Another muddling through scenario

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.