T

he economy is experiencing severe pressures as the rupiah has depreciated around 11.5 percent (year-to-date) to the level of 14,000 to the US dollar, the lowest level since the crisis in 1998.

The capital market index has also fallen by around 15 percent and the yield of government 10-year bonds increased by around 1 percent.

The economy is slowing down with growth falling to 4.67 percent in the second quarter. The usual blame for this slump is external factors, even though domestic factors also contribute significantly.

Externally, the plan of the US Federal Reserve to increase interest rates and the slowing down of the Chinese economy have contributed to the sharp rupiah depreciation.

The yuan devaluation has pushed more currencies down into depreciation. Investors flew out of the stock and bond markets, thereby pushing down the capital market index and propping up bond yields.

The worry is whether the 1998 crisis could happen again, but judging from the banking situation that is very important for financial stability, the conditions are still fairly good. Gross non-performing loans (NPL) are still at 2.6 percent and capital adequacy ratio (CAR) is still high at around 20 percent.

However, NPL could worsen as the economy is slowing down and the rupiah depreciation makes it more difficult for debtors to service their debts.

Indonesia, like China, is experiencing a downturn in its financial cycles that are characterized by the slowing down of credit growth and the decline of asset prices (capital and property markets).

The peak of the financial cycle in Indonesia took place between 2011 and early 2013 when credit growth exceeded 20 percent and asset prices were very high.

The downturn of the financial cycle brings stress to the banking and financial sector in general. In 1998 the downturn of the financial cycle led to a banking, financial and economic crisis caused by the cascading impact of the political crisis.

This time, the risk of financial crisis is not high yet. However, the uncertainties as to where the market correction will end and how effective the policies of the central bank and government will handle the situation has caused nervousness among investors.

The Financial Services Authority (OJK) anticipated the worsening of banking asset quality by relaxing the requirements for credit restructuring. Bank Indonesia relaxed the LTV (loan-to-value ratio) to spur credit growth.

In order to limit demand for the dollar, BI limited the amount of dollar buying that lacked underlying transactions from US$100,000 to $25,000 a month per customer.

Earlier in July, the central bank enforced the rule that makes the use of the rupiah mandatory for domestic cash and non-cash transactions.

However, those policies have not brought significant results yet.

The external pressures are simply too strong and the credibility of policy makers are not restored yet and are even shakier after the Cabinet reshuffle.

BI is very careful about intervening in the currency market, since this is not an effective measure and limited foreign exchange reserves are available. If the strong pressure continues, there is no other way for BI but to increase interest rates.

Certainly, if interest rates are increased, it will push down further economic activities, but the stability of the financial system is the top priority.

Unfortunately, the fiscal authority has not done enough yet to stabilize the economy as the pace of investment in infrastructure remains slow and the stimulus of tax incentives for certain sectors is undermined by the aggressive effort to increase tax revenues.

The fiscal authority should be more realistic in setting tax revenue goals, however dire is the need for bigger revenues to finance development. Under a slowing economy, it is better to launch tax incentives and let corporations and individuals spend more because even if the government is able to increase tax revenues, its institutional capacity to implement its budget is still very low.

Moreover, the government stance on foreign investment seems to be mixed. It is not the time for too many inward-looking policies as Indonesia badly needs foreign investment.

The recent increasing of inward-looking policies that are intended to support domestic production was badly timed and not effective to spur economic growth.

The government also needs to improve its policy coordination, especially now when the external and internal factors are not favorable. The policy makers should first regain market confidence to help maintain stability in the financial markets.
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The credibility of policymakers are not restored yet and are even shakier after the Cabinet reshuffle.
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The writer is senior fellow at the Center for Information and Development Studies and the Habibie Center, Jakarta.