Indonesia’s Minister Basri says China Slowdown a Bigger Threat than Tapering

Emerging Markets, ADB editions, May 2014

Indonesia’s finance minister has identified a Chinese slowdown as the biggest single threat to his country’s economy.

In an interview with Emerging Markets, Muhamad Chatib Basri said that slowing growth in China, coupled with declines in commodity prices, were more serious for Indonesia than the Federal Reserve tapering which caused drastic volatility and outflows from the country last year.

“Maybe I’m too pessimistic, but I will say the resources boom is over,” said Mr Basri. “Last year, because of that, our export revenue collapsed,” as well as tax revenues which are heavily focused on mining and plantations. “And for a country like Indonesia, a slowdown in China has a bigger impact: first, most of the products we export to China are primary products, so a slowdown in China will reduce our exports; and second, if China slows down, the demand for commodities will decline and the commodity price will also decline. It is a double blow for us because 65% of our exports are energy and commodity related.”

Consequently, Mr Basri said that one of the biggest priorities for Indonesia was to move away from resources. “It is very important for us to diversify our sources of income.”

A China slowdown is unfortunate because Indonesia has only just succeeded in weathering the storm of capital flight following Federal Reserve comments on tapering last year. Indonesia, which was named by the investment community as one of the so-called Fragile Five, was hit partly because of the large holdings foreigners had in Indonesian debt and equity, but also because it had a twin current account and budget deficit. It appeared that the situation also caused a considerable slowdown in the Indonesian economy, but Mr Basri said this was in fact a deliberate method to reduce the current account deficit.

“We are a country with a young population, with maybe 60% of them workers aged less than 30. People in their initial career buy cars, motorcycles, housing; that’s why consumption in Indonesia is very strong,” he said. However, since Indonesia was unable to supply the goods that this rapidly growing spending class required, imports of capital goods and raw materials shot up, pushing the capital account deficit to 4.4%, or US$10 billion, even as (or because) the economy was growing by 6.5%. “We were a victim of our own success,” he said.

“So as a minister of finance I had two choices. The ideal one would be to expand the supply side, increase productivity, improve infrastructure and the quality of human resources, but it takes time to get there. If I cannot handle this from the supply side, the only option is to slow down demand.” He then reduced fuel subsidies, pushing prices up 44% and relocating the money to poorer people, while the central bank raised interest rates by 175 basis points and the currency sank. The strategy worked, in accounting terms: the deficit is now 1.9%, or $4 billion, and Indonesia is being less targeted by worried investors. As an illustration, foreign reserves, which sank from $102 billion to $92 billion, have now recovered to $103 billion. “If we are able to consolidate the current account deficit at less than 3%, this will make the market less nervous,” he said, while conceding that in portfolio flows, “the risk of capital flight is still there.”

In other comments, Mr Basri said that a new land procurement bill will be enacted into law on January 1, alleviating long-standing infrastructure bottlenecks; and argued that the forthcoming presidential election will not see major differences in economic policy regardless of the winner.