IT IS not hard to be bullish about Indonesia’s economic prospects these days. Last year, while many countries remained bogged down by financial crises and the global economic slowdown, the Indonesian economy grew by 6.46 per cent, its fastest pace in 15 years.
Economists say recent risk rating upgrades and legislative changes aimed at making it easier for businesses to acquire land for infrastructure development augur well for future investment and growth. High international prices for Indonesia’s primary exports have also helped.
It is well to remember, however, that much of Indonesia’s economic expansion is dependent on domestic demand.
Consumption accounts for 55 per cent of gross domestic product (GDP). Strong growth in this area has largely insulated the economy from the global financial crisis. Underpinning domestic demand, as well as foreign investor confidence, say most observers, are sound fiscal and monetary policies.
But last month, when I met Mr Yudhy Purbaya Sadewa, a senior economist at Danareksa Securities in Jakarta, I heard a very different view about the way Indonesia is handling macroeconomic policy.
Mr Yudhy began by pointing out that there may not be as much money circulating in the country as policymakers seem to believe. He pointed to money on deposit in government accounts with Bank Indonesia (BI, the central bank). This money is not accessible to the financial system, and should therefore be subtracted when calculating M-zero. This is particularly so given the known reluctance of bureaucrats to facilitate spending on projects during their designated time frames.
M-zero is the most liquid measure of money supply. It includes only cash or assets such as bank deposits that can quickly be converted into currency.
Last October, M-zero came to 550 trillion rupiah (S$75.8 billion), of which almost half (240 trillion rupiah) was deposited with the central bank. This, says Mr Yudhy, is why bank lending rates have not been falling. There is simply not enough money in the system to allow this to happen.
For some time now, BI has been attempting to lower interest rates by reducing its benchmark borrowing rate to local banks. But local banks have been reluctant to do the same with time deposits.
Lending rates have also remained high. Average rates for working capital, investment and consumer loans in Indonesia are around 12 per cent, 11.7 per cent and 13.4 per cent, respectively – almost twice BI’s overnight policy rate. Statements by BI officials suggest that the monetary authorities would prefer a level closer to 10 per cent.
More recently, BI has begun resorting to non- market mechanisms. Regulations now stipulate that time deposits that attract interest rates in excess of the BI rate will not be guaranteed by the nation’s Deposit Insurance Agency (LPS). The idea is to force rates down by making time deposits with high interest rates inherently riskier.
But public confidence in Indonesia’s banking system is so strong that the regulatory measure has not worked particularly well. Last month, time deposits with local banks averaged 6.35 per cent, well above the 5.75 per cent BI rate.
The situation, notes Mr Yudhy, is similar to that in 2008, when a slowdown in government spending caused an unintended monetary tightening. Overnight rates soared, leading to the controversial bailout of Bank Century and a marked slowdown in economic growth in the final months of that year. A full-blown recession was avoided only after the government stepped up spending and BI moved aggressively in the following year to reduce its policy rate.
In other words, Indonesia’s economic problems in 2009 had more to do with inappropriate monetary policy than with the global financial crisis. GDP growth in 2009 was 4.6 per cent, significantly lower than the 6 per cent registered in 2008.
Danareksa maintains a “Banking Pressure Index” that attempts to capture the strains on Indonesia’s financial system. The index, first drawn up in 2000, with data going back to 1988, effectively captured the weakness in the system ahead of the 1998 financial collapse. It also revealed the problems experienced by the banking sector in 2008.
In recent months, this index has began to rise once again, although it has not yet reached a level Danareksa economists regard as serious.
The capital adequacy ratios (CARs) of Indonesian banks are much better now than they were in the late 1990s. But this is not the only indicator to look for when assessing Indonesia’s financial strength. The system is still vulnerable to rumours, and it may take only the failure of a few small banks (whose CARs are generally low) to have a significant impact on macroeconomic stability.
Indonesia is doing very well right now. Ignoring potential weaknesses, however, would not be wise.