Commentary: Certainly not crisis in economic fundamentals but in confidence
Vincent Lingga, The Jakarta Post, Jakarta | Headlines | Thu, August 29 2013, 9:38 AM
Bank Indonesia (BI), like central banks in other major emerging economies, has been in a dilemma over the past weeks due to massive capital outflows, because in order to keep more money in the country and tame inflation, interest rates need to rise.
But higher interest rates would make it harder for local companies to borrow, potentially causing a credit crunch and limiting economic growth.
What a strikingly different situation it is now compared to the period between 2010 and early this year, when Indonesia was still the darling of foreign direct and portfolio investors.
Indonesia had become the main destination of short-term portfolio capital from Europe and the United States, pushed out by their easy monetary policies. The huge capital inflows were pulled in by a robust economic outlook and high interest rate differential in Indonesia.
Even though it is widely recognized that the size and volatility of the flows created risks to financial stability through the build-up of financial imbalances, the liquidity management ran well as the government made the right policy responses to the capital inflows.
Structural reforms were implemented to improve the capacity of the economy to absorb the capital inflows and channel them into productive investment. The domestic bond and equity markets were deepened, and financial regulations and supervision were strengthened.
Put briefly, disciplined macroeconomic management, encompassing fiscal, monetary and exchange rate policies were able to well manage capital inflows and contain the buildup of excesses in specific sectors of the banking system.
But the eventual recovery in the US and the Federal Reserve signaling last May that it would soon tighten its money policy caused sudden stops and, finally, capital reversals.
After rejoicing over the sharp rebound of capital inflows from 2010 to early this year and robust economic growth of around 6 percent, Indonesia suffered the brunt of a sudden reversal in flows, unleashing tremendous downward pressure on the rupiah and equity prices.
The cascading impact of the upcoming tighter money policy by the US Fed and the series of distortive economic and business policies made by narrow-minded politicians and mounting economic nationalism have prompted portfolio investors to offload their rupiah assets and turn to more secure dollar assets that promise higher returns.
Fortunately, though, the debacle has not escalated to panic, especially because the offloading of rupiah financial assets was part of a general sell-off of Asian shares and currencies, prompted by fears that the forthcoming US Fed money tightening would raise bond yields.
The Jakarta benchmark stock market index has thus far dropped by almost 20 percent from its all-time record in May and the rupiah lost almost 12 percent, going down to as low as that at the height of the global crisis in early 2009.
The big question now is why is it Indonesia has seemed to suffer the most severely, compared to other Southeast Asian countries? And why Indonesia’s long-term growth path seems to have taken such a negative turn just in the past few months?
The answer is that the good times lulled policymakers and many politicians into hubris, resulting in a series of distortive policies in various economic sectors and the bashing of foreign companies (investors) amid the increasingly pervasive corruption in such key sectors as the law enforcement agencies and oil and gas industry.
Over the past year, the government has introduced distortive regulations in the petroleum and general mining and banking industries and erected more non-tariff barriers to imports of such vital commodities as food and livestock.
The regulation requiring investors in the mining sector to build smelters is good to generate higher added value. But the time schedule set for this rule is technically and commercially impossible in view of the huge additional investment needed to build smelters.
Yet even more damaging is the rule that accelerates the compulsory divestment by foreign mining investors to national interests at a time when they are required to put up huge sums of additional investment.
Likewise, the central bank cut the maximum limit on the foreign ownership of a national bank to 40 percent from 90 percent without an adequate transition period, unnecessarily creating uncertainty for foreign investment in the capital-hungry banking industry.
Consumers were hurt by steep increases in the prices of horticultural products and beef due to protectionist trade policies that did not bring any benefits to local producers.
In the meantime, while new investment in oil exploration and oil production has steadily declined, politicians at the legislature have stubbornly demanded drastic amendments to the 2001 Oil and Gas Law, which they perceive to be too strongly biased toward foreign interests.
Given the upcoming presidential and legislative elections next year, many are afraid that whatever amendments are made to the oil law will be too nationalistic.
No wonder, business leaders taking part in the panel discussions at the Singapore Channel NewsAsia’s Business Insights Indonesia here on Wednesday saw the latest turmoil in the financial market as a strong wake-up call for the government to restore confidence through a faster pace of reform measures.
As the London-based Economist weekly news magazine observed last week, “In good times, Indonesia might have been able to afford the luxury of such posturing. But those times, all of a sudden, are over. Now that profit margins are coming under pressure, many foreign investors will begin to look elsewhere, just at the moment when Indonesia might need them most.”
But higher interest rates would make it harder for local companies to borrow, potentially causing a credit crunch and limiting economic growth.
What a strikingly different situation it is now compared to the period between 2010 and early this year, when Indonesia was still the darling of foreign direct and portfolio investors.
Indonesia had become the main destination of short-term portfolio capital from Europe and the United States, pushed out by their easy monetary policies. The huge capital inflows were pulled in by a robust economic outlook and high interest rate differential in Indonesia.
Even though it is widely recognized that the size and volatility of the flows created risks to financial stability through the build-up of financial imbalances, the liquidity management ran well as the government made the right policy responses to the capital inflows.
Structural reforms were implemented to improve the capacity of the economy to absorb the capital inflows and channel them into productive investment. The domestic bond and equity markets were deepened, and financial regulations and supervision were strengthened.
Put briefly, disciplined macroeconomic management, encompassing fiscal, monetary and exchange rate policies were able to well manage capital inflows and contain the buildup of excesses in specific sectors of the banking system.
But the eventual recovery in the US and the Federal Reserve signaling last May that it would soon tighten its money policy caused sudden stops and, finally, capital reversals.
After rejoicing over the sharp rebound of capital inflows from 2010 to early this year and robust economic growth of around 6 percent, Indonesia suffered the brunt of a sudden reversal in flows, unleashing tremendous downward pressure on the rupiah and equity prices.
The cascading impact of the upcoming tighter money policy by the US Fed and the series of distortive economic and business policies made by narrow-minded politicians and mounting economic nationalism have prompted portfolio investors to offload their rupiah assets and turn to more secure dollar assets that promise higher returns.
Fortunately, though, the debacle has not escalated to panic, especially because the offloading of rupiah financial assets was part of a general sell-off of Asian shares and currencies, prompted by fears that the forthcoming US Fed money tightening would raise bond yields.
The Jakarta benchmark stock market index has thus far dropped by almost 20 percent from its all-time record in May and the rupiah lost almost 12 percent, going down to as low as that at the height of the global crisis in early 2009.
The big question now is why is it Indonesia has seemed to suffer the most severely, compared to other Southeast Asian countries? And why Indonesia’s long-term growth path seems to have taken such a negative turn just in the past few months?
The answer is that the good times lulled policymakers and many politicians into hubris, resulting in a series of distortive policies in various economic sectors and the bashing of foreign companies (investors) amid the increasingly pervasive corruption in such key sectors as the law enforcement agencies and oil and gas industry.
Over the past year, the government has introduced distortive regulations in the petroleum and general mining and banking industries and erected more non-tariff barriers to imports of such vital commodities as food and livestock.
The regulation requiring investors in the mining sector to build smelters is good to generate higher added value. But the time schedule set for this rule is technically and commercially impossible in view of the huge additional investment needed to build smelters.
Yet even more damaging is the rule that accelerates the compulsory divestment by foreign mining investors to national interests at a time when they are required to put up huge sums of additional investment.
Likewise, the central bank cut the maximum limit on the foreign ownership of a national bank to 40 percent from 90 percent without an adequate transition period, unnecessarily creating uncertainty for foreign investment in the capital-hungry banking industry.
Consumers were hurt by steep increases in the prices of horticultural products and beef due to protectionist trade policies that did not bring any benefits to local producers.
In the meantime, while new investment in oil exploration and oil production has steadily declined, politicians at the legislature have stubbornly demanded drastic amendments to the 2001 Oil and Gas Law, which they perceive to be too strongly biased toward foreign interests.
Given the upcoming presidential and legislative elections next year, many are afraid that whatever amendments are made to the oil law will be too nationalistic.
No wonder, business leaders taking part in the panel discussions at the Singapore Channel NewsAsia’s Business Insights Indonesia here on Wednesday saw the latest turmoil in the financial market as a strong wake-up call for the government to restore confidence through a faster pace of reform measures.
As the London-based Economist weekly news magazine observed last week, “In good times, Indonesia might have been able to afford the luxury of such posturing. But those times, all of a sudden, are over. Now that profit margins are coming under pressure, many foreign investors will begin to look elsewhere, just at the moment when Indonesia might need them most.”
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