiscal stimulus package deserves further scrutiny. If the worst case scenario of growth falling well below the projected 4 percent rate materializes, then the magnitude of the fiscal policy response may not be enough.

One can also express reservations about the composition of the fiscal policy package. Approximately 77 percent of the Rp73.3 trillion is in the form of tax cuts. They consist of reductions in both indirect taxes and income taxes.

The balance is directed towards infrastructure expenditure (Rp12.2 trillion) and direct subsidies (Rp4.8 trillion). Thus, a modest amount has been allocated towards enhancing job-creating public expenditure and hardly any resources seem to have been directed towards scaling up the social protection system.

Yet, it is widely acknowledged that tax cuts are not as effective as job-creating public expenditure or a scaled up social protection system in dealing with the consequences of a systemic global economic downturn.

The Indonesian government seems to have designed its fiscal stimulus package by focusing on its impact on the unemployment rate. A *simulation' exercise was undertaken by the Coordinating Ministry to work out how the unemployment rate will behave with expansionary fiscal policy and without it.

The exercise that was undertaken demonstrated that fiscal expansion along the lines described here would contain the rise in the unemployment rate to a prescribed threshold (8.3 percent in 2009).

Given the nature and structure of the Indonesian labour market, the aggregate unemployment rate is not a robust indicator of the well-being of the Indonesian work-force.

A lot more attention should have been given to poverty-sensitive indicators in designing the fiscal stimulus package.

In sum, throughout much of 2008, the Indonesian government did not seem particularly perturbed by the rapidly unfolding global economic crisis and its implications for the national economy.

There was a growing realisation in the final quarter of 2008 that Indonesia will not be immune to the global economic downturn.

It remains to be seen how effective national policy responses will be in dealing with the growing challenge of sustaining growth in the grim international environment of today.

One must also appreciate the fact that a global recession of the severity and magnitude facing the world today requires globally coordinated action. Indonesia, as a member of the G20, has an opportunity to play a pro-active role in urging such collective action.

Domestically, Indonesia must position itself among other developing countries so that it can be among the first to benefit from the global recovery.

PROBLEMS

Indonesia is suffering from gradually increasing impacts of the global financial crisis, with its export value growth in 2009 predicted to drop below zero.

Indonesian central bank (Bank Indonesia)'s Deputy Governor Hartadi A Sarwono said on Thursday that the country's export value is expected to drop 4.6 percent this year.

Hendri Saparini, director of the Econit Advisory Group, also predicted on Wednesday that the country's export value growth this year will stand at minus 5 percent.

"This year, it is not necessary to expect more from export activity, because growth in this sector will only stand at minus 5percent," he said.

The opinions of both the central bank and the consultant group are echoes of the prediction made by the National Development Planning Board on March 11, which said that Indonesia's export value would fall by 6 percent this year. According to the government department, Indonesia's non-oil product export value will fall 20 percent or 21.6 billion U.S. dollars this year from 108 billion dollars in 2008.

Their predictions have partly come true, seeing the country's export value dropped 17.7 percent month on month this January.

Suffering from the export decreasing, Indonesia's export-related companies, including traders and manufacturers, HAVE TO EXPAND LAY-OFFS so as to save their costs.

DESCRIPTIONS

Sofyan Wanandi, chairman of the Indonesian Employers Association, said on March 13 that the country's unemployed population had grown to 240,000 by this month, most of which came from labor-intensive industries, though the governmental statistics showed that figure was 37,909.

Nevertheless, the big unemployment inevitably reduced Indonesia's purchasing power and lowered market demands, while the country's major commodity supports remained adequate. Thus, Bank Indonesia, considering the low fuel price on the International market, predicted the country's inflation rate this year will go down to 5-7 percent, which gives it spaces to cut the benchmark interest rate.

Bank Indonesia cut the bank's benchmark rate by 50 basis points from 8.25 percent to 7.75 percent on March 4, seeing the country's inflation rate in February recorded at 8.6 percent. That is the fourth time for the central bank to cut benchmark interest rate since last December.

However, the commercial banks in Indonesia did not actively follow suit to cut their interest rates sharply, but only decrease the lending rate from 14.2 percent at the end of last year to 13.93 percent by the second week of March and the deposit rate from 8.75 percent to 8.32 percent, averagely

Those are not enough, said analysts, adding that banks should keep lending rates below 13 percent to guarantee the economy running at the targeted 4.5 percent economic growth.

Therefore, many analysts and some officials in Indonesia had lost their confidence in the 4.5 percent economic growth this year, even Bank Indonesia on Thursday reduced its economic growth expectation to 4 percent.

However, President Susilo Bambang Yudhoyono seems to remain optimistically about the figure.

President Yudhoyono's confidence came from the government's plan of allocating a total 73.3 trillion rupiah (about 6.1 billion U.S. dollars) economic stimulus package.

"Let us make the economic stimulus a success because it is the state's and people's money and therefore it should be aimed at the right targets and used as much as possible to improve the people's welfare," said the president on March 7, adding that he hoped the funds would be channeled in April.

Of the package, 12.2 trillion rupiah (about 1 billion dollars) is for certain departments and ministries for infrastructure development across the country, which is 2 trillion rupiah more than the government's previous plan. The president said that infrastructure development would accelerate economic growth and enable maximum absorption of the work force amid the global financial crisis.

According to the previous plan, the 10.2 trillion rupiah (about850 million dollars) could be used to create 1 million jobs directly and another 1 million to 2 million jobs indirectly. Besides, the money is also expected to bring 900,000 laid-off labor forces back to work.

Furthermore, the Indonesian government supports the proposal of raising fiscal stimulus to up to 2 percent of gross domestic product (GDP), particularly in 2010, at the meeting of G-20 finance ministers and central bank governors in London.

"The fiscal stimulus for 2009 is not a problem. The problem is the fiscal stimulus for 2010 that needs to be raised," Head of the Fiscal Policy Board at the Indonesian Finance Ministry Anggito Abimanyu said on Monday.

Although he said the government has not decided about the fiscal stimulus for 2010, it is possible for the country to allocate stimulus funds worth about 105 trillion rupiah (about 8.75 billion dollars) next year.

In spite of the big meaning, the huge stimulus package will definitely increase the budget deficit of the Indonesian government.

According to the Financial Ministry's official director general of budgetary affairs Anny Ratnawati, the deficit will hit 137 trillion rupiah (about 11.4 billion dollars) this year, accounting for 2.6 percent of the country's GDP, as against last year's 51 trillion rupiah (about 4.25 billion dollars), or 1 percent of the GDP.

Ratnawati made that calculation when the stimulus package was still 71.3 trillion rupiah. With the additional 2 trillion rupiah, the country's budget deficit in 2009 will reach about 139 trillion rupiah (about 11.6 billion dollars).

In order to cover the deficit, Indonesia has prepared standby loans worth 44.5 trillion rupiah (about 3.71 billion dollars) and is still seeking loans from other countries and international financial institutions.

Bank Indonesia' Sarwono said on Thursday that the government was in a process to finalize a standby loan worth 1 billion dollars from the Islamic Development Bank (IDB) and the French government. He also said that the government had received 5.5 billion dollars (from Japan, Australia and the Asian Development Bank) before that.

On the other hand, according to the Investment Coordinating Board (BKPM), Indonesia is expected to maintain a 20 percent foreign direct investment growth this year, which is another positive signal to the country's economic growth.

BKPM chief Muhammad Lutfi said on Feb. 24 that though investment growth was not too high this year compared with last year's 43.8 percent, in view of the current global economic crisis the country's economy was still better than that of other Asian countries.

CONCLUSION

The global financial crisis that started from the United States raises a very broad impact, to Indonesia. And the impact will last very long, at least until three years into the future. For that, all element of Indonesia must put extra efforts to overcome the crisis. Government strength and stability also a best solutions to overcome the crisis.

REFERENCES

http://indoprogress.blogspot.com/2009/03/pemilu-dan-depresi-ekonomi.html

http://news.xinhuanet.com/english/2009-03/20/content_11037243.htm

http://www.associatedcontent.com/article/1111886/impact_of_global_economic_crisis_in.html?cat=3

http://www.thejakartapost.com/news/2009/05/05/global-economic-crisis-and-indonesia.html