Reflecting on Economic Expectations and Prospects for 2020
In line with the endogenous growth theory in terms of aggregate demand amid the pressures on export performance, consumption and investment will remain the main sources of economic growth for Indonesia in 2020.
Therefore, the behavior and cycle of spending and investment are vital to predicting the economy’s future direction. Government spending can still affect the cycles of consumption and investment, either through the multiplier effect, regulation or deregulation, and the effects of announcing a new policy direction.
Foregoing the anxiety over recession and the trade war, the political year usually has minimal impact on these economic variables. However, with the current advancements in information technology in forming expectations, negative news is usually more easily accepted and remembered longer. Meanwhile, good news requires repeated verification.
Information environment
The year 2019 was full of challenges. Four storm systems emerged which, if they combine, have the potential to create the “perfect storm” for Indonesia. First is the potential for recession in the United States, marked by higher short-term interest rates compared to long-term interest rates (inverted yield curve). Second, the US-China trade war has slowed global growth. Third, Indonesia’s political year saw a huge “festival” of elections. Fourth is the technological disruption that could eliminate some manual, routine and repetitive labor and replace them with automation.
This final “storm” has increased people’s worries about their future job prospects, which in turn has impacted the shopping cycle to affect economic growth.
However, compared to other countries, Indonesia’s combination of prudent macroeconomic policies, large population, and also a small fortune from portfolio capital inflows due to uncertainty in the US and the European Union has led to annual growth of around 5 percent.
With regard to the risk of a US recession, although this is still debated, many parties have said that the decade since 2008 is the first time the US has not experienced a recession. Some have boldly stated that the inverted yield curve that appeared several times in 2019 was just a false alarm. This is mainly supported by US labor market data that shows job growth despite the major union strike at General Motors.
US growth is also not as pessimistic as initially projected. After declining from 3.1 percent in the first quarter of 2019 to 2.0 percent in Q2 2019, growth increased slightly to 2.1 percent in Q3. The figure was far from indicating a recession, defined as decline in growth over two consecutive quarters. Fresh air also arrived in mid-December 2019, when it was reported that the US and China had agreed to the first deal in restoring peaceful trade. This seems to have prompted the IMF to be a little more optimistic for 2020, projecting 3.4 percent growth and not 3.0 percent as it did in 2019, although recovery might only occur in a few regions.
Read more : Indonesian Economy Greets 2020
Employment and economic behavior
The Bank Indonesia (BI) Consumer Confidence Index (CCI) for 2019 reached its highest level in May 2019 after the presidential election with 128.2, also the highest since the final year of the commodities bonanza in 2012. If we look back further to January 2019, this indicator increased steadily up to the April 2019 presidential election. The indicator started declining with the election dispute petition filed with the Constitutional Court and reached its lowest level of 118.4 in October 2019. Accordingly, consumption growth declined from 5.05 percent year on year (yoy) in Q2 to 5.02 percent in Q3. In November, consumer expectation began to improve with a CCI of 124.2, signaling improved growth in public consumption.
A question has been raised whether the successive decline in the CCI from May to October was due solely to negative expectations generated by news on recession, the trade war, and the aftermath of the 2019 presidential election, or was it also affected by other factors? The CCI is only one indicator used to measure consumer confidence.
Other indicators are the Current Economic Condition Index (CECI) and the Consumer Expectation Index (CEI). One of the interesting things is that the Employment Trend Index (ETI) is part of the CECI. Technological disruption has the potential to replace human workers with automation, especially in repetitive jobs (McKinsey, 2018). The fear of job loss causes endogenous expectations, which helps explain why abundant information can lead to a change in consumer behavior that successively slows consumption expenditure.
Based on education level, senior high and vocational school graduates tended to be pessimistic about job availability for most of 2019. Meanwhile, undergraduates have a more optimistic view of job availability. In terms of expenditure, all age groups remained pessimistic until the latest data in November. However, almost all age groups and education levels had an optimistic outlook on job availability over six months.
Even significant increase in optimism was recorded in November. However, consumer behavior was determined more by the perception of currently available jobs and not future employment. Therefore, Indonesians are not very forward-looking as expected in an upper-middle income country. However, they pay more attention to trending news, especially with the increasingly widespread use of social media, including WhatsApp groups. It is like that news about baby cobras roaming parts of Jakarta is more interesting than news about the first phase of the US-China trade deal that could improve employment in 2020.
In the long run, the relationship between consumption expenditure and incomes (marginal propensity to consume/MPC) has tended to be stable. However, fluctuations in short-term income and expenditure are crucial to short-term economic growth. Therefore, the savings-to-income ratio (marginal propensity to save/MPS) can be used as an indicator instead of the MPC. Those with a monthly expenditure of up to Rp 3 million comprise around 18 percent of the MPS group, while the figure is 20 percent for the MPC group. The smaller the MPS, the greater their multiplier effect on purchasing power.
MPS consumers spending up to Rp 3 million increased in October to 19.3 percent, while MPS consumers with higher expenditure increased to 20 percent. These figures explain the slowdown in consumption growth in Q3 2019. The good news is that although the employment trends index (ETI) remained relatively pessimistic, November saw a new spending cycle with a reduction in all MPS income groups to an average 18.5 percent. This decline was accompanied by improved prospects in durable goods orders such as electronics and household appliances.
A simple calculation shows that investment growth of 8 to 9 percent per year is needed to achieve an annual growth rate of 5.3-5.4 percent.
After reaching the most pessimistic level in October, durable goods orders began to recover in November almost to the February level, two months before the presidential election. The improved sentiment could provide momentum for Q1 2020, although it has been estimated that economic growth will not exceed 5.3 percent this year. The sectors that are expected to remain under pressure are agriculture, mining, property, and manufacturing, with growth below 5 percent. Meanwhile, the sectors that continue to grow above the national growth average are wholesale and retail, transportation and logistics, hospitality (accommodation and F&B), information and communication, education and health.
Investor behavior has also led to interlocking endogenous expectations, especially after 2000. Investment follows economic prospects as in an unbroken circle, whichever comes first, the chicken or the egg. Growth requires investment, but investment only happens if the economic outlook is good enough. A recent example is a decline in consumption growth from 5.17 to 5.02 percent in Q3 2019, followed by a decline in investment growth from 5.01 to 4.21 percent. The picture at the micro level shows slight improvement in investment in machinery and equipment following an improvement in the CCI.
Looking at the improving pattern in durable goods orders at the end of 2019, it seems that this led to a boost in investment. Nevertheless, regulatory breakthroughs are needed to overcome current investor behavior to achieve higher growth. A simple calculation shows that investment growth of 8 to 9 percent per year is needed to achieve an annual growth rate of 5.3-5.4 percent. This is no easy task, considering that the highest year-on-year growth in real investment since 2013 occurred in Q3 2018 at 7.94 percent.
Breaking the cycle
The way expectations form in Indonesia has changed from exogenous to endogenous, which is not always conducive to the aspiration to achieve more than 5 percent growth. To maintain the economic growth momentum, dynamic exogenous factors are needed such as new foreign developments, revising regulations that impede and contradict each other, changes changing consumer/investor behavior, new directions in government policy, and changes in technology. The government can alter expectations by using the broad reach of the notification network in Indonesia.
Nevertheless, because forming public expectations in Indonesia is short-term and lacks foresight, the current momentum of positive expectations needs to be maintained. The expectations of people who are more interested in following today\'s trending headlines means that the positive effects of new policy notifications last only two quarters at most, after which the growth trajectory (saddle path) will return to its original level. Several domestic and foreign institutions have projected 5 percent growth for Indonesia in 2020, with slight variations.
One of the policy implications is that derivative regulations must immediately follow each new policy initiative to shift the growth path to a higher trajectory, along with technical instructions for using the upswing in the economic cycle towards Q1 and Q2 2020.
Ari Kuncoro, Rector, University of Indonesia