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Over the year, the unexpected surge in global commodity
demand, along with the rupiah's strengthening against the dollar, has
helped spare Indonesia from a severe economic downturn. But those very
elements that buffered the economy now seem to be running out of steam.
So, what's next for the economy?
Exactly a year ago this month, many economists forecast a gloomy
outlook for the Indonesian economy. This followed a dramatic hike in
domestic fuel prices and a spate of aggressive interest-rate hikes.
Yet three-quarters of the way through 2006, the downturn has not been
all that bad. The economy did decelerate amid reported low government
spending, lack of investment and rising unemployment. But the downturn
was far milder than had been anticipated. Furthermore, the much feared
"second-round" inflationary effects of the fuel-price increases also
dissipated quite rapidly, thereby moderating consumer-price pressures.
So, what happened? As Indonesia is a net oil importer, rising oil
prices were perceived as a threat since they lead to pressures on the
country's trade surplus. However, the ensuing surge in non-oil
commodity demand (and prices) surprised many in terms of the cushioning
effects it brought to the economy. That's because, on the whole,
Indonesia is a net commodity exporter.
The fact that basic commodities and related products account for over
one-third of Indonesia's exports resulted in exports reaching all-time
highs, which in turn facilitated a widening of the trade surplus and a
surge in the country's foreign currency reserves.
This surge in global demand for raw commodities such as coal, copper,
palm oil, etc., came to the rescue of the economy at a time when
household consumption and fixed-capital investment were bearing the
brunt of rising fuel prices and interest rates.
There were also positive surprises on the inflation front. Following
the hike in interest rates, rupiah-denominated bonds and money-market
instruments promised appetizing returns as they offered high yields.
The potential for price appreciation was also significant as Indonesia
was one of only a handful of countries in which the market expected
imminent interest rate cuts (bond prices move inversely to yields).
The result was a doubling of foreign participation in the bond market
during the year, which, together with robust trade surpluses, lead to a
strong appreciation of the rupiah. The currency had gained nearly ten
percent by May from the start of the year, before easing slightly over
the past several months. As the rupiah strengthened, inflationary
pressure on consumer prices moderated because of disinflation in the
prices of imported goods.
Unfortunately, what goes up eventually comes down. As the U.S. economy
shows signs of slowing down, commodity prices have recently been
leveling off from their record highs. This could be the result of
shrinking speculative demand, but could also mark the beginning of the
end to the global commodity-demand surge and Indonesia's export boom.
In the meantime, the global appetite for rupiah bonds has been waning.
Amid expectations of peaking interest rates in the US, the yields on
U.S. treasury notes and many emerging market bonds have started to
decline as prices start to rise -- thereby widening the range of bond
markets that offer a high potential for capital gains. In a further
diminution of the incentive for foreign investors to put their money in
rupiah bonds, the once roomy differential between domestic and US
interest rates has also dwindled following the spate of domestic
interest rate cuts.
As a result, substantial amounts of foreign funds were seen exiting the
rupiah bond market in September. Concurrently, the rupiah depreciated
by a modest extent against the dollar. Conclusions cannot be drawn just
yet, but the evidence suggests that the influence of the economy's
unexpected saviors -- global commodity demand and a strengthening
domestic currency -- is gradually fading away.
Hence, for recovery and economic growth to now be sustained, the
non-export components of the economy (i.e., household spending and
real-sector investment), must be stimulated. Recent moves to cut
interest rates are encouraging, but not sufficient. A lot more needs to
be done, e.g., creating a more business-friendly investment
environment. Stalled reforms, such as the revision of the tax and labor
legislation, need to be expedited.
Furthermore, if the export surge is really over and the capital flows
into the bond market continue to run out of steam, Indonesia will no
longer be able to rely too much on currency appreciation to curtail
inflationary pressures. Indonesia must focus on lowering the cost of
doing business by streamlining the bureaucracy and accelerating
spending on infrastructure development so as to relieve bottlenecks.
Many promises have been made to date. But the challenges faced are
daunting. It remains to be seen whether so much can be achieved in so
little time. But, one thing's for sure, time is rapidly running out.
Will the country be able to accelerate economic growth next year in the
midst of the new challenges, or should we just hope for another lucky
break?
The writer is an economist at Bahana Securities.
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