Insight: Riding out economic storm

The Jakarta Post, Gita Wirjawan, JAKARTA | Tue, 01/27/2009 9:47 AM  

The theory of chaos in natural science explains how a butterfly beating its wings over the Amazon can lead to a hurricane in the Caribbean. 

Chaos theory is at work in the international economy today. 

The tangled web of complex financial products created to bankroll America’s housing boom has unleashed the worst financial crisis since the Great Depression. 

Major corporate failures have induced pressures powerful enough to bring down the US financial system and a painful global economic slump. 

Markets have entered a vicious cycle of asset deleveraging, price declines and investor redemptions. They have had a tempestuous effect, causing Alan Greenspan, the former chairman of the US Federal Reserve, to describe it as a “once-in-a-century credit tsunami”. 

Consider the effect it has had on the world’s largest economies. 

Volvo truck sales in the US in the third quarter of 2007 were 42,000. During the same period last year, they crashed down to 75. Instructively, the US industrial output was down 7.8 percent last month. Construction of new homes fell 15.5 percent from November to December last year, to an annual rate of 550,000, the slowest pace on record. The pace of new-home construction was 45 percent below its level of a year earlier. 

The American unemployment rate has risen to 7.2 percent, and economists warn that the rate could reach 9 percent as the recession drags on.  

Elsewhere, the ramifications are just as galling. Japanese industrial output fell by 8.1 percent in November 2008, the largest on record. 

In the 27-nation European Union, new industrial orders fell by 17.9 percent year-on-year in October. 

Along the same lines, Germany saw exports plunge by 10.6 percent in November last year, a record month-on-month decrease for the world’s largest exporter. This is already resulting in negative GDP growth and declining overall trade volumes. 

China’s economy slowed so sharply in the final quarter of 2008 to just 6.8 percent as thousands of factories that sold to overseas markets shut, dragging growth of the world’s third-largest economy to a seven-year low. 

As many as six million people have now lost jobs in the cities as the export-dependent economy is hammered by a slowdown in demand. Not all butterflies though cause hurricanes or tsunamis. Millions of butterflies flap billions of times all over the world with marginal consequence. 

Asian countries like China, Japan and Singapore are clearly facing the full wrath of credit tsunami. But others in the region, especially Indonesia, appear to be coping a lot better. There are two broad reasons. 

Firstly, several of these countries are not dependent on exports for economic growth. 

And secondly, the financial systems of several of these countries are relatively safe from any immediate crisis. 

The underlying reason for Asia’s seeming insulation is that the region’s financial institutions, unlike their European counterparts, have only limited exposure to toxic assets — subprime and related products. 

Post-1998 reform and restructuring have significantly improved these institutions.

 Empirical evidence supports this: The low incidence of non-performing loans, high capital adequacy ratios, rates of return on assets, and other key indicators. Indonesian banks, in particular, have one of the best risk-weighted capital adequacy ratios in Asia. They also have the lowest ratio of loans to domestic deposits in the region after China and the Philippines. Indonesia is fast emerging as the babe in the woods. 

This might not be immediately apparent. The rupiah has stabilized at around 11,000 per dollar in recent weeks after suffering from a sharp sell-off last year as investors pulled out from Indonesia’s stock and bond markets, taking the unit to a decade low. The currency fell 14 percent in 2008, becoming one of the worst performers in Asia, while Indonesia’s main stock index plunged nearly 51 percent. 

Certainly, the Indonesian economy is slowing. It did in the final quarter last year as global demand for commodities cools. Jakarta has estimated that the economy expanded 5.8 to 5.9 percent in the fourth quarter of the last year from the same period in 2007. The economy grew 6.1 percent in the third quarter from a year earlier. 

The government forecast is 6.2 percent growth for 2008. It might be lower though in 2009, hovering between 4.5 to 5.5 percent. But this is still much better than many other Asian countries. 

Singapore, the region’s most prosperous economy, is hurting. Its GDP is expected to shrink up to 5 percent this year. It contracted a seasonally adjusted 16.9 percent in the fourth quarter, the largest decline since the Singapore government began publishing the indicator in 1975.

Malaysia’s economic growth this year might slow to an eight-year low of 2.5 percent. In Thailand, the economy is also struggling from a drop in business confidence after protracted political unrest last year. 

Indonesia appears to be coping much better economically. In part, this is a function of political stability which was conspicuously absent in 1998. There is also greater freedom of maneuver, the government no longer constrained by conditions set by the International Monetary Fund. There is no panacea for this crisis. But Jakarta has taken a number of critical steps in reviving the economy — some of which pre-dated the current problems. 

Indonesia’s central bank has already cut its benchmark rate by three-quarters of a percentage point in the past two months. With the BI rate kept at 8.75 percent, Indonesia offers a healthy 8.5 percentage-point premium over the US fed funds rate, which should help revive growth.

Keeping government debt low has been a priority. Today, Indonesia has US$52 billion in reserves — a marked improvement from over a decade ago. 

These initiatives have allowed President Susilo Bambang Yudhoyono to push forward a large fiscal stimulus that would ease some of the pressure on unemployment.  He has announced plans to spend more than Rp 72 trillion on infrastructure and other projects to boost growth and create jobs in a country where the unemployment rate is the highest in Asia. 

But government spending, along with a resilient FDI and strong private consumption ensures that the Indonesian economy appear to be on the front foot compared to other regional states. 

Credit agencies in the main are affirming a stable outlook for Indonesia. Fitch Ratings has retained Indonesia’s BB sovereign rating. It is one notch above the rating of both its rivals Standard & Poor’s which has a BB-minus rating and Moody’s which has rated the country Ba3. 

Indonesia is still vulnerable to external finances. Efforts to raise foreign direct investment and export competitiveness will likely remain challenging against a backdrop of palpable weakness in resource-based activities, as well as poor investor appetite for risk. 

These risks, however, are offset by the strength of Jakarta’s fiscal discipline. It is also explained by the fact that it is not export-dependent. 

China, Japan, South Korea, Singapore, and to a lesser extent Malaysia and Thailand, are reeling as exports evaporate. Just a small chunk of Indonesia’s GDP — 12 percent — relies on exports to Europe and the United States. As a result, it is riding out the storm better than its neighbors. 

After being underrated, for so long, with critics repeatedly writing its economic obituary, the country might appear to be an anomaly in this global financial crisis. 

There is no butterfly effect for Indonesia. 

Gita Wirjawan is Chairman of PT Ancora International.