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In Indonesia, Will COVID-19 Trigger Another Asian Financial Crisis?

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In Indonesia, Will COVID-19 Trigger Another Asian Financial Crisis?

History may not repeat, but it does rhyme. 

In Indonesia, Will COVID-19 Trigger Another Asian Financial Crisis?
Credit: Unsplash

While the government of Indonesia struggles to contain the public health side of the COVID-19 crisis, the economic hit from the pandemic is starting to bite in earnest. The government now expects GDP growth to slow to between 2.3 and .4 percent for the year – and even this may be optimistic. As the scale of the crisis became clear in early March, capital outflows began to pummel the rupiah, eventually pushing it to over 16,600 to the dollar, a level not seen since the Asian Financial Crisis. As the crisis unfolds, it is thus natural to wonder if the turbulence of the 1990s is repeating itself. 

I would argue it is not. The challenge posed by the COVID-19 crisis is something wholly new and different, with limited parallels in historical precedent. If anything, the scale of this crisis is greater than those that came before and so requires different policy responses. On its face there are superficial similarities with the Asian Financial Crisis: COVID-19 is causing capital outflows, currency depreciation, a huge economic contraction and potentially some political or social instability if the situation drags on for a long time.

But those are just symptoms. 

This time around, the root cause and therefore the appropriate treatments are different. The Asian Financial Crisis was, first and foremost, a liquidity crisis. For much of the 1990s, capital flowed into Indonesia from abroad as President Suharto warmed to the neoliberal development model and the rent-seeking opportunities it created. When investors fled the market in 1997, it put immense pressure on the currency (which at that time was pegged to a basket of other currencies) and the rupiah had to be floated, resulting in rapid and massive loss of value. This, in turn, exposed the house of cards that was Indonesia’s banking system as foreign debt suddenly became impossible to service. 

Such a shock would have crippled practically any banking system, but in Indonesia what it revealed was that domestic banks had been propping up conglomerates connected to Suharto cronies by disguising their bad debt. There were riots in Jakarta. The IMF sailed in with a lifeline. Suharto stepped down. The economy went on ice for a few years. And in the end, Indonesia emerged as a more robust democracy. 

There is almost nothing in that story that resonates with the underlying drivers of the COVID-19 crisis. The rupiah is not pegged anymore; it can and does adjust very quickly to even minor moves by the Federal Reserve. Bank Indonesia has over $100 billion in foreign exchange reserves at the ready to prop up the rupiah in the face of capital outflows. But perhaps the biggest difference between then and now is that Indonesia’s domestic banks are much healthier. 

Take the four largest banks in Indonesia – Bank Central Asia, Bank Mandiri, Bank Rakyat Indonesia and Bank Negara Indonesia. At the end of 2019 they had combined total assets of 4,500 trillion Indonesian rupiah (IDR) (approximately $300 billion, using an exchange rate of 15,000 rupiah to the dollar). They had IDR 2,924 trillion ($195 billion) in loans outstanding against IDR 3,166 trillion ($211 billion) in customer deposits. That is an average loan to deposit ratio of 92 percent, which is generally within industry standards. It also means Indonesia’s banks are originating loans the old fashioned way – from customer deposits – rather than through financial shenanigans that would leave them over-leveraged. 

The average capital adequacy ratio (a metric that gauges a bank’s ability to cover its liabilities) of these four banks was 21.84 percent — under international banking standards established by Basel III, the minimum required ratio is 8 percent. Underwriting standards have also apparently improved quite a bit, as their average rate of gross non-performing loans was 2.15 percent, which is relatively low. Indonesia’s domestic banking sector is much less of a systemic risk than in the 1990s – the banks are better capitalized, are issuing higher quality loans, and are not over-leveraged. If the situation continues as is, we might nevertheless see more capital outflows or a wave of bankruptcies but the financial system is more robust and the central bank has several tools that can help ameliorate such an eventuality. 

COVID-19 is thus not first and foremost a liquidity crisis. It is a simultaneous demand and supply shock to the real economy precipitated by an external event — a pandemic — and it is less clear whether the government has the tools for combatting it. There is no comprehensive unemployment scheme in Indonesia, so at the moment the responsibility of avoiding mass unemployment is falling on individual business owners who, if they can, are keeping staff on even as they operate at a loss. 

But trying to staunch unemployment by relying on the altruism of business owners is not a long-term solution, and in the end it will bankrupt businesses and millions will become unemployed anyway. The government must do more to get cash to those who need it most. Given Indonesia’s patchy social safety net and bureaucratic inefficiency this is the biggest short-term challenge facing the government, and one they are struggling with. There are some mildly encouraging signs. A poorly conceived online job training program is apparently being modified to serve as a simpler direct cash transfer scheme. But more is still needed to keep the most vulnerable afloat until demand more fully recovers. 

When will demand recover? It is possible that the business friendly omnibus bill currently under consideration by the legislature, as well as a weakened rupiah, will lead to more investment and more exports that will help revive economic growth quickly. But that is far from a sure thing. This means the only certain way through this in the short-term is domestic consumers. 

Fortunately, consumption and expenditures in Indonesia before the crisis were fairly robust. Travel is one obvious example. In 2018 15.8 million foreign tourists came to Indonesia; during that same time period there were 300 million domestic tourists. This is just one example, but it holds true for most sectors in Indonesia – demand is not sustained by external forces as much as it is from within. This is the primary reason Jokowi sought to avoid a strict lockdown that would result in business closures or loss of income — Indonesia’s capacity for resilience in the face of this crisis is rooted in the ability of local consumers and businesses to carry on and bounce back.

Another area that could bubble over into systemic crisis is in the supply chain. Supply chains in Indonesia, especially when it comes to staple goods, are very complicated and intensely political. Food is one such good and the state-owned commodities broker BULOG is the key player. BULOG’s mandate is to ensure a stable price for certain goods – primarily rice – by intervening to correct for market imbalances in supply and demand, such as those created by COVID-19. BULOG’s record in successfully executing this mandate is mixed, but that is in any event their official purpose. 

The next several months will reveal if they are up to the task. So far the signs in this area are also moderately encouraging. BULOG has promised that it will buy surplus rice from producers if the price falls below a certain threshold, and then distribute it to regions experiencing shortages. The government also relaxed import licensing requirements for onions and garlic as prices skyrocketed in March, which has helped bring the price down dramatically. I just bought some onions last week and they were a sixth of the price they were a month ago, which suggests the government can act quickly to relieve supply chain pressure when it has to. More actions along these lines will likely be required in the months to come. 

This also underlines another critical difference between now and 1998 – the role of state-owned enterprises. When the IMF extended their bailout, it was conditioned on Indonesia complying with various neoliberal priorities such as deregulation and privatization of state-owned companies. This time the state-owned sector is one of the pillars of the Jokowi administration, having massively ramped up during his first term. And it will almost certainly be key to Indonesia’s economic recovery. 

For one, SOEs can borrow money that does not count against the government’s borrowing caps. So while the government can only borrow around 5 percent of GDP to finance its fight against COVID-19, its phalanx of SOEs can borrow and raise money on capital markets that does not count toward that limit and will greatly expand its financial firepower – as long as there are investors willing to hold the debt. Bank Mandiri (which is majority owned by the government of Indonesia) just issued $500 million in bonds that were oversubscribed by five times, indicating such a willingness still exists, at least for certain companies. 

The other unique characteristic of SOEs, especially those that hold monopolies on the provision of staple goods like fuel or electricity, is that the government can essentially force them to provide these goods at a discount and eat the losses. The state-owned electric utility, PLN, has already said it will provide low or no-cost power to millions of vulnerable households for the next several months. If the government cannot directly send cash to these families, it can at least force the state-owned electric utility to provide in-kind services for free. There will likely be many similar examples in the months to come.

History may not repeat, but it does rhyme. On the surface, the COVID-19 situation bears similarities to the Asian Financial Crisis. But dig a little deeper, and the underlying causes as well as the proportional policy responses are different. This time the banking system is on sound footing and the political leadership is reasonably strong. The puzzle is how to keep economic activity on life support until demand can more fully recover, while minimizing supply chain disruptions. And this time, instead of being the villains of the story, state-owned companies will likely play a critical supporting role. The road ahead is undoubtedly challenging, but just as in the 1990s the resilience of the Indonesian people and their economy will likely persevere in the end. 

James Guild is a Ph.D. Candidate in political economy at the S. Rajaratnam School of International Studies in Singapore. His work has previously appeared in The Diplomat, New Mandala, East Asia Forum and Jakarta Post. Follow him on twitter @jamesjguild.