The Indonesian government should not let the IMF’s high praise of Asia’s leadership of the global economic recovery go to its head. There are looming risks of further shocks and potential spillovers from the euro zone crisis.
International Monetary Fund (IMF) managing director Dominique Strauss-Kahn noted at the opening of the Asian economic conference in Daejeon, South Korea, on Monday that Asia had emerged as a global economic powerhouse from the recent worldwide financial crisis.
He said Asia’s leadership of the global economic recovery had continued unabated in the first half of this year despite recent tensions in global financial markets.
An IMF update on Asia’s economic outlook released earlier last week revised upward growth projections for the region to 7.75 percent this year, against an average global growth rate of only 4.6 percent.
The report cited Indonesia, China and India as three economies in the region with sustained high growth rates last year, despite the contraction in most other countries, because of large domestic markets.
We should not read too deeply into the generous praise and should instead pay more attention to the note of caution the IMF conveyed regarding the heightened risks of tough times ahead. They warned that policy makers in Asia need to remain attuned to negative shocks.
As Indonesia has been experiencing over the last few weeks, the turmoil in Europe and sluggish growth in Japan and the United States has prompted exuberant investors to pour much portfolio capital into rupiah financial assets such as government bonds and the central bank’s instruments. Without proper management, these gushing capital inflows could overheat the domestic economy, bringing about risks of instability and causing dangerous credit and asset bubbles.
Further spikes in global risk aversion could precipitate capital outflows from the country and weaken equity valuations, undermining the positive feedback loop between favorable financial conditions and domestic demand.
Bank Indonesia last month introduced a set of new measures to regulate short-term capital flows by widening the difference between two key interest rates to a range of 5.5 to 7.5 percent and selling longer-term bills. The measures are certainly not sufficient to withstand external shocks from the high volatility of capital flows.
We need a longer-term policy to stimulate further direct investment and private consumption, in anticipation of the potentially extended period of sluggish economic growth in Europe and the US.
Given the lingering big risks of financial instability, as pointed out by the IMF, it has become more urgent and imperative now for the government to accelerate the enactment of laws regarding the financial-system safety net and financial service authority.
The worst of the financial debacle after the impact of the financial and economic crisis in the US, may be long over, but the political contest over the bill regarding the protocols and underlying legal frameworks for managing a financial crisis is still going on without clear schedule for enactment. This put us in a vulnerable position because no one in the government will dare take a decision in case of a financial distress.
The bill on the integration of the supervision of banks and other financial services companies into a single institution (Financial Service Authority) has also been stuck in the House, while Bank Indonesia continues trying to fend off the political move to strip it of its supervisory authority.
