Why Indonesia Must Recover Faster
"When all else fails, nasi padang prevails". I know this expression is exaggerated. An economic stimulus is perhaps similar to nasi padang (Minang-style rice with various side dishes).
"When all else fails, nasi padang prevails". I know this expression is exaggerated. An economic stimulus is perhaps similar to nasi padang (Minang-style rice with various side dishes). It saves the day when our efforts have failed. However, like nasi padang, it can cause health problems, especially if we eat too much of it.
Economic stimulus generally has the same character, such as the quantitative easing (QE) provided by the United States Federal Reserve (Fed). As We know, the Fed implemented a QE policy to save the economy through the purchase of long-term securities from the market. This resulted in an increase in liquidity and bond prices but a decline in yields.
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However, as demand is still weak – as is the case in Indonesia today – people choose to keep their money in banks, or invest in financial markets. Because yields in emerging markets (EM), including Indonesia, are more attractive than those in the US. The funds (liquidity) then flow to EM. That is why the financial market in Indonesia is booming, and the rupiah is strengthening. The problem is, it\'s only temporary.
Financial crisis risk
Aizenman and Ito (2020), in a paper for the National Bureau of Economic Research (NBER), note that aggressive fiscal and monetary policy will indeed boost economic growth in the US in the short term, but it may cause a financial crisis in the future. When inflation starts to rise and the US economy begins to recover, the Fed must exit from this policy.
Former US Finance Minister Larry Summers warned a few days ago that US President Joe Biden\'s US$1.9 trillion stimulus would trigger inflation.
The Fed itself has learned from this mistake and tries not to repeat it.
The EM\'s got traumatized by this policy, which we know as a taper tantrum. The Fed itself has learned from this mistake and tries not to repeat it. Look at the statement of the chairman of the Fed, Jerrome Powell, “[One] lesson of the global financial crisis is: Be careful not to exit too early…”
Powell also said that the Fed had to be careful in communicating the direction of its asset purchase policy, which is an instrument of QE. Harvard University economics professor Kenneth Rogoff, in a panel discussion at the Mandiri Investment Forum (MIF) on 2 Feb. 2021, also said that he did not expect a Taper Tantrum 2.0 to occur.
Powell\'s statements and Rogoff\'s view make us feel relieved, at least for a while, particularly with regard to a concern that emerged nearly eight years ago. I remembered that during a discussion forum at the G-20 meeting in Sydney in 2014, Janet Yellen (the then-chairman of the Fed and recently appointed US Treasury secretary) and I were asked to talk about macroeconomic conditions.
One of the aspects I highlighted was the importance of clarity on the tapering plan (ending the purchase of assets by the Fed at that time). If the Fed only focused on domestic issues in the US, such as unemployment and inflation, without considering the impact of its policy on EM, global economic growth would be disrupted. This could occur because the EM\'s contribution to global economic growth was rising. At the time, within seven months, Indonesia and India had succeeded in stabilizing their economies. We came out from the group of the fragile five countries (the five most vulnerable countries). I remember The Economist magazine in February 2014 published an article entitled: "Indonesia: Fragile No More". At that time, Brazil, Turkey and South Africa were severely affected. It hit the EM even deeper.
The Fed\'s way of communication changed after being led by Yellen. I thought Powell had learned from it. That was why he had emphasized the importance of communication in the asset purchase policy. Rogoff, at the MIF event, said the Fed would not conduct tapering (reducing asset purchases) before the US inflation rate exceeded 2 percent. However, if inflation was above 2 percent, a monetary policy normalization may occur.
What will be the impact on us, if that happens? What to do? Several things must be considered to answer these questions.
In other words, if the vaccination drive in the US is successful, the pandemic can be overcome, and the inflation rises to above 2 percent, the Fed will normalize its monetary policy.
First, a normalization of the overnight interest rate will occur. Unfortunately, we don\'t know when. We can only predict it. In the minutes of its Federal Open Market Committee (FOMC) meeting on Jan. 27, 2021, the Fed clearly said that the direction of the US economy would depend on the development of the pandemic. In other words, if the vaccination drive in the US is successful, the pandemic can be overcome, and the inflation rises to above 2 percent, the Fed will normalize its monetary policy.
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When the Fed starts reducing its asset purchases, bond yields will increase, while the interest rate will rise. As a result, there is a risk of capital outflows from the EM. Countries, whose budget deficit financing is dominated by external borrowing, or whose current account deficit financing is dominated by portfolio investment, such as Indonesia, will be quite vulnerable. In the event of a shock in the US, investors will exit the bond and capital markets. As a result, the rupiah will be at risk of a sudden collapse.
To overcome this, the central bank usually implements a stabilization policy. One of the options is to let the rupiah follow the market (depreciation of the rupiah) or to increase interest. Of course there may be a policy mix in which the interest rate is raised slightly to let the exchange rate weakens slightly and to regulate the capital flows through prudential macro policies.
In 2013, to prevent Indonesia from a financial crisis due to taper tantrum and pressures in the current account deficit, the government had to cut fuel subsidies by increasing the retail fuel price by an average of 40 percent, while Bank Indonesia (BI) raised the BI rate by 175 basis points (bps) and allowed the rupiah to depreciate. This is known as an expenditure reducing and switching policy.
In 2018, Indonesia again experienced the same problem. Fortunately, Indonesia had started to tighten its fiscal policy in 2017, when the budget deficit was cut significantly. Meanwhile, in 2018, BI had increased the interest rate in six steps from 4.5 percent to 6 percent.
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Second, unfortunately, it will be unwise to apply the same recipe at present. Why? In 2013 we had the luxury of a tightening economy. Indonesia\'s economic growth was relatively high at 6.2 percent at the time. In 2018, we were lucky, because at the end of the year, the Fed gave a signal to hold back the increase in the interest rates, due to the risk of a trade war. This, in some ways, helped us to maintain the stability of the exchange rate and our financial sector. How about after 2023?
If BI is conducting monetary tightening and the government is carrying out fiscal tightening to stabilize financial markets, the policy may affect economic growth. The economy, which has just begun to recover, will plummet again. Conducting an economic stabilization, when growth is low, is not a wise option.
Third, what should be done? We must encourage foreign investment (PMA) in the export sector. If the current account deficit is financed with PMA, capital will not fluctuate easily. Conversely, if the current account deficit financing is in the form of a portfolio investment, the current account deficit will disturb us, because the foreign funds will easily leave Indonesia.
To reduce the volatility of the portfolio financing sources, a financial deepening should be carried out by providing incentives to create more sources of financing from local investors, so that the portion of external financing will decline. The market of retail bonds and private placement should be further expanded.
In the Tobin Tax, short-term capital inflows are taxed. Meanwhile, in reverse Tobin Tax, the government provides tax incentives if investors reinvest their profits.
Almost three years ago, I wrote in this daily (24/5/2018) about the need to implement what I called a reverse Tobin Tax. In the Tobin Tax, short-term capital inflows are taxed. Meanwhile, in reverse Tobin Tax, the government provides tax incentives if investors reinvest their profits.
The idea that I proposed several years ago seems to be welcomed, as reflected in a new draft government regulation (RPP) for investment financing institutions. In the draft, if the foreign tax subjects (tax payers) don’t repatriate their profits, but reinvest them in Indonesia, the profits will not be taxed.
In addition, more financial market instruments or products should be created, so that Indonesian exporters have the option to place their portfolio investments in foreign currencies in Indonesia (onshore). It is better for Indonesian exporters or investors to invest in their foreign currency onshore rather than abroad (offshore).
Fourth, most importantly: Indonesia must recover faster, possibly before tapering occurs. Statistics Indonesia (BPS) recently announced that Indonesia suffered a 2.07 percent contraction in 2020. The economy had indeed begun to recover since the second quarter of 2020. If this trend continues, the economy will record positive growth in the first quarter of 2021.
The economic recovery pattern will take the form of a swoosh shape (the Nike shoe logo) on the condition that the pandemic can be overcome. A study by the Office of Chief Economist at Bank Mandiri shows: Each time the number of the new Covid-19 cases increases sharply, people’s mobility is tightened and, as a result, economic activities slow down.
If this continues, the economic recovery will take longer, or it even risks following the pattern of the letter W. My study is consistent with this: Private investment will not increase if mobility is still disrupted. The economy will not be able to operate at 100 percent if the public health problem cannot be overcome.
In coping with the pandemic, health protocols and vaccination are the keys. The problem is that the vaccination can take a long time. Data from the Health Ministry shows that from 13 Jan. to 8 Feb. 2021, the number of people inoculated in the first phase of the vaccination program was recorded at 814,585 people. That means that the average per day is around 30,000 people. However, we know that, with a vaccine target of 181.5 million people, around 497,000 people must be vaccinated per day.
However, one thing should be noted: There has to be significant acceleration if we want to reach these targets.
This figure is clearly much lower than the target. We understand the vaccination has just begun and has taken place less than a month. Going forward, the number may increase sharply. However, one thing should be noted: There has to be significant acceleration if we want to reach these targets.
Learning from India
The Economist Intelligence Unit of The Economist magazine estimates that vaccination in Indonesia will only reach 60 percent of the population in the third quarter of 2023. While that may be too pessimistic, the data show that the vaccination process is indeed much slower than expected. It happens almost all over the world. The Economist estimates that the US may be able to complete this vaccination by the end of 2021.
If this is true and we refer to Powell\'s statement, the US economy may begin to recover in 2022. It means that it is not impossible that tapering will occur after 2023. If we are to avoid a global economic tightening, the economic recovery and completion of vaccinations must take place by 2022. Can we do that?
It would be good for us to learn from India. India was once considered one of the countries with the largest Covid-19 cases. However, it has shown an improvement. The number of new Covid-19 cases is decreasing. However, I\'m not smart enough on this issue. Epidemiologists have the insight to discuss this. However, as stated by Health Minister Budi Sadikin, I believe that 3T (testing, tracing and treatment) is an important factor.
Paul Romer, winner of the Nobel Prize in economics, suggested the need to conduct a test on residents every two weeks to separate which ones can do their activities and those that are not, so that economic activities are not disrupted.
One of the obstacles with the polymerase chain reaction (PCR) test is the access and the cost, which is still too high. In fact, it is very much needed by the community. I think there should be government intervention here. The PCR problem reminds me of a joke from a friend about the Padang restaurant: The name is Sederhana (modest) but the price is not necessarily inexpensive.
Muhamad Chatib Basri, Lecturer at the School of Economics and Business, University of Indonesia
(This article was translated by Hendarsyah Tarmizi).