T

he year 2013 was not the brightest for many emerging economies, including Indonesia. While in 2012 Indonesia reached its '€œusual'€ 6 percent economic growth, thanks to its large consumer economy and growing middle class, prospects are bleak for 2014.

In the last few months of 2013, the rupiah, along with other soft currencies, suffered severe depreciation. The value of the rupiah has plunged dramatically since the beginning of the year, which has damaged market confidence.

The rising middle class helped Indonesia weather the 2008 crisis, but in 2013 it may have contributed to our blooming '€œcrisis'€.

This pattern is similar to that of the economic crisis in 1998. During the 1990s, Indonesia'€™s economic boom crashed as investors pulled out their dollars from the domestic market, leading to a liquidity crisis. Massive bankruptcies
occurred because the increasing burden of dollar-denominated debt.

The International Monetary Fund (IMF) stepped in and forced the central bank to increase the interest rate, resulting in another wave of pivot sector collapses. While the IMF had contributed to escalating the economic crisis, the options were limited as Indonesia had to restore faith in its currency.

The situation in 2013 resonates with the situation in 1998 where market confidence diminished due to currency depreciation. A weakening currency is ideally good for exports. In a perfect market, the market will correct itself as exports increase, a country will gain from surplus and new foreign reserves and the currency will strengthen again and find a new level of equilibrium.

But at the moment Indonesia is enjoying a double-edged economic boom. Mass consumption stimulates economic growth, but the economic fundamentals are not completely ready for a mass consumer economy. Take a look at the food sector: Indonesia has the serious problem of not being able to produce its own food sufficiently.

As the largest rice consumer in Southeast Asia, Indonesia is very vulnerable to crop failures because people are reluctant to switch to other staple foods. When local rice production cannot fulfill the domestic market demand, rice has to be imported to pick up the slack.

It is also the largest producer of instant noodles, and Indonesia is one of the biggest noodle consumers in the world; however, the industry depends entirely on imported wheat. This year, Indonesia has also suffered from rising prices of beef and onions due to protectionist sentiment.

While Indonesian decision makers have coordinated to issue appropriate policies to tackle this situation, options are limited because Indonesia has ratified various free trade pacts. Indonesia cannot unilaterally impose tariff barriers as they would violate its international treaties.

It has become prisoner of its own free-trade treaties and may end up as a loser in the free-trade game.

So far, the government has introduced various policies to offset this problem, such as increasing taxes on luxury goods, reducing oil imports and stopping the export of raw minerals starting next month. The central bank has also eased its restrictions to ensure banks and exporters can increase liquidity.

However, these short-term policies do not address the fundamental problems in the Indonesian economy. The policies could help temporarily offset the painful trade deficit and weakening currency, but they are not enough. Medium-term or long-term strategic policies have to be formulated to address the real problems instead of the symptoms.

For example, the state should give incentives (such as easy credit) to vulnerable sectors and small and medium enterprises affected by the free trade pacts.

Unfortunately, financial institutions tend to give easier access to consumer activities instead of loans for small and medium enterprises.

The major difference between 1998 and now is that the Indonesian rupiah is now managed under a floating exchange rate regime.

The central bank no longer needs to dip into its foreign reserves as aggressively as before to defend the rupiah'€™s rate.

In the worst case scenario, Indonesia may need to ask for another liquidity injection from other sources, though the IMF is no longer the only option. The central bank has signed bilateral swaps with other central banks.

There is also the Chiang Mai Initiative, which provides liquidity from pooled foreign reserve currencies from the ASEAN+3 members with less draconian conditionality.

While the situation is not as severe as in 1998, the current '€œcrisis'€ is an opportunity to examine what is wrong with Indonesia'€™s economy.

Namely, a consumption-based economy is not always viable in a country with a weak currency and a high import rate. It triggers overheating in the economy that could end with a crash.

The reality of 2013 has shed light on the weak foundation of Indonesia'€™s consumption-based economy. It is fragile because of its over-dependence on imported goods. Indonesians consume more than they produce. Mass consumption will not be sustainable in the long run if the export sector remains sluggish.

The Indonesian middle class has helped to shelter the country from 2008 crisis, but it has also contributed to the trade deficit, because it is easier to import and consume rather than to produce and export.

Financial institutions also more aggressively disbursing loans for consumption instead of loan for small and medium enterprises.

Perhaps the 2013 '€œcrisis'€ is a signal for decision makers to pay more attention to the export sector, to introduce strategic long-term policies and a wake-up call to not be disillusioned by Indonesia'€™s autopilot economy and rising middle class.