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.