Energy Crisis, US Dollar and Recession

In its Global Economic Prospects report published on 7 June, 2022, the World Bank warned of the threat of the global recession accompanied by high inflation (stagflation) as a result of the Russia-Ukraine conflict. The World Bank cut its global growth forecast from 4.1 percent to 2.9 percent. This estimate is predicted to remain constant for the next two years because the war in Ukraine has disrupted the flow of investment and international trade, especially in the food and energy sectors.

The current situation bears many similarities to the 1970s, where supply-side disruptions were persistently preceded by accommodative monetary policies in developed countries.

The risk of world recession is growing because the United States, as the world's economic engine, recorded a negative 1.5 percent growth in the first quarter of 2022, while inflation reached 8.6 percent in May. The euro zone growth reached 0.2 percent in the first quarter of 2022, down from 0.3 percent in the previous quarter.

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One thing that is encouraging: with an adequate policy mix, countries with large populations and economies that are diversified into agriculture, manufacturing, services and have export products appear to be in a better position vis-à-vis coping with a recession. For example, China has just relaxed its lockdown for the city of Shanghai. Its growth in the first quarter of 2022 exceeded expectations, namely 4.8 percent, surpassing the initial estimate of 4.4 percent on an annual basis.

The difference with the 1970s recession

The Russian-Ukrainian conflict has produced an interesting phenomenon. In the recession of the 1970s, the US dollar weakened, but currently it is at its highest. This happened not only because of the policy of the US central bank or the Federal Reserve, which in early May raised its benchmark interest rate by 50 basis points, but also because of the exodus of capital from Russia which was hit by economic sanctions.

Usually the strength of the dollar is inversely related to international oil prices, but now both are increasing.

The US dollar index had reached 107, although it has dropped slightly to 104. Usually the strength of the dollar is inversely related to international oil prices, but now both are increasing.

For net importers of energy and food, this development is a double blow. Developing countries and emerging markets are facing a difficult dilemma. The first alternative is to let the price increase be borne by the community. Thus, budget priorities can be allocated towards sectors with long-term impacts, such as education, health, energy transition, climate change and food.

AFP/JOHN THYS

Spanish Environment and Energy Minister Teresa Ribera (L) and French Minister of the Ecological Transition Barbara Pompili (C) talk with Portuguese counterpart Minister for the Environment and Climate Action Duarte Cordeiro (R) during the Special European Energy Ministers Council on Russian gas and petrol crisis at the EU headquarters in Brussels on May 2, 2022.

The consequence is that there will be a decline in people's purchasing power which has an impact on the economic slowdown, in addition to the potential to cause social unrest. Another option is to increase the allocation of subsidies for food and energy with the risk of reducing the budget for long-term competitiveness through human resource and infrastructure-capacity building.

In the 1970s, Indonesia was a net exporter of oil and gas. The world-energy crisis brought the US and other industrialized countries to the brink of stagflation. However, for Indonesia, it was a period of bonanza. Earnings from oil and gas exports were then injected into the domestic economy, including via irrigation improvement programs, infrastructure and other development programs.

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The energy crisis is now more complex because it was preceded by an economic slowdown due to the pandemic. Indonesia is in the process of restoring its growth which has been disrupted by mobility restriction to cope with the pandemic.

The energy crisis and world recession have the potential to hamper economic recovery due to increasing prices on the production side and disruption of mobility based on fossil energy. It also undermines the demand side of society because prices are too elevated.

Mobility stimulus

Last week, the price of West Texas Intermediate (WTI) oil reached US$122 per barrel, although it then fell back to about $120. However, there is good news. The price of wheat, which soared to close to $12.70 per bushel after India banned wheat exports, had dropped significantly but remained elevated at $10.50 per bushel.

This price decline occurred due to news of abundant harvests in Australia.

For Indonesia, the required policy design may not be the same as in 2020-2021 when COVID-19 was rampant with massive fund allocations for the health sector and maintaining the purchasing power of vulnerable groups.

For countries named by the World Bank as being in a better position to cope with the threat of a world recession, the work of mitigating the impact of the world's energy and food crises will not be easy. For Indonesia, the required policy design may not be the same as in 2020-2021 when COVID-19 was rampant with massive fund allocations for the health sector and maintaining the purchasing power of vulnerable groups.

One of the new strategies is to take advantage of the purchasing power of the middle class who want to find a new atmosphere after being confined for two years due to the pandemic.

In the midst of elevated aviation fuel prices, the phenomenon of many flight delays in developed countries in the northern hemisphere in early June is interesting to observe. This is due to the limited number of airport employees and flight capacity amid the increase in the public interest in traveling in the spring.

AFP/SERGEY BOBOK

People carry their luggage as they walk to Russian side at the check point of Ukrainian-Russian border, some 40 km from the second largest Ukrainian city of Kharkiv, on February 16, 2022.

The high demand for services is a factor in why slowing growth in the European Union and the United Kingdom has not entered the negative zone. This phenomenon was also seen during the long Idul Fitri holidays last May, which has led to the sharp increase in the number of visitors to tourist attractions, especially during the weekend.

The World Bank estimates that Indonesia's growth in 2022 will remain at 5.1 percent, slightly above the 5.01 percent growth rate in the first quarter. The growth will be supported by mobility-based sectors.

Recent observations have shown that, apart from classic stimulus policies, such as cash transfers for vulnerable groups, the policy to maintain the Pertalite fuel subsidy appears to be intended to maintain growth momentum by leveraging the spending power of the middle class.

The middle class' preference for relaxation by travel to remote areas of the country has the potential to support sectors dominated by micro, small and medium enterprises, such as trade, accommodation, culinary and light manufacturing.

The Indonesian middle class is estimated at 57 million people or 21 percent of the population. The middle class' preference for relaxation by travel to remote areas of the country has the potential to support sectors dominated by micro, small and medium enterprises, such as trade, accommodation, culinary and light manufacturing.

Given that every policy always has a dilemma or trade-off, moral hazard and free-rider, the significant price difference with unsubsidized Pertamax fuel has caused owners of luxury cars to turn to the subsidized Pertalite fuel.

Related to this, wise words say, "It is better to do something imperfectly than to do nothing perfectly”. The most important thing is to pay attention to sustainability, feedback and make continuous improvement.

KOMPAS/HERU SRI KUMORO

Ari Kuncoro

ARI KUNCORO, Rector of the University of Indonesia

(This article was translated by Hendarsyah Tarmizi)