'€œIf you know the enemy and know yourself, you need not fear the result of a hundred battles,'€ Chinese philosopher Sun Tzu wrote in his book on military strategy Art of War. The statement is relevant in the question of how bad the US Federal Reserve rate increase will hurt Indonesia in 2016.

It would be impossible to guess without knowing the fundamental condition of Indonesia and its competitors, especially after Bank Indonesia released foreign-exchange reserve at US$105.9 billion as of Dec.  2015.

The country is indeed in a fight against the global slowdown, decreases in commodity prices and the negative impacts of any US benchmark interest rate hike in 2016--after the 25 basis points rise announced on Dec. 16 to a range of 0.25 percent to 0.5 percent.

A further increase could lead to capital outflow as investors seek rising yields in the US bonds market '€“ which in turn would pressure the Indonesian economy further as it would weaken the rupiah and further burden local companies with debts in US dollars.

The impact is more worrying for Indonesia as the country has a current-account deficit, which is when capital outflow from imports, services and investment is more than capital inflow.

Fitch Ratings head of Asia-Pacific sovereigns Andrew Colquhoun said the real uncertainty was how quickly the Fed rate increased and to what extent. There is still a significant difference in where the Fed says it sees the rate going and what the market is pricing in.

'€œAn out-turn closer to Fed guidance would be a substantial shock for a region where private sector debt levels have risen rapidly and where capital flows have already started to reverse,'€ he said in a statement.

This uncertainty, he further said, puts a premium on credible and coherent policy responses by authorities in buffering sovereign credit profiles. BI's foreign reserves registered a $5.9 billion year-on-year decline, partly as a result of intervention to control currency volatility this year.

Thus, the rupiah depreciated 11 percent this year to around 13,800 to the dollar. For comparison, the ringgit weakened 18 percent against the US dollar in the same period. Indonesia and Malaysia have similarities, especially in the big portion of commodity-based exports amid the global slowdown.

In such a situation, larger capital outflows and further currency depreciation as a result of an increasing rising Fed rate is bad news. '€œHow big will the impact be?'€ is a tricky question and '€œhow to deal with it?'€ is an important question.

Therefore, it is interesting that Coordinating Economic Minister Darmin Nasution has predicted a gradual increase in the Fed rate next year that will put pressure on the Indonesian economy at least until 2018.

"We should be aware that the Fed will increase its interest rate by 100 basis points in a year. This means there will be pressure, particularly in countries that have current-account deficits. There will be constant pressure and this can last three years until 2018," he said in Banten last week.

His statement shows his understanding not only of the risk of a Fed rate increase next year but also of the vulnerability of the Indonesian economy. Without the right measures, the condition could worsen as pressure awaits next year, he said. Then, what formula will he prepare for next year?

"To deal with the medium-term effect, we must answer it with better economic growth. It will be a big problem if our economy stagnates while the current account continuously records a deficit. The key is investment growth," Darmin said.

The government recently announced seven economic policy packages, containing regulations and deregulations, to expand the economy amid external pressures, such as capital outflow and commodity price drops.

Darmin '€“ likely to end up being known as "the father of deregulation" because of the number of economic deregulation-oriented policies he has issued '€“ has pledged to introduce further stimuli to boost the economy next year.

AEC challenge

The momentum seems rights as the country will face the ASEAN Economic Community (AEC) starting next year. All economies in the region are facing the same slowdown and trying to survive.

With simplified bureaucracy and more investment incentives as a result of deregulation, the government hopes to lure more investors from the region.

This will not be as easy as it sounds. Currently, Indonesia ranks 109 in the 2015 ease of doing business survey. Five Asian countries have left us way behind. Singapore ranks first, Malaysia 18th, Thailand 49th, Brunei Darussalam 84th, Vietnam 90th and the Philippines 103rd.

However, according to BI senior deputy governor Mirza Adityaswara, the survey does not take into account the effects of the seven policy packages, which, according to Darmin, will only be felt in 2016.

"Despite the survey results being released prior to the issuance of the economic deregulation policy packages, our ranking has improved. Hopefully we will move up [in ranking] next year," Mirza told thejakartapost.com.

Assuming that the packages work effectively and more investors weigh in ­'€“ instead of more imported goods flowing in, squeezing out uncompetitive local products and leading to unemployment, bigger trade and current accounts deficits '€“ new problems are likely to emerge.

As more regional foreign investment flows in due to the AEC, Indonesia will see more investment and services earnings flow out of the country, as investors usually build factories or establish companies in Indonesia to sell goods and services to serve Indonesian market.

The investment returns as well as the earnings will be sent back to their holding company abroad. In the end, it will put further burden on the current account, and will not be simply a short- or medium-term condition but a long-term one as long as the business and the economy flow.

The central bank--as the monetary policy maker--has anticipated capital outflow by preparing to intervene and establish more swap agreements, such as with Australia's Reserve Bank. But how about the fiscal-side? Simplifying permits and regulations or giving tax incentives in its stimuli packages is one thing, but having most stimuli to retain earnings in the country and benefit foreign reserves is another.

Ironically, the country has yet to maximize existing earnings from exports. BI reported that only 11 percent of export earnings were converted to rupiah, with only the remaining 98 percent being reported to the central bank.

BI Governor Agus Martowardojo has therefore urged the government to issue the promised government regulation (PP) on tax incentives for export earnings converted to rupiah and deposited in local banks.

This is what President Joko '€œJokowi'€ Widodo and his administration, especially BI, need to address proportionally while deregulating the structure of the high-cost economy. The stimuli must ultimately benefit the nation in the form of better a current-account deficit.

It also should be implemented by the government effectively, a measure that most previous governments failed to do.

'€œWe believe President Jokowi is switching gears from government-led economic growth to a private sector-driven one. We have witnessed aggressive tax collection and direct market intervention,'€ said KDB Daewoo Securities Indonesia head of research Taye Shim. 

Through a series of economic policy packages, he further said, he expects to see more efficient growth as the government sets the stage for private-sector professionals to do what they do best.

However, efficient growth will not be enough if the biggest problem, namely corruption, persists. This is the biggest enemy the country has failed to defeat for decades, especially amid public pessimism in response to the less-than-promising Corruption Eradication Commission (KPK) commissioners, most of whom are newcomers whose integrity in battling corruption has yet to be proven.

We should not forget about corruption being a systemic problem, since the biggest problem of all battles is usually the enemy within, just like Sun Tzu warned centuries ago when he wrote: '€œThe most important fight is against the enemy within.'€ (dan)

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