R

ecent economic data suggest that economic activity has continued to weaken. Yet at the same time, the Leading Economic Index (LEI) - the index which predicts the direction of the economy 6 to 12 months ahead - provides an early indication of a possible end to the current economic contraction in the near term.

Nevertheless, there are some risk factors that might prevent the economy from recovering.

The weakening in current economic activities is evident in the falling trend of Danareksa's Coincident Economic Index (CEI) - the index which tracks the current state of the economy.

The index has been on a downtrend since July 2008. And it fell even further in February 2009, thus suggesting that the Indonesian economy is contracting.

Indeed, the Indonesian economy technically entered a recession in November 2008. And, as suggested by the firm downtrend of the CEI, the economy continued to contract in the first quarter of 2009.

There are, however, some positive developments that suggest a bottom is in the making. Take the car sales index (a component of the CEI), for example. In February, the car sales index rose by 3.43 percent month-on-month.

This is the first time the index has increased in five months and might be an early indication that the downtrend in the car sales index is over.

Another component of the CEI that has shown an improvement is the Cement Consumption Index. This index started to fall in June 2008 as a result of the fuel price hikes in the previous month that eroded consumer purchasing power. Consequently, households reined in their spending (this included spending on home building and home renovation).

Against this backdrop, cement consumption fell significantly. In August 2008, however, cement consumption appeared to stop declining. Indeed, cement consumption tended to increase in the following months - albeit not very strongly. Nevertheless, the uptrend in cement consumption suggests that household purchasing power did improve.

Although the Cement Consumption Index did fall rather sharply in February 2009, the index still appears to be in an uptrend given that the level of the index in February is still significantly higher than its level in October 2008.

Moreover, on the back of the fiscal stimulus (which is expected to be realized by the end of the second quarter) coupled with monetary policy easing, it is unlikely that Indonesian economic activity will weaken significantly going forward.

Indeed, the dRi Leading Economic Index (LEI) suggests that the economic contraction is likely to come to an end in the near term.

Even though the LEI was little changed in February 2009, the LEI does seem to have stopped falling, thus indicating that the Indonesian economy will soon bottom out.

Nonetheless, there are still some risk factors that might prevent the hoped-for economic recovery from taking place. First is the risk of slow state-budget disbursement. Note that the disbursement of the state budget in the first quarter of 2009 was far from satisfactory.

As a result, the central government funds with the central bank rose sharply in the first three months of 2009 (from around Rp 92 trillion to Rp 172 trillion in March).

The position in March 2009 is significantly higher than the 105 trillion rupiah in March 2008, thus showing that the government still faces difficulties in disbursing its budget.

The slow disbursement of the budget is of concern since the funds, if disbursed, would provide a timely stimulus to the economy from the fiscal side. As the economy is still contracting, economic stimuli - from either the fiscal or monetary side - are badly needed. Failure to provide the economy with a sufficient stimulus will likely delay the recovery of the economy.

The slow disbursement of the budget also reduces liquidity in the banking system. When the Indonesian government collects taxes or issues bonds, it absorbs money from the financial system.

Under normal conditions, when the budget disbursement process is swift, the money is immediately pumped back into the system by way of government spending. As such, tax collection or bond issuances should not unduly impact the financial system.

If the budget is disbursed slowly, however, then the money absorbed by the government remains with the central bank and is not circulated back into the financial system. As a result, given the significant amount of government money with the central bank, the slow disbursement of the budget leads to a tightening of liquidity in the financial system.

Worse still, the banking system currently has to cope with the global economic downturn and the slowing domestic economy. Although the Indonesian banks are still well capitalized overall, Danareksa Research Institute's Banking Pressure Index (BPI) indicates that pressure on the banking system has increased.

The BPI tracks pressure on the banking system and is constructed using data such as the real effective exchange rate, the Jakarta Composite Index, the money multiplier, Real GDP, the leading economic indicator, exports and the short-term interest rate.

A BPI reading above 0.5 means that the banking system is under pressure while a BPI reading below 0.5 is indicative of a healthy banking sector.

The BPI has now been above the 0.5 threshold level since October 2008, and even rose to 0.94 in February 2009. This suggests that the Indonesian banking system is under pressure - the main reason being tightening liquidity, we believe. Under such conditions, disbursement of the state budget would surely help improve conditions in the banking system. Hopefully, this will happen soon.

We conclude that the Indonesian economy went into recession in November 2008 and that it is currently still contracting. However, there are early signs that the current economic downturn will not be prolonged. Nonetheless, there are some risks to recovery, and if the Indonesian fiscal and monetary authorities do not address these issues properly then the recovery will be delayed.