The COVID-19 impact
The COVID-19 outbreak has hit Indonesia’s economy hard. Indonesia was one of the few countries in the Asia region that didn’t opt for a stringent lockdown. The difficulty in implementing and enforcing social distancing measures and the absence of well-developed health infrastructure—a challenge for most emerging economies—meant that efforts to contain the pandemic haven’t been fully successful: Indonesia has one of the highest infection rates in the region across many metrics, including fatality rates.¹
It isn’t too surprising then that GDP turned sharply negative in Q2—its third straight quarter of negative growth. Crucially, it marks the first time the economy contracted since the Asian financial crisis in year-over-year terms.² Reflecting a similar trend globally, consumption growth in Indonesia weighed on overall economic growth during the quarter and the negative demand shock has exacerbated the preexisting disinflationary trend.
Prompt policy response
In response, Bank Indonesia (BI) has been very active, cutting its benchmark policy rate by a cumulative 100 basis points year to date, flooding the market with liquidity to the extent that short-end Indonesian bond yields have fallen the most within the region since the start of the pandemic.²
We’ve also seen significant activities on the fiscal front. In March, the government temporarily suspended the statutory limit of the budget deficit, which will be reinstated at 3.00% of GDP in 2023.³ The government also announced a debt monetization program in mid-July, assuring investors that it would be a one-off.⁴
"The proposed amendments effectively place the central bank under government direction and finance government debt at a discount."
In early August, the government proposed slower fiscal consolidation in its 2021 budget, with a deficit projected to peak at 6.34% of GDP this year, more than twice the previous 3.00% deficit limit.⁵ Recently, the government unexpectedly announced a proposal to change the BI charter.
The proposed amendments effectively place the central bank under government direction and finance government debt at a discount. Specifically, a monetary policy council, chaired by the finance minister and comprising other government nominees, will provide guidance on monetary policy. As part of the proposed changes, BI’s mandate may be expanded to include growth and jobs, besides financial market priorities and inflation.
In our view, the key question investors need to consider is: Does Indonesia have the space to sustainably monetize debt? To answer this question, we must consider the key constraints facing any government attempting to do so.
Monetizing debt—factors to consider
By virtue of having entered into the health crisis with sustained twin deficits (fiscal and external) and exposure to international financial markets, we believe Indonesia faces real—and financial—constraints if it wants to engage in extended debt monetization. Even so, there probably isn’t a more palatable alternative right now; the government needs to quickly step up spending to avert the unprecedented economic and health crisis. In our view, the government spending should prioritize policies aimed at lifting economic prosperity and building resilience against future shocks—for example, absorbing Indonesia’s severe youth unemployment⁷ through investment in permanent infrastructure and providing job guarantees for those working in sectors that compete directly with foreign imports or are involved protecting the environment.
Long-term potential remains undimmed
From a macroeconomic perspective, we believe Indonesia holds a lot of promise: opportunity to grow domestic investment, favorable demographics, relatively low household debt, scope to accelerate foreign direct investments, geographic proximity to key markets, and an improvement in the country’s performance in the annual ease of doing business ranking. Productive use of the limited room to monetize debt could tap into all of that potential and go a long way to lift Indonesia’s GDP, both in terms of growth and level, back toward trend, or even above.
1 “With world's lowest testing rate, Indonesia far from Covid-19 peak,” The Straits Times, September 3, 2020. 2 Bloomberg, Macrobond, as of September 14, 2020. 3 “Indonesia announces Rp 405 trillion COVID-19 budget, anticipates 5% deficit in historic move,” The Jakarta Post, March 31, 2020. 4 “Indonesia's debt monetization scheme only for 2020, says finmin,” Reuters, September 4, 2020. 5 “Indonesia's Widodo proposes $186 billion 2021 budget, 5.5% of GDP deficit,” Reuters, August 14, 2020. 6 “Workers once again protests against job creation bill,” The Jakarta Post, August 25, 2020. 7 Pre-COVID-19, the International Labour Organization estimated Indonesia’s 15- to 24-year-old unemployment rate to be ~17%, the second highest in Southeast Asia. The unemployment rate of this group has remained sticky above 15% since the 1998 economic crisis.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
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