http://www.thejakartapost.com/Outlook/eco01b.asp
January 12, 2007
Next year is being approached by many with optimism. But just how fast will the economy recover, and which industries will the recovery touch upon first? After last year's spate of crippling fuel price adjustments, signs of revival in domestic demand have been emerging. Bank credit disbursements recently started showing signs of improvement, with incremental credits outstanding in September and October being almost 40 percent higher compared to the same period last year. Twelve-month moving averages of monthly car and cement sales have also shown upticks in November, which may be indicating the start of a rising trend. Monetary, instead of fiscal, policy seems to have been supplying most of the air to the economy. Bank Indonesia has lowered the BI rate by a total of three percentage points this year. Concurrently the long-awaited stimulus from fiscal spending, in terms of realization in goods and capital expenditure, seems to have only improved a little. With more rate cuts forthcoming, monetary policy is still expected to be the key driver next year. As fiscal decentralization is still in its early years -- marked by lack of experience in implementation and human resource limitations -- improvements in the realization of capital expenditure are expected to come gradually. So for the government's budget balance, forthcoming budget deficits are expected to be mild and the ratio of public debt to the economy may continue to decline. Although the government's 6.3 percent assumption in economic growth for 2007 looks challenging for revenue collection, overall fiscal risk will remain muted since spending is also expected to fall below the budget. Monetary stimulus will remain strong as much of the lag effects of this year's rate cuts will kick-in. Furthermore, since the Bank Indonesia reference rate is still at around four and half percentage points above the annual rate of inflation in November, there still seems room for interest rates to fall further -- although the pace is likely to be slower. (With excess liquidity in the banking system, currently some Rp 400 trillion, taking interest rates down too fast would fuel the risk of asset price bubbles. Of course this may be a chicken and egg problem, but the lowering of interest rates should go hand in hand with the availability of real investment opportunities.) Which industries will recover first? Naturally, the strongest recovery in consumption growth would at first involve households that are most sensitive to interest rates, which are in the middle to upper income classes. Spending would originate from both credit and savings. Therefore, we may start to see the recovery in consumption being led by spending on durables and big ticket items such as electronics, motorcycles, cars and property. For the masses at the grass-roots, recovery may come slowly and gradually. Data published by the statistics office shows that real wages for farmers -- which comprise over forty percent of the labor force -- have risen slowly, and haven't reached the point where they were before the 2005 fuel price hikes. A similar, if not worse, trend is seen in urban informal sector workers. There is apparently not much that can boost the income at the lower levels, apart from job creation in the formal sector and perhaps government subsidies. Investments in new palm oil plantations for the government's biofuel project may help somewhat. However most of the benefit will accrue to the farmers living outside Java (since that's where the plantations are located), which do not constitute the bulk of the farming population. It is also still unclear whether many of the presumably labor intensive infrastructure projects offered at the second infrastructure summit will begin construction next year. Therefore, the obvious path of recovery for the economy will begin from the higher income segments of society, before trickling down to the masses. But of course for the trickle-down effect to be significant, spending on durable goods and big ticket items must be accompanied by new investments and new job creation to fulfill that demand. The thirst for durable spending must not be fulfilled solely through imported goods that have little domestic value added. Hence, much depends on how reforms in the investment climate are carried out next year and whether or not they lead to a reduction in the inefficiencies and distortions that have so far choked the manufacturing sector. (Some issues that are often highlighted are inflexibilities in outsourcing, excessive protections for workers and high severance payments). Mind that whereas output growth in service-oriented sectors has returned to pre-crisis levels, growth in the manufacturing sectors hasn't. This is unfortunate since investments in the manufacturing sector tend to absorb more jobs compared to the services sector. As for the general price level, there is no guarantee that the easing trend in consumer price inflation would continue next year. However many would agree that inflation will not sky rocket as it did last year. This year the government and parliament have agreed not to raise electricity tariffs. Meanwhile subsidized fuel prices are unlikely to be hiked again unless oil prices soar to over US$85 per barrel. Sporadic kerosene scarcities will probably haunt the news as the fuel is sold at well below the market price. However the problem is not expected to be so severe as to warrant another fuel price hike -- especially considering the slow recovery of purchasing power at the grass-roots. Even the forthcoming price adjustments aren't expected to have a dramatic effect on consumer prices. The retail price of fertilizers next year may rise by around 50 percent to Rp 1,800 per kilogram, but the impact may not necessarily be dramatic, as reports suggest that fertilizers are already selling at above the government price. The planned 50 percent increase in Liquid Petroleum Gas prices for households is also estimated to have a moderate impact of not more than 0.5 percentage points to the inflation rate. Next year government attention on food prices (import policy) would be crucial. The government seems to have been responsive in responding to shocks in rice prices; several months ago it proceeded with rice importation despite condemnation from a number of politicians who claimed to represent the interests of farmers. If this persistence is continued through next year, then we might be able to see more positive surprises on the inflation front. Naturally, stronger economic growth would have some implications. On the external front, maintaining a strong trade surplus in the face of rising import growth would be the main challenge when economic growth does start to accelerate. The global thirst for energy would probably keep the prices of soft and hard commodities high -- although no dramatic surge is expected as the U.S. economy slows. But stronger economic growth would naturally need stronger imports of raw materials, capital goods and consumption goods. So the trade surplus should naturally narrow and provide less support for the rupiah's strength against the dollar. Indeed many think that with the dollar expected to weaken next year, to adjust for the massive trade deficits in the U.S., capital will keep flowing away from the dollar towards Asian currencies, including the rupiah. However this would be counterbalanced by stronger pressure from rising imports. So if next year could be summed up in one paragraph, it would be as follows. The light at the end of the tunnel has been seen. Monetary policy will play a crucial role; but the increase in purchasing power will initially be narrow-based. Hence the speed of recovery is expected to be gradual. Whether improvements can touch upon the living standards of the masses will depend on the ability and willingness of the politicians and decision makers to finish long overdue reforms. The writer is an economist at PT Bahana Securities. The views expressed in this piece are personal. =================================================================================== http://www.thejakartapost.com/Outlook/eco02b.asp
January 12, 2007
It seems probable that, when economic historians look back on the opening decade of the current century, they will regard this as a time of significant structural shift. New patterns of behavior, in both the real economy and the financial markets, are being established around us. It is an exciting time to be an economist -- but also a difficult time. As investors (rightly) demand forecasts for the future that reflect higher and higher levels of certainty, economists feel less and less secure in what they are projecting. Economists look to the past to provide guidance for the future. The problem is that the past (at least, the immediate past) may provide little insight into the new, changed world in which we find ourselves. The situation can be summarized in the somewhat notorious expression coined by former U.S. Defense Secretary Rumsfeld -- "known unknowns". We know that there are things changing in the global economy (the "known" part of the phrase). What we don't know is how they will resolve (hence "unknown" knowns). Consider the current situation. The U.S. has seen unprecedented levels of home ownership, unprecedented levels of indebtedness, and a rapid rise in house prices over the last five years. This is ending, and it is difficult to determine how the U.S. consumer will react to what UBS expects will be a 10 percent drop in U.S. house prices in 2007. The world economy has been dependent on the U.S. consumer to drive growth to a remarkable degree, and it is unclear how the global economy will respond to the stalling of that engine of growth. The dependence on the U.S. consumer has led to the imbalances of the global economy as represented by the U.S. current account deficit -- at around 7 percent of GDP, a level that is without parallel in the 176 years of recorded U.S. economic history. This deficit in turn has led to over half the actively traded U.S. Treasury market being owned by foreign investors (again, without precedent), itself in part a function of the dramatic accumulation of reserves by Asian central banks. Chinese central bank reserves exceeding a trillion dollars (as they did in 2006) is without parallel for any country. In Europe the economy is still adjusting from the structural changes of monetary union, with considerable debate about how the economy is coping. Added to this, there has been a significant change in population -- Western Europe has the fastest rate of population growth it has experienced since in 30 years, as a result of migration from Eastern Europe. The trend rate of growth (UBS contends) has risen with a higher rate of labor productivity. Meanwhile Japan is emerging from the dark period of deflation that dogged that economy in the 1990s. The attempts to normalize monetary policy are raising concerns about the sensitivity of the Japanese consumer. The last few years have seen growth encouraged by significant investment, in particular from the service sector. As this structural investment cycle concludes (as most economists believe it will in 2007) there is less certainty about what replaces it. How are financial markets reacting? Not as one would expect. Volatility has been unusually low -- and critically, unusually low across all asset classes. Credit spreads, for both corporate and country debt, remain at very low levels. There is uncertainty about the future, as my conversations with all sorts of investors, all over the world continue to demonstrate. However, a casual glance at the risk premia financial markets would indicate an undue degree of confidence in the future. Financial liquidity is reducing risk premia, and it is possible that investors are confusing liquidity with low risk. So what are the known parts of the unknowns ahead? There are seven key ideas that I think can be applied to the economy and financial markets. 1. The U.S. economy will continue to slow down. The U.S. housing led slowdown is clear. Already consumption is weakening in those areas that have been sensitive to mortgage refinancing, like autos and home improvement. The negative wealth effect has yet to run its full course. 2. The rest of the world can not compensate. Household cashflow growth is slowing in Europe in the face of higher interest rates from the ECB, tighter fiscal policy, and subdued income growth. Japan's consumer has disappointed so far, and seems unlikely to be able to replace U.S. consumer demand. China is an important consumer of raw materials (and is not expected to slow domestic demand any further), but simply is not rich enough to replace the U.S. consumer. The 65 million middle class in China have a per capita income of around US$6,000. 3. Central banks will shift their positions. In the United States, which is leading the growth slowdown, we expect the Federal Reserve to cut rates aggressively. We are expecting a cumulative 1 percent reduction in Fed funds, to take the target rate to 4.25 percent by the end of the year. The European Central Bank (ECB) is not expected to follow the Fed in easing interest rates, but after a further increase in February we see rates on hold for the remainder of 2007. The Bank of Japan, similarly, is expected to make one rate increase (in January, taking the call rate to 0.5 percent), before holding for the remainder of the year. Australia should see unchanged rates, while the Bank of England should ease in the face of a softer labor market and falling inflation pressures. We also believe Indonesian interest rates will fall. 4. The dollar will continue to weaken. U.S. consumer growth should slow -- but so too will growth in the rest of the world. UBS does not see a decline in the U.S. current account deficit, but instead another increase in nominal dollar terms. As a result, the pressure to find the finance for the U.S. current account position is expected to push the dollar down further against both the euro and the yen. However, the dollar's decline should remain relatively orderly, with central banks continuing to provide a significant degree of support. 5. Commodity prices should remain fairly firm. Although global growth is slowing, the composition of growth is adjusting. First, more of the world's growth will be generated by relatively intensive consumers of commodities (like China). Second, more of the world's growth will come from industrial activity (industrial production is projected to slow less than is GDP). Finally, the dollar is expected to continue to decline, which supports (dollar) commodity prices. 6. Global bond markets should remain relatively strong. Although there may be a tactical correction in the near term, when the UBS monetary policy outlook is validated by central bank action, there should be further support for government fixed income markets. With the exception of Japan, G7 government bond markets are likely to continue to experience very flat yield curves (encouraged by institutional demand for longer dated bonds). 7. Global equity markets could perform better than fixed income. Although the slowdown in growth suggests a slowdown in earnings growth, the economic scenario is one of soft landing rather than recession (assuming that policy makers respond appropriately to the evidence of economic weakness). This should allow some increase in price to earnings ratios -- from historically suppressed levels. The multiple expansion outweighs the consequences of slower earnings growth, and allows a stronger equity performance. Although this is a scenario based on slowing growth, it is also a benign scenario. This is the fabled soft landing -- an outcome often sought but rarely achieved. Although the U.S. is likely to grow at 2 percent next year, this is not a recession. Prompt action by the Fed, coupled with a labor market that is relatively good, should prevent a worse reaction from taking hold. Europe, Japan, and China all slow with the U.S., but not to the same degree (mitigating the damage at a global level). Markets do not react in a disorderly fashion. Where is the risk? The risk is in the lack of risk. Markets are pricing for the best case scenario, and in the view of most economists are not attributing any probability to alternatives. This is not unprecedented -- financial markets are not perfect at pricing risk, and often underweight risk scenarios. However, if markets do chose to price in a higher probability of a risk event in 2007, then there will be a more volatile response from assets. It is right to focus on the positives for 2007. The benign slowdown has played out almost exactly as it should so far, and the base case must be that (with appropriate policy responses) it continues on this course in 2007. However, what we know about 2007 is matched by the uncertainty of the outcomes -- the known unknowns. There is also the risk of something totally unforeseen hitting the market, from a political, military or financial market cause: The unknown. That is not factored into financial markets at all -- nor is it likely to be until it is too late. Therefore, pity the poor economist. It is an exciting time to be working in the profession, but uncertainty and structural change are uncomfortable companions to economics. The writer is Managing Director of Global Economics, UBS Investment Research. This is a personal view. He can be reached at paul.donovan@ubs.com. ==================================================================================== http://www.thejakartapost.com/Outlook/eco03b.asp
January 12, 2007
In the course of 2006, the government and its economic mandarins have tried to persuade us that the country's economy is in the ascent. The stability of macro-economic indicators is discernible, and there has been no turbulence in inflation, exchange rates or stock indexes. If we don't see how all this has any relation to the economic plight of ordinary people, it must be due to our myopia. Or, is the persuasion only a form of wishful thinking that is expected to happen as a self-fulfilling prophecy? Different observers may have different opinions, but in my view the most important economic news in 2006 came on Dec.7. Instead of the official numbers on the poverty rate -- up from 35.1 million people in 2005 to 39.05 million in 2006 -- the picture of poverty trap suddenly became more appalling. On that day the World Bank released a 350-page report, Making the New Indonesia Work for the Poor, which tells us that those living in poverty number 108.78 million. This is almost half of the Indonesian population. For those familiar with the standard of living in many areas, the news was not entirely unexpected. Still, it brought us to our senses. The above figures are of course based on different assumptions; the former on a much lower standard, whereas the 108.78 million poor are those living on less than US$2 a day, or what you pay for a cappuccino in a modest cafe in Jakarta. But what does this mean for policy makers who are preoccupied with thinking about the economy in terms of the modern corporate outlook? The reality of immense poverty and the modern corporate outlook are a continent apart. And the implications may run counter to the textbook and economic outlook that is being perpetuated by economic and business reports in most magazines and daily newspapers. First, to admit that 108.78 million people live on less than $2 a day is also to concede that any attempts at poverty reduction in Indonesia must start from a very low base. The term "low base" should be taken literally, referring to low purchasing power, low capital, low productivity, etc. This starting point has far-reaching implications. Second, economic diagnoses that are too fixated with the glittery corporate economy have hardly anything in common with the true state of affairs. Of those 108.78 million, 69 percent live in rural areas, 64 percent work in agriculture, 75 percent work in the informal sector and 55 percent have less than a primary education. In view of this naked fact, obsessions with the capital market, government bonds, the stock index, mutual funds, derivatives and the like, while useful, are insensible to say the least. What's the stock index got to do with a life on less than $2 a day? Third, suppose I am a corporate executive with a modern corporate outlook, and the only training I have is the arts of corporate economy. It is only expected that the solution I instinctively see is to integrate those 108.78 million poor into the ambit of the corporate economy. So, quite like some globalization maniacs, I will see that the problem is not that there is too much corporate force involved, but rather that too little of it has been employed. Fourth, but then, deep within, I concede that I have to deal with the insurmountable problem of very low purchasing power as well as low productivity, which involves not only 1 or 2 million people, but 108.78 million. What a colossal number! Caught in a dilemma, I, with my corporate instincts opt to treat them as potential consumers. Fifth, suppose that I am a corporate banker. I will then devise a scheme for micro-credit. It's an opportunity I cannot refuse, for if I can turn just 10 percent of them into my clients, that's already a handsome profit for my bank. But there is another problem, for they have hardly any formal assets to use as collateral. Well then, I will set up a committee to organize a high-profile event in Jakarta, at which the likes of Hernando de Soto should be the main speaker. He is a well known economic mandarin, and his task, as he writes in The Mystery of Capital, is to convince the government to produce certificates for the idle assets belonging to each family of the poor. Then the certificates can be used as collateral. If this is too rude, I will devise a more polished scheme in which the strategy to turn the poor into my clients is not as gross as it first appears. It won't be too difficult, for I will rally many uncritical journalists to write reports about the importance of my corporate pursuit. The above exercise in imagination may sound unlikely, but it is not so far away from the line of economic thinking currently in vogue. The above exercise may also lack the technical jargon that usually characterizes economic analyses, but certainly it doesn't obscure the point to be explained. Indeed, the problem of colossal poverty in Indonesia has been understood from the high pitch of the modern corporate world view for some time now. And the solution pursued is to integrate the poor as quickly as possible into the working ambit of the modern corporate economy. The problem is, between poverty and the modern corporate economy there is a yawning cultural gap that cannot simply be bypassed. Any quick formula to integrate the poor who live on less than $2 a day into the modern corporate economy is bound to be a mirage. Instead of empowering them for economic survival, this recipe is more likely to entrap the poor into further dependence. Even if the integration of the poor into the modern corporate economy is to be pursued, it will be a long and gradual process. And most importantly, the process of such integration should neither be given nor entrusted to the modern corporate sector. To which sector then is the task to be entrusted? To the government? Aside from being beset by fiscal constraints due to its heavy debt burden, the clumsy hands of the government are not to be trusted with this delicate task. The poor will have to rely mainly on themselves. Indeed, pulling up the poor is a nobler calling than pulling down the rich, but how do you do it? Here lies the difference between Hernando de Soto and Bangladeshi Muhammad Yunus, the 2006 Nobel Peace Prize winner. If de Soto's solution to serious poverty is the formalization of the informal economy, Yunus would see such formalization as making the poor even more dependent and vulnerable to corporate exploitation. The most important task of poverty reduction is not to integrate the poor into the modern corporate economy, but to facilitate capital and entrepreneurship formation that is based on their own strengths, potentials and energies. Formalization is not the issue. It may help the government with more revenue from the newly formalized sectors, but it means little if the poor become more dependent. As is well known, Yunus' most distinctive solution is not based on the management of risk by collateral or legally enforceable contracts, which is the practice of modern and conventional banks. Instead, trust and sociality in micro-credit cooperatives are the basis. Loans as small as $30 are available for self-employment and income-generating activities, as opposed to consumption. All this may sound primitive to the inhabitants of the modern corporate world view, but is familiar to those who live on less than $2 a day in rural areas. Instead of presenting a certificate a la de Soto as collateral, a borrower must join a group of five. Loans are given to two persons, while the other three act as guarantee. These three cannot borrow until the two borrowers repay. The threat of being shamed by their peers is a strong force to deter those considering a default. It is this cooperative process that was gradually institutionalized into Grameen Bank, which now has 6.7 million borrowers in Bangladesh, 97 percent of whom are women. Its loan recovery rate is as high as 98.5 percent, compared to 45-50 percent in modern and conventional banks. The genius of Yunus' approach is that it starts from a very low base and it keeps economic activities embedded in social trust. Unlike the modern corporate economy, it doesn't require any legal literacy, which is alien to the poor anyway. The point, of course, is not to keep the poor outside the law. Rather, the point is to not impose requirements on them that are confusing and foreign. If they are to be gradually integrated into the modern corporate economy, let it happen through a trial-and-error process, not through exploitation. Most modern corporate executives are likely to loathe this approach for fear of being deprived of tens of millions of potential clients. What should the government do? Its noblest task is to ensure that the poor grow economically through self-supporting networks of capital formation and social trust, and do not fall into the corporate maw. The writer, a postgraduate program lecturer at The Driyarkara School of Philosophy in Jakarta, holds a PhD from The London School of Economics. ==================================================================================== http://www.thejakartapost.com/Outlook/eco04b.asp
January 12, 2007
Over the 25 years up to 1996, Indonesia experienced average annual economic growth of 7 percent while poverty declined from 40 percent of the population in 1976 to 11 percent. But this stellar performance came to a rude end during the economic and financial turmoil that swept across East Asia beginning in 1997. Since then, attempts to restore Indonesia's economy to a sustainable path of high growth have met with limited success. As it is, annual GDP growth since 1997 averaged only 2.6 percent if 1998 is included when the economy shrank by 13 percent. Only recently has per capita income reached its pre-1996 peak. Jakarta has taken steps that should be applauded, For example, sales of publicly-owned assets, reduced fiscal deficits and less government control of the economy helped push the ratio of public-sector debt to GDP down from a high of 94 percent in 2000 to 39 percent this year. Consequently, debt servicing payments fell from 24 percent of the total budget in 2000 to 11 percent of total government expenditure. All these steps have helped reduce sovereign risk. As such, credit-rating agencies raised credit-rating risk on government debt with Indonesian sovereign debt now rated by Moody's as B1 and by Standard & Poor's as B+. But improvements on the macroeconomic side have not been matched by gains on the microeconomic side. For example, unemployment has risen every year for the past 10, increasing from 5 percent to 11 percent of the labor force and underemployment is estimated to be 40 percent of the workforce. Initially, Indonesia's economic rebound was hindered by the heavy costs of recapitalizing a collapsed banking system that were the most expensive in the world, costing 15 percent of GDP. But the biggest problem is that investment never staged a full recovery. From the late 1980s to 1997, Indonesia attracted more than US$23 billion in FDI. But since 1997, there has been a net outflow of $8.0 billion. If there is any hope for a return to the glory days, Bank Indonesia and the central government must abandon conventional macroeconomic dogma. In particular, policy choices based on the mistaken beliefs that household consumption, government spending or exports are drivers of economic growth, should be jettisoned. These misguided macroeconomic myths induce the central bank to tamper with interest rates to create an artificial and temporary boost in economic activity. A similar intent drives higher fiscal spending, often based upon new public-sector debt. But by themselves, neither more consumption nor higher public spending will bring a sustained rise in prosperity. As it is, economic booms based on public spending or artificially-low interest rates are illusory and temporary. Sustainable economic growth requires increased real earnings and should be supported by increased productivity that comes from more and better investments. But the private sector will invest more only if economic fundamentals improve. Neither the amount of pieces of paper money nor the amount of government spending or its timing can change anything real about the economy. For its part, Bank Indonesia operates under a mistaken belief that economic growth can be fine-tuned or manufactured by fiddling with interest rates. It uses the BI rate to act as a reference for bank rates and bill sales. Lower rates are expected to induce banks to lower their rates and lend more to households and businesses to boost consumption and investment as a prelude to higher economic growth. Artificially-low interest rates (or increased government spending) can trick consumers or business leaders into being more confident. But when temporary stimuli dry up or are reversed, new borrowing or investment inspired by higher future expectations will be unfulfilled. A reversal of policy-induced stimuli is inevitable and occurs when consumer prices begin to rise. Then, ill-advised investments must be liquidated so that unemployment rises as the economy slows down. In all events, lower interest rates cut both ways. Lower deposit rates discourage some amount of savings. And since the stock of real savings out of long-term income is the basis of sustainable economic growth, less saving leads to economic underperformance. Unfortunately, the belief in voodoo macroeconomics does not end with monetary policy. Earlier this year, chief economics minister Boediono announced that public-sector spending would be accelerated in order to stimulate the economy. His game plan predictably failed because the timing of government spending, per se, cannot boost real economic growth. Frontloading government spending cannot have a greater benefit than leaving it to a later date. But never mind timing, fantasies of economic textbooks aside, the real world provides no evidence that government spending permanently stimulates higher real economic growth. If prosperity and recovery could be conjured up by increasing government spending, no country on earth would be poor! As such, monetary and fiscal stimulus will NOT solve Indonesia's economic problems because they boost total demand artificially. It is far better for households and businesses to be given greater control over their earnings and spending as the basis of sustainable investment so more new jobs and more wealth are created. A third recommendation for changing Indonesia's economic policy orientation is to shift away from an obsession with export-led growth and recovery. While increased foreign demand for goods and services is a good thing, it is a poor substitute for having a healthy and competitive domestic sector of the economy. In all events, the advantages from trading are NOT from exporting. Adam Smith view discredited this notion in his withering attack on mercantilism and imperialism in the 18th Century. Instead, the advantages of trade are in allowing producers and consumers to buy from least-cost providers. As such, imports are a better motivator of growth since they enhance efficiency and increase real purchasing power as a basis for sustained economic growth. And greater competition induces domestic producers to be more innovative and efficient. When such improvements bring gains in labor productivity, higher wages contribute to rising household incomes and greater consumption. Productivity gains also boost profits as unit costs decline whereby enhanced shareholders wealth boosts domestic consumption. Then the benefits extend to the international sector since businesses can import inputs or intermediate goods that lower operating costs. Falling costs and rising productivity will then enhance the ability to export without any government policy interventions. In the end, President Susilo Bambang Yudhoyono faces a clear choice in the approach to economic policy. He can make populist promises of redistribution that bring temporary economic gains and electoral gains. Or he can provide the leadership to promote policies that lead to sustainable economic growth. These choices are incompatible. Up to now, he and his team deserve praise for pushing through some unpopular measures to help sort out government finances. Their job in the future can be made easier if citizens understand that attempts to promote employment through deficit spending involve NO net gains to the economy. This is because salary payments to a new government employee create tax obligations that kill off private-sector jobs since businesses have less to spend. The best-case economic scenario for more government spending is a "zero-sum game" whereby gains exactly offset losses. But administrative costs and deadweight losses of government spending tend towards a "negative-sum game" whereby overall losses exceed overall gains. As such, net employment growth can only occur through undertaking by private sector actors. This can be facilitated by introducing more market-based economic reforms can reduce the barriers to business while increasing labor market flexibility. It would also help if government interferences and regulations are inventoried so unnecessary interventions can be eliminated. Currently, the costs of doing business in Indonesia are high and uncertain since both domestic and foreign investors face a bureaucratic swamp of red tape and corruption. Understanding that Indonesia's economic future can be brighter if better policy choices are made. It shows that whether future economic performance involves greater poverty or more prosperity is a matter of public-policy choices. As such, pessimistic and fatalistic notions like a "poverty trap" as a natural condition can and should be discarded. Economic Minister Boediono, Finance Minister Sri Mulyani Indrawati and Bank Indonesia Governor Burhanuddin Abdullah had considerable success. For example, they oversaw economic reform to reinvigorate the local investment climate and speed up dispute resolution encountered by foreign investors. And they took steps to restore public balance sheets so the ratio of Indonesia's public-sector debt to GDP is the lowest in ASEAN (except for Singapore with zero debt). They or their successors have to muster sufficient political will to do more to enhance the opportunities for job and wealth creation in the second largest democracy. A first step in this direction involves the realization that policies of Bank Indonesia and the central government are the main cause of macroeconomic instability and sluggish growth. The writer is Senior Fellow at the Centre for Civil Society in New Delhi and Visiting Professor of Economics at Universidad Francisco Marroquin in Guatemala. ==================================================================================== http://www.thejakartapost.com/Outlook/eco05b.asp
January 12, 2007
Five clear patterns have emerged in 2006. First, the decline in inflation allowed interest rate cuts. Second, gross domestic product (GDP) growth in the first quarter was the slowest since the last quarter of 2004, but started to rebound in the 3rd quarter. Third, growth throughout 2006 was sustained by net exports. Fourth, the pattern of the non-tradable sectors dominating growth persisted through the year. Fifth, fiscal consolidation continued with the deficit now likely to come in below target. And, sixth, relentless capital flows into the financial markets lead to a stronger rupiah and growth in foreign reserves. Against this backdrop, meeting the fiscal assumptions for 2007, on the surface, should be undemanding. However several possible developments warrant close attention. Monetary policy going forward is also far from a foregone conclusion. And by merely meeting fiscal targets and achieving low inflation as a long-term monetary policy objective, we might overlook the more important welfare challenge. Monetary policy was decisive early in the inflation upcycle, when the central bank almost doubled interest rates in 2005. And Rates were then lowered 300 basis points (bps) in 2006 on confirmation of receding inflation. High interest rates managed to dampen consumer spending. Investment spending also took a hit, but this was merely continuing the trend from last year. Despite the large rate cuts, lending rates remain stubbornly high as banks defend their earnings in the face of lower loan growth by expanding margins. The result: Indonesian banks enjoy the highest net interest margin and return on assets in Asia, except for China. The same goes for capitalization (in the form of capital adequacy ratio). However, the loan to deposit ratio is also the highest in East Asia, leading to excess reserves. Indonesia's banks, therefore, give very good value to their shareholders, but have a minimal impact on economic growth. Bank Indonesia recently warned that interest rate cuts in 2007 would not be as aggressive as this year. We agree that this should be so. With inflation of between 6 percent and 7 percent likely next year, interest rates may end up at 9 percent. This level gives a wide margin for Bank Indonesia to stimulate growth, but not excessively so. An interest rate of 8 percent may lead to excessive spending, thus producing demand-pulled inflation. With its fragmented economy and sub par infrastructure, Indonesia is particularly susceptible to sudden spurts in inflation. We are hoping prudent monetary policy will result in long-term inflation stability. This is essential in an increased appetite to invest is to be created. In a low interest-rate environment, loan growth should rise. Indonesian banks are certainly poised to expand lending. Assuming that the tenet that the banks follow business is true, growth expectations and expansion needs would then become the leading factors encouraging expanded lending. Higher growth expectations will almost certainly manifest themselves next year. One reason is almost full capacity in certain sectors. Another is the expectation that the low-inflation-cum-low-interest environment will also last in the medium term. As regards expansion into consumer related loans, a number of banks are already engaged in stiff competition, as evidenced by declining lending rates for auto and housing loans. Four key features stand out from the 2007 budget: the reasonableness of the assumptions, the need to step up tax collection, the fact that subsidies still account for a big chunk of expenditure, and reliance on bond financing. An unambitious growth target of 6.3 percent looks achievable. Despite a possible global economic slowdown, our exports, especially to China, look resilient. This is because exports to China are tied to that country's domestic growth, which is expected to remain robust. Demand from other areas, like India and the Eurozone, should also provide a comfort cushion. On the domestic front, the consumer sector is reviving. Besides the auto and telecoms sectors, the property sector should recover soon, pulling up building materials, home financing and other related activities. The rupiah-U.S. dollar exchange rate of 9,300 is conservative, and appears to already be taking into account rising imports. A tapering off of the current account is natural for a growing economy. Only much later once our export base has been developed can we expect the currency strengthen again. However, weak American dollar fundamentals are helping to prop the rupiah up at the moment. Forecasting oil prices is always a dangerous exercise. The current consensus forecast is for an average price of $60/bbl next year. The key supply drivers will remain political tension in the Middle East and restraints in key Latin American producers. The proposed withdrawal of U.S forces from Iraq by early 2008 could result in one of two outcomes. Either the Iraqi government becomes strong enough so as to be able to maintain stability or chaos breaks out. We hope that the former will be the case, thus ensuring stable oil prices. On the demand side, India and China's energy needs will keep up the pressure on prices. But as long as the U.S economy remains weak in 2007, the possibility of stable oil prices at around current levels is quite high. We calculate that only when the oil price breaches the $84/bbl level and stays there will oil-subsidy spending rise to Rp 100 trillion, thus putting pressure on the national budget. Increasing tax revenues from 13.6 percent to 14.3 percent of GDP will be no easy matter. The probable shortfall in tax revenues this year was due to low growth in the early part of the year. The natural response to this is usually to raise revenues by increasing the tax effort, which is, unfortunately, also usually associated with disincentives for businesses, something to be avoided in a recovering economy. But this does not have to be the case if greater revenues can be generated by enlarging the tax base instead of playing around with rates. It is probably high time to assign part of the responsibility for tax collection to local governments, along with giving them greater responsibilities. One example of this would be responsibility for poverty alleviation. Another is agricultural development. Obviously, central government guidance and local capacity-building would be needed in the early stages. Prior to the crisis in the late 1990s, we saw growth averaging 7 percent per annum. But since 2000, we have been in the 5 percent range. Going forward, we expect to see 6 percent in 2007 and probably 6.5 percent in 2008. However the overall growth figure masks the tremendous structural changes taking place. The main difference between the two periods is the role of the tradable sectors (agriculture, manufacturing and mining), versus the non-tradable sectors (all the others). Prior to the crisis, the tradable sectors grew on a par with their non-tradable counterparts. But since 2000, the non-tradable sectors as a whole grew by half the rate of the tradable sectors. This resulted in lower job creation for each percentage of growth rate, thus leading to growing unemployment, income disparities and poverty. Certainly, reorienting the growth pattern will take more than a year. But failing to start will mean growing disparities. This creates a double irony, with unemployment in the slow growing sectors, while in the fast growing sectors the labor market is very tight. Without broad-based growth, sooner rather than later the fast growing sectors will run out of consumers able to afford theirs products. Fiscal and monetary policy should be geared toward solving this underlying problem. It is not enough to incorporate poverty alleviation as one of the program in the national budget. A conscious effort with clear targets for the medium term will be needed. The central government's resources are limited after taking out routine expenditure, debt servicing and transfers to the regions. What it can do is to fine-tune its own development and regional government expenditures in concert so as to overcome these sectoral imbalance. Tweaking monetary policy to alter sectoral growth patterns is a lot trickier. The mandate of the central bank is to maintain price stability, rather than ensure higher growth or falling unemployment. But sustainably low inflation in the face of growing disparity invites volatility. We must innovate to achieve long-term stable inflation based on which social stability can be strengthened through more equitable income distribution. With lower interest rates and returning confidence, growth is set to be faster next year. This is based on reviving domestic demand and resilient exports, despite the possible global slowdown. The rupiah might be under some pressure as imports rise, but will remain favorable on the back of a structurally weak dollar. The national budget is also in safe waters with reasonable assumptions. But tax efforts need to be revamped, if possible by including regional elements. In the longer term, however, sectoral imbalances leading to growing unemployment needs to be resolved. To this end, fiscal and monetary policy should look beyond annual targets and move to the long-term horizon of stability with vibrant growth, but growth that is more equitable. The writer is the chief economist at CIMB-GK Indonesia. The view expressed in this article are personal. The writer is Senior Fellow at the Centre for Civil Society in New Delhi and Visiting Professor of Economics at Universidad Francisco Marroquin in Guatemala. ==================================================================================== http://www.thejakartapost.com/Outlook/eco06b.asp
January 12, 2007
Will 2007 see Indonesia's resurgence as a global hot bed for investment? A New York fund manager, asked why his company has not returned to Indonesia, said: "Well, Indonesia's small potatoes these days. Besides, there's too much risk and no upside." Such remarks are too often heard and leave a negative stereotype of Indonesia in the eyes of foreign investors. In the early 1990s, Indonesia was touted as the next Asian tiger. Investors from around the world flocked to Jakarta struggling to get a slice of the action. Today, many people are anxiously holding their breath, asking when this long-awaited second coming of investment will arrive. The second coming is not imminent-at least not in 2007. Many people believe corruption to be the main culprit behind Indonesia's weak investment and sub-optimal economic growth. But this is far from the truth. Anybody that has done business in China would concur that China is tantamount to corruption, yet they have been flirting with a double-digit growth rate. Corruption is not the problem. The problem with Indonesia is its lack of decisive government leadership, which unfortunately shows little sign of improvement. Second of all, massive investment will not come until Indonesia's sovereign rating reaches a minimum of "investment grade" level. Although Indonesia is moving in the right direction, it cannot happen overnight. It is unlikely to happen even in the year to come. Ultimately, the litmus test is whether Indonesia can compete. What has our government done to allow Indonesia to compete with other investment destinations? Indonesia's incentives are unattractive and its infrastructure is dismal. Indonesia does not have to be competitive in everything, but as it is, it is competitive in nothing. On a slightly more positive note, it has been a year since the fuel subsidy cuts, and a combination of lower inflation and falling interest rates have helped Indonesian consumers to rebound. But government spending, which has helped push growth in the second quarter, seems to be slowing down, and growth in exports have been more in value rather than volume. Investment too, has been sluggish. Foreign direct investment from January to October of 2006 has dropped 48 percent compared to the same period in 2005. A more dynamic economy must be driven by investment. In response to the three challenges to attracting investment as stated above, here are some recommendations for the Indonesian government: First and foremost, the Indonesian government must show decisive leadership. Only if we can assume that our government actually has the ability to exercise decisiveness in policy-making and effective implementation -- a big if -- can discussion about the particular policies then be useful. Granting the fact that our president comes from a party that controls only 11 percent of the House of Representatives, Susilo Bambang Yudhoyono must stop trying to please everyone. Our president's lack of decision making is attracting widespread ridicule. There are not very many areas where I believe Yudhoyono should learn from President George Bush. Learning to be unpopular is one of them. More concretely, there are three areas that our government should focus on to increase Indonesia's competitiveness: in implementing the correct incentives, investing in infrastructure, and adjusting the "price" of doing business in Indonesia to an appropriate level. Allow me to elaborate. Incentives can best be achieved through the use of taxes. Taxes serve four functions: To raise revenue, redistribute wealth, punish unwanted actions, and encourage favorable behavior. It is a pity that Indonesia currently only uses taxes for the first purpose, and arguably the second. The development of China's special economic zones was predicated on tax incentives. The same is true for Singapore's ability to attract investment. While Singapore, a country of four million people, attracted US$20 billion of foreign direct investment in 2005, Indonesia only attracted a mere $6 billion. Indonesia should follow suit. No country is perfect. Having that said, to attract investment, a country must compensate its weaknesses. Workers in China are uneducated, yet factories choose to relocate there because it is cheap (although becoming less so) and relatively productive. Indonesia's workforce, like China's, is also generally uneducated. But in addition, due to labor regulations that dampen labor mobility and reward the wrong behavior, Indonesia's workforce is neither cheap nor productive. Indonesia must reform its labor and investment laws. Infrastructure is also vital to attracting investment. Dubai and Sharjah, both neighboring emirates of the UAE, are real world examples. Both states are endowed with billions of petro-dollars; and both are also located in the middle of the dessert. The difference: While Dubai has received more investment than the combined amount of money controlled by the top four investment banks on Wall Street, its neighboring emirate has not changed much since the time of the Prophet Muhammad. The variable that best explains the difference is the amount of hard infrastructure, such as roads and proper sewage, and soft infrastructure, namely an educated workforce, which Dubai has managed to accumulate. There are many reasons that make the Middle East a poor comparison to Indonesia. However, the fact remains that if a country makes the necessary investment in infrastructure, people will invest. Indonesia needs around $70 billion of infrastructure investment over the next five years. Poor infrastructure is hampering Indonesia's ability to not only accelerate economic growth, but also in being able to deliver basic public services. Indonesia is already experiencing power shortages and 70 million people still have no access to electricity; this will be exacerbated as demand grows by 7-9 percent annually. The same picture emerges with regard to sewage networks. Half of all district roads have been classified as "poor or in bad condition". There are around 649 km of toll roads, but the country needs a minimum of 2,000 km. Almost 75 percent of shipments out of Indonesia are re-loaded onto larger ships at Singaporean or Malaysian ports because of inadequate port capacity at home causing exporters to lose $700 million annually in foreign exchange. Furthermore, devastation caused by natural disasters in Central and West Java has increased the need for infrastructure. While inducing investors through tax incentives and the development of infrastructure is good in theory, it may prove to be too difficult for Indonesia. A more feasible alternative would be to adjust the value of doing business in Indonesia to a competitive level. This could be done, for example, by doing what China has done: adjusting the rupiah to, say, Rp10,000 to US$1. By doing this, goods made in Indonesia would cost less to produce, and hence making them more competitive. This should in turn boost exports and attract investment. This alternative no doubt has its pitfalls but our government should at least give it a serious consideration as it may be the wise course of action given the existing constraints. If incentives, infrastructure, and value adjustments as explained above are relatively short term policy areas, two longer term measures that should also be enacted is in regards to Indonesia's country rating, and education. First, positive country ratings is a prerequisite for large scale investment. Most investors manage funds that belong to other people. These managers take risks on every investment they make and must to some extent be able to justify the risk they incur. A more favorable rating will allow investors to justify investing in our country, and also give them a certain level of comfort. Also, bad ratings translate to a higher cost of capital and thus a loss in companies' competitiveness. Before moving on to the fourth and final point, it is important to take a step back and remind ourselves why it is that a country desires investment, or more particularly, FDI. Economists tell us that FDI is desirable, amongst other reasons, because it facilitates the transfer of technology, and stimulates domestic investment. Such things are in turn favorable because they contribute to economic growth. Economic growth, then, is desirable because it will hopefully help eradicate poverty and decrease unemployment. This will in turn improve living standards. Consequently, given the ultimate end of FDI in improving the living standards of Indonesians, this fourth point is perhaps the most compelling: Indonesia must invest in education to empower its people and accelerate growth. Education's impact is twofold. First, it has a direct positive impact on living standards, which we have said to be the goal of FDI. Second, more education means a better educated and more productive labor force-the kind of soft infrastructure Dubai has. Given that wages do not increase proportionally to equalize the relative price of labor in relation to productivity, this should attract more investment. Economic measurements, such as GDP per capita or investment per head, are mere numbers that are supposed to reflect the well being of a country's population. While the achievement of more positive figures could be a result of a real improvement in the well being of a country, this is not necessarily so. For example, GDP per head could be increasing but if inequality also increases, the increase in GDP will be accrued by those who least need it. Investing in education is probably the surest way to guarantee that a real and qualitative improvement in lives is attained. Indonesia's future is promising and the second wave will come. Indonesia has gone a long way in rebuilding itself since the East Asian financial crisis, and it has also coped pretty decently with the constraints that this so-called democracy has imposed. While it is proper and salutary that governments should in general leave economics alone, it is however, right that from time to time they offer leadership and encouragement. Currently, carrying out the necessary policies to set the stage for investment would be prudent. Unfortunately, prospects for improvement are mixed given that Jakarta may find it hard to make politically difficult decisions as the 2009 presidential election draws closer. However, if successful, perhaps by this time next year, Indonesia will be next in line as the world's premier destination for foreign investment. The writer is a Government and Economics graduate of Georgetown University. He can be reached at jr284@georgetown.edu. ==================================================================================== http://www.thejakartapost.com/Outlook/eco07b.asp
January 12, 2007
The year is fast drawing to a close, and however hard I may have been trying to avoid facing up to harsh realities, duty calls. Emulating an ostrich has never been my forte, lest my turban get stuck in the mud (oops, sand). Interestingly enough, agriculture is doing modestly better in 2006 than in previous years, although that has much to do with improvements in the terms of trade, and almost nothing to do with public policy. Governments -- at national and local level -- have done extremely little to develop Indonesia's agriculture sector. The current administration compares its triple-track strategy to Roosevelt's New Deal, as their purported intent is to be pro-growth, pro-jobs, and pro-poor at the same time. The launch of the Revitalization of Agriculture initiative in May last year should, thus, be seen as a serious attempt to live up to their promises, since enhancing rural labor productivity could achieve all three objectives. If successful, it would prove, yet again, that Indonesian agriculture is a sector that could turn the economy around. Although one has to always bear in mind that many of the problems plaguing agriculture are part of an inherited legacy, it is still incumbent upon us to try to see whether the tail has indeed wagged the dog. Alas, this very comprehensive strategy document has yet to find its way into government or even presidential instructions, let alone to resource allocation decisions in the field. What has gone wrong? It is beyond our scope to conduct a full-fledged evaluation; however, this poor follow-through does not seem to be all that unusual in contemporary Indonesia. As one astute senior foreign diplomat recently observed, Indonesia seems to have the distinction of being the only country where presidential directives need not be followed. Although this is indeed a presidential cabinet, every minister appears to be marching to a different drummer. But many scholars had not expected it to work wonders in the first place, as major congenital defects had been detected early on. At first sight, the very same defects seem to be plaguing the Making the New Indonesia Work for the Poor report launched recently by the World Bank. Our elite remain in a state of denial; continuing to proclaim that the Indonesian people have overcome the crisis. They, hand-in-glove with our "beloved foreign saviors", do not want to admit their guilt in making such a mess of handling the crisis. Reading the tomes extolling their "New Indonesia", one notes that their lips are always sealed on the role assets play in poverty alleviation. Another major item which is invariably conspicuous by its absence is that we have not been able to feed our hungry, heal our sick, teach our children, maintain our rural infrastructure, simply because we are broke. And for that we have to thank the IMF-World Bank and the elite, who exonerated all the conglomerates of their crimes, and have been spending a large part of our budget on repaying all of their odious debts. So, they have succeeded in depriving tens of millions of people basic services, instead of negotiating a democracy dividend, whereby we could have obtained some debt relief. What the IMF-World Bank has managed to achieve, instead, through the infamous letter of intent, is to force the free market upon the poor Indonesian farmers without any preparation at all. Rather than invest in the sector that generated five million new jobs in the wake of the crisis, they further recapitalized the poor farmers. These are the free market evangelists who do not practice what they preach. During their university years, did they all happen to skip classes on the U.S. Farm Bill and the European Common Agriculture Policy? Are they blind to the fact that the agricultural trade and subsidy policies in the United States, European Union and Japan are harming poor people in developing countries and hindering rural development? A few numbers may help illuminate their hypocrisy. The annual subsidy payment received by farmers in rich countries is about US$280 billion. The total annual development assistance to developing countries is about $60 billion, or less than one quarter of the subsidies. A Japanese dairy cow receives about $3,000 in annual subsidy, and the dairy cow in the EU gets about $1,000; in comparison, the average annual income of citizens in Indonesia is about $700. If Indonesian farmers, who do not receive subsidies, cannot sell their products at a price above production costs, they cannot earn the incomes needed to escape poverty and generate the multiplier effect that would help others climb out of poverty, too. The net result is persistent poverty, hunger and related misery. Why is such injustice being allowed to pass? Why is poverty increasing even while the elite and the World Bank are gloating that we have achieved macro-economic stability? Impunity, dripping in blood, is hanging above the Indonesian polity. Many who have got away with robbing the poor are now even more comfortably ensconced in respectable positions, in the much-touted "New Indonesia". Such elected officials are adept at increasing their pay, and going on shopping junkets abroad at the taxpayer's expense. Deformation and decentralization have created hordes of "roving bandits", which do not care whether their victims survive. None of the regional legislatures are allocating more than 5 percent of their budgets to agriculture. Borrow the glasses of the weak and poor, and you will clearly see that there has been much more continuity than change. Two simple statistics bear testimony to the extractive nature of our national policies. During the past five years, the share of agriculture in our GDP has crept back up from 16.04 percent to 23.34 percent, while our agriculture budget has merely inched from 0.7 to 1.01 percent of the national budget. Whereas total credit extended has multiplied more than 370 percent from 2000 to 2005, agriculture investment credit has actually declined from 7.08 percent to 2.07 percent. You are expecting agricultural revitalization? Hello, is anybody home? One does not need a doctorate in economics to realize that we are pursuing the impoverishing policies of our erstwhile colonial masters with renewed vigor. In plain English, the Indonesian elite, with the imprimatur of the IMF-World Bank, are living off the toil of our poor farmers and landless laborers. Their rapacity has left us an agricultural sector that is in free-drift. Some years, if global commodity prices are high, the sector will do well, and in others, it is bound to sink. We have long-term trends -- out-migration of skilled young people; resource degradation, and increasing land pressure -- that have successively reduced the productivity potential of the sector as a whole. Technological change has slowed, since the green revolution gains have been practically exhausted, and since the private sector has little attractive new technology to offer to small farmers for cash crops, livestock and fisheries. So, the future does not look terribly bright, although 2006 has been a fairly good year for agriculture as a whole. The more the sector moves sideways, the faster it is bound to sink -- if for no other reason than for that natural resources get mined; skilled and energetic young people migrate to the cities; capital flows into the banks and into urban real estate; and tiny plots of land get divided into even tinier plots of land. If this continues, one can expect "new trends" that are all too apparent in countries such as the Philippines and Sri Lanka, to emerge -- we will see even further widening rural-urban inequality; the hollowing out of the rural labor force; the creation of a large generation of landless indentured rural families; and distress-push factors that create gangs and criminals simply because there are no other ways to make ends meet. Can President Susilo Bambang Yudhoyono do anything about this? Well, he does have a large amount of training, empathy and sympathy for the farm community. But thanks to the unholy alliance of politicians, conglomerates, and the IMF-World Bank, we have not been in terribly good fiscal shape ever since the 1997 crisis. What he could still do, however, is signal that it is time to re-centralize several aspects of agriculture and rural development, and he could unleash a number of crash programs to get the rural economies moving. The regents might grumble a bit about losing these responsibilities, but since they are captured by local urban elites, we can expect that their protests will not have real bite. And if the President does indeed wish to make agriculture a national priority once again, he has only to look at China, India, Thailand, Malaysia and Korea for dozens of examples of recent programs aimed at fostering agricultural modernization and rural economic empowerment that have worked well. However, to accomplish all this, he would need his own cabinet, fully committed to delivering his campaign promises. Like any other problem, the first step on the road to recovery is to recognize that you have neglected something serious for far too long. The writer, a senior governance advisor, is head of the Jakarta-based Centre for Agriculture & Policy Studies. ==================================================================================== http://www.thejakartapost.com/Outlook/eco09b.asp
January 12, 2007
Even though the economy was quite tough in early 2006, as shown by the high inflation and low growth, at the end of the year the economy picked up as inflation went down significantly. The improvements in the economy will likely continue as we enter 2007. Low inflation, followed by low interest rates and the starting up of infrastructure projects, at least on a selected basis, will create a better environment for the economy to grow. Growth of 6 percent or higher is reachable in 2007, as the government has forecast, if the infrastructure projects run well and the roadblocks to investment are overcome. With better macroeconomic conditions, the banking sector will be able to allocated more loans to various business activities and consumers. As the banks allocate more loans to consumers, particularly for house purchases, the construction sector, especially housing development, will benefit. Also, lower inflation and lower interest rates will increase the purchasing power of consumers. This will lead to higher growth in the retail trade sector. The telecommunications sector will remain the star in terms of growth as the number of wireless telephone subscribers continues to grow. Investment in this sector is also substantial, as different from other infrastructure projects, the telecommunications sector does not face serious problems in terms of land acquisition and government guarantees. However, the manufacturing and mining sectors will continue to face low growth. The manufacturing sector still has the problem of high production costs and weak demand, except probably the automotive sector, including motorcycles, which will benefit from the expansion in bank lending. The mining and oil and gas sectors still face structural problems in terms of a lack of incentive and cumbersome regulations. This, of course, does not apply to companies that currently operate optimally and are taking advantage of high commodity prices. The issue is the lack of new investment on a large scale. Agricultural growth is traditionally low, although plantation crops, such as palm oil and rubber, are benefiting from high commodity prices. The issue of managing rice prices will remain the hot issue in public policy, as rice imports are needed to stabilize prices, while local governments and lobbies protest such imports. From the expenditure side, household consumption growth will resume although not fully recover from the decline in purchasing power since the fuel price increases in October 2005. The lower inflation and interest rates encourage consumers to spend more. This is in line with higher growth in the retail, automotive and housing sectors. Exports will likely perform relatively well on the back of higher prices of commodities and selected manufactured products, such as textiles, garments and electronics, despite the tough competition from China. However, the issue of the inflexibility of the labor law will continue to discourage production and expansion in this sector. Meanwhile, imports will likely pick up both in the category of intermediate and consumer goods. Many companies have started to expand production so that there is higher demand for imported intermediate goods. Similarly, there will be higher demand for imported consumer products among consumers with higher incomes. However, investment might still face the serious problem of structural issues, especially regulations at the national as well as local levels. The government has claimed success in implementing its investment policy package. However, the most important laws that the government promised to enact, namely the tax and investment laws, remain uncertain, while the planned revision of the labor law has been annulled. The revisions of the tax laws has been delayed for political reason. The PDI-P faction at the House of Representatives has opposed the revisions in an effort to score political points. Meanwhile, the Golkar faction is likely to wait and see whether the President accommodates its interests with more seats in the Cabinet before they decide whether to support the revisions. The investment bill is too broad and is considered too liberal by several factions at the House. The government also promised to facilitate investment under the concept of special economic zones, starting with Batam, Bintan and Karimun. Steps such as improving investment procedures through one-stop service and one document for customs have been implemented, but these are still far from sufficient to woo new investment as many opaque procedures essentially remain the same. Furthermore, tax and other incentives will likely be postponed as they are incorporated into the revisions of the tax and investment laws. It is also unclear as to whether the government will propose a law on special economic zones. Selected infrastructure projects, such as power plants and toll roads, will start to be implemented in 2007. The government seems willing to give guarantees for power plant projects. Nevertheless, the government has yet to do so for fear of the implications later on, especially related to the completion of the projects and accountability matters. In addition, the issue of land acquisition remains a serious hurdle for toll road projects. Unemployment is a serious social issue. A moderate growth level of 6 percent is not high enough to absorb all the new people entering the labor force. The deadlock over the labor law revision will further discourage companies from hiring more workers. This certainly will create the more serious issue of a widening social gap between the haves and the have nots. As the rich enjoy better opportunities with the lower interest rates and selected opportunities in business to get higher returns, the poor will still face serious problems of unemployment and poverty. This certainly will test the popularity of President Susilo Bambang Yudhoyono, which is still high. The government itself has been acting seriously to allocate more money for programs that address the unemployment and poverty problems. However, the relatively low capacity of national and especially local governments to implement the programs, as shown by the slow pace of capital spending of capital expenditures, will make these poverty-alleviation programs less effective. The challenge in general remains the same, except in a better macroeconomic environment. The environment for investment has not been improved significantly. As a consequence many business opportunities are not being utilized optimally. Economic growth is mainly supported by better macroeconomic conditions, which have led to higher confidence among consumers and businesses. More fundamental improvements in the economy will depend on the ability of the government to overcome the major hurdles to investment. The writer is chairman of the Center for Information and Development Studies (CIDES) and a senior fellow at the Habibie Center. This is a personal view.
http://www.thejakartapost.com/Outlook/eco11b.asp
January 12, 2007
Observing the rapid development of malls and shopping centers around Jakarta, a curious friend asked me, with a puzzled face, why are there so many malls? Who wants to open a shop there and who wants to shop? Do Indonesians have enough money in their wallet to spend? These questions intrigued me because of course I believe the developers are smart people, and there must be a reason behind this frantic pace of construction. Do M&A's (mergers and acquisitions) signal higher inflation ahead? On a global scale, we have seen waves of mergers and acquisitions ranging from steel-makers, banks and pharmaceuticals to mining related businesses. One event that interests me most is the recent acquisition of the Four Seasons Hotel, a Canadian luxury hotel chain, by Saudi Price Alwaleed bin Talal and an investment firm owned by Bill Gates. The price tag was US$3.7 billion, which is 30 percent of the share price on the day the announcement was made. In investment terms, the acquisition price valued Four Seasons at 44 times its 2007 earnings per share, that's a meager return of 2.25 percent for year 2007. To top it all off, Four Seasons reportedly has no underlying real estate. Hence there is strong reason to believe that the acquirers must have assumed a booming travel market. Considering that the 30-year U.S Treasury bond currently yields 4.6 percent per annum. Four Seasons has to generate more than twice the earnings of 2007 to justify the acquisition. Also interesting are reports that oil producers tend to convert their U.S. dollar earnings into euros, yen, and sterling. According to the Bank for International Settlements, the central bank for developed world's central banks, OPEC's dollar deposits fell by $5.3 billion, while euro, and yen denominated deposits rose by $2.8 billion and $3.8 billion. One thing to think about is, are acquisitions part of the diversification away from U.S dollar assets, or are there deeper underlying fundamentals that are moving the market. Chart displays the consumer price index (CPI) of commodities in the U.S. It shows that since year 2000, the index and its core components (which exclude food and energy) appear to have diverged following rising energy and commodity prices. Assuming that the CPI, less food and energy, is an unbiased measure of the core, then the two indexes should converge again at some point in time. Naturally this could be achieved by way of the core rising faster or the headline rising slower. With the oil market still tight, the possibility of the former should not be ruled out. This may be one reason behind the waves of merger and acquisitions: there is potential for real asset prices to rise faster in the future. Avoid buying U.S dollars. One obvious way to narrow the U.S current account deficit, currently at over 6 percent of GDP, is to boost exports and dampen imports. Higher exports mean that products must be competitive or cheaper, which requires dollar depreciation. Along with that is reduced appetite for the dollar after the Federal Reserve pauses its rate hate hikes. Therefore, it is quite difficult to see factors that will create high demand for U.S dollar, which then induces U.S dollar appreciation. Take China for example. Its State Administration of Foreign Exchange, an agency under the central bank, has for some time attempted to diversify out of U.S T-bills. It is also believed to have been gradually diversifying its currency holdings, especially euros, while at the same time getting out of Japanese Yen because of its low yield. Well we have to follow where the smart money goes. Are you interested in commodities, or energy? There is an ongoing debate on the course of commodity and energy prices. Both sides have their arguments, and ample supply of data to back up them up. We are not the sole authority to provide guiding lights. However, we think the argument boils down to the possibility of a U.S. economic slowdown and whether the reduced demand of energy can be absorbed by other growing economies. The problem is how to measure China, India, and other growing economies' demand. Are these growing economies not affected by U.S slowdown? Can their domestic demand pick up the excess production if export declines? This particularly interesting chart shows the energy dependence of developed economies (OECD economies) on emerging markets. With significant imbalances and with each major player trying to protect their resources by depleting other countries' resources first, should we really think energy prices will decline in the medium term? Back to the Price Alwaleed story, the acquisitions of Four Seasons, which manages about 68 hotels around the world, must have been based on expectations of bright and sunny future of the world economy where the number of wealthy people who travels rises significantly. Will energy prices come down in Prince Alwaleed's world? We are keen on stocks. Learning from the experts the likes of Prince Alwaleed, who is ready to buy at 30 percent premium to market price, we think there is still value in stocks, especially if you believe in rising inflation environments. Stocks traditionally are considered to be inflation-hedged assets, as companies are considered to have the ability to pass on rising costs to their customers. Jakarta's stock market has risen 150 percent since the end of 1999 or post Asian crises. What is the justification for that? Our argument is the growth of post-crisis nominal Gross Domestic Product (1999-2006) has been 180 percent. Nominal GDP represents value added in the domestic economy, therefore it can be used as a less than perfect approach to overall revenue growth of companies under the Jakarta Stock Exchange (JSX) universe. It's up to you on how much you're going to apply as a discount for that factor, but as revenue increase so does the value of the companies. Since JSX index approaching the historical revenue growth, the next leg would depend on how much revenue growth companies can register in 2007. Say nominal GDP grows by around 12 percent to Rp 3,500 trillion, which is a 218 percent increase over end-1999 figures. Applying the same rate of growth to the JSX index and applying a 10 percent discount would lead us to year-end index estimate of nearly 1950. This would put the JSX index at 15.4 times it 2007 earnings, according to our estimate, still below 44.4 times the 2007 price earnings (PE) of Four Seasons. But of course that is not an apple to apple comparison, as Four Seasons depends on the world economy and JSX on domestic economy. But should we think that both go in opposite directions? If not, then it'll just be a matter of growth rates. We're not so keen on bonds. If there is a question and answer session on Four Seasons acquisitions, my question would be: Did they use debt financing for the purchase? If the answer is yes then they must think that the return of 2.25 percent in 2007 must grow at such a rate that the investment would pay off debt which rate is higher than the 30-year U.S.-Treasury yield of 4.6 percent. Hence would you buy Four Seasons or buy Treasurys? In a rising inflation environment, bond investments would reduce your investment value as your earnings will be fixed, while interest rates are rising; i.e. unless you buy TIPS (Treasury Inflation Protection). What about domestic bonds? Indonesia's inflation next year may nudge up slightly as economic growth and import growth accelerates. The 5-year Government Bond currently yields 9.6 percent, or at a 4.3 percentage point spread over the 5.3 percent annual inflation rate in November. The downside is that if inflation rises significantly so as to result in our bond investments have zero or even negative real returns However Indonesia's case is probably unique as there is potential for lower inflation in the long run if the structural inefficiencies are being diminished. Indonesia's inflation rate is the highest compare to comparable peers such as Thailand and Malaysia, where inflation is at around 3 percent. This indicates inefficiencies, since our economy is considered to be an open economy with less administered price than before. Therefore investment in domestic bonds still makes sense. We are bullish on property. Still using theme of rising inflation worldwide, physical property would be our pick. Of course one should remain selective on picking locations, but with rising inflation and a young population, the demand of property would be sustained if not increase. Another catalyst for property price increase is stronger economic growth unleashed by infrastructure development and forthcoming property regulations that allow foreigners to own property with Certificates of Ownership, as opposed to the current Right of Usage. So what's the catch? The catch would be if central bankers around the world suddenly decide to increase their benchmark interest rates significantly to stem the inflation threat. That would create a temporary shock in the economy, with asset prices tumbling down. The writer, a certified financial analyst, is Head of Research at PT Bahana Securities. The opinions expressed in this piece are personal.
http://www.thejakartapost.com/Outlook/eco12b.asp
January 12, 2007
These were the returns on stocks for the year 2006 as recorded by Dow Jones and MSCI on Dec. 12, 2006: These fine returns were preceded by similar, positive returns for every single year, going back to 2003. So, global and domestic investors are now looking at four years of positive returns, most of them in double digits! The JSX (the Jakarta Stock Exchange) has been going from one high to another (now 1,755), but the Dow Jones (now at 12,310) has also reached an all time high. To put this in perspective, the S&P 500 at 1,412 is still off its high, reached in 2000 (1,553), and the Nasdaq 2000 (currently trading at 2,437) is still far off its 2000 peak (5,049) "Will investors be able to find investments providing similar returns in 2007, and if so, where?" is certainly a question on many investors' minds. By the same token, a prudent investor would be justified in asking another question: "After four years of sun, is there any chance of rain in 2007?" And when the possibility of "rain" is a realistic perspective, investors in the JSX need to be aware that: when it rains here, it pours! In speaking with Indonesian friends in these last weeks, I definitely pick up that the "chase for high returns" is alive and well. Bankers advise Indonesian investors to consider investing in the JSX, China, Emerging markets and any other markets that have recorded 30 percent plus annual returns in recent years. Also, most analysts in the U.S. have become increasingly positive and confident about the markets, projecting returns in the 8-12 percent range. One of them is Abbey Cohen of Goldman Sachs, who earned some reputation as a bullish analyst in the late '90s. The economy moves in cycles, and over time, will show phases of: Expansion, contraction (recession) and recovery. Generally speaking, stock prices go up in the phase of expansion, as the world has been experiencing for a couple of years now, but fall in the phase of contraction (recession). Many studies have been done on the actual returns that private investors make, compared to the funds they invest in. And study after study shows that there is a big difference: Where funds make money, private investors often do not. The reason is: The majority of private investors join the bull market at the end of its run, and then sell when the bear market is about to end. There are reasons for caution and one of them is the length of the current bull run. According to some commentators, the current bull run in the U.S. equity markets is almost unprecedented, as it is the second lengthiest since World War II and has lasted 89 percent longer than average (according to Ned Davis Research Inc.)! This "fact" may carry a bias, depending on how one defines bull market, but it is indicative of a notion all investors should be aware of: We had a good run, lasting four years, and these runs do end! The indices presented here, the Dow Jones, FT World Index (both in U.S. dollar and Euros) and the JSX, all clearly show the good run investors have had. The Dow Jones index, going back to 1920, provides a truly long-term perspective. Indonesian investors have had the best of all worlds for the last couple of years: Excellent returns in the JSX, excellent returns when investing overseas, and excellent returns in investing in property at home! So, could we be at the end or in the latter phase of a bull run? Or, put in more economic terms: Are we getting close to the Peak of the phase of expansion? And is there a chance that the U.S. economy is heading for recession after a couple of years of strong growth rather than the "soft landing" that most analysts are expecting? If a true recession scenario in the U.S. materializes, it will be bad for equity investors, wherever in the world you invest! Less than expected earnings will be the news of the day, and the U.S. market will head south. Recession in the U.S. will mean that the U.S. consumers have no money to spend, and this will immediately affect the global economy. Economists are notoriously bad at predicting markets and psychologists-financial planners, such as myself, do not do better. So, trying to read the newspaper of 2007 does not make sense. However, what does make sense is to identify trends and topics that constitute the key factors influencing where the markets are heading in 2007, and developments in the U.S. will lead the way! Right now, (time of writing, mid-December) the indicators do seem to point to the "soft landing" scenario and a continuation of the bull market for stocks. Some of the bullish indicators are: o An unprecedented amount of take-over activity in both Europe and the U.S. o Lots of cash ("liquidity") around. Note: One of the trends of 2006 was "Private Equity funds" and "Hedge funds" flexing their muscles o reasonable P/E ratios, e.g. for the U.S. at 15, Europe at 14 and Asian markets (excl. Japan) at 16. o Continuing high growth in China, which may positively affect the Japanese economy The indicators, which point to, at least, slower growth are: o Lower economic growth figures for 2007 for most developing countries o Slowing housing market in the U.S. o Longer term U.S. bonds return less interest than short term bonds (the so called "inverted" yield curve), indicating that investors expect that interest rates will come down, and this would happen when growth slows. Another factor is the U.S dollar! In the latter part of 2006, the U.S dollar started to drop further against the Euro and the Yen. Few analysts truly understand the specific timing of this downfall, as the U.S dollar has for a long time been seen as "overvalued". However, a further sharp decline would render the financial markets unstable. So, investors who want to keep some kind of control over their investments should pay attention to: o how the "slower growth" scenario in the U.S. unfolds. Interest rates staying at current levels in the U.S. (5.25 percent), or coming down slightly, inflation declining from 2.4 percent now to under 2 percent, probably mean that "the soft landing" is in place. A sharp decline in interest rates and inflation can cause turbulence in the stock markets. o how the U.S dollar fares; if e.g. the Euro-U.S dollar conversion rate stays close to where it now stands (1.33), there would not be any negative effect, but if the rate moves beyond 1.4, this benign picture would alter. If the "soft landing" in the U.S. materializes, there is, indeed, little to stop the Indonesian stock market from going further, and making new highs in uncharted territory. Interest rates in Indonesia will most likely continue to come down, and this will continue to make stocks attractive The writer is CFP and FPC qualified financial planning professional. INVESTMENT STRATEGIES FOR 2007: Step 1: Assess your base currency Is it the U.S. dollar, the Euro, the GBP or perhaps the IDR? As currency fluctuations are highly unpredictable, it is a sound advice to: o Invest at least 50 percent of the stock section in your base currency (example: U.S. dollar holders investing in the U.S. stock market) o Invest 90-100 percent of the fixed interest section in your base currency (example: Euro holders investing in Euro denominated bonds) Step 2: Asses your tolerance for risk and diversify between asset classes Stock markets are volatile and can experience downturns of 40-50 percent. Can you tolerate this kind of volatility and how much time do you have to recover from losses? A guideline for allocating between the asset classes, considering your risk profile is: Low risk : 80 percent fixed interest-20 percent stocks Medium risk : 40 percent fixed interest-60 percent stocks High risk : 20 percent fixed interest-80 percent stocks Step 3 for U.S dollar, Euro, GBP investors: o Invest 70-80 percent of your stock section in the U.S. and Europe (and most of it in the market of your base currency) and 20-30 percent in Asian markets and/or Emerging Markets; o "Spread" the maturities in your fixed interest section by investing in bonds with short-, medium and long-term maturities. Alternatively, invest in well managed bond funds and/or inflation indexed bonds consider low risk "fund-of-fund" hedge funds", to replace part of the fixed interest section. Step 3 for rupiah investors: o Invest 50 percent of your stock section in the Indonesian market and 50 percent "overseas", predominantly in the U.S., Europe, and then Asian markets o Invest at least 80 percent in Indonesian bonds with medium and long maturities and up to 20 percent in US$/Euro fixed interest funds (to diversify) Step 4: Assess your appetite for truly high-risk investments (speculation) If you have a desire to speculate, to get truly high returns, give this part of your financial assets a name: "the gambling envelope". Then consider: * High growth markets such as India, China, entering these markets using mutual funds * Playing stock index and currency futures * Trading in options * Investing in one stock Be realistic with your expectations about returns in the Chinese stock market; this market may be overbought at current levels. Consider the Japanese stock market, as this has been the one market that did not perform in 2006, and so may be well positioned to catch up with the other global markets in 2007!
World (in US$): +17.4 percent
Europe (in Euros): 14.4 percent
Asia Pacific : + 8.4 percent
U.S. (broad market): +12.3 percent
Asia Pacific excl. Japan: + 21.9 percent
Indonesia: +48.9 percent
http://www.thejakartapost.com/Outlook/eco10b.asp
January 12, 2007
The overall outlook for banks in 2007 is positive, thanks to favorable economic trends. The sector, however, is not without challenges, being the most regulated and, at the same time, the most open and competitive. And by the end of 2007, controlling shareholders of more than one bank will ultimately have to make an important decision which could significantly alter the banking landscape going forward. Current economic trends are casting a favorable light on banks. Oil prices dropped from a peak of US$80 per barrel, dampening inflationary pressures and setting the stage for a drop in interest rates toward the latter half of 2006. Inflation year-on-year is now at 6 percent and is expected to remain at this level going into 2007. Interest rates have also dropped from a high of 12.8 percent to 9.75 percent by the end of this year and could drop further. In the meantime, the exchange rate, having strengthened slightly against the weakening U.S. dollar, is now holding steady at Rp 9,100 per dollar. All this has helped raise economic growth estimates to 5.5 percent for 2006 and a further 6 percent is forecast for 2007. Banks have benefited from this trend. With deposit rates dropping faster than lending rates, and adding to that a rise in loan growth, bank earnings are on a rise, a trend which should extend into 2007. Banks' profits before tax for the last 10 months of 2006 reached Rp 32.6 trillion, already close to 2005's full-year profit of Rp 33.9 trillion. Loans in October 2006 also reached Rp 755 trillion, up 8.5 percent from Rp 696 trillion in December 2005. Loan growth was slow in the first three quarters of the year, but started to pick up steam in the last quarter as interest rates dropped. Bankers, in general, remain cautious when it comes to growing loans, with the painful memory of the 1998 financial crisis still not too far from their minds. As a result, loan levels have stayed below that of deposits, making banks very liquid. Much of this liquidity has been invested in short-term Bank Indonesia certificates, which have ballooned to a high of Rp 190 trillion. Many have faulted banks of being too cautious and not translating this liquidity into more loans, especially to corporations and infrastructure projects. Bankers, however, respond that they have been steadily raising their loans in proportion to deposit levels, noting that the industry's loan to deposit ratio has risen from a low of 33 percent in 2001 to 61 percent in October 2006. They also have argued that there remains too much uncertainty in corporate lending, making it risky. Bankers cite current labor laws, making corporations reluctant to hire workers and grow their businesses, and an inconsistent interpretation of tax laws as just a few areas that the government needs to address should it want banks to channel more loans. So far, much of the loan growth has been directed to individuals and small and medium enterprises (SMEs), making banks' loan portfolios more balanced, granular and diversified than before the crisis. This has improved banks' loan portfolio quality, allowing them to better withstand business cycles. Non-performing loans (NPLs) currently stand at around 8.3 percent, with state banks carrying a larger share of NPLs (16.3 percent of total loans) compared to a more comfortable 3 to 4 percent for private banks. The government has recently come out with regulations providing more flexibility for state banks to write off their bad loans, so NPLs for state banks should decline going forward. The ultimate backstop for bad loans is a bank's provisions and capital, which, at the moment, are at a comfortable level. The industry's capital adequacy ratio stands at a healthy 20.8 percent, one of the highest levels in the region. But the banking sector is not without challenges. One challenge faced by banks is regulatory in nature. The regulators plan to reduce the number of banks from 130 to around 80 through mergers. One measure is a minimum capital requirement of Rp 100 billion by 2010. In 2007, the minimum capital banks have to reach is Rp 80 billion. However, many owners of small banks, rather than having to raise additional capital or seek merger opportunities, have opted to sell their banks and the buyers have turned out to be mostly overseas banks. So the number of banks remains, while foreign ownership is on the rise, which has stirred some nationalistic sentiment. In 2006, seven small-sized banks were picked up by foreign banks. Bank Indomex was bought by State Bank of India; Rabo Bank bought Bank Haga and Bank Hagakita, both controlled by the owners of cigarette manufacturer Djarum; Mitsubishi UFJ Financial Group bought control of Bank Nusantara Parahyangan; China's Industrial & Commercial Bank of China (ICBC) bought Bank Halim from the owners of another cigarette manufacturer, Gudang Garam; Bank of India bought Swadesi; and the Commonwealth Bank of Australia bought controlling interest in Bank Arta Niaga Kencana. Another measure meant to reduce the number of banks has been Bank Indonesia's single presence policy, whereby the government limits a bank shareholder to controlling interest in only one bank. Although there is confusion on how wide the ruling's coverage will extend, in its current form it would impact four large state-owned banks, Bank Mandiri, Bank Negara Indonesia (BNI), Bank Rakyat Indonesia (BRI) and Bank Tabungan Negara (BTN), Singapore's Temasek-owned Bank Danamon and Bank Internasional Indonesia, Malaysia's Khazanah-owned Lippo Bank and Bank Niaga, as well as a couple of smaller-sized banks with similar controlling shareholders. By the end of 2007, bank owners with controlling interest in more than one bank would have to submit their respective plans to choose from three options, provided by Bank Indonesia. One is to merge the banks in which it has controlling interest. Two is to keep just one and sell the other bank or banks. And three is to create a holding company that would own the various banks. This plan is due by the end 2007. Then bank owners will have until 2010 to make this plan a reality. Although bank controlling shareholders with interest in more than one bank are still deliberating on which option to choose, newspaper reports have been largely focusing on the merger option. Mergers, it is argued, would increase the size of banks instantaneously and allow benefits from economies of scale. But past bank mergers have not always been happy. The reality has often been painful rationalization and conflicts in marrying two or three different bank cultures and systems, which consumes time and diverts attention away from growing the business. The holding company option, on the other hand, is often felt to be costly and inefficient as it means an additional layer of management at the holding level. Many feel that this option was included for the state banks, which politically might have a harder time merging or sell one of the banks. This leaves the third option, which apparently has been the favored choice of owners of the smaller banks to address the minimum capital levels. The problem with sales is one of getting the optimum price when there is a set timeframe. In addition, organic growth can take time to realize compared to the merger option. It would be interesting if this was the preferred option for bank owners trying to address the single presence policy. If so, then a significant reduction in the number of banks won't materialize as planned. Whatever the outcome, though, it is the bank customers who ultimately will reap the benefit from increased bank competition. Bank services and convenience has already significantly improved on the liability side with increased branch and ATM networks. Now this convenience is being extended to the asset side, whereby it is easier for people and companies, especially SMEs, to borrow from banks. Looking further ahead, the battle of the banking sector lies in the ability of banks to get cheap third-party liabilities or deposits. With competition, lending rates are at the same level. However, it is the banks that can get cheap deposits because of their branch networks and cash payment systems that will earn large interest margins and gain market share. Bank Rakyat Indonesia with its vast rural branch network and Bank Central Asia with its network in commercial urban centers have consistently shown strong performance and are the ones to follow. The writer is a financial and business analyst and a lecturer at University Tarumanegara.
http://www.thejakartapost.com/Outlook/eco13b.asp
January 12, 2007
The Indonesian banking sector has recovered from the banking crisis of the late 1990s. There has been considerable progress in the growth of its assets. By mid-2006, the capital adequacy ratio (CAR) was a robust 21 percent reflecting the strength of the banks capital. Except for state banks, the majority of banks have been able to reduce their non-performing loan levels, indicating an improvement in their risk management skills. Prudential regulation and supervision by Bank Indonesia have achieved substantial progress, making the Indonesian banking system less vulnerable to macroeconomic and financial shocks in the future. There have been some bank failures and banking scandals recently. However, these episodes seem to be a minor diversion from the established pattern, which has been emerging recently. However, in 2007, Indonesian commercial banks will face more challenges in terms of interest rate volatility, major banking restructuring and the phasing out of the government blanket guarantee. The realignment of global interest rates within industrial countries has not shown any clear direction, and therefore, the volatility of global interest rates will remain a threat to global economic growth. In the domestic economy, Bank Indonesia (BI) will also have to watch carefully several developments that could produce an upside risk for inflation. The salary increase for civil servants in 2007 would inject more purchasing power and increase monetary demand. The increase in minimum wages as already mandated by several regional governments would raise the cost of wages and eventually businesses will pass on these cost increases to their consumers. BI is also known to have been worried about the excess liquidity of the banking system resulting from bank inability to channel their funds for lending fast enough. Bank lending grew at 11,9 percent annually, while bank deposits grew by 14,3 percent. Excess liquidity could have a destabilizing influence if it is used to speculate in foreign exchange markets, or if it spills over into monetary demands causing inflationary pressure. To mop up this excess liquidity BI would have to conduct an open market operation by issuing bonds and increasing interest rates. The government has been phasing out blanket guarantee, -- remnants of the bank bail-out policies in response to the banking crisis in the late 1990s -- and replaced it with limited coverage through a deposit insurance scheme. The blanket guarantee has been the source of concern because it exposes the government to the fiscal risk in the event of bank failure. Once the phase-out is completed, the safety net of the banking system would be based on market incentive and discipline. Instead of unlimited coverage, the deposit insurance was reduced to Rp 5 billion as per March this year, and is to be gradually reduced to Rp 100 million by March 2007. The introduction of the new schemes exposes banks to unknown and uncertain risk. With limited guarantee, depositors would be more careful in selecting a bank so that only those banks with a strong balance sheet would still attract customers. It is possible that this bank shakeout would shake market confidence. It is important therefore that BI develop an appropriate strategy, where a bank failure should not trigger financial panic and bank runs, with its devastating domino effect on the banking system. The banking system restructuring as laid out in the BI banking architecture will gather steam in 2007, when more stringent capital requirement are enforced. By 2010, each bank has to have capital of at least Rp 100 billion. This would force small banks either to increase their capital or to merge with bigger banks. However, to proceed smoothly, the banking architecture plan needs several preconditions. First, the government's willingness to provide a fiscal incentive for the bank merger might be required. So far, it is not clear whether the government is indeed willing to make such commitment. Second, the government should use the BI banking architecture plan as an opportunity to restructure its state banks. State banks have significant influence on the banking industry in Indonesia. There are only five state banks out of 130 banks, but they control 40 percent of banking assets. State banks have an overlapping market making them compete with each other unnecessarily. Third, A further push for state bank privatization would strengthen their competence, as there would be less political intervention from the government. In the past state banks were set up by the government to ensure that bank lending could be channeled to politically designated projects. However, since banking deregulation was introduced in the 1980s, banks have been operating in a free market environment. Under this condition the rationale of continuing the existence of state banks has been questioned. After all, it is impossible for the government to avoid having a conflict of interest when it has to act as bank owner and at the same time as bank regulator, a situation which is unhealthy for the banking system. Rather than contributing to the progress of banking architecture, the current structure of state banks could be a hindrance for the successful implementation of the banking architecture plan. Fourth, banks that have not listed their shares in the capital market should be encouraged to do so. The capital market is the only arena where banks can show their courage to make themselves transparent and accountable to the public. Nothing is more valuable for the success of banking architecture than the willingness of the banks to adopt good corporate governance practices by going public. It is encouraging to note that the policy of opening up the banking sector in Indonesia has resulted in more acquisitions of Indonesian banks by foreign banks. The flurry of acquisitions is still going on, with the target banks broadly based involving big as well as small Indonesian banks. The country of origin of the acquiring banks is no longer confined to developed countries but has extended to some developing Asian countries. These are positive development as linkups with foreign banks could strengthen the national banks in terms of capital and banking skills. Even mergers among national banks would create bigger and better banks. With stronger capital and improved risk management, the new structure of the banking system that will emerge in 2007 should be able to withstand any major macro economic volatilities in the future. The writer is an economic analyst.
http://www.thejakartapost.com/Outlook/eco15b.asp
January 12, 2007
Indonesia's economy is gathering momentum. The gross domestic product (GDP) growth accelerated to 5.5 percent yoy in the third quarter from 5.3 percent in the previous quarter. Manufacturing grew by 5.3 percent while construction grew 8.4 percent during the quarter. The transport and communications sector was especially strong at 13.5 percent. Interestingly, the economy gathered pace despite a slowdown in domestic consumption to 2.8 percent from 5.6 percent in the previous quarter. Gross fixed capital formation also slowed to -0.3 percent from 1.2 percent in the second quarter. However, growth was helped by an acceleration in net exports as well as some accumulation of inventories. Despite these demand-side indicators, we feel that domestic demand conditions will be strong enough into 2007 to support an acceleration in growth. There are a number of reasons why we feel that growth will accelerate next year. The most important factor is that interest has declined very sharply over the year, reversing the equally sharp monetary squeeze seen in the latter half of 2006. As monetary conditions ease, we expect the private sector to feel far more confident about borrowing to consume or invest. As shown in the chart below, the absolute level of bank credit to the private sector has been growing strongly for several months now (even if the year-on-year growth rate has not yet recovered). The second reason for expecting growth to pick up is that the Government's finances are now looking very strong. The public debt-to-GDP ratio will fall below 40percent in 2007 and the government can take advantage of low interest rates to borrow and invest in infrastructure. The country's infrastructure is now creaking from the lack of spending since the Crisis and there has been a lot of talk about pushing investment into the sector. Unfortunately, actual spending has lagged due to procedural delays. However, we now hear that the experience of rebuilding Aceh and other disaster affected areas is smoothening the procedures so that we can expect a more generalized spending program in the next two years. As had been widely expected, the inflation rate declined sharply in October as the statistical base effect of last year's fuel price hike was absorbed. However, trend in prices has proven to be even weaker than what had been anticipated in subsequent months with consumer price index rising barely 5.2 percent yoy in November (core at 5.9 percent). One important factor is that food prices have been especially well behaved this year but almost all other categories (expect clothing) saw at least some declines in yoy inflation. The acceleration in the economy will probably improve pricing power in some categories next year but overall, inflation should remain subdued at 5.4 percent (unless oil price flares up again). This is a very reasonable level by Indonesia standards and should allow the central bank to keep reducing rates into early 2007. We expect the benchmark rate to be reduced from 9.75 to 8.5 percent in a series of 25 basis point cuts. Non-oil exports have been reasonably strong going into 2006, while non-oil imports have been weak and volatile. This has allowed Indonesia to run a sizeable merchandise trade surplus this year's resulting in a current account surplus despite growing services imports. Although we do expect non-oil imports to pick-up next year as the economy accelerates, we feel that the trade balance will rise moderately next year's good enough to keep the current account surplus over US$7 billion. We feel that a current account surplus of this level (i.e. 2percent of GDP), rising foreign exchange reserves and an external debt-to-GDP ratio of 35 percent suggests an economy that is now robust enough to survive fairly significant external shocks. In other words, there is scope for another sovereign upgrade by rating agencies in 2007. With external accounts in surplus and the US dollar weakening, Rupiah will probably be under some pressure to appreciate. However, Bank Indonesia's behavior in 2006 suggests that it will have a preference towards accumulating foreign exchange reserves. We expect foreign exchange reserves will stand at $43.3 billion at the end of this year, compared to $34.6 billion at the end of 2005 (despite accelerated repayment of debts to the International Monetary Fund). It is likely that the central bank will continue to prefer further accumulation of reserves in 2007 and this will hold back the rupiah. In our view, this is a prudent approach given the history of this currency (especially with simultaneous reductions in interest rates and the risk that portfolio inflows could reverse in the second half if bond investors decide to take-profit). From a macroeconomic stability perspective, Indonesia has finally recovered from the Asian Crisis: public finances look healthy again, external debt is manageable, the exchange rate appears stable and even inflation appears tamed. However, it does not yet seem to have regained the economic dynamism that characterized many South-East Asian countries before the Crisis. Over the last decade, investor attention has drifted away to China, India and even Vietnam. Nonetheless, Indonesia's industrial sector is at last showing some signs of competitiveness. Manufactured goods exports rose 18 percent yoy in the first eight months of the year and, if sustained, they will probably bring back much needed fresh investment. A Special Economic Zone in the Riau islands is under implementation and this may trigger a revival. This could be an important step towards bringing back dynamism to the Indonesian economy. The writer is senior economist of Global Markets Research, Deutsche Bank. This is a personal view
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