Soedradjad's warning

Soedradjad's warning

The warning sounded last week by Bank Indonesia's (central
bank) Governor Soedradjad Djiwandono about the tendency of the
economy to overheat should get adequate responses from other
government agencies and businesspeople before the external
balance shows signs of crisis. True, the developments, as
Soedradjad explained at a banking seminar, are not yet a sign of
crisis but it is a definite warning signal.

Soedradjad cautioned that rapidly expanding economic
activities have caused the monetary growth to exceed targets set
by the monetary authority, to maintain stability, curb inflation
and to reduce the pressures on the balance of payments. That has
forced domestic interest rates to remain high.

Even though the 6.8 percent cumulative inflation rate during
the first nine months was lower than the 7.4 percent in the same
period last year, and the June trade deficit of US$205 million
was reversed into a surplus of $362 million for July, the
situation is still a cause of great concern.

First of all, the cumulative trade surplus for the first seven
months of this year was much lower than that in the corresponding
period last year, due to the very high growth (29 percent) of
imports.

The sharp increase in imports, partly caused by the robust
pace of new investments, has been causing greater pressure on the
balance of payments. Soedradjad acknowledged that the current
account (balance of commodity and service trade) in the balance
of payments may end up with a much larger deficit than last
year's US$3.1 billion. Some analysts even forecast the current
account deficit to reach as much as $8 billion, or six percent of
the gross domestic product. That is much higher than the 2.5
percent target set by the government as a sustainable level.

The impact of the upward trend in the current account deficit
can still be contained by the high pace of capital inflows, both
through foreign direct investment and portfolio capital. Heavy
dependence on portfolio investments, which are highly speculative
in nature, makes the country highly vulnerable to uncertainty,
which has often been the main hallmark of the international
financial market of late. Jittery investors could suddenly
withdraw their capital simply because of wild rumors, which have
nothing to do with the fundamentals of the country's economy.

That is why, we feel, export promotion becomes even more
imperative and that calls should be made for concerted efforts to
remove high cost components in the production and trading
sectors. This suggestion sounds like the same song over again,
especially because a great portion of the economic growth has, of
late, been spurred by the domestic market demand. However cliche
may be the suggestion, the warning is loud and clear.

The dependence on portfolio capital, to cushion the impact of
the widening current account deficit, also makes it more
imperative for the government to remain consistent with the
spirit of its economic and bureaucratic reform and to continue
deregulation packages. Inconsistencies, however short term they
may be, would provide the wrong signal to investors, which would
cause double blows: Stopping, or sharply reducing capital inflows
and setting off capital flight.