How to avoid recession? Learn from China and Vietnam

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Gede Sandra Economics and politics analyst for the People’s Sovereignty Movement (Pergerakan Kedaulatan Rakyat)

IO – China and Vietnam are two countries that have apparently avoided recession throughout the COVID-19 pandemic. China’s economic growth, despite having dropped to -6.8% in Quarter I of 2020, has recovered up to 3.2% in Quarter II of 2020. On the other hand, Vietnam’s economic growth in Quarter I of 2020 was 3.82%, dipping again but remains positive at 0.32% in Quarter II of 2020. Therefore, the two countries are technically not in a recession. 

What is the secret of these two communist countries that allow them to maintain their economic health even though many other countries are already in a recession? One of the main reasons is credit growth in the banking sector. 

“Credit growth” is the effectiveness rate of banking’s distribution of third-party funds to private businesses. The higher credit growth rate, the faster private business activities develop. On the contrary, low credit growth means that private business activities also get impeded. 

Amid the COVID-19 pandemic, China’s credit growth remains high, in a 16.1% range. On the other hand, Vietnam’s credit growth is quite depressed, but it is still in the 8.6% range (way down from an average of 20% within the past few decades). What a stark comparison with the credit growth in Indonesia, that crashed to the 3% range now! 

What causes credit growth to remain high in China and to remain decent in Vietnam, and to become very low in Indonesia? That’s because of the “crowding out” effect, which does not occur in China and Vietnam but occurs in Indonesia. Indonesia’s banking decision-makers prefer to buy Government bonds instead of distributing funds towards private business credits. Consequently, Indonesia’s private businesses cannot grow, even though the Government continues to issue bonds to finance development and Government spending. 

Indonesia’s banks are interested in obtaining Government bonds because their interest rate/yield is extremely high. The yield for 10-year maturity bonds is in the 6.7% range on average. In fact, the Government sometimes issue 7%-8% coupons on shorter maturity periods. Naturally, they would find investing into bonds much safer and easier than investing in much riskier private businesses (even though they could impose interest as high as 12%), as the rate of non-performing credit rose to 3%. Consequently, private businesses get crowded out of the funding market. They do not get any funding, because cash generally rotates between the banking sector and the Government. 

Lowering Bond Yield 

The question is, “How come banks in China and Vietnam continue to distribute credit to private companies and do not get onto the bandwagon of massive Government bond investments?” this is because the yield of the two countries’ Government bonds is quite low, even lower than their Central Bank interest rate. For comparison, Indonesia’s current Central Bank reference interest rate is 4%, while its Government bond yield rate is (10 years) is 6.7%. In China, the Central Bank reference interest rate is 3.85%, while its Government bond yield rate is (10 years) is 3.05%. In Vietnam, the rates are respectively 4.5% and 2.9%. 

What does the above data tell us about the difference between China and Vietnam compared to Indonesia? Yes, the yield of China and Vietnam’s bonds is lower than Central Bank reference interest rate. On the contrary, the yield of Indonesian bonds is higher than its Central Bank reference interest rate. If the Central Bank reference interest rate is higher than bond yields, banking funds will not go towards bonds. Consequently, banks will do their best to distribute credit, and the crowding out effect in the country’s economy is prevented. That’s how China and Vietnam get to be where they are now. 

The question is, “Can we implement low yield in Indonesian bonds?” 

The answer is, “We must!” Why else did our financial officials get such high levels of education? Indonesia’s officials in the Ministry of Finance has its own formula for determining the rate of bond coupons (presented in the Ministry of Finance’s Directorate General of Funding and Risk Management (Direktorat Jenderal Pengelolaan Pembiayaan dan Risiko – “DJPPR”) official website), is “Central Bank reference interest rate plus spread.” 

How did they come up with this formula? Why do the Ministries of Finance in China and Vietnam use different formulas? They deduct reference interest rate with spread instead! Why can’t our officials use the same formula in order to lower Indonesia’s bond yield in turn? 

Perhaps some economist or official will say that “Yield rate cannot be lowered because it is purely determined by market volatility.” 

Oh really? It shows how little these so-called “economists” and officials read! There is such a thing called the “yield curve control” policy. This is a policy that limits yield bonds in order to reduce bonds’ interest liabilities in the future. It’s implemented in countries like the United States, Japan, and Australia – and it works!