Another muddling through scenario

Muhammad Chatib Basri

How do we mark the economic performance in 2002 and what is the prospect for 2003? The average real GDP growth (y-o-y) up to the third quarter of 2002 was recorded at 3.4 percent. It is true that the Bali blast is predicted to have impacted on the overall Indonesian economy. Our sensitivity analysis shows the 15 percent decline in the number of tourists will reduce the GDP growth by 0.15 percent.

The impact on 2002 is predicted to be limited due to the fact that only one quarter of the year is left. However, we predict that the number of tourist arrivals will be 20 percent less compared to that in 2001. Thus we revised down our GDP growth projection from 3.8 percent to 3.6 percent in 2002. As in 2001, in 2002 the main causes were private sector and government consumption, which grew by 5.8 percent and 10.8 percent respectively.

The strong growth of private consumption was driven by non- foods. The strong non-food consumption is consistent with some leading indicators including motorcycle sales and motor vehicle sales, nonetheless cement sales slowed. The non-foods consumption growth rates in fact, had accelerated since mid-2001 thanks to the increase in consumer credit, wages, and the decline in prices of some goods. In addition, some recovery of consumer confidence might have contributed to it, while some lags and inflation hedging activities of consumers might have prompted durable goods consumption.

The sales of motorcycles has been remarkable since a few years ago. For 2002, the sales of motorcycles is projected to reach 2.5 million units. A similar trend also occurred in motor vehicle sales. Although the growth may slightly decline after 2003 due to market exhaustion, this positive sales trend is likely to continue. Similar trends also occur in cement and electricity sales.

This phenomenon raises a question as to why does consumption continue to grow even in the midst of the economic crisis? There are several possible explanations. First, hedging consumption. Second, a tendency of treating durable goods as assets. Third, the relative price of traded to non-traded. An Economy and Social Research Institute at the School of Economy, University of Indonesia (LPEM-FEUI) study shows an inverse relationship between motor vehicle sales and the real interest rate.

The lower the real interest rate, the higher the motor vehicle sales. It is worth noting that most people buy vehicles not in cash but on credit, from banks as well as automotive producers' multi-finance operations, thus a higher real interest rate will reduce the demand for motor vehicle.

In addition, the decline of the real interest rate (due to the high inflation) will lead people to alter their portfolio investments from time deposits to the durable goods. We also find that motorcycle sales increase with inflation. A similar trend also applies to cement and motor vehicle sales.

All of these figures show that the sale of durable goods increases with inflation. This finding suggests a possibility of hedging consumption. Consumers think that it is better to buy durable goods now in order to avoid high inflation in the future.

This inflation anticipation induces many consumers -- who otherwise would wait -- to bring forward the purchase of the durables. In addition, consumers spend more money than they have planned. Since many consumers bring forward their purchase of durable goods -- and it is only after sometime that those durable goods will need to be replaced -- an inevitable slowdown follows the initial boom, simply because consumers need not to buy new durable goods.

However, those arguments cannot explain the whole story of why consumption continues to grow. Thus, in order to understand the big picture, it is worth looking at the unemployment figure. The unemployment rate -- for both open and under employment -- showed a declining trend from 8.9 percent in 1999 to 8 percent in 2001 and from 31.3 percent in 2000 to 28 percent in 2001 respectively. In addition, the real wages for the manufacturing sector for instance increased by 14 percent from March 2001 to March 2002.

The positive trend also appeared in the poverty incidence. The head count index, poverty or incidence poverty shrank from 24 percent in February 1999 to 19 percent in February 2001 and to 17 percent in February 2002. These figures suggest a possibility of increasing purchasing power, which in turn drove the consumption.

But how do we explain this phenomenon under the economic slowdown? My presumption points to the role of the so-called hidden economy that is getting important. The growth of electricity sales for example is still relatively high. By employing electricity sales as an indicator, I predict that the share of the so-called hidden economy increased from around 20 percent prior to the economic crisis to around 40 percent to 50 percent in 2001. If my guesstimate is correct the economic growth maybe higher than reported.

So how do we paint the prospects of the Indonesian economy in 2003? I think that in 2003 the Indonesian economy will still be propelled by private consumption. Foreign investment will remain low, unless Indonesia creates a more competitive climate. LPEM- FEUI predicts that consumption and exports revive barely enough to keep the GDP growth at 3.6 percent at 2002 and 3.8 percent in 2003. On the internal front, although the banking re- capitalization is complete, the banking sector is still in difficulty. Under these circumstances it is hard to expect that monetary policy will be effective. Coupled with business uncertainty, labor problems and local taxes, those factors will influence Indonesia's economic growth during 2003. However, whilst the road to economic recovery is still winding and bumpy, it is not unpromising. In 2003 the economy has yet to muddle through.