Notes on Indonesia’s economic fundamentals

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(illustration: IO/Rudraksha)

IO, Jakarta – Entering the fourth year of Joko Widodo-Jusuf Kalla leadership, the strength of Indonesia’s economic fundamentals, frequently boasted of in the media, has begun to be seriously questioned. Consider how alarming is the ominous steady weakening of the Rupiah against economic fundamentals. According to the Jakarta Interbank Spot Economic Fundamental Rate (JISDOR) Reference Exchange Rate from the Bank Indonesia website, Rupiah’s exchange rate to the Dollar on 30 April 2018 was recorded at Rp 13,877. The highest rise of the exchange rate occurred on 26 April, when the Rupiah hit the Rp 13,930.00 mark.

President Jokowi’s excuse is that the depreciation of the Rupiah against the American currency is the result of global sentiment, in this case related to the policy of the Fed (US Central Bank), which may potentially crank up the reference interest rate. The Rupiah is not the only marker threatened: increased unemployment and weak purchasing power of the people has driven many retailers to shut their doors. Our economy is in fact at a crossroads.

Fragile Economic Fundamentals
Amid all these economic problems, President Jokowi, who attended the Opening of the National Development Planning Deliberations (Musyawarah Perencanaan Pembangunan Nasional – “Musrenbang”) 2018 at Grand Sahid Jaya Hotel, Jakarta, on Monday (30/4), remains confident that Indonesia’s economic fundamentals are sound. He said that this is reflected in a healthy growth rate, inflation controlled at a low level, and a responsible balance of payments figure.

However, this is contrary to the views of Senior Economist Kwik Kian Gie. According to the former Coordinating Minister of the Economy during President Gus Dur’s reign, Indonesia’s economic fundamentals are currently fragile, with several indicators pointing to this, the main one being a dependence on imports, especially for daily consumer items.

According to data from Statistics Indonesia (Badan Pusat Statistik – “BPS”) Indonesia relies on imports of many basic food commodities: rice, wheat flour, sugar, cattle, beef, salt, butter, frying oil, garlic, pepper, potatoes, powdered dry chili, processed and preserved chili, and eggs. Kwik further pointed out that with imports being higher than exports, currency reserves are being steadily drained. “This is the impact of the fall of the Rupiah exchange rate. Despite intervening measures from Bank Indonesia, which has cut quite a bit into currency reserves, the Rupiah exchange rate continues in a downward spiral,” he said.

Even worse: continued increase of State debt, plus the commercialization of infrastructure (because construction is entrusted to private enterprises, which invest in them purely for profit), put pressure on the principal price of Indonesian goods and services, so that these cannot compete.

Kwik’s views are similar to those of Bhima Yudhistira, Economic Observer from the Institute for Development of Economics and Finance (INDEF). Bhima said that indicators show that current fundamental economic conditions are actually quite fragile, as seen from the reduction of public purchasing power, especially in the lower 40% of the population, the suppression of farm laborer wages within the past 3 years due to inflation, and the weakening of the Rupiah not only against USD, but also against other currencies in Asia.

Data from the Investment Coordination Agency (Badan Koordinasi Penanaman Modal – BKPM) shows that incoming investments do little to encourage the absorption of workers, as demonstrated by a drop of 216,000 in 2017 compared to the previous year’s figure. Structurally, the portion of the processing industry continues to shrink. It is currently 21% of the Gross Domestic Product, while the 2006 ratio was still 25%. “This industrial shrinkage causes insufficient tax income, and transaction deficits have increased in consequence,” Bhima said.

Senior Economist Fuad Bawazier also admits to the fragility of economic fundamentals. According to the former Minister of Economy during the Soeharto era, it is true that rates of inflation are relatively controlled, and that bank interest rates are higher than those of neighboring countries. However, economic fundamentals are not viewed from macro factors only, as there are other factors at play. “What most people tend to forget is the micro factors. Our micro economy is encountering a lot of trouble as well. Nowadays, entrepreneurs – high, upper middle, lower middle, down to small and micro entrepreneurs have reason to complain. Farmers, laborers, complain that there is lack of work. So, this is extremely serious,” Fuad said.

Fuad further pointed out that our economic fundamentals are highly fragile, as the biggest economic actor is our Government, but our State Budget is struggling because tax income targets – or even State income targets in general – fail to be met, while such income is the very breath of the State Budget. “Most of the State Budget liquidity is fueled by debt. That includes the new State Bonds (Surat Utang Negara – “SUN”). However, our SUN is not so easy to sell nowadays: it sells poorly because investors are getting wary of the Indonesian Government. If tax income is struggling and the State Budget is in a permanent deficit, new debt will be applied to pay down principal on old debt, and the interest on new ones. People become even more mistrustful of our ability to repay our debt: they fear that we will fail to pay them off,” he said.

Meanwhile, Burhanuddin Abdullah, former Governor of Bank Indonesia, said that economic fundamentals are quite good when you see the figures on paper. For example, inflation rate is at 3.5%, current account deficit has a balance of 2%. However, when the economic fundamentals are assessed in detail, structural weaknesses will become clear, starting from income gaps, a high number of unemployed citizens, and other economic structural issues.

For the past century, Indonesia has failed to change the dualistic economic structure into a more evenly-balanced economic structure. On one hand, a very small part of our economy is a capital-intense, technology-intense, modern and market-oriented system. Indonesia has also been stated as an “investment-grade” nation by three international ranking agencies. Unfortunately, this “investment grade” status has become meaningless, because interest rates are on the rise, and risks are thus increased. Again, these structural weaknesses show just how fragile our economic fundamentals really are.

When assessing economic fundamentals, 6 indicators are viewed: inflation rate, Rupiah exchange rate, bank interest rate, trade balance, gross domestic product (GDP), and unemployment. Kwik said that an analysis of Indonesia’s economy will not show good news in any of these indicators. “Inflation is creeping up, and a lot of people feel it and complain about it. Bank interest rates are higher than those of neighboring ASEAN countries. Trade balance is mostly negative – it is occasionally positive due to comparative advantage, not because of competitive advantage. The positive is caused by increased prices of coal and other natural resources, which are mined and exported just like that without any domestic processing, and thus receive no added value. GDP increases, but at a lower level than what is targeted in the State Budget, and high unemployment persists,” he said.

According to Bhima, inflation within the past 3 years has kept low, but that is because the people’s buying power has been degraded, as reflected in the slow movement of core inflation. The potential of increased inflation this year must be watched, because there are pressures from a weakening Rupiah and increasing global crude oil prices. The Rupiah exchange rate is easily shaken by global factors, such as increased Fed rates. Domestically, there is a distrust of Government policies, as they are deemed to have failed to stimulate the economy. There is no more room for increasing reference interest rate: in order to control the Rupiah exchange rate and inflation rate, Bank Indonesia is expected to raise the 7-day repo rate for 25-50 bps reference interest rate to 4.5%-4.75%.

Trade balance is in deficit for 3 consecutive months, i.e., from December 2017 to February 2018. Even though a surplus was recorded in March, this was actually due to the decline of imported materials and consumables. This condition will not last long, because during Eid-el-Fitri, consumer imports will rise again. This condition limits deficit of current transactions, which is estimated to reach 2.1% of GDP this year. GDP growth remains stagnant at a 5.1% range in 2018. The trend of growth stagnant from the past 3 years is expected to continue. “There is a reduced percentage of unemployment, but the main sectors supported are transportation services and public services. We suspect that this is due to the existence of online transportation and village funds,” Bhima said.

Rupiah Remains Depressed
Burhanuddin predicts that the Rupiah exchange rate will continue to weaken until the end of the year, because of the bad economic structure, as reflected in the deficit of current transactions. Within the past 50 years, current transactions have been continuously in deficit, and surpluses only occurred 4 times. “The surpluses did not occur because of our prowess either, but due to external conditions, such as the Korean War in 1953 and the Yom Kippur War in 1973,” he said.

After the 1998 economic crisis, Burhanuddin said, Indonesia’s economic capacity nosedived. “Now there is more than the current account deficit: there is a trade balance deficit too. If we want to be able to grow 7%, we have to make more imports, which will increase current account deficit. This is why economic fundamentals need to grow, and the Rupiah depreciates,” he said.

Bhima sees that the Rupiah exchange rate weakens due to global factors, such as the Fed rate having increased 4x so far this year. This makes investors reconsider placement of their funds in developing countries and decide instead to hunt for US bonds, whose yield is much more attractive. Within past months, Rp 10.1 trillion of foreign investments have exited the Indonesian capital market. To worsen the external factor, domestically there is a general distrust of Government policies.

Until the end of the year, there is a potential for the Rupiah will continue to weaken until it crosses the psychological limit of Rp 14,200.00 per USD. Bhima suggests to immediately increase the BI interest reference 25-50 bps, recover investor trust, strengthen economic fundamentals by encouraging exports, and finally, control capital by issuing a regulation that Export Foreign Currencies (Devisa Hasil Ekspor – “DHE”) must be deposited in domestic banks for a minimum of 6 months (as is the case in Thailand).

Kwik concludes that the weakening of the Rupiah exchange rate is caused by the inability of the entire nation to obtain foreign currency. Foreign currency is obtained from loans. In 1970, USD 1.00 = Rp 378.00; now it is practically USD 1.00 = Rp 14,000.00. “This shows a depreciation of 3,600 %. Compare it with the depreciation of other ASEAN currencies,” he said.

Fuad admits that our foreign currency reserves are unhealthy. Healthy foreign currency reserves originate from exports. Unfortunately, our exports continue to weaken, so that the trade balance frequently goes into a deficit. “Within 3 months, i.e. December 2017-February 2018, our payment balance had a deficit of USD 1.1 billion from economic fundamentals. In these 3 months, we imported more than we exported. So, we are overdrawn,” he said.

According to Fuad, Bank Indonesia (BI) has intervened with the weakening Rupiah exchange rate to keep it from weakening even further. “If we let it remain unassisted, we’d have exceeded the Rp 14,500.00 level. However, BI also has the problem that it has limited foreign currency reserves, so it won’t dare to keep intervening indefinitely. Rupiah will tend to continue weakening throughout the year. There are external factors, such as improved US economy, increased US interest rate, but if Indonesia is in a good condition, profitable, investors will remain here. But Indonesia gets hard up, American investors will prefer to keep their assets at home. If we pick up, they will return,” he said.

Our economy is so bad, Fuad said, that the SUN interest is the highest in Asia Pacific at 7%. Compare that to Vietnam’s National Bond interest at only 4.4%. “We bribe people with 7% so that they will buy our SUN, and people are still doubtful. They only offer 4.4% there, but the people are confident about the government,” he said. “Until the end of the New Order, manufacturing industry income was only 30% of the GDP. It is now 20%. And this is our very support for takeoff. Our exports have declined because we do not have anything to rely on: there is no industry that we can rely on for exports. So, our strategies are unclear,” he said.

Fuad appreciates the construction of infrastructure, because Indonesia needs it. Unfortunately, it is often of low quality, which will cause many problems when completed. “Firstly, people will hesitate to use it, because Jokowi’s constructed infrastructure tend to break down, and people will fear for their safety. Second, when they are put up for sale, such infrastructure will only fetch low prices or even be unsaleable. Jokowi said that he is going to sell toll roads when they are completed, but candidate buyers will think twice – are these poor goods with high maintenance and care costs: they won’t want to get involved unless it is offered very cheaply. Well, the infrastructure is constructed using bank loans, so it will be difficult to repay the bank then. I don’t know why the budget is good, but the quality of the finished product is low. This makes it generate low income, and it will only fetch a low price if sold. Government’s credibility continues to decline day after day. Economic prospects under Jokowi are in trouble,” he said.

Debt Must Be Controlled
When President Susilo Bambang Yudhuyono was in power for 10 years, he left behind a debt total of Rp 2,608.8 trillion, with a debt ratio of 24.7%. During the 3 years of Jokowi-JK reign, in September 2017, Indonesia’s foreign debts are recorded at Rp 4,636 trillion, with a ratio of 27% of GDP. Of this total amount of debt, the Government portion reached Rp 3,866.45 trillion.

Kwik said that the increase of debt in the Jokowi era is unnatural and must definitely be limited. Similar to Kwik, Bhima states that the growth of debt in the Jokowi era is too quick and must therefore be limited. “Not all debt is directed for the productive sector. Most goes for employee expenditures, operational expenditures, and for purchase of goods. If it does not get limited, there will be smaller and smaller fiscal room to repay principal and interest, which totals more than 480 trillion per year,” he warned.

Fuad, on the other hand, considers that the Government is not sufficiently disciplined in terms of using which part of loans for construction, thus creating a deficit of primary balance. “Debts have now increased 2 digits, to 12% or more, while economic growth is only 5%. If we get more into debt, there will be more obligations to repay principal and interest. On the other hand, economic growth is low and tax growth is stagnant. How are we going to repay our debts then?” he asked.

Stagnant Economic Growth
During Jokowi’s reign, economic growth hovers at 5%. This growth rate will not absorb many workers. “Absorption of workers starts at 7% growth. With the current growth rate at 5%, and such growth being partially capital intensive, not many workers are absorbed,” Fuad said.

“We should do over the entire concept of infrastructure construction – we should direct it to be more worker-intensive. Industrialization is the next key, because one of the biggest possibilities of worker absorption is in processing. Finally, encourage entrepreneurship by guiding digital startups to help improve economic growth,” Bhima said.

Burhanuddin said that if we want economic growth, we need to change our economic orientation. We must not simply depend on a capital-intensive and technology-intensive economy, because it will only absorb a small number of workers. We should concentrate on developing the agricultural and food and beverage industries, because they will absorb the most workers. For each 1% growth of the economy, only 140,000 workers can be absorbed. However, a different economic orientation can increase the number to 300,000 people being absorbed for each 1% growth. The work force can be absorbed best if economic growth reaches 8%-9%. With good economic growth, Indonesia will become a high-income country with 12,000 economic fundamental income per capita (with current income ratio at only 3,700 economic fundamentals per capita). If there is no significant economic growth, Indonesia will be stuck in the “middle income trap”.

Bhima said that it is possible to increase job opportunity absorption, if a stimulus to the industrial sector is optimized, especially for worker-intensive sectors such as textiles, food and beverages, electronics, and footwear. Apprenticeships and vocational school programs should be intensified, in order to encourage absorption of workers with an educational level of High School graduate equivalent and below.

Input for the Government
“Reforms” is the key word for the government to improve itself, specifically State Budget reforms. “Our State Budget contains too much fat. Does the Government dare? This will be unpopular, because many people enjoy illicit benefits, such as profits from marked-up prices. Some budget items are also useless,” Fuad said. Furthermore, it will be much better if the State Budget is simplified and effective, instead of looking big but ineffective. “Simplified, but it supports the economy properly, and reduces debt significantly,” he said.

The Government must rationalize its projects. “For example, don’t construct toll roads where there are no people, or don’t just construct toll roads for people: build for industry as well. It must also resolve short-term issues, because many prices go up – like fuel, electricity, food, while pay remains the same. Don’t allow the market to do as it pleases: the market must support those who need the most. And it’s the lowliest of our people who need it the most,” Burhanuddin said.

Bhima requests that the Government focus on encouraging one or several economic sectors only. For example, the Government’s 16 policy packages want to regulate everything, from gas prices to beef prices, but ended up getting stuck in implementation. It should focus on encouraging industrialization, for example by improving infrastructure in industrial areas, and by focusing incentives on industries that are to be included in the Special Economic Zones.

However, Bhima continued, the country is mismanaged and it has already diverged from the framework of the Constitution of 1945. “It has deviated very far, and it is extremely dangerous for economic survival. For example, the resources of the nation should be controlled by the State. Yet we are helpless before Freeport. Not to mention other inequalities that occur post-reform – in 2000, the Gini ratio was 0.3, but it became 0.39 in 2017,” he explained concernedly.

Similar to Bhima, Fuad also admits that the country has been mismanaged. “Nowadays, international trust in Jokowi has also nosedived, because they think that he is incompetent, that he is unable to rule the country. Even in the public eye, farmers are disappointed because of the food imports, workers are disappointed because of the influx of Chinese laborers while people here struggle to get work. Highly credible government is a necessity; otherwise, investors will be scared to invest in us,” he said. (Dessy Aipipidely)