Winarno Zain, Jakarta – As the world economic outlook worsens dramatically, the Indonesian economy will be heading into a dangerous zone next year. It is clear now that the full impacts of the global economic meltdown will be felt here next year. All signs indicate the economy is decelerating rapidly. But the scary thing is that the resources at the government's disposal to fight the impacts of the economic crisis are so limited.
Bank Indonesia (BI), the central bank, has not been able to mount an effective policy response so far, because they are facing dilemmatic situations. Instead of supporting growth, BI is still mired in the fight against inflation, the depreciation of the rupiah and lately rescuing a failed bank – Century.
BI is one of the central banks in the region that has not cut interest rates in the face of slowing economic growth. The expectation is that a steep decline in commodity prices would bring down inflation. But the coming holiday season at the end of the year will put upward pressure on prices in general. On the other hand, the precipitous fall of the rupiah would push import prices up. Under these circumstances, loosening monetary policy could risk undermining our macroeconomic fundamentals.
The economy is facing a credit crunch resulting from the current tight monetary policies of BI. Banks are not lending even at higher interest rates for fear of loans turning sour in the weakening economy. Nonperforming loans could increase next year, undermining banks' profitability and capital ratios. The risk of bank failures will also increase. But the more serious risk is that the real economy could grind to a halt.
Given the dire consequences of a prolonged credit crunch, BI should come up with bolder measures in terms of restoring confidence and liquidity in the banking system. As the name of the game is now confidence and liquidity, BI should consider expanding bank deposits and loan guarantees to help Indonesian banks compete for depositors with fund banks in other countries that provide unlimited guarantees.
BI's efforts to bolster the rupiah have turned out to be a losing battle. As global liquidity tightens, the foreign exchange market faces increased volatility with the rupiah continuing to depreciate against the US dollar. Investors are pulling back from the Indonesian market at a time when the trade surplus is shrinking, and capital inflows both of foreign investment and loans are slowing to a trickle.
The severe imbalance between supply and demand has pushed the US dollar-rupiah rate to record highs since 1998. As BI tries to intervene in the market to ease volatility, foreign exchange reserves are coming under pressure.
As long as there is a severe imbalance between supply and demand in foreign currencies, especially the US dollar, BI intervention will require enormous amounts of reserves, which may not be adequately supplied using BI's own money. In one month, BI already spent US$10 billion of its $60 billion reserve on market intervention. But so far the intervention has had little impact in stemming the slide of the rupiah against the US dollar.
The problem is that BI can not carry out intervention in the market on a sustained basis, since this could pose serious risks. Sustained intervention could produce a backlash, because the market could lose confidence in the credibility of the central bank. Intervention in foreign exchange markets should be limited.
The purpose of intervention is not to restore equilibrium between supply and demand of foreign exchange, as that task should be left to the market. Intervention is warranted to smooth excess exchange rate volatility and to address possible overshooting.
However, it is necessary for the government to establish some lines of defense against the possibility of reserves drying up. As capital inflows and exports are not likely return to pre-crisis levels for some time to come, it is imperative the government starts negotiating for external funding from various institutions.
It is also doubtful that such institutions would have enough funds if several countries seek loans at the same time. Even the IMF itself (despite some additional funding commitments from developed countries) is not quite sure whether its funds will be enough to meet additional requests for emergency loan facilities from its member countries, should the requests come at the same time.
The government should also look into the possibility of using foreign exchange swaps among ASEAN+3 countries as agreed under the Chiang Mai Initiative. It is important for ASEAN countries to push these swap mechanisms into place before the economic storm hits the region harder.
It is also important for the government to immediately design and implement fiscal stimulus to inject liquidity and revive demand in the economy. Even here, the government would face enormous constraints. Sharply tighter credit conditions and weaker economic growth would cut into the government's revenue and its ability to invest in health, education and other projects to alleviate poverty.
Given the limited funds available for fiscal stimulus, the challenge for the government is to finance high quality projects that have the greatest impact in terms of generating demand and employment, and fending off the poor from further pains. The other challenge would be to overcome bureaucratic obstacles that could slow down the fiscal stimulus. Experience shows us that this is extremely difficult.
Unfortunately, the government will face a general election next year, and the national attention will shift toward political campaigns. As the fight against the economic crisis would get relegated to a lower priority, the question is who will care about the plight of the unemployed and the poor?
[The writer is an economic analyst.]