Chronic deficits threaten economic sovereignty

Anthony Budiawan
Managing Director of the Political Economy and Policy Studies (PEPS)

IO – The Current Account Balance began to experience a deficit since the fourth quarter of 2011. This deficit has continued to the pres­ent. Even the current account deficit of 2018, is getting bigger, reaching 31.1 billion US dollars, or 2.98 percent of GDP (Gross Do­mestic Product).

First quarter of this year (Q1- 2019), the current account bal­ance is still in a deficit of 6.97 billion US dollars, equivalent to 2.6 percent of GDP. This deficit is greater than that of last year (Q1- 2018), a deficit of only US $ 5.2 bil­lion, or only 2.01 percent of GDP.

The current account deficit will push down the Rupiah exchange rate because the deficit means there is an outflow of dollars. The Rupiah exchange rate (Bank Indo­nesia) at the end of the third quar­ter (September 30) in 2011 was re­corded at Rp. 8,823 per US dollar. Since then, the current account has sustained a deficit, and the Ru­piah exchange rate has depreciated very sharply, breaking Rp. 15,200 per US dollar in October 2018.

To keep the Rupiah exchange rate from depreciating, the govern­ment must try to attract a flow of dollars through foreign investment, which consists of Direct Investment and Portfolio Investment, or “hot money”. Direct investment is in­vestment in the real sector, while Portfolio Investments are invest­ments in securities, both stocks and bonds.

With the growing current ac­count deficit, dollars incoming through Direct Investment are no longer sufficient to cover the defi­cit, while stock investment has a high enough risk, so it is more limited. Therefore, investment in debt securities is in great demand, especially government bonds and state-owned companies (BUMN).

This means that the current account deficit has resulted in increased foreign debt. If not, then the Rupiah exchange rate will drop. So, the greater the current account deficit, the greater the addition­al foreign debt needed. Not sur­prisingly, Indonesia’s total foreign debt has increased rapidly, from 141.2 billion US dollars at the end of 2007 to 377.6 billion US dollars as of the end of 2018, or up 236.4 billion in 11 years, equivalent to 167 percent. The government’s foreign debt also rose rapidly, from 76.9 billion US dollars at the end of 2007 to 183.2 billion US dollars at the end of 2018. It rose 106.3 billion US dollars, or 138.2 percent.

If the current account deficit continues, and even increases, Indonesia will face a dilemma. First, the current account deficit will depress the Rupiah exchange rate. It is not impossible that the Rupiah exchange rate will drop to Rp15,000, even Rp16,000 per US dollar. If we do not want the Rupi­ah to drop, then foreign debt must skyrocket to compensate for the deficit.

During the first three months of 2019, Indonesia’s foreign debt rose by 10 billion US dollars, even though the current account deficit is only 7 billion US dollars. So, far beyond the need, aka “overdose”. As a result, the Rupiah exchange rate rose sharply due to the with­drawal of foreign debt that over­dosed.

In turn, swelling foreign debt will increase the risk of a curren­cy crisis. The ratio of foreign debt to exports rose sharply, from 20.7 percent in 2007 to 54.3 percent in 2018. This indicates the risk of In­donesia’s foreign debt getting big­ger. It can be fatal if foreign inves­tors hold off on their investment in Indonesia.

 On the other hand, the govern­ment does not seem to have been able to reduce the current account deficit programmed. That is, the current account balance is beyond the control of the government, and depends on fluctuations in the prices of international commod­ities, which are the mainstay of Indonesian exports, such as coal, palm oil and rubber, and oil pric­es. If commodity prices rise and oil prices fall, the current account bal­ance will improve.

If the opposite happens, then the current account will deteriorate, and the deficit will increase. In this case, we can only wait for foreign mercy to buy our debt. Foreign debt will increase, and the risk of currency crises as happened in Argentina and Turkey is looming larger.