Rising interest rates, an appreciating US dollar and tighter global financial conditions are squeezing firms and households throughout Asia and Indonesia’s in the frontline.
Indonesia’s President Jokowi has spent recent months dancing with K-pop bands, appearing in motorbike stunts and appointing himself to The Avengers to fight trade wars. Now it’s back to the job.
Indonesia’s election focused more on personalities and political intrigue than the economy. This is a problem. Risks are rising and Indonesia’s new financial crisis management framework has serious flaws.
If Jokowi’s next term as President is to be successful, he’d best fix the deficiencies sooner rather than later.
Uncertainty In The Global Environment
Indonesia has managed a challenging global environment pretty well.
Capital outflows have been relatively low, Indonesia’s stock market has outperformed its peers, growth forecasts are stable, inflation is low, unemployment is below its five-year average and the government budget has improved through a smaller deficit and cheaper borrowing costs.
But despite solid fundamentals, our recent survey shows that there are serious risks for Indonesia on the horizon.
The US–China trade war is doing some squeezing of its own. It is uncertain how the trade war will end but the long-term damage it will do to Asian trade and supply chains is crystal clear.
The global policy environment is highly uncertain. The 2016 Brexit referendum caused volatility in Asian financial markets and the probability of a “no deal Brexit” still looms.
The Trump administration continues to weaken the global rules and institutions which have underpinned much of Asia’s prosperity, particularly the World Trade Organisation.
The International Monetary Fund downgraded its global growth forecasts in January, particularly for emerging economies, and the advanced economies could soon follow.
The United States will likely enter recession in 2020 and limited monetary policy space may see the Federal Reserve return to unconventional monetary policy, sending a fresh wave of volatility towards Asia.
Challenges At Home
While growth has been steady and supported by infrastructure investments, and with inflation also under control, Indonesia nevertheless has challenges at home too.
Sixty per cent of Jokowi’s infrastructure promises were to be funded by state-owned enterprises and the private sector. But to date, state-owned enterprises have funded almost 100 per cent and have become substantially more indebted as a result.
There are concerns in what has been a relatively stable banking system in the past decade. High demand for loans in 2018 and portfolio capital outflow have drained liquidity from Indonesia’s banks, particularly smaller banks.
Increased short-term borrowing by non-financial corporations and the large stock of government debt held by foreigners similarly creates vulnerabilities.
The Indonesian parliament passed the Prevention and Resolution of Financial System Crisis Law in 2016 to ensure better cooperation, collaboration and preparation between Indonesia’s regulators and institutions. The objective of the new law is commendable but it has serious weaknesses.
As Indonesian policymakers know from experience, when a financial crisis hits, speed is everything.
If authorities are slow to act, liquidity shortages can become solvency crises, banking crises can become currency crises, currency crises can become sovereign debt crises and what started as a financial crisis quickly becomes an economic and political crisis. Staying ahead of the curve is critical.
New Law Needs Improvement
Indonesia’s new law needs improvement. A bank suffering a liquidity shortage would ordinarily receive assistance from Bank Indonesia, the central bank. Under the new law, the remedy is not so simple, particularly given bank bailouts have now been outlawed.
The law creates a Crisis Committee consisting of Bank Indonesia, the Financial Services Authority, the Deposit Insurance Agency and the Ministry of Finance. If a troubled bank needs emergency assistance, there must be agreement between all four.
The bank must request assistance. The Financial Services Authority must prepare advice for the Committee on whether support is necessary. All four agencies must agree that liquidity support is appropriate. Bank Indonesia must confirm to the Committee that the bank has adequate collateral.
Although not prescribed in law, our survey of officials suggests two other steps are likely.
First, the Crisis Committee would request that other banks in Indonesia, or foreign parent banks or shareholders, provide the assistance rather than Bank Indonesia. Historically this has been unsuccessful.
Second, there is a high probability that the Committee will seek political cover and brief the President directly on the situation, seeking presidential approval before any decision is made.
This process is slow and bureaucratic to say the least. Why would such a law be created?
The law’s motivation dates back to the government’s US$700 million bailout of Bank Century in 2008, Indonesia’s then 13th largest bank. Unexpected losses over the bailout of Bank Century led to riots outside parliament and numerous investigations against senior policymakers and officials.
These are real concerns for Indonesian policymakers. They do not have the legal protections enjoyed by those elsewhere. Revision of the law is needed to protect officials who are acting in good faith, to help officials do their jobs quickly and effectively, and to reinstate Bank Indonesia as the lender of last resort.
With risks rising at home and abroad, Indonesia’s crisis management framework could end up tested sooner rather than later.
Indonesia’s macroeconomic management has been strong and has weathered storms well. Strengthening its crisis management framework should Jokowi’s top priority.