The euro crisis and its impact on Indonesia’s economy

At the beginning of 2012, economists expressed optimism regarding the future of the eurozone after a second bailout package for Greece of ¤130 billion plus ¤1 trillion of low-interest, long-term loans from the European Central Bank (ECB) were granted in December 2011. At that time, markets were convinced that Europe would recover from its prolonged crisis even though that recovery might take time. 

This optimism was further underpinned by improved economic conditions in the US, after it published its latest economic data, which revealed lower unemployment and higher growth projection.

Nevertheless, this respite only lasted a few months as Europe now once again faces economic terrors. One of the causes is the dispute between German Chancellor Angela Merkel and new French President François Hollande. Merkel shares the same vision with Sarkozy, France’s former president, namely to squeeze the budget through the Fiscal Austerity Plan. On the other hand, Hollande has been given a mandate by the French voters to alter austerity into economic growth, even though it will mean more government debts. The dispute between the leaders of Europe’s two largest economies is undermined further by the upcoming vote in Greece.

Following Greece’s second vote since the crisis hit, political parties in the country have been struggling to form a government. If voters choose to reject the spending cuts and bailout from Europe, the crisis could deteriorate into something far worse. If this happens, Germany, as Europe’s largest debtor nation, would be trapped between two difficult choices: 1) follow the wishes of the Greek voters, which could contain moral hazards, or 2) remove Greece from the eurozone (also called Greexit). 

Either of these two options would seriously impact on European economies and would not necessarily guarantee a resolution to the crisis. 

If the Greek crisis remains unabated, Europe’s peripheral economies, such as Spain, Portugal and Ireland, may be exposed to the contagion. If this occurs, such an event would clearly provide a new wave of negative sentiment that could plunge the global economy into another recession.

Overall, Indonesia’s economy has not been too affected by the euro crisis, as Europe is not the country’s main export destination. Indonesian exports mostly go to Asian countries, such as China and Japan. The share of Indonesia’s exports in terms of gross domestic product (GDP) is also relatively small compared to other export-oriented countries like China or Singapore. In addition, Indonesia can rely on its domestic market, thanks to its huge population. 

Indonesia proved its resilience when it survived the 2008 crisis, which was triggered by the Lehman Brothers’ shock.

So far, Indonesia’s economic indicators have shown remarkable results. According to Haver Analytics think tank, GDP growth during the first quarter (Q1) of 2012 was recorded at 6.3 percent, and growth for 2012 is predicted by the Economist Intelligence Unit to be around 5.9 percent due to the global economic slowdown. 

Year-on-year inflation as of April 2012 was relatively low (4.5 percent) and still within Bank Indonesia’s inflation targeting range (4.5 percent to 1 percent). In addition, the interest benchmark is set at 5.75 percent. The unemployment rate during QI 2012 was recorded at 6.3 percent, better than India (9.8 percent), the UK (8.2 percent) and the US (8.1 percent). 

At least, these statistics show that Indonesia has good economic fundamentals amid the global economic uncertainty. Nevertheless, the main issue might come from the financial sector, as reflected by the falling stock exchange (JSX) in May 2012. At the beginning of May, the JSX reached its highest level (4,226) but since then it has been on a progressive downturn, reaching its lowest level since March 2012, at 3,902. 

Moreover, the bond market has also been affected since most government bonds showed sharp corrections last week. Further, the rupiah is also depreciating against the US dollar, which hit Rp 9,600 to the dollar on May 29, its weakest level in 30 months.

One of the causes of this financial turbulence is the immaturity of the domestic financial market, with foreign investors still playing a crucial role in the marketplace. It was evident, for instance, in the mass withdrawal of money by panicking foreign investors due to the worsening global economy. The JSX recorded net sales of stock worth Rp 968 billion with total transactions of Rp 4.87 trillion (Bisnis Indonesia, May 25).

In other words, foreign investors can have a positive impact during healthy market conditions, but can deal a significant blow to the Indonesian economy if there is negative sentiment toward global economic conditions. 

Hence, it is necessary to increase our awareness regarding the importance of the domestic financial market. By utilizing more local investors, Indonesia’s financial market would be more resilient from external shocks.

Another possible cause of the fluctuations is the lack of government credibility. One example is the uncertain implementation of the subsidized-fuel reduction. The unclear decision-making process caused the JSX to move reluctantly in February and March. The ongoing uncertainty has also prevented businessmen from adjusting their costs in order to efficiently run their businesses. 

Another adverse impact of this bad policy-making is the delay of Standard and Poor’s decision to upgrade Indonesia’s investment rating, despite, fortunately, still giving a positive outlook on Indonesia’s economy. In this regard, a paper by Canavan and Tommasi from Boston University concludes that a more credible government would be more capable of executing policies than one with an unclear policy-making strategy. 

Hence, in order to increase the government’s credibility in times of crisis, it should implement unambiguous policies in order to prevent uncertainty, which can lead to negative perceptions. In other words, policy implementation should be based solely on objective considerations that provide positive welfare rather than merely political interests. By doing so, policy implementation would work efficiently.

Comment :

In summary, Indonesia’s economy is resilient enough to prevent the contagious effect of the European crisis due to its positive outlook, which is supported by strong domestic purchasing power. of the euro crisis could be minimized further by enhancing the role of local investors. If this happens, the market will be able to withstand any shocks resulting from foreign-fund withdrawals.