Ground Prepped for Soft Landing?

INDONESIA - Report 05 Sep 2013 by Cyrillus Harinowo and Maria Kartika Purisari

Executive Summary

The Indonesian economy has shown signs of overheating over the past few months. The Consumer Price Index has risen significantly, given higher domestic fuel prices, the flawed trading system and Ramadan festivities. We’re seeing further economic pressures in the form of a continued trade deficit. And the rupiah has been under pressure.

In such times, the typical approach is to slow the economy, and steer it toward a soft landing. Otherwise, the economic bubble could burst, with unexpected consequences. Nonetheless, accustomed to 6%+ growth rates over the past few years, the government continues to aim to maintain that level of growth, as reflected in both the 2013 and 2014 budgets. Yet such ambitions have sometimes been dampened by reality.

Given that background, the report of Q2 GDP growth at 5.81% year over year was both a relief and a disappointment. It was a relief because it shows that the steam in the economy can be slowly released, and that activity can proceed at a more measured pace. Yet it’s disappointing, because it signals an unfulfilled ambition to keep growth above 6%. At the firm level, however, reports of continued high sales growth in various public companies are still plentiful. Unilever Indonesia, for instance, reported sales growth of over 15% in Q2. And the banking system continues to be profitable.

On the eve of the August 17 Indonesian Independence Day, President Susilo Bambang Yudhoyono unveiled the proposed 2014 budget. Prepared in the midst of continued global uncertainty and the softening domestic economy, the budget continued to aim for 6%+ growth. Unfortunately, the budget plan itself was an inadequate contributor to growth, as in real terms the infrastructure budget would shrink, even though the fiscal space has been widened due to the reduced energy subsidy.

Trade, the current account and the overall balance of payments all continued to show a deficit in Q2. Therefore, Central Bank foreign exchange reserves also fell significantly. That drew speculative action that weakened the rupiah further. The trade deficit grew in July, due to the decline in exports, although imports, too, showed a similar but smaller decline.
Initially in August, Bank Indonesia had tried to navigate the economy to a soft landing, by maintaining the benchmark rate, but with tightened liquidity. However, in the third week of August, the government and the Central Bank issued monetary, fiscal and structural measures in order to stabilize the foreign exchange market, support economic growth and reduce the incidence of layoffs. Since the measures were not seen effective in stabilizing the currency, the Central Bank convened a special session of the Monetary Council on August 29, 2013 and decided to raise the bench mark rate by 50 basis points to 7%.

Now read on...

Register to sample a report