FOCUS : WILL INDONESIA IS DRAGGED INTO THE MIRE OF U.S. FINANCIAL CRISIS?

INDONESIAN COMMERCIAL NEWSLETTER

September 2008

FOCUS :

WILL INDONESIA IS DRAGGED INTO THE MIRE OF U.S. FINANCIAL CRISIS?

The U.S. economy has been badly jolted by devastating financial crisis culminated with the collapse of world investment giant Lehman Brothers. The Lehman Brothers foundered after it failed to settle a US$60 billion bill as an after effect of the subprime mortage crisis that begin in 2007.

The U.S. monetary authority refused to offer bail out to save the Lehman Brother that the fate of the 150-year investment bank had been sealed.

Meanwhile, two other financial giants Morgan Stanley and AIG are reeling on the brink of bankruptcy . The U.S. government, however, seems to decide to help prop up the two companies on fears of worst impact.

The repercussions of the crisis that hits the world's largest economy has been felt throughout the world. The heaviest impact of the fall of the Lehman Brothers is certainly suffered by the financial agencies that have been the creditors of the investment bank including a number of large banks in Britain and Japan. The ones to suffer the worsts, however, are the American people.

U.S. consumption sector weakning

The huge fund funnelled in to the market to prevent more giants from falling apart has badly weakened the U.S. consumption sector as well as the business sector. The interest rate has been too high and inflation is soaring forcing the U.S. households to cut consumption.

Similarly, the business sector has found its more difficult to raise fund for working capital or to finance investment. High cost of fund weakens their competitiveness. In fact many factories have slowed down even stopped production swept by the financial storms.

The weakening consumption sector in the United States, has direct impact on other countries especially its main trading partners. A decline in the U.S. consumption of textiles has resulted in a cut in its textile imports. The United States has been the largest export market for Indonesian textiles. That country accounts for 43% of Indonesian exports of textiles and garments.

The subprime mortgage crisis in 2007 has left its marks not only in the Unirted States, but in almost all countries in the world. The world's economic growth began to slow down that year. The crisis has caused a fall in the value of the U.S. dollar that many investors were drawn to primary commodity market resulting in soaring of the prices of various prmary commodities. The skyrocketing prices triggered inflation badly weakening the purchasing power of the people in primary commodity importing countries like the United States and number of other major industrialized countries.

However, there are limits to which the prices could go up. The prices began to nosedive after reaching their peaks. The crude oil prices which peaked at US$147 a barrels in July 2008 began to scale down to less than US$90 a barrel in the second week of October.

Impact of economic crisis on Indonesia

The financial woe and sharp fluctuations of commodity prices are feared to seriously dampen the Indonesia's economic resilience. The country has gained from leapfrogging increases in the prices of primary commodities in the past two years. Indonesia's exports have been dominated by primary commodities that the country's exports were booming when the world's economy was on the decline.

Indonesia was lucky that it had been able to go through its own crisis triggered by a sharp increase in price of oil fuels brought about by the soaring prices of crude oil. The impact of the fuel price hikes was offset by the booming exports of primary commodities. The difficulties created by the rising prices of rice, cooking oil and other food products had been bad but the damage was more than offset by the gain from soaring prices of crude palm oil, rubber, tin, coal, pulp&paper, etc.

Despite the rising interest rate, consumtion credits continued to increase marked by surges in the sales of cars, motorcycdles and property. The contribution of the consumption sector to the country's economic growth, therefore, grew. The country's GDP in 2008 is expected to exceed the level of 6% predicted by the World Bank and ADB. In the first half of the year the economy already expanded 6.3% or the same as in 2007 and higher than in the previous years.

The investment sector also grew driven by ventures in agribusiness, mining, construction and manufacturing sectors.

However, Indonesia will not go unscathed amid the global financial woes. The oil price fluctuations have disrupted financial market stability. When the prices of primary commodities were on the increase many foreign investors sought to turn from stock market to commodity trading in emerging economies like Indonesia. On the contrary when the prices began to take a downtrend, the U.S. dollar regained strength and many investors truned again to investing in the U.S. currency causing a decline in the rupiah value. The surges in the prices of the commodities in the world market had also brought about an increase in inflation in Indonesia.

In a bid to curb rising inflation, Bank Indonesia (BI) had adopted a tighter policy by raising its benchmark interest rate. The move by the central bank was followed by banks raising their interest rates, putting a break on the expansion of the business sector. The central bank also cautioned banks against credit expansion and stop tariff war in attracting third party funds. On Sept. 24, 2008, Bank Indonesia succeeded in bringing major Indonesian banks to agreement to set maximum interest rate of 13% on deposits and averted worse tariff war.

So far the government and BI could still play effectively in keeping tariff war within control as the country's economic fundamentals are still strong shored up by strong export performance and household consumption.

However, the fundamentals could easily be caved in by relying only too much on exports and consumption sector. Exports are feared to be affected with the prices of commodities on the decline and the consumtpion sector weakened by rising inflation.

Expectation to go through the crisis

Despite the dreary picture we still hope for the best that the country would go through the crisis . Support from a number of factors is still encouraging to keep the country's economy on right track. The present condition was not the same as in 1997/1998 when the country 's economy was devastated by monetary crisis . The crisis in 1997/1998 was worsened by havest failure following long drought. The cash strapped government was forced to spend heavily on rice imports when the rupiah sank to the rock bottom against the U.S. dollar.

Currently the country is facing no problem in food supply. The country has even regained self sufficiency in rice supplies. Large surplus in rice supplies discouraged speculators.

In order to maintain healthy economic growth , the government has to be able to provide stimulant facilitating flow of funds from the state budget to productive sectors. The purchasing power of the people could be strengthened again with larger government spending on the real sector.

Although a number of macro ecomomic indicators show that the country's economic fundamentals are still quite strong fears are growing that the country would be dragged to the global crisis. The confidence that the government is seeking to implant about the country's economic fundamentals could prove false with the unpredictable and rapid changes in the world economy in the past few days.

Although the U.S. Congress finally threw its support to the US$700 billion bail out program of the U.S. government , it proved to have little effect on efforts to stop the raging financial storms from spreading to other countries including emerging economies like Indonesia.

Household consumption and must be boosted

There has been no panacea that could end the global financial crisis immediately. The crisis is feared to rage still in the next one and two years. Indonensia is not expected to be able to escape the crisis wihout hard work. The best the country could do is to reduce the impact. For that purpose, the government needs to focus more on maintaining high public consumption and exports such as by offering reasonable credit interest rate. The central bank, therefore, needs to be more careful in setting its benchmark interest rate by continuing to take into consideration inflation. Too high interest rate would result in a decline in consumption. The government has to facilitate the flow of funds from the state budget to the real sector to keep the economy moving.

Meanwhile, the government needs to address the problem faced by exporters with the decline of purchasing power in traditional export markets such as the United States, Europe and Japan. Exports to the traditional markets are feared to decline . Meanwhile , the prices of major export earners like palm oil (CPO) are now taking a downtred. Indonesia , however, still hopes to gain from a high price of tin and other mining commodities despite the peak prices have been over. It is time for the country to focus again on reviving the manfacturing sector to produce export commodities to be disposed of in non traditional markets Middle East and South America where the economy is still growing such as in Brazil. With the exprience in handling the condition in the wake of the 1997/1998 crisis, the government and the business sectors should be better prepared to cope with the present crisis. The government has pledged that the nightmare of 197/1998 would not be repeated .