JAKARTA – Indonesia may be on safe ground for now, but Finance Minister Sri Mulyani Indrawati is preparing for a worst-case scenario in 2023 by slashing line ministry spending and drawing up contingencies for a now widely-expected global recession.
The impact of US Federal Reserve rate hikes, persistent inflationary pressures and a slowdown in global growth is likely to buffet Indonesia as it readies for the February 2024 general and presidential elections and the end of Joko Widodo’s two-term presidency.
Worried about sudden changes in the price of commodity exports, particularly crude palm oil (CPO) and coal, Indrawati has directed an across-the-board 5% cut in ministerial spending to ensure she has the reserves necessary to blunt the expected headwinds.
“She wants to build a buffer,” says one well-placed source familiar with her plans. “Officials are being urged to work within the worst-scale scenario. She also wants to clean up the SOEs (state-owned enterprises) so she doesn’t leave a ticking time bomb for her predecessor.”
Seen by many as Widodo’s most trusted minister, Indrawati will also be well aware of the need to prevent political parties from using the ministries they control to raise money for their Covid-depleted campaign coffers.
The president is already under pressure to take back the three portfolios held by the National Democrat Party (Nasdem) after leader Surya Paloh surprisingly announced its support for opposition presidential candidate Anies Baswedan last month.
Indonesia is in a better position than most countries in the region, but that’s largely due to the way costly energy subsidies and direct financial assistance to the poor have allowed it to deal effectively with monetary tightening in the West.
Former finance minister Bambang Brodjonegoro has also pointed to the role of the State Logistics Agency (BULOG) and the Ministry of Trade’s direct market intervention in tackling inflationary pressures affecting food security across the country.
In addition, the newly-created National Food Agency (Bapanas) is charged with coordinating, formulating and implementing policies related to the availability and price of 11 food staples, namely rice, corn, soybeans, sugar, garlic, eggs, beef, poultry, fish, chili and cooking oil.
In the US and Europe, reliance on market mechanisms leaves central banks as the only real tool for combating inflation, demonstrated again last week with the US Fed raising interest rates by a further 75 basis points, the sixth consecutive increase this year.
Historically, the higher cost of borrowing has helped to stall the economy as fewer customers take new credit accounts. But current inflation is being fed by a number of complicating factors, including the Russia-Ukraine war, the after-effects of Covid and supply chain issues.
Analysts say Indonesia’s fiscal and external accounts are far more secure compared to the so-called “taper tantrum” of 2013-14 – the term coined to describe the reaction from investors when the Fed sought to slow down bond purchases.
So far, elevated commodity prices have driven strong growth and also widened Indonesia’s annual goods trade surplus beyond a record US$50 billion, turning the current account from deficit to surplus.
The healthy trade surplus is complemented by a 58.1% surge in tax collection to 1.17 quadrillion rupiah ($75.4 billion) in the first eight months, buoyed by export receipts and strong economic growth, now forecast to reach 5.4% for 2022.
Foreign direct investment jumped 63.6% to 168.9 trillion rupiah ($10.8 billion) in the third quarter, the highest level in decades. Domestic investment increased by 22.5% to 138.9 trillion rupiah ($8.9 billion), bringing overall investment to 307.8 trillion rupiah ($19.7 billion).
World Bank senior economist Csilla Lakatos says there are clear signs the comprehensive reform program under the 2020 Omnibus Law on Job Creation has played a key role in boosting investment, particularly in fully-liberalized sectors.
But she says the government still needs to do more to dismantle or reduce “burdensome and unnecessary” non-tariff measures, including pre-shipment inspections, Indonesian National Standard (SNI) rules and port-of-entry requirements.
Officials warn that 2023 could present a very different story, with the Asian Development Bank (ADB) already winding back economic growth rate projections from 5.2% to 5.0%.
Although still in surplus, a declining trade balance last month has signaled the possibility of a slowdown in the coming months if exports of such top foreign exchange earners as CPO continue to slide.
That has mainly been the result of a reduction in tax levies and a worrying fall in prices from a high of $1,500 a tonne in May to $210 in mid-September, though in recent weeks it has bounced back to $850.
Fears of a global recession may turn into a self-fulfilling prophecy. A recent Bank Indonesia (BI) board of governors meeting settled on a 50 basis points rate hike for the third consecutive month, bringing it to a total of 125 basis points for the year.
But so far it has done little to stem the rupiah’s depreciation, with the US dollar exchange rate just topping the 15,600 rupiah mark, where it has doggedly remained since mid-October. Last May it was at 14,380 rupiah.
Financial sources say BI began making preparations for the rate hike last April, but for unclear reasons governor Perry Warjiyo waited until August to act, weeks after the Fed decided on its second consecutive 75 basis points increase.
A career central banker, Warjiyo, 63, was appointed to the top BI post by the House of Representatives in 2018 and is due to come up for renewal in May next year. He is believed to be eligible for a second term.
Analysts sense the BI will now maintain a more aggressive monetary stance to stave off further currency depreciation, economize on its FX reserves, play catch-up with the Fed and attempt to bring domestic inflation under control. The next BI board of governors meeting is on November 16-17, with a final session scheduled for December 21-22.
Higher interest rates will have an impact on Indonesian companies, forcing more redundancies on top of the wave of lay-offs that followed in the wake of the pandemic as managers found new ways to automate their businesses.
The latest Statistic Indonesia (BPS) data shows headline inflation, covering all commodities, goods and services, slowed to 5.7% last month, down from 5.9% year-on-year recorded in September thanks to reduced prices for many basic food staples – with the exception of rice.
The government hopes to keep inflation below 6% for the year, but economists warn that private consumption, which accounts for more than half of GDP, could slow as household earnings fail to keep pace with rising costs.
Most concern rests on whether the trade surplus shifts to deficit, particularly with the Chinese economy still constrained by the “zero-Covid” policy and the recent sharp downturn in China’s property market.
Despite the Indonesian government’s careful decision in September to partly remove domestic fuel price subsidies, it is still forecasting an increase in the subsidy allocation by an additional 4.4% next year.
Analysts warn that balancing a swelling subsidy bill against a fast-sinking commodity cycle will prove challenging and risks a troubling return to twin deficits in the fiscal and current accounts.
Another worry is BI’s burden-sharing arrangement under which it has purchased 837 trillion rupiah ($53.6 billion) in bonds, or about 4.5% of gross domestic product (GDP), over the last three years direct from the Ministry of Finance to help fund the government’s fiscal imbalance.
The arrangement is due to be unwound next year, but there have been few details so far on how this will be managed. Treasury experts say the gap left when the BI steps away will have to be filled from elsewhere, perhaps by domestic banks which are currently flush with cash.
Indrawati does not want foreign investors in the mix, wary of the way foreign capital flooded out of the country during the taper tantrum. The circumstances now are different, however, with foreign entities owning just 17% of Indonesian debt, compared to 35% in 2013.
For Indrawati, one major priority is the country’s financially-troubled state-owned enterprises and the prospect of their financial collapse in an environment of soaring interest rates.
She intends to use the newly-created Indonesia Sovereign Wealth Fund (INA) to act as a recycling agent, buying assets such as parts of toll roads and other infrastructure and selling a minority stake to private investors.
Coupled with that is the Asian Development Bank’s Energy Transition Mechanism which will leverage a market-based approach to accelerate the transition from fossil fuels to renewables.
Under that scheme, the ADB and private investors will provide concessional financing to buy coal-fired power stations, which will then be retired a decade ahead of their scheduled closure.
Two plants have been earmarked for the program, but it is not clear how that will fit with state-owned Perusahaan Listrik Negara’s (PLN) plans to provide a renewable alternative to fill the gap, even if there is a current over-supply on the Java-Bali grid.