FOCUS : COULD THE INDONESIAN REAL SECTOR WEATHER THE GLOBAL FINANCIAL CRISIS?

INDONESIAN COMMERCIAL NEWSLETTER

November 2008

FOCUS

COULD THE INDONESIAN REAL SECTOR WEATHER THE GLOBAL FINANCIAL CRISIS?

The country's real sector has suffered a big blow since mid 2008. The global financial crisis that began in the United States began to have its impact on Indonesia's real sector. However, it is yet to be seen which industries in the sector is the hardest hit and which are strong enough to stand up to the stormy condition.

The global financial woes would not be the same in impact with the regional crisis in 1997 on the Indonesia real sector.

The monetary crisis in 1997 was preceded by banking financial crisis marked with large non performing loans as a result of poor and irresponsible credit management. Many bank and companies were trapped in large debt especially foreign debts which resulted in larger repayment burden with the fall of the rupiah. The real sector was one of the victims badly hit by the monetary crisis.

At that time there was almost no rich and advanced countries affected significantly by the regional crisis. A number of European and U.S. banks were hit by non performing credits, but the impact was insignificant on their economies. Industrialized nations continued to record normal growth.

The world market also remained normal allowing crisis hit countries like Indonesia to continue normal exports. With the fall of rupiah, the country's export commodities were even more competitive in the world market opening an opportunity to boost exports.

The collapse of the real sector such as the manufacturing sector at that time was more on weak capital structure. Fund was not easily available to finance working capital and investment. Long delay in the process of restructuring led to the collapse of many factories.

Foreign investors had lost confidence in the country's economy and they were reluctant to resume operation in the country on high investment risk, bad investment climate, political instability and legal uncertainty. Poor and badly battered infrastructure added to discouraging investors.

In the monetary crisis that continued to have its impact until 2002, the one that managed to weather the condition was the small and medium enterprise sector and primary sector producing export commodities like crude palm oil and coal. Domestic market oriented industries that could stand up to the condition included industries producing food, and pharmaceutical products and other essential products.

The real sector began to revive after the government succeeded in creating a more favorable investment climate, better security, healthier financial sector and political stability despite a sharp fuel price hikes toward the end of 2005. .

A number of industries like automotive, electronics and steel industries began to grow strongly and impressive growth was recorded in the agro based industry.

Starting 2005, the country began to chalk up a relatively high economic growth of 6% annually with low interest and inflation rates of below 10% that greatly attracted investment.

In 2007, after the impact of the fuel price hike in 2005 began to recede, the real sector grew briskly especially the automotive industry. Production and sales of car and motorcycles hit new record. Similarly strong growth was recorded in electronic goods industry and building material industry like cement and steel industries. The support from the banking sector in the form of consumer credits contributed considerably to the expansion of those sectors. Banks even rushed to offer consumer credits including housing credits (KPR), and credits to finance the purchases of cars and motorcycles.

In mid 2007, global economy began to slow down signaling financial crisis especially in the United States. It was obvious with the sub prime mortgage crisis fell out of control marked by huge defaults in the housing sector.

Meanwhile, the Chinese and Indian economies which were on fast tract were still thirsty of basic materials and energy resulting in leapfrogging increase in the price of primary commodities like coal, steel, nickel, crude palm oil and oil.

The commodity prices climbed to a peak when the U.S. financial sector was fast on the decline. The crisis in the United States that caused the collapse of a number of big financial institutions spread like an epidemic to other industrialized nations in Europe and Japan. The share price fall in the New York Stock Exchange (NYSE), prompted investors to put their money in primary commodity market especially oil resulting in a surge in the prices of primary commodities while U.S. dollar sank deeper.

In July, 2008, the oil prices hit all time peak at US$ 147 per barrel, while the commodity prices were fluctuating. The gloom of recession began to spread not only in the United States. The financial storms slammed across the oceans taking victim in other parts of the world. The threat of world wide malaise has come to reality. Industrialists and business leaders have all complained about global economic slowdown. The purchasing power of consumers in the United States has plunged that the world's largest economy is forced to cut imports from all over the world including Indonesia. The United States is the country's largest trading partner.

Europe also has suffered badly. Governments of major economies in that region have been forced to funnel large fund in bail out to reeling financial institutions and to maintain liquidity. As a result the trend reversed in the market. The prices of crude oil in the world market fell sharply almost as sharp as it had climbed earlier. The prices of CPO, coal, steel, etc. fell to follow the trend in the crude oil market. In November 2008, the crude oil price dived to as low as US$50 a barrel the same level as in 2005 when the oil price began to rocket upward.

The condition since mid 2008, signaled uncertainty in the country's economy. In the beginning of the crisis in 2007, Indonesian banks that were not exposed directly to the U.S. financial crisis managed to continue growth. Some of the banks even gained from the condition.

The surging oil prices pushed up the prices of various export commodities like CPO, coal, nickel, tin, rubber and other primary commodities. For over three years the condition was in favor of the producers of primary commodities. However, the market of other export commodities like shoes, timber and textile had been in the doldrums.

In the country, the price of automotive products began to climb up in 2007. The market began to be hit by slump in mid 2008. The impact of the global financial crisis was also felt in other industries in the real sector. Slump began to hit the market of automotive products when the oil fuel price was raise din mid 2008. The textile and electronic industries were among the first to suffer under the global economic slowdown because of falling exports to the United States, which has been the main buyer of the country's textile and electronic products. .

The exports of non oil-gas commodities in October, 2008 fell 8% from US$ 9,796.4 million in September 2008 to US$ 9,002.9 million. The decline in the export earning was caused by falling exports in volume and value. It is feared the downtrend will continue until mid 2009.

With the decline in exports many export oriented producers seek to dispose of their goods on the domestic market. Meanwhile some countries like China turns to Indonesia after they found no buyers in their traditional markets like the United States and Europe. The domestic producers, therefore, are facing marketing problem facing strong competition from imported goods offered at cheaper prices. Indonesian producers, therefore, are facing heavy challenges not only in international market but also on the domestic market.

Increase in benchmark interest rate of Bank Indonesian (BI Rate) to curb inflation resulted in higher credit interest rates. As a result consumer credits declined and sales of automotive products, electronic goods and houses declined. The global financial crisis begins to bite but the question is how far the impact of the crisis on the country's economy. In 1997/1998, internal factors were more to blame for the crisis but now the crisis was brought in to the country or come from abroad.

The damage, however, is not expected to be as bad as in 1997/1998. The country's economy suffered a contraction in 1998, but now many observers believed that the crisis would not cause a contraction. The country's economy is expected to continue to grow though at a slower rate. The government is confident the country's economy would grow 5%-6% in 2009. Bank Indonesia was more conservative predicting only a 5% growth. Some business leaders are also more pessimistic saying the country's economy would not grow by more than 4% in 2009.

Indonesia might fare better than Malaysia and Singapore, which are more export oriented. The GDP of Singapore almost 100% depends on exports.

The economic growth shows that a number of sectors would continue to expand in 2009 despite the crisis. The country's big market contributes to the economic growth. In addition, there is still opportunity to shift export destination to regions like Middle East or China which will be least affected by the crisis.

With the problem faced in exports, the government should take measure to reserve the domestic market for domestic products. The domestic market is quite big to help offset a decline in exports especially exports of manufactured goods.

The market of automotive products begins to decline but the downtrend could be preventing if the Central Bank cut its interest rate. Though declining sales of automotive products are not expected to fall as low as in 2006 when slump hit the market following the fuel price hikes late 2005.

Textile and footwear industries which are export oriented are expected to receive a big blow as local products are also facing sharp competition on the domestic market from imported products. The domestic products are feared to find it difficult to meet in competition Chinese products, which are generally more competitive in price.

Industries which are oriented more too domestic market like food processing industries are expected to fare better as they are better able to face competition from foreign products.

The government should take steps to protect the domestic market without being protectionist by cracking on illegal imports. Illegally imported goods have a considerable share of the domestic market especially electronic, footwear and garment markets. Illegally imported goods are estimated to have a 30% share of the domestic market.

The central bank began to cut the BI rate in December from 9.5% to 9.25%. Further cut in the interest rate would revive consumer goods industry. With inflation well under control, the central bank could cut the BI rate by phases to 8% the level before the financial crisis.

The government has also cut the prices of subsidized oil fuels. Further cut to the pre crisis level of Rp 4,500 for premium gasoline and automotive diesel oil would be a big boost for the industry and would improve the purchasing power of the people.

Strong purchasing power of the people would certainly revive the domestic market and help shore up consumer goods producing industries at least until 2010 when the world economy is expected to regain lost strength.