Rupiah's meltdown brings about economic hardship
By Riyadi
JAKARTA (JP): Economic recession and stagflation are looming in the wake of the rupiah's meltdown.
After experiencing a high growth of over 6 percent per annum for more than 25 years, Indonesia's economy is projected to slump over the next two years.
Economic growth will slow down drastically to below 5 percent next year due to dwindling domestic demand, while inflation rates are likely to rise significantly.
The year-on-year inflation rate is expected to break into the double digits this year as a result of the unexpected overshooting of the rupiah and the long drought.
Higher inflation this year has increased inflationary expectations for 1998.
But the rupiah's depreciation will make Indonesia's current account deficit go downhill this year. The deficit is expected to decline further or even become a surplus next year.
In the capital account, Indonesia will hardly see private capital inflows next year because foreign investors' confidence in local corporations has evaporated.
Most capital inflows will be official, either from multilateral or bilateral loans.
It is the floating of the rupiah in mid-August and subsequent policy measures which have turned the economy around.
Before floating the currency, Bank Indonesia, the central bank, had tried to defend the moving band system from speculative attack, following the devaluation of the Thai baht on July 2, by widening the band from 8 percent to 12 percent and selling dollars in both spot and swap markets.
The bank also raised its benchmark Bank Indonesia Certificate (SBI) rates several times from 7 percent to an unbelievable 30 percent per annum, hoping that high interest rates would attract capital back to the country and prevent further depreciation.
Discourage
After the float, the government squeezed liquidity tightly, absorbing more than Rp 10 trillion (US$3.8 billion) of public sector funds from commercial banks to discourage people from buying dollars with expensive rupiah.
But still, the rupiah continued to weaken against the U.S. dollar.
In early September, the government tried to impress the market by promising to revise its budget, liberalize foreign purchases of shares, strengthen the banking industry and raise the luxury sales tax on several goods.
The government met its promise by first lifting the 49 percent foreign ownership limit in new stock offerings at local stock markets.
The government then cut import tariffs on 153 groups of commodities.
Later in September, the government announced a vague list of infrastructure projects, mainly those requiring heavy imports, that had been postponed or targeted for review and possible postponement. But the government did not touch foreign exchange- consuming strategic industries and the national car project.
By the end of September, the rupiah never recovered from falling below Rp 3,000 to the U.S. dollar.
Realizing the scarcity of dollars in the local currency market, the central bank encouraged exporters in early October to unload their dollar holdings by offering swap and forward facilities to them.
Still the rupiah continued to drop to new lows almost every day as the supply and demand for dollars was far from being balanced, prompting the central bank to step into the currency market.
IMF help
All of these developments motivated President Soeharto to seek help from the International Monetary Fund (IMF). Soeharto then appointed former senior cabinet minister Widjojo Nitisastro to coordinate efforts with related agencies to press for financial aid.
After three weeks of negotiations, Indonesia reached an agreement with the IMF on a financial and economic reform package at the end of October.
The IMF assembled $23 billion in loan commitments as the first line of defense, consisting of $10 billion from the IMF, $4.5 billion from the World Bank, $3.5 billion from the Asian Development Bank and $5 billion from Indonesia's own foreign assets.
Then there were bilateral loan pledges as a second line of defense, including $5 billion from Singapore, $5 billion from Japan, $3 billion from the United States and $1 billion from Malaysia. Australia, China and Hong Kong had also expressed an interest in helping.
To comply with the IMF package, the government moved to liberalize trade by eliminating the State Logistics Agency's monopoly on wheat, wheat flour, soy beans and garlic.
The government also closed 16 private commercial banks, which it claimed were insolvent.
The rupiah then strengthens from Rp 3,600 to Rp 3,300 to the dollar. But the rupiah's recovery was short-lived. The rupiah dropped again and again, passing Rp 4,000 in early December on unfounded rumors about President Soeharto's health. Barely a week later, the rupiah passed the Rp 5,000 barrier and touched an all- time low of Rp 6,000.
Many parties, including the government, attributed the drastic fall of the rupiah to a sudden loss of confidence in the currency on the part of investors, both domestic and foreign.
Initially, it was a private-sector driven crisis. Investors were concerned about the level of short-term debts owed by the private sector.
According to the government, Indonesia's external debts totaled $117.3 billion as of last September, of which $65 billion was owed by the private sector. Many private debts turned out to be unhedged. It was these large unhedged debts which sparked a dollar-buying frenzy.
Suddenly, a variety of economic entities and wealthy individuals found themselves trying to buy dollars. Companies with unhedged loans denominated in dollars had good reason to start buying dollars in a belated attempt to hedge their exchange rate risks.
Consequently, when the rupiah meltdown began, there was a rush for dollars that compounded the fall of the rupiah. Companies also found themselves unable to borrow to cover short-term servicing obligations.
This rupiah meltdown has punished not only the private sector but also the public sector.
The government's foreign debt servicing burden has also increased as, according to the minister of finance, every drop of Rp 100 to the U.S. dollar has increased the government's debt servicing by Rp 500 billion ($98 million).
Before the crisis, foreign debt servicing accounted for almost 20 percent of the total state budget. With the rupiah staying above Rp 5,000, the ratio of debt servicing to total budget will increase significantly.
Nevertheless, the government has repeatedly affirmed that it will continue to fulfill its international commitments despite the increasing burden on the state budget.
The weakening rupiah, tight liquidity and high interest rates have often been cited as factors responsible for shrinking domestic demand, corporate bankruptcy and the banking crisis.
Businesspeople, bankers and economists have repeatedly called on the government to ease liquidity and lower interest rates to revive dying local businesses. But the government is still reluctant to ease its grip.
The government even plans to tighten its fiscal policy to achieve a budget surplus of 1 percent in gross domestic product (GDP) in the next fiscal year, as required by the IMF.
The tight fiscal policy will lessen public investment and reduce product demand and eventually help curtail economic growth.
Outlook
The National Development Planning Board (Bappenas) has predicted that the economy will expand by between 5 percent and 6 percent for 1996 and 1997.
But many private analysts have said that 5 percent growth for next year would be too optimistic for an economy already deserted by both domestic and foreign investors. Some have even said 4 percent growth would be hard to achieve.
The Econit supervisory agency has said Indonesia could achieve 5 percent growth next year provided the implementation of IMF's programs and other structural adjustments went ahead smoothly and that there was no serious social and political turbulence.
An expected drop in private sector consumption would be the most responsible factor in next year's economic slowdown. Private consumption is expected to expand by 5.8 percent this year and 3 percent next year, down from 12.2 percent in 1996.
The Institute for Development of Economics and Finance noted that sectors most affected by the economic crisis would be construction, finance, transportation and telecommunications.
Meanwhile, significant growth would come from mining, agriculture, fishery, forestry, electricity, gas and clean water sectors.
Even the IMF has slashed its growth revision for Indonesia, and other countries in the region.
Last October, the fund forecast that Indonesia's economy would grow by 6.2 percent next year. But last week, it revised its growth forecast for Indonesia to only 2 percent next year.
Despite the projected slow growth, inflation rates are expected to rise due to imported inflation factors. Imported inflation accounts for about 50 percent of domestic price increases, according to economist Sri Mulyani Indrawati.
Even though the crisis started in July, inflation for this year is expected to pass 10 percent. Year-on-year inflation to November had already reached 9.96 percent. Most of the increase occurred in the last three months, with each month booking a month-on-month inflation rate of over 1 percent.
The weakening rupiah, however, will make Indonesian products cheap and imported products expensive. Thus, this will likely help boost non-oil exports, curb imports and eventually cut the account deficit.
Official data shows that Indonesia's total exports grew by 9 percent during the first three quarters of this year to $39.5 billion -- including $30.8 billion in non-oil exports -- over the same period last year, while imports were down 0.5 percent to $31.8 billion.
The government has said there should be about $42 billion in exports this year and about $45 billion to $46 billion next year.
Because of the increasing trade surplus, the account deficit is expected to decline significantly this year and next year.
Taking export-import data from the third quarter of this year into account, William Wallace, an economic consultant to Bappenas, calculated the account deficit for the quarter at $500 million -- far below the average quarterly account deficit of $1.8 billion in 1996 and the first half of 1997.
The government, as prescribed by the IMF, is planning to reduce the current account deficit to 2 percent of GDP and will maintain official gross reserves at about five months of imports.
But in the capital account, Indonesia will hardly see private capital inflows next year because foreign investors' confidence has not yet returned.
Nevertheless, the Investment Coordinating Board recorded foreign investment commitments totaling $29.6 billion from January until November of this year.
In the entire year last year, foreign investors committed $29.9 billion.
But many analysts have questioned the implementation of foreign investment commitments and if most of them are really translated into real projects.
Mari E. Pangestu of the Centre for Strategic and International Studies has predicted that foreign investors will not come back here until after the presidential election in March.
The government has projected that the private capital account will be negative this fiscal year, with a deficit of $200 million -- a sharp contrast to an earlier estimate of $10.5 billion in surplus.
Most optimistic analysts have predicted that foreign investors will come back to Indonesia soon after the presidential election. They argue that now most listed stocks are already undervalued and worth buying and the weakening rupiah will cut down the cost of doing business here.
Soon after the return of foreign investors, domestic investors will follow suit, and the economy will eventually recover to the level before the crisis.
In an optimistic scenario, Mari and Rizal Ramli of Econit have said the economy might recover by the end of next year or the beginning of 1999, if supported by the return of foreign investors and good governmental measures.