The usual suspects of economic doldrums

The Jakarta Post
September 06, 2006

Kahlil Rowter, Jakarta

A friend recently complained his investment in the food industry
was not bringing in the results he had hoped for. Three years
ago he was told -- thankfully not by me -- the future belonged
to whoever directly catered to consumers. In retrospect, this
seemed obvious during the economic crisis and in its wake.
People can cut back on everything else but basic consumption.

In the last three quarters, however, this tenet has come under
question. All consumer-related indicators point south. That
consumption will continue to be the engine of growth in the
long-term does strain credibility. But in the aftermath of the
economic crisis this appears to be the only solid thing to lean
on.

A longer-term view reveals that consumption was indeed resilient
in the crisis year. But since 2001 this engine has stalled.
Consumption growth in 1993-2005 was a little over 4 percent
compared with gross domestic product (GDP) growth rate of close
to 5 percent. And the decline in consumption growth has
intensified in the last five years compared to pre-crisis years.
Should the slow consumption trend continue, in the next ten
years we will likely revert to 1993 proportions of consumption
to GDP.

If consumption cannot cut it, who can then take up the slack?
Government spending, investment and exports are the usual
suspects. At 8 percent of the GDP, government consumption is too
small to play a role. Investment and exports, each with 25
percent and 29 percent proportions to the GDP, are indeed two
very important contributors. Investment resurfaced in 2004-2005,
growing at 15 percent and then 10 percent per annum. And with so
much attention on the infrastructure bottleneck and
manufacturing capacity usage close to maximum at a time when
there was excess domestic liquidity and a lot of interest from
offshore; we should be optimistic that the only way to go for
investment is up.

Exports grew impressively at 14 percent in 2004 and then 9
percent in 2005. This was mainly on the back of a commodities
price rise. Other than in the resources sector and perhaps
agriculture, it is difficult to imagine increasing production
for exports before infrastructure bottlenecks can be overcome.
And even then, increasing production capacity will entail a
period where imports must rise first, mainly in the form of
capital goods.

Domestic macroeconomic development certainly does not occur in
an international vacuum. In round one, assuming
investment-funding inflow is front-loaded we can expect a
swelling in the capital account. This will finance capital goods
imports and factor payments like interest.

In round two, once production capacity is installed, we can
increase exports, which at the same time will increase
intermediate goods imports. As wealth builds up we may see some
additional increases in consumption goods imports. Foreign
reserves first swell up, then taper down, increase again and
eventually stabilize.

Unfortunately this neo-classical world-view with smooth
adjustments is not how actual economies work. And in addition to
rigidities, over-shooting responses, delayed behavioral or
government actions, there are also global transmission
mechanisms that makes a stable equilibrium itself more of a
point of departure than anything else.

As Napoleon would have it, the bad news first. Take the present
case where inflows in the last three quarters are mainly
investments in the financial sector. Hence the impact is
confined to prices, including the exchange rate. Given the
nature of fickle portfolio flows we cannot expect the present
high reserve level to sustain real sector investments.

Global interest rates and comparative equity returns play the
leading roles of transmission mechanisms to direct financial
flows among developed and emerging markets. But so does
sentiment. And do not forget the role of differential impact to
shocks like oil prices.

The good news for Indonesia is we are comparatively well
positioned. Politics appear stable and well managed. The
macroeconomy is stable, with inflation declining and interest
rates to follow suit. Government debt is also well managed as
exemplified by the recent upgrade by S&P.

Unfortunately resource utilization is woefully lacking. As a
result, growth is dwindling to below 5 percent. We expect to see
4.7 percent growth for the first half of 2006 compared to the
same period in 2005. Poverty and unemployment are on the rise.
Most retail indicators are still down although on a monthly
basis the drop is declining, which could signal a turnaround is
near.
Let us hope this positive sentiment persists long enough for
regulators to get their acts together and direct investments to
start, before investor confidence slides or the country loses
its appeal.

Investments and exports are the only engines of growth Indonesia
can pin its hopes on in the future. But we are fast running out
of time to take advantage of the present virtuous cycle.
Reduction in interest rates can only add to equity valuations so
far before growth concern starts to bite.

Sustained growth depends on an increase in demand for domestic
as well as external (exports). But the infrastructure bottleneck
and near maximum capacity use constrain this. Unless this hand
brake can be released, growth will continue to suffer.

The writer is chief economist, CIMB-GK Securities Indonesia.
This column is a personal opinion.