Policy Normalization and G20 Presidency

KOMPAS/RADITYA HELABUMI

Coordinating Minister for Economic Affairs Airlangga Hartarto gave a speech at the opening of the G20 Indonesia Presidency at Banteng Field Park, Jakarta, Wednesday (1/12/2021).

In 1977, Kydland and Prescott, winners of the 2004 Nobel Prize in Economics, introduced the concept of Time Inconsistency. A policy that was considered optimal in the past may no longer be optimal today, and what is considered optimal today may no longer be deemed so in the future.

Fiscal and monetary policies in the United States, for example, are used to support the demand side that declines due to reduced mobility by providing cash transfer assistance to households. The Federal Reserve, the US central bank, injected liquidity into the economy through the purchase of financial assets. It has resulted in the reduction of the cost of credit for the housing sector, one of the main drivers of economic growth.

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The effect is the drastic increase in economic growth from minus 31.4 percent in the second quarter of 2020 to positive growth in the following quarters of the year and to as high as 6.7 percent in the second quarter of 2021.

It seems that the Fed will carry out a policy normalization by accelerating the program to reduce the purchases of financial assets (tapering).

However, it caused an increase in the inflation rate to above the long-term average trend because the supply chain was not ready. The US annual inflation rate in October 2021 was recorded at 6.7 percent, well above its long-term average of around 2 percent. It seems that the Fed will carry out a policy normalization by accelerating the program to reduce the purchases of financial assets (tapering).

Such a policy is intended to reduce the inflationary pressure so that in 2022 and beyond, inflation will return to normal levels. However, inflation also comes from a labor shortage. The pandemic has encouraged people there to choose to live a simpler life with a quality of life rather than having stress due to long working hours (the Great Resignation).

KOMPAS/RADITYA HELABUMI

The launch of the official website G20.org also marked the opening of the G20 Indonesia Presidency at Banteng Field Park, Jakarta, Wednesday (1/12/2021).

The tapering policy is also faced with the warning of the World Health Organization (WHO) about the finding of a new Covid-19 variant which has a greater potential for transmission than the previous ones. The warning caused an announcement effect, prompting a wave of state border closures. The world oil market is anticipating the worst case scenario amid the decline in international mobility.

In a matter of days, the price of West Texas Intermediate (WTI) crude oil fell drastically to around US$65 per barrel after rising to above $80 per barrel in the previous months. For the US and other industrialized countries, this poses a dilemma in policy normalization because the economy is still in the recovery stage. Meanwhile, inflation largely stems from problems in the supply chain. It is feared that the hasty normalization policy will worsen the production sector, either directly or due to the sharp increase in inflation, which may cause other problems, such as stagflation.

Normalization

To maintain the interaction between the demand and production sides during the pandemic, Indonesia has introduced several extraordinary policies, including widening the budget deficit, burden sharing with Bank Indonesia, and credit restructuring by the Financial Services Authority (OJK). The government has also provided a number of incentives to support the labor market and the informal sector such as pre-employment cards, social assistance and productive social assistance.

As an anchor representing the boundary condition, the budget deficit is targeted to return to 3 percent of gross domestic product (GDP ) in 2023. As a signal, this terminal boundary condition is quite credible. This can be seen from the healthy performance of rupiah amid expectations that portfolio capital inflows would continue to support Indonesia's balance of payments.

The annual inflation in October was recorded at 1.66 percent despite imported inflation from the world supply system.

At the beginning of the pandemic, the rupiah exchange rate experienced an overshooting to about Rp 16,700 per US dollar. However, the implementation of the pandemic mitigation policy with the support of the government funding helped the Indonesian currency to gradually strengthen and is now in the range of Rp 14,300 per US dollar. The annual inflation in October was recorded at 1.66 percent despite imported inflation from the world supply system.

AFP/MOHD RASFAN

A passenger wearing a face mask queues to check-in for her flight at the Kuala Lumpur International Airport (KLIA) in Sepang on November 29, 2021, as countries across the globe shut borders and renewed travel curbs in response to the spread of a new, heavily mutated Covid-19 coronavirus variation dubbed Omicron.

The implementation of the multi-tiered public activity restrictions (PPKM) policy has succeeded in bringing health and economic indicators to a recovery path. The Purchasing Managers’ Index (PMI) and Bank Indonesia’s consumer confidence index (IKK) have entered the expansion or optimistic zone. The PMI and IKK were recorded respectively at 57.2 and 113.4 in October.

The discovery of the Omicron variant makes things even more complex. PPKM as a mobility controller may be tightened based on the assessment on the potential for Covid-19 transmission.

Economic growth of 3.51 percent in the third quarter of 2021 indicates that the normalization policy will shift more toward the optimal timing of the discretion. However, the effort to bring back the budget deficit to 3 percent of GDP is expected to be maintained to guide the most important expectation variables toward stability.

One important prospect for the economy is the appointment of Indonesia to assume the G20 presidency. In addition to its direct leverage effect, the presidency reintroduces Indonesia into a world supply chain that is currently in lethargy. This provides an extra buffer when the pandemic mitigation programs are gradually normalized.

A global demand that is faster than the recovery of supply chains has caused a new commodity boom.

The opportunity can be seen from the surplus in the trade balance during the last 18 consecutive months. A global demand that is faster than the recovery of supply chains has caused a new commodity boom. Indonesia's exports rose sharply although imports also increased due to growing economic activity in the country.

With the good handling of the pandemic, Indonesia has become one of the alternative producers, while other countries in the world supply chain system are still hibernating.

KOMPAS/ISMAIL ZAKARIA

A woman arranges a display of locally produced coffee on Thursday (23/7/2020) at a business meeting on micro, small and medium enterprises (MSMEs) in Mataram, West Nusa Tenggara (NTB). Local MSMEs have developed superior products from the NTB administration’s economic assistance for earthquake-affected communities. Today, MSMEs in Lombok have said they have been encouraged by the transition to the “new normal” phase of the Covid-19 mitigation measures.

The change in philosophy toward a sufficient economy, such as working from home, is also an opportunity for micro, small and medium-scale enterprises (MSMEs). The opportunity to increase the long-term domestic leverage of the G20 presidency is to make it a promotion and networking event for Indonesian products, cooperation in inclusive health research, digitization and energy transition. All of which can ensure a smooth transition to policy normalization.

ARI KUNCORO, Rector of the University of Indonesia

(This article was translated by Hendarsyah Tarmizi)