Author: Ross H. McLeod, ANU

Indonesia was one of very few countries not to suffer a severe decline in growth as a result of the global financial crisis.

Even at its lowest point in mid-2009, the GDP growth rate remained above 4 per cent per annum, recovering to a surprisingly high 6.9 per cent by the end of 2010 — with growth being driven primarily by investment spending, indicating a high level of business confidence. Read more…

Author: Ross McLeod, ANU

The visit of Indonesian President, Susilo Bambang Yudhoyono (SBY) to Australia, five months into his second five-year term, provides an opportune moment to take stock of Indonesia’s progress over the last few years. Like Australia, Indonesia has performed remarkably well in the face of the global financial crisis. Its annual economic growth rate fell from about 6 to 4 per cent, but has already accelerated again to well above 5 per cent. Inflation is only about 3 per cent, and the currency is strong. The budget deficit is small and well under control, as is public debt.

A number of factors have contributed to this good performance. Read more…

Author: Ross McLeod, ANU

Some of the world’s most reputable banks have been found to have insufficient capital relative to the risks they were carrying, and are now being taken over and recapitalised by their governments. This raises the question: should Indonesia’s regulations on capital adequacy be strengthened?

The reported average capital adequacy ratio in December 2008 was twice the regulatory minimum of 8%, so a doubling (say) of this minimum would not be a problem for the average bank.

Banks with relatively less capital would be obliged to inject new equity or to cut back their lending. Read more…

Author: Ross McLeod, ANU Indonesia Project

Along with the monetary authorities in many other countries, Bank Indonesia and the government are now acting to increase liquidity in the Indonesian economy, in the hope that this will protect against the possibility of a recession.

It would be possible to increase liquidity simply by reducing the quantity of SBIs (central bank certificates) outstanding. Although BI signalled this as a possibility last week (i.e. increasing liquidity through open market operations), more recently it has announced an alternative policy of reducing the minimum reserve requirement, which determines the amount of funds the commercial banks need to place at the central bank. Until now, calculation of minimum reserves has been absurdly complex, depending on both the size of the bank (four different categories) and its loan to deposit ratio (LDR) (six different categories). Theoretically, the ratio of reserves to deposits could be anywhere in the range 5 to 13%. The average level is currently about 9.1%, and BI has announced that the new reserve ratio will be a flat 7.5%, with no adjustment for bank size or LDRs.

Read more…

Author: Ross McLeod, ANU Indonesia Project

Indonesia’s inflation rate is now well over twice as high as the central bank’s target of about five per cent. There are two convenient scapegoats: big increases in both oil and rice prices. But the real explanation, as always, is unduly loose monetary policy.

Such an assertion will seem implausible, perhaps, to most observers. After all, Bank Indonesia has increased interest rates in recent months, which seems to suggest a tightening of monetary policy. That can hardly be denied, but the fact remains that monetary policy still remains quite loose. The best indicator of this is the growth of currency in circulation, which has accelerated significantly over the last several months, and is now running at rates of almost 30% annually. Read more…

Author: Ross McLeod, ANU Indonesia Project

The fourth amendment to Indonesia’s Constitution requires both central and regional governments to allocate at least 20% of their budgetary spending to education. Though it attracted little attention at the time, the absurdity of this amendment is now becoming more apparent. The entirely arbitrary 20% level far exceeds typical levels of expenditure on education in the past, and so this minimum requirement has simply been ignored by central and regional legislatures in the years since the amendment.

Perhaps not surprisingly, a group of teachers has brought a case before the Constitutional Court, asking it to rule on the validity of the central government’s current annual budget, in view of the fact that education spending remains well below the mandated minimum. The court had no choice other than to agree that the current budget violates the amended Constitution, but it was not prepared to go so far as to annul the law in which that budget is contained. Read more…

Author: Ross McLeod, ANU Indonesia Project

It was reported last week that the government intended to continue to maintain ownership of Merpati Nusantara Airlines, even though the airline is losing over US$2.2 million a month on average. Indonesia’s airline industry has been growing at a remarkably rapid rate of around 16% annually during the last several years, and yet Merpati has seen its fleet shrink from 90 planes to just 19, suggesting clearly an inability to compete with new private sector entrants.

This is a good example of the true rationale for privatisation: the desire to increase efficiency in the use of productive resources. State-owned airlines such as Garuda and Merpati were able to survive in the past because the private sector was not permitted to compete with them on an equal footing. Since the airline industry was deregulated several years ago, many new firms have been established, and there has been an explosion of domestic passenger traffic—to the extent that flying has become an attractive alternative to traveling by rail or bus. Indonesia’s taxpayers have every reason to question the logic of keeping companies like Merpati in government hands when it is blindingly obvious that the private sector can do a better job. Read more…

Ross McLeod, ANU Indonesia Project

The rationale for privatisation of state enterprises is not well understood in Indonesia. Most seem to think that the objective is to generate extra revenues for the government, but the government can easily issue more bonds if it needs to generate more funds.

The true economic rationale is in fact the desire to increase the efficiency with which productive resources are used—thus raising national income—and to avoid undesirable redistribution of income, through corrupt practices, in favour of those already well off. Privately owned firms have no scope for shifting funds from the general public to particular individuals, because they do not have the power to impose taxes. And they are almost always better managed than those in the hands of the state, for several reasons.

The first is that they have much stronger incentives for efficient management. If they fail to achieve this, their owners will make losses, and they will respond by replacing the managers. By contrast, the ultimate owners of state enterprises—namely, the general public—are in no position to replace managers, regardless of how bad their performance. Nor do they have any opportunity to divest their ownership in order to avoid future losses.

Read more…

Author: Ross McLeod, ANU Indonesia Project

Bank Indonesia has announced that it is considering the use of a change in the required reserve ratio as a possible method of bringing inflation under control. This ratio specifies the amount of deposits commercial banks must hold at the central bank as a proportion of their own customers’ deposits. Banks’ deposits at BI are a component of base money, so increasing the ratio has the effect of artificially increasing the demand for base money. With a fixed supply, increasing the reserve ratio therefore creates an excess demand for base money, putting upward pressure on interest rates and, consequently, downward pressure on inflation.

The obvious question here is: why not simply increase official interest rates, such as those on Bank Indonesia Certificates (SBIs)? Increasing the SBI rate allows more SBIs to be sold, which decreases the supply of base money and likewise therefore creates excess demand for it, resulting in increased interest rates throughout the market. In terms of the inflation outcome, it really doesn’t matter which of these two instruments is used.

My guess is that the only reason why BI would consider reverting to the rather old-fashioned policy of varying the required reserve ratio is that this allows it to escape the odium attached to directly increasing interest rates.

But that is only a short term political gain. In the slightly longer run, it will be obliged to increase SBI rates to the now higher level ruling in the market. If it does not, it will find it difficult to sell sufficient quantities of SBIs, which will result in an excess supply of base money and a consequent further boost to inflation. The appropriate way forward is simply to increase SBI rates directly.