Thu, 11 Aug 1994

An ounce of prevention

One should not read too deeply into the note of caution about Indonesia's macro-economic stability and growth, which was written by Bank Indonesia's (central bank) Governor Soedradjad Djiwandono on Tuesday, or become apprehensive about the upcoming economic trends.

Certainly, we have to take some precautions, especially because two of the three variables that will affect the Indonesian economic situation -- oil prices, import expansion and yen rate volatility -- are regrettably beyond our control.

We think Soedradjad's warning is also quite opportune in view of the rise in international oil prices over the last few weeks, which has gone as high as US$20 per barrel. This encouraging trend might bring about a sense of complacency regarding the constant need for a tight fiscal and monetary policy.

We should be especially cautious in reading the latest oil price movements because these trends have not entirely been created by the law of supply and demand. In fact, we see that the sharp price increase is mostly a result of production problems in Nigeria, Yemen, Angola and Venezuela because of various forms of labor and domestic unrest.

Even though the proportional role of oil and natural gas in the state budget has indeed declined to as low as 21.50 percent of total internal revenue, we should not underestimate the impact of the international oil market. As Soedradjad rightly observed, our concern over a drop in oil prices is not linked to their impact on government revenue but on the psychological impact it would have on business confidence and the people's expectations about the economic future.

Though the possibility of the oil prices declining below $16 -- the average price used for oil and gas receipt projection for the current fiscal year -- is quite remote, we must still take precautions to provide for such a development. This is especially important because of the severe constraints we are encountering within the balance of payments due to the heavy foreign debt service burdens.

We have no intention sounding the alarm about the impact of a depressed oil market. But the possible psychological impact, as hinted by Soedradjad, might have far-reaching repercussions upon the monetary stability. Past experience shows that sharp oil price declines always sets off currency speculation and, given Indonesia's open capital account system (free foreign exchange regime), such development might cause monetary instability.

The second variable mentioned by Soedradjad, the volatile yen, is also out of our hands. However, this factor also may strongly influence our economic situation because more than 40 percent of our $83.3 billion in foreign debts are denominated in the Japanese currency, while the prices of our oil and natural gas are set in the American dollar.

We take Soedradjad's caution about the dangers of excessive expansion in imports as a warning against the implementation of many big projects which have a long gestation period. There seems to be a misunderstanding regarding big projects: Many businessmen assume that since they are private ventures their big imports do not in any way affect the macro-economic situation. They apparently do not realize that their big imports also put severe pressures on the overall balance of payments. Hopefully, the ministerial team in charge of overseeing foreign commercial borrowing by the public and private sector continue to tightly manage new debts.

Though the trends so far do not give us anything to be alarmed about, Soedradjad's note of caution still serves as a much-needed reminder both to the government and private sector on the safe way to manage the economy. The old adage still rings true, that an ounce of prevention is worth a pound of cure; adequate precautionary measures will prepare Indonesia to contain the damage from any adverse developments caused by uncontrollable, external factors.