Indonesia: The Epicenter of the Economic Crisis

Indonesian journalists on World Labor Day

Indonesian journalists on World Labor Day

By Eddy Suprapto
Contributor AsiaN. 

The process of economic recovery in Indonesia due to COVID-19 will clearly face a new chapter that is facing an economic crisis. Gross Domestic Product growth is only 1.8%, inflation is at 2.7% and unemployment rate rose from 8% to reach 10%. Indonesian National Budgeting revenue was only IDR 1.761 trillion, while spending rate by IDR 2.614 trillion. The Indonesian national budget deficit is widening.    

JAKARTA: The world economic, social and political order changed suddenly due to the spread of the coronavirus (COVID-19). The virus spreads through human interaction quickly and knows no boundaries.

As a result, all social and economic interaction and activities must be limited to prevent worldwide spread. This limitation is very closely related to the prediction of when spread will cease, and that is when human activities will return to normal.

Uncertainty about when the virus is vanquished will obviously have an impact on the economic and financial sector, including supply surprises, falling consumer demand and fundamental changes in the psychology of economic actors. There was a shift in shopping patterns from purchases of types of fast food to raw products. Consumers who are accustomed to eating at fast food restaurants now cook on their own or prefer frozen food, so it can be stored longer, through the purchase of goods online. These are all indications of a shift in consumption patterns. The cut in the portion of discretionary consumption spending is usually reflected in the sharp decline in the retail sales index.

During the period of social restrictions for 8 weeks there was a decrease in economic activity between 6-8%, resulting in a decline in industrial production estimated at around 9-13%.

With this condition, if the economy is assumed to start moving again in the third quarter of 2020, household consumption growth in 2020 is likely to reach only 2.2% over one year and the rate of gross domestic fixed capital formation will shrink around 1%.

Indonesia’s economic conditions are getting worse due to the dependence on imports of food products, energy and raw materials. Our high dependence on investment flows has led to a sharp decline in the availability of capital goods and the supply of production machinery. The shrinking of the Chinese economy has disrupted Indonesia’s production and export flows. This is reflected in the decline in the industrial production index and the decline in production capacity utilization. This reliance pattern also caused the depletion of the stock of some food and food groups are experiencing supply shocks.

Bursting Increase

Referring to the composition of the labor force based on the economic sector classification of business types, there are 56% of the Indonesian workforce in the informal sector, while from the duration of working hours, a quarter of the Indonesian workforce are working part time or underemployed. This simultaneous crisis has the potential to increase the number of open unemployment by 3.5-8.5 million people throughout 2020. This means that the unemployment rate has the potential to rise from the current 5.2-5.3% to 7.7% and up to 10.3%.

Sectors directly affected by the 2020 crisis include services, tourism, hospitality, transportation, and the cessation of tourist flows seen in the tourism, hotel and transportation sectors in Indonesian tourism centers such as Bali and Yogya.

The sharp decline in population mobility as a consequence of social restrictions, has caused contractions in several sectors, such as construction, trade, hotels and restaurants, transportation, and entertainment services. It is estimated that the decline in activity in various economic sectors is quite sharp, varying between 35 and 55%.

Fiscal Policy

The state budget deficit for 2020 is expected to widen from 1.8% to 5.1% of the GDP. The deficit figure is based on the assumption that revenue reaches Rp1,761 trillion, 21% lower than the previous target. The expenditure assumption of Rp2,614 trillion or 3% is higher than before. Additional 2020 Government Expenditures include health handling COVID-19 and BPJS subsidies of IDR 75 trillion, Social Safety Net Rp110 trillion, support for the industry in the form of import taxes and others worth Rp70 trillion, and funding the National Economic Restructuring Program in the amount of Rp150 trillion. This represents an additional total of IDR 405.1 trillion.

Funding for a deficit of this magnitude is planned to originate from a number of sources remaining in the previous year’s budget – Endowment funds managed by the Ministry of Finance such as LPDP, funds managed by the Public Service Agency, issuance of IDR and foreign currency denominated bonds, foreign loans from bilateral and multilateral institutions, as well as the issuance of new debt bonds labeled “Pandemic Bond”.

In practice, it is not easy to cover a deficit target of 5.1%. Constraints will come from several factors. First, the target of acceptance will most likely be missed. The fall in the level of supply-demand balance provides an indication that the realization of tax revenues in 2020 will be similar to conditions in 2018 or 2019. It is easier to imagine the decline in the prospect of income tax and VAT as a consequence of the decline in economic activity.

Various types of tax breaks and decreases in corporate tax rates from 25% to 22% will significantly erode tax revenue. The fall in oil prices will also reduce non-tax revenues. The average Brent price in 2020 is expected to fall to $40 per barrel versus the average Brent price of $65 per barrel in 2019, while the average Rupiah to Dollar exchange rate is at 15,625 in 2020, which means an average depreciation by 10% compared to 2019. The fall in oil prices by nearly 40% was not offset by rising rupiah receipts from IDR depreciation.

Indonesia Enters Recession

The crisis epicenter in all parts of the world has led bond investors in many countries to better direct their ammunition to help fiscal financing in their respective countries. Indonesia central bank provides a monetary solution to help fiscal financing by increasing the ratio of Macroprudential Liquidity Buffer (PLM) and decreasing the reserve requirement ratio by the same proportion.

This monetary solution will encourage banks to allocate IDR 100 trillion to absorb government bond issuance in the primary market. As a result, the need for gross issuance (gross insurance) of government bonds amounting to approximately Rp. 900 trillion is expected to be bridged through banking operations, taking into account the realization of the APBN deficit in the range of 4.5% of GDP, or 0.57% short of the target.

Indonesia has experienced the world economic crises in 1998, 2008 and 2020. However, the crisis in 1998 and 2008 cannot be compared to the one in 2020. The 1998 crisis was triggered by a corporate crisis but not all countries were affected. The 2008 crisis was triggered by the global financial crisis, but transactions between countries were still ongoing. The crisis of 2020 has a multi-dimensional impact. All countries are affected; all countries stopped their business activities; all countries shut down; all countries are having unemployment and budget deficits. Only the percentage and endurance of each country are different.

With such micro and macro conditions, we can say we are entering the economic recession in 2020. High uncertainty about data trajectories and fundamental changes in the relationships between variables due to changes in behavior make the economic picture different. The fact is that economic growth in the first quarter of 2020 will be lower than the fourth quarter of 2019, even when taking into account seasonal factors.

GDP growth will also be negative in the second quarter of 2020. For the whole of 2020, GDP growth reached only 1.8% year to year with an average inflation of 2.7%. The unemployment rate is quite consistent with the definition of open unemployment adopted by Indonesia at 8%. What will rise sharply is the number of part-time and underemployed workers. Thus, the 2020 crisis will change the composition of the Indonesian workforce.

The government’s step in reducing the pace of the economic crisis is expected to be effective. Support for the industry in the form of PPh21 and VAT, import taxes and the suspension of principal payments are expected to be able to move the economic stimulus. On the other hand, there is funding for the national economic restructuring program of Rp 150 trillion, which can be used by the sector to reduce Indonesia’s imported products, namely the food, energy and pharmaceutical industries.

The government’s step in reducing the pace of the economic crisis is expected to be effective, namely support for the industry in the form of tax, import taxes and suspension of principal payment are expected to be able to move the economic stimulus. On the other hand there is funding for the national economic restructuring program of IDR 150 trillion, which can be used by the sector to reduce Indonesia’s imported products, namely the food, Energy and pharmaceutical industries.

Will this stimulus and government policy be enough to “kick” to improve Indonesia’s current economic condition, with the remaining time available for 2020? There will be an answer if the government, economic actors, and the people of Indonesia have a united heart in facing the 2020 crisis with a determination to rise again.

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