Analysis: Can Indonesia Sail Smoothly Through the External Storm?
The global economy has been showing signs of stalling with leading indicators across the world flashing warning signals.
With policymakers in both the United States and the euro zone constrained by political bickering and unable to instill confidence in investors, there is an increasing fear that negative sentiment may be self-reinforcing, leading to a downward spiral in global demand.
Yet, amid the gloom on the external front, the Indonesian government has maintained a target in gross domestic product rising close to 7 percent.
Can Indonesia really sail smoothly through the external storm if the going gets bad? Is the confidence justified?
Broadly speaking, there is very little not to like about Indonesia, and it is expected to be one of the most resilient economies in the event of a synchronized global slowdown. It has often been argued that domestic demand orientation, as opposed to export dependency, has insulated the country from external headwinds.
Indeed, with private consumption making up the lion’s share (57 percent) of GDP, a decline in global demand should theoretically have a relatively small impact on the economy as a whole.
In 2009, Indonesia’s economic growth did slow to 4.6 percent, but the figure is sanguine compared to a contraction suffered by export-oriented economies such as Singapore.
If we examine the long-term trend of private consumption, the global financial crisis was a negligible blip and the economy is already almost 30 percent larger, compared to 2008 in nominal rupiah terms.
The investment growth story is also firmly intact. With a rapidly rising middle class and a youthful population, the potential for organic demand growth is immense. The outlook for developed economies is looking increasingly shaky, so an emerging market like Indonesia has become comparatively a lot more attractive as a longer-term play.
Having established that the longer-term outlook is positive, the situation in the short term has to be examined as well.
The outlook for the next six months is still good, but negative sentiment will inevitably spill over into the export market as well as the capital markets.
Capital flows remain as Indonesia’s Achilles heel. Strong economic fundamentals do not change the fact that market flows are dependent on sentiment and can be irrational especially in the short term.
During the 2008-2009 downturn, the rupiah and the Jakarta Composite Index both overreacted and sold off sharply.
Not surprisingly, the rupiah and the JCI recovered in a relatively short time and have even risen above their pre-crisis highs.
Arguably, Indonesia is even more vulnerable to capital outflows now. Foreign ownership of tradable government bonds has increased to around 35 percent, compared to less than 20 percent in the middle of 2008.
During the crisis, data showed that foreign investors pared their holdings in these securities by around 25 percent. Plainly, if foreign investors repeat their feat again, the magnitude could be much larger.
However, that is only one side of the story. Bank Indonesia has exercised prudence in dealing with capital inflows, and this has been reflected in the sharp increase in foreign reserves in the last two years.
By preventing excessive currency strength and accumulating reserves, the central bank has now built a war chest — amounting to $123 billion that can be used to cushion the impact of a sudden outflow of funds. That figure is more than double from the middle of 2008.
In terms of exports, Indonesia has become much more reliant on commodities. Commodities now account for around 50 percent of total exports, compared to around 45 percent just a few years ago. Part of the increase can be explained by a larger output, but the bulk of it may just be due to elevated commodity prices.
As commodity prices eased in recent weeks, nominal exports will start to come under pressure. Earnings at commodities-related firms will also take a hit.
That said, we should not ignore the fact that lower commodity prices directly implies that inflation is going to be less of a problem in the near future.
Should commodity prices continue their downward trajectory, it would provide BI with more leeway to maintain its loose monetary policy. Consumers will also be able to allocate more funds towards other goods. Moreover, the relatively low borrowing costs should also serve to further stimulate domestic demand.
There may be some turbulence ahead, but Indonesia should be able to navigate the short-term rough waters without too much trouble.
Eugene Leow is an economist at DBS Group Research