Indonesia's (re)solution: mind the other outflow

Arif Gunawan Sulistiyono

“If you know the enemy and know yourself, you need not fear the result of a hundred battles,” said an ancient Chinese philosopher Sun Tzu, who authored the ancient book on military strategy Art of War.

The statement is quite relevant to answer a question of how bad the US Fed Fund Rate increase will hurt Indonesia in “the 2016 fight”. We will never know it unless we know the fundamental situation of Indonesia, and our competitors.

The country is indeed in a fight against global slowdown, commodities prices drop, and a striking impacts of the projected US benchmark interest rate hike in 2016—following a 25 basis points rise on Dec. 16 to a range of 0.25 percent to 0.5 percent.

A further increase, we’re all aware of it, may lead to capital outflow as investors seek for rising yield in US bonds market—which in turn would squeeze Indonesian economy further as it will weaken the rupiah and bear more burden to local companies owning US dollar liabilities.

The impact is more worrying for Indonesia as the country scores a current account deficit—a term used to describe a situation when the capital outflow from import, service and investment activities is bigger than the inflow.

Fitch Ratings’ Head of Asia-Pacific Sovereigns Andrew Colquhoun said that the real uncertainty remains on how quickly The Fed Rate rises, and to what peak. There is still a significant wedge between where the Fed is telling how it sees rates going and what the market is pricing in.

“An out-turn closer to Fed guidance would be a substantial shock for a region where private sector debt levels have risen rapidly and where capital flows have already started to reverse,” he said in his statement.

This uncertainty, he further said, puts a premium on credible and coherent policy responses by authorities in buffering sovereign credit profiles. Bank Indonesia, currently holds US$100.2 billion of foreign reserves.

The reserves shrank by $11.7 billion among of which is used for taming the volatility in the currency this year. However, the rupiah still depreciates by 17 percent this year to around 14,400 against the dollar.

In that situation, larger capital outflows, and more currency depreciations, due to rising US Fed Rate will be bad news. “How big is the impact?” is a tricky question and “how to deal with it?” is an important question to answer.

Therefore, it is interesting to see that the Coordinating Economic Minister Darmin Nasution projecting that the gradual increases of the Fed Rate in 2017 will put pressure on Indonesia’s economy for at least until 2018.

"We should be aware that the Fed will increase its interest rate by 100 basis points in a year. It means there will be pressure, particularly in countries that have current-account deficits. There will be a constant pressure and this can last three years until 2018," he said in Banten on Thursday.

His statements show his understanding not only on the risk of the Fed Rate increase next year, but also on the vulnerability in Indonesian economy. Without the right measures, situation could get worse as the pressure awaits next year, he said. Then, what are the formula he prepares for next year?

"To deal with the medium-term effect, we must answer it with better economic growth. If our economy is stagnating while the current account continuously records a deficit, it’s going to be a big problem. The key is investment growth," Darmin said.

With an economic growth of 4.73 percent in the third quarter of 2015, compared to the 4.92 percent growth at the same period of 2014, it doesn’t take an economic Nobel Prize winner to conclude that the slowdown in Indonesia has yet to end.

The government has launched seven economic policy packages, containing regulations and deregulations, to expand the economy amid external pressures such as capital outflow and commodities prices drop.

AEC challenge
Darmin—likely to be known as ‘the father of deregulations’ due to massive economic deregulation-oriented policies he has issued—pledged to create further stimuli for boosting the economy next year.

The momentum seem rights, as the country will face ASEAN Economic Community (AEC) which will be effectively implemented next year. With simplified bureaucracy as the result of deregulations, the government creates more chance for himself to lure investors from the regions.

It sounds easy, but in fact it is not. Currently, Indonesia is ranked at 109 in ‘ease of doing business’ survey 2015. Five Asian countries left us way ahead. Singapore is at the first, Malaysia at 18, Thailand 49, Brunei Darussalam 84, Vietnam 90, and Philippines at 103.

However, according to Bank Indonesia (BI) senior deputy governor Mirza Adityaswara, the survey results had yet to include the effect of seven policy packages that—according to Darmin—will take effects in 2016.

"Despite the survey was released prior to the issuance of the economic deregulation policy package, our ranking has improved. Hopefully we will be able to move it up again in next year's survey," Mirza told thejakartapost.com responding the release.

Assuming that the packages will work effectively with more investors coming—instead of more imported goods flowing, squeezing uncompetitive local products, and leading to unemployment, trade deficit as well as current account deficit—there will be a new problem appears.

As more regional foreign investments mushrooming in the country due to AEC, Indonesia will see more earnings of investments and services flow out of the country as they usually build factories or companies in Indonesia to sell goods and services in ASEAN biggest market, instead of exporting them abroad.

In the end, it will give more burden to current account deficit and it will be running not merely in the short term, but in the medium and even long term as long as the business and the economy flow.

If the central bank already anticipated the capital outflow by preparing intervention and creating more swaps agreement such as with Australian central bank lately, the government is yet convincing enough to anticipate the risk of this medium-term earning outflow in the real sector.

Giving stimuli by simplifying permits and regulations or tax-incentive is one thing. But having most stimuli enjoyed by local companies to retain earning in the country and benefit the foreign reserves is other thing.

Even the country, ironically, has yet to successfully maximize the existing earnings from export. Bank Indonesia reported that only 11 percent of export earnings (DHE) converted to rupiah, while the remainders 98 percent only reported to the central bank.

Thus, Bank Indonesia governor Agus Martowardojo urged the government to issue the promised government regulation (PP) on tax incentives for export earnings deposited in local banks and converted to rupiah.

This is what President Joko “Jokowi” Widodo and his administrations, especially Darmin, need to address proportionally while deregulating the structure of the high cost economy. The stimuli must be ultimately benefiting the nation in the form of better current account deficit.

And, it has to be implemented effectively—a measure that most preceding governments had failed to do so, and the current government expected to be able to conduct it.

“We believe president Jokowi is switching gears from a government-led economic growth to a private sector driven one. We have witnessed aggressive tax collection and direct market interventions,” said KDB Daewoo Securities Indonesia’s Head of Research Taye Shim.

Through unpacked series of economic policy packages, he further said, he expects to see more efficient growth going forward as the government sets the stage for the private sector professionals to do what they do best.

However, an efficient growth is not enough if the biggest problem, namely corruption, persists. This is the biggest enemy that the country has yet to defeat for decades, especially amid public pessimism responding the less-promising Corruption Eradication Commission (KPK) chairs who are composed with “new comers” whose integrity in battling corruption questioned.

We should not forget about corruption as the systemic problem in Indonesia, since the biggest problem of all battles is usually the enemy cleaving inside us, just like Sun Tzu had warned centuries ago. “The most important fight is against the enemy within.”***