Indonesia slides into recession

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

IO – The world’s stock markets are crashing, taking down the Indonesian stock exchange with them. In fact, Indonesia has been one of the worst-hit markets in the world. The IDX Composite Index, which is the performance barometer of Indonesia’s shares, has dropped sharply within the first two months of 2020: it went down 12.13%, from 6,299.54 (30 December 2019) to 5,535.69 (27 February 2020). This is the lowest the index has been for the past 3 years.

Such a sharp drop of the stock index for the past two months shows just how grim overall economic prospects are for 2020. The potential for recession has become scarily real and uncomfortably close – it might happen in a matter of days, weeks, or months. Indonesia’s economy will find itself hard to weather the storm of the Covid-19 plague, because it is fundamentally very weak. Indonesia’s industrial structure is simply horrible. Exports depend on raw material / ingredients and commodities such as coal, palm oil, and rubber. If commodity prices for Indonesia’s best export goods bottom out, our export income would naturally fall as well.

Because of the Corona virus, international trade – and the global economy in turn – will suffer a drastic drop. Commodity prices will also suffer a sharp drop: crude oil and palm oil prices have slid more than 15% within the first two months of 2020. The double impact of weak global demand and lowered commodity prices have depressed our exports in turn. Exports in January 2020 are down 3.7% from those of January 2019, while exports in 2019 already headed downward quite steeply from those of 2018. Consequently, the trade balance deficit continues, from the deficits in 2018 and 2019. In fact, our trade balance deficit in January 2020 was a shocking USD 864.2 million.

A bigger cause of concern is that the export and trade balance deficit in February can become even bigger, as the Corona virus issue has not shown any sign of resolving favorably. Even worse, Indonesia’s internal fiscal system is also poor. Tax earnings ratio to GDP (including from customs and excises) have plummeted to a critical level. If left alone, this could trigger both a State Budget (fiscal) crisis and exchange rate crisis.

Tax earnings in January 2020 were down 6% from those of January 2019, from IDR 90.04 trillion to IDR 84.66 trillion. January 2020 tax ratio to GDP can be expected to tighten up even more than 7%. Consequently, State expenditures are down 9.1%. This is what is meant by “fiscal State Budget crisis”: The State Budget is no longer reliable for the purpose of providing income and economic growth with it. On the contrary, the State Budget dropped sharply, and this will sharply curtail economic growth as well. The drop in State income will further worsen the State Budget deficit, and increase Government debt in turn.

In fact, the Government has been taking on much more debt than what is required to cover State Budget deficit. Most of this debt is obtained from foreign loans, and contracted in order for us to gain USD to dope up the Rupiah exchange rate. Up until the end of last year, this abnormal policy worked reasonably well: the Rupiah exchange rate went up to IDR 13,500.00-ish per USD.

This “abracadabra” policy can only work when global economic conditions are favorable. In such a case, global investors have extra funds that would allow them to buy Indonesian Government bonds. However, with a weakened global economic condition, and many countries expected to enter recession soon, the global financial condition has become straitened. Global investors would tend to hoard their cash instead of paper assets (shares and bonds) whose prices can drop any time, as they, too, must remain vigilant in case global economic conditions worsen. Therefore, they would tend to sell off their paper assets and portfolios in order to get cash. Consequently, stock prices fall everywhere, and the Index falls with them. The yield from selling these shares and Government bonds will be converted into cash (in the most sought-after currency, the USD), and capital outflow occurs. Naturally, this depresses the Rupiah exchange rate to rapidly slide down beyond IDR 14,000.00 per USD.

If global economic conditions do not improve soon, economic growth in the first Quarter of 2020 will crash, and it is not impossible to see it settling below 4%. State income will become critically lower, State expenditures will decrease, the trade balance deficit will rise along with State Budget deficit, and it will be hard for us to pay back debt. In fact, we will suffer from a massive capital outflow in the form of dollars.

The unfortunate combination of all these phenomena will result in the balance of payments to suffer a sharp deficit, and our foreign reserves and Rupiah exchange rate will go into freefall as well. Do not be too surprised if the Rupiah exchange rate drops again to the IDR 14,500.00 per USD level, or even crosses IDR 15,000.00 per USD psychological limit, before heading lower. We will sharply feel the sting of economic crisis in Quarter I, and the bite will become even more intensely painful in Quarter II. It may even turn into a recession. The Government is really helpless to do anything other than further increasing interest rates in order to reduce dollar outflow, which will further worsen the economy. Massive layoffs seem to be inevitable, especially in the export and import sector (due to inability to obtain materials and supplies) and the tourism sector will dry up as well (following strict travel restrictions).