CORONANOMICS: Policies for getting through the recession

Illustration: Agung Wahyudi/IO

IO – Covid-19 has ruined the global economy, leading to its deepest contraction since World War II. The Economic recession not only affecting developed countries, but also developing ones. In June, the IMF and World Bank projected the global economy suffering negative growth of between -4.9% and -5.2%. However, the uncertainty regarding the duration and intensity of an ongoing pandemic has the potential to further drag the global economy downhill. 

In the latest development, Indonesia has officially joined the “Recession Club”, along with other countries that had already plunged into recession. The Indonesian economy itself shrank 3.49% on an annual basis in the third quarter of 2020. Negative growth mainly occurred in exports of goods and services, with a -10.82% contraction, followed by Gross Fixed Capital Formation (-6.48%), and Household Consumption Expenditures (-4.04%). Meanwhile, imports of goods and services (another factor in the decline of GDP) contracted by -21.86%. There are several interesting conclusions that can be drawn from the growth figures released by Statistics Indonesia (BPS). 

First, investment has stalled, due to concerns about the country’s economic prospects and declining government capital expenditures. The pandemic has put immense pressure on investment prospects, both from the government and the private sector. The gloomy economic outlook for the year has prompted the government to cut major spending, particularly capital expenditure. The private sector and state-owned enterprises have also slashed their investment targets, in line with projections of weakening domestic demand and slowing exports. 

As a result, contracts for new projects, particularly in the construction and housing sectors, which are the main contributors to fixed investment, fell quite sharply. Several ongoing projects had to be halted, due to the sluggish flow of liquidity needed to finance them. Investment in non-construction capital goods also declined, due to the negative response of business actors, particularly in the manufacturing sector, to domestic and global demand contraction. 

Investors are expected to take a wait-and-see position regarding business expansion, in response to social restriction measures implemented in many places; this will also impair demand and disrupt global supply chains. According to UNCTAD and OECD, this year’s foreign direct investment (FDI) is projected to contract between 30% and 40%. 

Export pressure resulted because several major trade partners, including Japan, the European Union and ASEAN, were impacted by Covid-19. Due to weaker consumption and fewer exports from these countries, demand is lower compared to the previous year. In addition, the fall in export growth was also influenced by commodity prices, which continued depressed. Indeed, the trade balance surplus in the past five months, from May to September, has not been able to boost export growth, due to a deeper contraction in import than export growth. This means that in reality export growth is still weakening. 

Nevertheless, there are hints of optimism behind the economic growth in the third quarter. Government spending has grown significantly by 9% (YoY). This cannot be separated from a higher realization of government spending. There was growth in goods and services spending, especially for non-operational items. In addition, social assistance spending also surged significantly, by up to 78%, supported by the realization of the National Economic Recovery (PEN) program. 

Apart from regular social assistance, the government has provided a social safety net allocation to the tune of Rp110 trillion, consisting of more funds allocated for the Family Hope Program (PKH) for 10 million households, Rp10.9 trillion worth of staple food for 4.8 million households (from 15.2 million to 20 million), Rp10 trillion for Pre-employment Card, Rp3.5 trillion worth of electricity subsidy for customers whose power consumption falls within 450 and 900 VA categories, Rp32.2 trillion of housing incentive for low-income households, Rp25 trillion for basic needs reserves and market operations, and Rp20 trillion in education budget adjustments for Covid-19 handling. The aim of the stimulus is of course to revive domestic consumption that has been depressed as a result of the pandemic. The additional social assistance fund is hoped to help 57 million households. 

The realization of this program is quite successful and to date has reached 87% of those targeted. People are also very enthusiastic about the program. The pre-employment card program, which aims to improve workers’ skills during the pandemic, for example, has seen enrolment of 30 million applicants. 

As a result, various indicators have shown improvement in household consumption. The retail sales index, a growth indicator for consumer goods, grew by -9% (YoY) in August, a significant improvement from -12% (YoY) in July. 

Sales of two-wheeled motor vehicles in the third quarter of the year shrank -46.14% (YoY), but when compared to the previous quarter the figure has grown by up to 190%. Likewise, four-wheeled motor vehicles contracted by -59.30% (YoY) but this was an improvement by 362% compared to quarter before. This consequently led to improvement in domestic consumption, which grew -4% in the third quarter, slightly better compared to the contraction of up to -5% in the second quarter. 

Improved household consumption is inseparable from the policy of Large-Scale Social Restriction (PSBB) relaxation, which saw increased public mobility, although Covid-19 transmission is still rampant in the community. The figure from July-August 2020 showed that the number of positive cases in Indonesia is still on an upward trajectory, but with a higher recovery rate and steadily sliding mortality. 

Many regions have started relaxing their PSBB measures since the end of the second quarter. Data pointed to increased public mobility in June 2020, although it dropped again in July 2020 and has yet to reach the pre-Covid-19 level. The trend of increased public mobility is recorded evenly in a number of major cities in Indonesia. 

PSBB relaxation is indeed positive news for various sectors, including Micro, Small and Medium Enterprises (MSME). Many MSMEs in the regions have started to see an uptick in their business amid the ongoing pandemic. 

MSME recovery cannot be separated from government assistance, which included Rp35 trillion of interest subsidies, Rp6 trillion guarantee for working capital loans, tax incentives, government fund placement, up to Rp1 trillion investment funds for cooperatives. Finally, the government has also disbursed Rp2.4 million in cash benefits to ultra-micro businesses who are cash-strapped because they have difficulty accessing traditional bank loans. 

Furthermore, the government assists MSMEs in restructuring their current bank loans. Based on data from the Financial Services Authority (OJK) in August, the realization of bank loan restructuring has reached Rp837.64 trillion for up to 7.18 million MSMEs. 

Most beneficiaries of the loan restructuring program were MSMEs, which comprise 5.73 million borrowers or 79.8% of total borrowers with a total of of Rp357 trillion in outstanding loans have been restructured. MSME borrowers who applied for loan restructuring were still around 45% of the total 12.55 million businesses who are eligible for the outstanding loan restructuring funds, which reach Rp561 trillion. 

The government’s all-out efforts in propping up the MSME sector are highly justified. As we all know, MSMEs are one of backbone of Indonesia’s economy. They are the main driver of economic activities, making a very significant contribution to the country’s economic growth. 

According to a 2020 report from the Cooperatives and SMEs Ministry, the contribution of MSMEs to GDP at current prices is around 47% per year, over the period between 2016- 2018, and this has been consistent. In terms of value, MSME contribution to GDP at current prices is Rp6,044,086 billion for the same period. [ FIGURE-1 ] 

Other than their contribution to GDP, MSMEs also contribute to the economy thanks to their large labor absorption capacity. The MSME sector employs a very large workforce, up to 116 million people or around a staggering 97% of the total workforce in 2018. Compare this to the average labor absorption by MSMEs in developing countries in Asia which ranges around 50%-80%. 

MSMEs are also relatively resilient to crises. When the 1997-98 Asian financial crisis hit Indonesia real hard, MSMEs were able to weather the storm while many large corporations collapsed. There are a number of reasons why MSMEs are more resilient in facing crises. They generally produce goods and services that are widely used by the general public. Besides, many MSMEs don’t depend on imported raw materials so they are relatively unaffected when an international trade crisis arises. 

Again, MSMEs proved their resilience by continuing to grow when a global financial crisis rocked Indonesia in 2008-09. During this period, the GDP growth of micro and small enterprises continued to rise, from 3.87% to 6.02%. This outperformed the small and large enterprises whose GDP fell from 7.53% to 5.55% in the period 2011-13. 

In the context of the crisis and recession brought about by the Covid-19 pandemic, stimulating household consumption (as mentioned above) and providing financial assistance to MSMEs are essential to jumpstart national economic recovery. Domestic consumption in itself accounts for 60% of Indonesia’s GDP, to the extent that even a small increase will be a significant boost to national economic growth. This has been proven in the third quarter which, while still negative, was better than the economic growth in the second quarter. 

Improving the performance of MSMEs can also be key to surviving tough economic times – like this current pandemic. The financial crises of 1997 and 2008 showed us that MSME have the ability to cushion the blow for the economy and prevent it from sinking even deeper. This is interesting if we compare Indonesia’s economic growth with that of several other countries, especially those that are also in recession. Singapore, for example: when it was officially declared that the city-state was in a recession, its economic growth contracted by minus 12.6%. When compared to Indonesia, the growth contraction felt by Singapore was far more dramatic. 

Many economists believe that this is related to the smaller number of MSMEs in Singapore, compared to Indonesia. Singapore has around 271,000 MSMEs, far less than Indonesia’s 64 million. Interestingly, if we look at the labor ratio, Singapore also has far fewer workers employed by MSMEs compared to Indonesia. 

The large number of MSMEs can be a blessing in disguise, because we know that informal businesses that are widespread at the grassroots level are themselves part of the MSME ecosystem, especially micro and small businesses. Increased unemployment caused by the pandemic is inevitable. However, MSMES can become AN economic savior. As an illustration, BPS reported in August that 2.67 million more people have lost their jobs because of Covid-19. 

Nevertheless, at the same time BPS also reported that there were 5.72 million more people working in the informal sector. If we assume that informal workers are also MSME workers, this added employment means that currently there are more people who work in the MSME sector. On the back of various forms of assistance from the government and the experience of MSMEs in previously weathering two crises in Indonesia, of course this migration to the MSME sector can send a positive signal regarding Indonesia’s economic resilience during the pandemic and subsequent recovery. 

However, in order to sustain hope and optimism about economic recovery being on the right track, of course the government needs to improve some of its policies, especially considering how the pandemic may last longer than previously thought. Therefore, a design for an economic recovery path must be clear and flexible, to anticipate potential uncertainties. The government needs to continue monitoring various indicators to mitigate the pandemic. The three most important one that the government should heed: 

First, health sector reform. The Covid-19 pandemic is a test for health care systems around the world. Countries with stronger health care systems tend to fare better in their pandemic response. Prior to Covid-19, the health care system in Indonesia had faced various challenges. Despite a nominal increase in health care spending, the output is not yet optimal. Since 2016, the government has fulfilled the mandate of Law No. 36/2009 on health, which stipulates 5% state budget allocation for health care. 

In 2020, the health budget was Rp132.2 trillion, or almost twice as much the 2015 health budget realization, partly due to the increase in premium assistance for recipients of contribution assistance of National Health Insurance (JKN) scheme. However, when compared to neighboring countries in Southeast Asia, health care expenditures by both central and local governments are still relatively low. 

In addition, inadequate health care facilities still pose a major challenge for the health sector. Based on the World Development Indicators (WDI) data published by the World Bank, the ratio of hospital beds per 1,000 population in Indonesia is only 1.2, lower than Singapore and South Korea. In addition, there are still high disparities between regions in Indonesia. Likewise, the ratio of doctors is very low, namely 0.4 doctors per 1,000 population, which is lower than other developing countries in the region. Hamstrung by inadequate medical devices and insufficient numbers of health workers, health care facilities in Indonesia are ill-equipped to rise to the unprecedented challenge posed by the COVID-19 pandemic. [ FIGURE-2 ] 

Thus, in the short term, the government needs to focus on funding the procurement and expansion of health care facilities, medical equipment and health workers. In addition, the government should also work to improve access to health care facilities and health workers, especially in underdeveloped areas, borders and outer islands. This can only be done through strong coordination between the central government, local government, SOE/ROE (Region-owned Enterprise) and the private sector. Additionally, there needs to be a long-term strategy to improve the quality of human capital, especially health workers and building basic health infrastructure that is able to deal with public health emergencies such as an outbreak. 

The Global Health Security (GHS) index also shows that many countries, developed and otherwise, are not properly prepared in dealing with an epidemic or pandemic. This can be seen from the average 2019 GHS Index which scored 40.2 out of 100. Of 195 countries, Indonesia ranks 30th, lower than Singapore (#24), Malaysia (#18), and Thailand (#6). 

Secondly, social protection revamp. As the pandemic has driven more people into poverty and unemployment, the social protection programs should be improved so the momentum for economic recovery can be maintained. 

As mentioned before, one indicator of economic improvement is increased household consumption. This is driven by the various social protection assistance that the government has provided. However, there is still room for improvement in its distribution. 

The basic concept of social protection includes three components, namely, social assistance, social security, and social safety net. In its implementation, the social assistance and social security programs still face various challenges that can potentially affect their effectiveness. 

The major challenge faced by the social assistance program is the large number of targeting errors, both inclusion and exclusion errors. Target errors occurred in almost all social assistance programs with the worst happened in the Food Assistance and the National Health Insurance Contribution Assistance. Subsidy, one of the instruments the government can use in its poverty alleviation programs still tends to have more exclusion errors than the social assistance program. 

Another challenge in social protection is related to program effectiveness in reducing poverty. A study conducted by the Fiscal Policy Agency in 2020 shows a decline in effectiveness in almost all social assistance programs and subsidies. This was mainly due to targeting problem, which still contains errors and the amount of funds which remain unchanged. In addition, the schemes and benefits of social assistance are relatively the same across regions, despite the high disparity in poverty rate between one region and another. 

One of the root causes in the distribution of social protection programs is the lack of integrated data on potential beneficiaries. The government is still using the Integrated Data of Social Welfare (DTKS) which contains the social, economic and demographic information of approximately 99 million individuals with low income status in Indonesia. 

However, the main source of DTKS is the Integrated Database Update carried out by BPS in 2015. This means that this data is already outdated in terms of recipients, not to mention the problem in the regions that are not disciplined or active in updating DTKS. Based on the data, only 50 regions have renewed their DTKS so far. This should be one of the issues to be addressed by the central and regional governments in carrying out social protection reforms, to maintaining the momentum of economic recovery. 

The last thing that the government also needs to pay attention to is the state budget financing policy. The government has implemented an expansionary fiscal policy to support economic growth and economic recovery. Through a Government Regulation in Lieu of Law (Perppu), authorities have also increased flexibility in the budget deficit which was previously limited to less than 3% of GDP. With a very expansive expediture policy to promote economic recovery, the widening of the budget deficit is inevitable. Moreover, in the next two years, Indonesia’s economy will still be in a consolidation period, so the budget deficit will still be relatively large. [ FIGURE-3 ] 

Thus, the government should pay more attention to its financing strategy. Indonesia is relatively adept at formulating strategies to finance its deficit. The main strategy is by issuing Government Bond (SBN) denominated in Rupiah. This policy is also partly aimed at reducing the exchange rate risk, due to the volatility cause by a widening budget deficit and also as a result of the financial market deepening policy. 

Even amid the Covid-19 pandemic, the momentum for financial market deepening through diversification of the profile of SBN investors has become even greater. Before the pandemic, foreign ownership of SBN decreased from 39% to around 30% of total issuance. The government can take this opportunity to increase the portion of retail investors. 

Moreover, the interest from retail investors continues to increase every year. This is also supported by the increased proportion of Millennial investors, namely investors born between 1980-2000 who hold a relatively large proportion of around 50% of retail SBNs. With a demography currently dominated by Millennials, this trend of domestic investor ownership by that group could serve as a momentum for more massive financial market deepening during the economic recovery period. 

Financial reform can also be carried out by encouraging the participation of Indonesian banks in assisting government financing. The participation of Bank Indonesia in helping the government fund a widening fiscal deficit in 2020 state budget and also next year could have a positive impact in reducing pressure on economic growth caused by the Covid-19 pandemic. Although it is relatively late, stronger coordination with the government will send a positive signal to the financial industry. 

BI’s expansionary monetary policy is in line with the measures taken by central banks in other countries during the pandemic, which include quantitative easing policy to finance fiscal stimulus. In fact, BI and central banks from several other countries are actively buying government bonds. [ FIGURE-4 ] 

Some central banks directly injected liquidity into the economy by disbursing loans to MSMEs and buying corporate bonds. 

Abundant global liquidity resulting from central banks’ policy has opened up a window for capital inflows into developing countries such as Indonesia, which yield higher profits for investors. With the inflow of foreign capital, the Rupiah has strengthened since April and is currently quite stable at around Rp14,000 per US dollar. Apart from the abundant global liquidity, another factor that has also eased the downward pressure on the Rupiah was the improvement in the current account position triggered by weakened imports due to restrictions on economic activity during the Covid-19 pandemic. 

The Rupiah stability provides room for BI to continue loosening its monetary policy. In 2020, the central bank has lowered its benchmark interest rate, primary reserve requirement (GWM), and is buying government bonds on the primary market. Amid the global liquidity flush, many predict that BI will continue loosening its monetary policy. 

This is definitely positive news amid expansionary fiscal policy. The easing of monetary policy will lead to cheaper costs in financing the budget deficit. Ultimately, the government can still implement its economic recovery programs to boost economic growth in the coming year. (Yusuf Rendy Manilet)

 Yusuf Rendy Manilet is an economic researcher at the Center of Reform on Economics (CORE). He earned his Bachelor’s degree in Economics from Syarif Hidayatullah State Islamic University (UIN), Jakarta. His research interest is in macroeconomics, fiscal policy, sovereign debt, and poverty alleviation. Before joining CORE, Yusuf worked with several leading banks in Jakarta.