Recent Turbulence a Wake-Up Call, But No Repeat of the 1997-98 Crisis
(JG Graphic)
What a difference a few months make. Since May 21 many emerging markets, including Indonesia, have seen sharp falls in their stocks, bonds and currencies. In a world with deep global connections, the immediate cause was not purely domestic but also external. After Fed Chairman Ben Bernanke indicated a reduction of asset purchases due to continued improvement in the US economy, US interest rates rose, and capital that had left since 2008-09 to find higher yields in Asia began to flow back. Countries with current account deficits, like India, Turkey and Indonesia, have been disproportionately hit because investors were concerned about the stability of future funding. As a result, the Indonesia Stock Exchange (IDX) is down 20 percent and the rupiah stands at around 11,000 to the dollar.
Some people say we are at the beginning of a new Asian crisis, like 1997-98. However, this is likely a correction, not a crisis. After a few years in which land prices, equity valuations and banking lending has grown very strongly, it may even be a useful correction.
There are five reasons why 2013 is not likely to be 1997.
First, debt levels are low. In Indonesia, household debt levels are 17 percent of GDP, mortgages are below 5 percent and government debt is 31 percent of GDP. Even if there was a sustained loss of confidence in the rupiah and fiscal and monetary policy were tightened dramatically, there is a limit to how far the economy can fall because the debt stock is insignificant.
Second, around 70 percent of the bond market is denominated in local currency — compared to high levels of foreign currency-denominated debt in 1997.
Third, foreign exchange reserves are much larger, giving authorities flexibility to intervene against panic-selling of the currency.
Fourth, the lack of currency pegs as in 1997 means that the shock of adjustment is not compressed into single, destabilizing moves but is spread out over longer time periods.
Fifth, we have seen no significant political reaction so far. In 1997, we had a presidential resignation, a transition to democracy and general social unrest.
2013 is not 1997.
Nevertheless, there are some causes for concern. The recent volatility is a wake-up call reminding us that the Indonesian economy is still highly dependent on what happens abroad and that we must create an environment that allows us to control our own economic destiny.
First, and most immediately, our current correction is a crisis of credibility. We need to restore investor confidence through decisive crisis management. The main policy package announced in August was solid but did not impact sentiment greatly. Other things should be considered: The central bank should enter into swap agreements with other central banks to ensure we can stabilize the rupiah if necessary. The $12 billion swap deal just agreed with the Bank of Japan is a good template. Also, there has been talk of a tax amnesty, which would lead to billions of dollars to be sent back into Indonesia — this should be expedited. Finally, the government should push through a number of impending transactions held up by regulatory delay.
Over the past three to five years, we have become overconfident and protectionist. A signal to investors that Indonesia is open for business would improve things dramatically.
A second, and more long-term, cause for concern, is that we need to increase local ownership of financial assets. Foreign investors own around 60 percent of Indonesian shares and about 33 percent of all government debt — a large amount.
There is nothing wrong with foreign investment. However, investors everywhere demonstrate significant "home bias," preferring to deploy capital in home markets because of psychological comfort, regulatory requirements, or the need to protect domestic market share. This means that foreigners are more likely to leave in a crisis. As a result, regulators should encourage local investors to invest in equity and debt markets. Building out the pension system is crucial for this.
The upcoming National Social Security System (SJSN) will invest employee contributions and would create a buyer of last resort for long-dated Indonesian debt. As has happened in Mexico and Peru, such a system would decrease volatility in sovereign debt markets and over time attract more foreign investors. The second way is to increase regional integration with the Association of Southeast Asian Nations through bond and equity trading links. If citizens in Asean can invest in each other's countries more easily, this will be a greater source of permanent capital.
Third, we need to improve the conduct of monetary policy. The previous regime at Bank Indonesia arguably kept rates too low and was not mindful enough of inflation. That was based on a mistaken view that there are trade-offs between inflation and growth — widely debunked during the stagflationary period of the 1970s. Wealth cannot be built merely by cutting interest rates by a few points. In fact, in the long run, monetary policy has little impact on prosperity. Rather, real factors like productivity growth, educational attainment, technological capability, property rights and a clean government is what boosts a society's wealth. Central bankers should focus on price stability and the stability of the banking system. Thankfully, the new BI governor is moving in this direction.
Fourth, to prevent inflation from getting out of hand, we must not make blatant policy mistakes based on misguided protectionism. For instance, tempeh prices are high right now despite the collapse in soybean prices globally. This has been due to import tariffs to encourage local producers as well as domestic price caps — policies that actually contradict each other. Policy mistakes like these are especially harmful because they increase the cost of living for ordinary people.
Until we take steps to improve the resilience of our financial system, we are going to be prone to sharp boom and bust cycles that create and destroy wealth in the same amount. To achieve true progress and prosperity, we need to make our economic model more resilient and more subject to our own actions rather than those of others. The recent turbulence is no repeat of what occurred in 1997, but it is a good wake-up call.
John Riady is executive dean at the Faculty of Law of Universitas Pelita Harapan and editor at large at BeritaSatu Media Holdings. Comments to Twitter: @johnriady.
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