FOCUS : EXTERNAL FACTORS AFFECTING INDONESIAN MACRO ECONOMY

INDONESIAN COMMERCIAL NEWSLETTER

April 2008

FOCUS

EXTERNAL FACTORS AFFECTING INDONESIAN MACRO ECONOMY

Sub-prime mortgage crisis and U.S. dollar weakening

The U.S. subprime mortgage crisis has jolted and caused huge losses to the entire world financial industry. The crisis has forced the U.S. central bank to cut its benchmark interest rate to 3% and inject large fresh fund to regain the confidence of investors after the share price crash in the world's largest economy.

Indonesian financial agencies are not directly exposed to the crisis as the Indonesian and other Asian banks have been more wary of crisis after being hit by the regional crisis in 1998. However, the country's economy could not escape the impact.

A 3% cut in the Feds' interest rate widened the difference between the U.S. Central bank key interest rate with the BI Rate, now at 8% resulting in larger cost of money in Indonesia. Meanwhile Bank Indonesia (BI) is in difficulty to cut further the BI Rate amid the threat of rising inflation with the rising prices of energy and other commodities. BI has to maintain if not raise the BI Rate in order to keep inflation under control.

Therefore, the steady cut in the BI Rate to boost the real sector would ground to a halt. Even the central bank may have to raise the interest rate if the prices continue to climb. The impact would be further weakening the purchasing power of the people. Credit expansion which has been increasing to the real sector in the past two years will likely be slowed.

Oil price hikes

The global economic woes this year have been blamed for the U.S. financial crisis and soaring oil prices sending the prices of other commodities sky high.

The oil price hikes reaching nearly US$120 a barrel in April is feared to render a negative impact on the country's economic condition as it would require larger fuel subsidies burdening the government.

The 2008 state budget was calculated with oil price assumption of US$ 95 a barrel. Based on the price assumption, oil fuel (BBM) subsidy would be Rp126 trillion. With prices exceeding the target, the subsidy would have to be increased if the government continued to maintain its decision not to raise BBM prices.

However, with the oil prices continuing to scale up, the pressure would be greater for the government to raise the prices of subsidized BBM or reduce consumption of subsidized BBM. Currently the government has not decided what step to be taken although it is likely to opt for an increase in the prices of subsidized. Either way the consumers will be badly hurt.

Although the prices of subsidized BBM have not been raised, the impact of soaring prices of crude oil in the world market have been felt. The prices of oil fuels for industry follow the prevailing prices in the world market resulting in an increase in production cost and rising prices of manufactured goods.

The country's inflation is estimated to reach 8.5% exceeding exceed the government's target of 6.5%. Any increase of 10% in the prices of premium gasoline would cause an increase of 1 percentage point in inflation. The impact of an increase in the kerosene prices would be worse on inflation.

Increase in commodity prices

Indonesia, however, gains from the increase in the prices of its primary commodities like nickel, coal, gold, tin, oil and gas and agribusiness products including palm oil, rubber, and cacao.

Indonesia as an exporters mining commodities gained from the rising prices of mining products. Many mining companies have reported all time record increases in profit. All mining companies listed on the Indonesian Stock Exchanges posted an increase of 176.6% increase in net profit in the average in 2007 mainly on price hikes.

Eight company reported net profit of Rp 3.3 trillion (US$ 359.7 million) or an increase of 215.6% from the previous year. PT International Nickel Indonesia (Inco), the subsidiary of the Canada-based Inco Limited, reported a handsome profit of Rp10.8 trillion (US$1.2 billion) . A sharper increase in net profit was posted by state-owned tin mining company PT Timah. which chalked up a 757.3% rise to Rp1.78 trillion.

The country's largest coal mining company PT Bumi Resources reported a net profit of Rp 7.3 trillion or tripling previous year profit . The net profit of oil and gas companies rose by an average of 8.7%. The prices of the commodities are predicted to continue to scale up this year.

The increases in the prices of the commodities have been followed with proportional rises in the prices of goods for domestic consumption such as cooking oil soybean, rice , and coal. The hardest hit by the rising prices are low income people.

Increase in the prices of food products

The increase in he prices of oil has brought on an increase in production cost and the prices of oil substitute products. The prices of food products have caused greater concerned world wide. Fear of wide spread food shortage and hunger is growing.

Indonesia is luckier than the Philippines, which is now the world's largest importer of rice. The prices of rice shot up when Indonesia has just succeeded in regaining self sufficiency with large stocks. The government has announced an increase in its purchasing price of rice from farmers to allow the farmers to enjoy from the price hike in international market and at the same time discourage smuggling. The government has banned rice export to guarantee supply on the domestic market.

Fixed income people, however, have suffered with the skyrocketing prices of food products such as soybean cakes and wheat flour.

Projection of Indonesian economy

Projection by the World Bank

The global economic slowdown has also put a brake on Indonesia's economic development as the country's exports to its traditional markets mainly the United States, which is struggling to avert worse recession, would likely decline. The World Bank has revised won its prediction of the country's economic growth to 6% from previous estimate of 6.4%.

The World Bank also predicted a decline in the country's export growth to 7% this year from 8% last year. Domestic demands especially investment and consumption demands are expected to remain strong. With soaring prices of fuels and swelling subsidies, the deficit in the state budget is estimated to widen to more than 2% of the country's GDP, from 1.3% in 2007 with debt to GDP ratio down to 31% from 35%.

The World Bank, however, predicted the country's economy will recover in 2009. Last year Indonesian economy expanded 6.3% or the highest in the past 10 years.

Projections by the government and Bank Indonesia (BI)

The government has projected the country's economic growth at 6.2%-6.3% in the first quarter of this year. Bank Indonesia was more conservative saying the growth rate would not be more than 6%.

Official estimate of growth for the first quarter of this could be released in May by the Central Bureau of Statistics (BPS).

Meanwhile, head of the fiscal policy of the finance ministry Anggito Abimanyu Anggito said household consumption (after being deducted with inflation) grew 5.15% based on indicators that including 3.7% increase in domestic value added tax (VAT), 32.3% rise in import VAT and 12.4% income tax 21.

Encouraging increases were also recorded in car and motorcycle sales respectively by 60.5% and 28.6%.

The government consumption grew 4.02% driven mainly by 10.36% rise in rising civil servants spending. Investment was estimated to grow 9.5%, investment credits was estimated to rise 17.9%, working capital credits to increase 20.6% and government spending to expand by 49.4%.

Causing concern was a decline in direct investment. Domestic investment (PMDN) was estimated to decline 13.6% and foreign investment PMA) by 19.6%.

Senior Deputy Governor of Bank Indonesia Miranda Goeltom said earlier the country's economic growth would be slower than expected in the first quarter of this year as a result of the global economic slowdown.