A year ago Indonesia, like other oil importers, was grappling with the effects of soaring global oil prices on the domestic budget. The challenge, as finance minister Sri Mulyani Indrawati put it to Emerging Markets, was to “control inflation without choking economic growth itself”.
Her efforts – including getting a tough fuel hike through parliament – largely paid off. But then in October, the global financial pandemic hit Asia.
For Indonesia, as across Asia, painful memories of the 1997 crisis came rushing back as foreign investors fled bond markets at the end of last year, forcing yields dramatically higher while credit protection exploded to 1,200 basis points (bps). Foreign investment in onshore government bonds has dropped by 15% since August last year.
In January, Indonesian exports plunged by 35.5% year-on-year – the steepest drop in over two decades. The rupiah, a fully convertible and well-traded currency, has weakened 10% against the dollar since January 2008. And to top it off, slowing household consumption and investment will drag growth down to just under 4% this year. Though comparatively strong, growth is still a third less compared with the four-year average.
Meanwhile, the spectre of a private-sector financing crunch looms as liquidity conditions have tightened and firms struggle with a large stock of short-term debt repayments, while the currency has depreciated sharply. The current account looks likely to tip into deficit this year.
Although Indonesian asset prices have now largely rebounded from perilous lows, the near-term outlook remains troubling. “If the rupiah weakens further, foreign portfolio investors may be forced to cut their losses and pull out of Indonesian bond and equity markets altogether, which would further pressure the currency,” says Fauzi Ichsan, economist at Standard Chartered in Jakarta.
Systemic deleveraging is not only driving capital outflows; it is also fuelling market fears over the estimated $17.4 billion of private-sector foreign debt that needs to be refinanced this year. Given the dysfunction in global capital markets, a host of companies are increasingly borrowing in rupiahs to buy dollars to pay off their foreign debt – increasing credit costs and further pressuring the exchange rate. In addition, the central bank, in an attempt to shore up the currency and boost inter-bank liquidity, has seen its reserves decline from $60 billion in the fourth quarter of 2008 to $51 billion.
Strength in numbers
As a measure to guard against such external vulnerabilities, 13 Asian nations pledged in February to expand the so-called Chiang Mai Initiative – a multilateral currency swap facility – from $80 billion to $120 billion. But the catch is that once 20% of a country’s allocated quota is accessed, politically unpalatable IMF conditions kick in.
Even if countries access a portion of the facility untied to the IMF, markets could see the move as a kiss of death, says Ichsan. “Many central banks, including Bank Indonesia, remain reluctant to use them because this may adversely affect perceptions (both in the markets and among the public) of their ability to manage their currencies.”
But the Indonesian government has been quick to seek alternative tools to combat the downturn: it is poised to embark on a $6.1 billion stimulus package to finance public spending in energy and infrastructure and compensate for lower taxes and declining revenues, thanks to standby facilities with the World Bank, ADB, Japan and Australia – amounting to $3.4 billion in total and domestic borrowings.
This would increase the proportion of government debt to 30.3% of GDP this year – levels not seen since 1996, and as such, a reversal of the country’s fiscal austerity. But given the government’s solid grip on the public finances, analysts believe the plan is workable. Says Milan Zavadjil, the IMF’s senior resident representative in Indonesia: “The country’s credit profile has not been weakened by this.”
He argues that market fears over corporate indebtedness this year are overblown. Of the $17.4 billion total, $6.4 billion is defaulted debt from the Asian financial crisis while $5.2 billion comprises inter-company lending that is likely to be rolled over due to relationship-based lending, says Zavadjil.
In addition, foreign creditors are unlikely to cut their cross-border lending limits to the same extent as during the Asian financial crisis owing to the country’s stronger relative growth prospects this year. A spike in defaults on loans dished out during the bull run is more likely, with gross non-performing loans currently standing at 4.3%.
This year “bank balance sheets will be tested, but since the capital adequacy ratio is high at 17.7%, the system is relatively healthy,” says Felia Salim, vice-president director at Bank Negara Indonesia, the country’s fourth largest lender.
Looking up
Still, despite a painful economic adjustment this year, early indications suggest slowing growth is unlikely to disrupt the political environment. In April, president Susilo Bambang Yudhoyono’s Democratic Party gained a boost in parliamentary elections – the third since the demise of the Suharto dictatorship in 1998. Analysts now predict Yudhoyono will win another five years in office come July – “reassuring investors that Indonesia’s orthodox economic policies are set to stay,” says Anton Gunawan, chief economist at Indonesia’s Bank Danamon.
Thanks to its relatively closed economy (exports comprise just 30% of GDP) and its clean banks, Indonesia is set to grow faster than the rest of Asia this year, says Gunawan.
But with 5.5% growth needed to absorb new entrants into the labour market and businesses under siege by the global crisis, the country’s national motto ‘Unity in Diversity’ will be tested to its core.
Nevertheless, as Minister Indrawati told Emerging Markets last October, the key ingredient of the policy-mix may lie elsewhere: “As policy-makers, you try to formulate good policy; you are struggling to build up good institutions – but in the end you need good luck.”