Thank you, Mr Tony, glad to be here at this excellent conference in front of the distinguished speakers. Indeed, we are living in a very difficult, volatile, uncertain, complex and often ambiguous time. What do we have to do about it? We need to maintain resilience but at the same time support growth. It is very difficult, very challenging. In daily life, we are always being taught three things that we have to do. First, of course, make your body healthy.
The biggest challenge is to stay healthy. Fundamental economics to be right, some policies to be right but it is not enough. Second, we have to have a blanket in case there is unfortunate weather, we have to have a blanket to cover ourselves. We have to build resilience on the buffer. Third, make a lot of friends. In case you need it, call a friend to help us. Three things that we have to do. We have to think in this VUCA way. I want to talk about how we need to do this conceptually and how we implement it in Indonesia.
This is the situation. The recent crisis had a much deeper and shorter impact, yet a prolonged recovery compared to crises in the 1950’s, 1960’s and 1980’s, as shown by recent IMF studies. This is actually what the left graph shows. What do we need to do? I was talking about the guiding principle of the policy on the strength of sustainable macroeconomic structural reforms, strengthening institutions, as well as the first account system policy framework. Nevertheless, we have to be mindful this policy may not be going in the consistent way. We have a policy mix. Some of the policies can strengthen growth but some of them are more fragile. Financial market deepening can support growth but at the same time may increase vulnerability but structural reforms on the institutions, labour and so on may, at the same time, support growth and also increase resilience.
Dr. Perry Warjiyo
Deputy Governor of Bank Indonesia
In ASEAN, to sustain growth and maintain resilience we need to build layers, multiple layers of safety nets at the national as well as regional and global levels. The first line of defence, of course, is to make your economic fundamentals sound, including sound economic policy, macroeconomic policy, financial structural reforms, adequate FX reserves as well as prudential management and strong institutional policy. First line of defence – you have to be strong, be prepared.
The second line of defence is to make a lot of friends. Have bilateral cooperation with other central banks, regionally, through the Chiang Mai Initiative (CMI), as well as globally. This is the main line of thinking that we have to formulate nationally to be able to maintain resilience and support a multi-layer safety net.
Nationally, we need a policy mix. We have to have a proper policy mix of central bank monetary and macroprudential policy as well as fiscal policy and, at the same time, implement structural reforms. The central bank policy mix supports monetary and financial stability through interest rate policy, exchange rate policy, macroprudential policy and other policies, fiscal policy and, at the same time, support macroeconomic stability as well as supporting structural reforms to increase productivity, reform investment, infrastructure and others.
This is why it is very important to have an optimal policy mix. As I said, every policy has an objective. We need to have coherent synergy of the objective and the right optimal policy instruments. As we understand, monetary policy as well as fiscal policy can stimulate economic growth in the short term through the demand side as well as policy on the financial sector. To increase potential growth, however, we need structural reforms - investment, infrastructure, products and labour. At the same time, we can increase our economic growth but at the same time we can manage our demand through macroeconomic policy. This is the stability and growth nexus through monetary-fiscal policies, immediate and structural reforms.
But in the VUCA world, this is not enough because globalisation is introducing more cycles - economic, financial, boom and bust. In the VUCA world, the line of thinking to make proper fiscal, monetary and structural reforms is not enough. We have to be able to manage the economic and financial cycles from financial development as well as from the capital flows. Studies have shown
Maintaining Resilience and Momentum of Growth in the VUCA World that many crises occur because of excessive external debt, excessive lending, excessive leverage and so on. This is the issue of macroprudential policy and capital flow management needed to manage the cycles –countercyclical policy is very important for the boom and bust cycle. As I said, this is fiscal and monetary policy as well as structural reforms being complemented with macroprudential policy and capital flow management.
What kind of a buffer is needed against any external shock? Whether we are talking about an excessive current account deficit, capital flight or others.
Of course, we have been taught that exchange rate flexibility is important but in the VUCA world it is not enough. We need to build adequate foreign exchange reserves. Theoretically, more flexible exchange rates require smaller FX reserves. In the VUCA world, fear of floating is real, not theoretical. Even if we maintain exchange rate flexibility, we still need to buffer adequate foreign exchange reserves. This is important and, at the same time, also be mindful of the volatile capital flows. Theoretically, greater exchange rate flexibility, open current account is the mantra of the concept and in the real VUCA world it is not like this. Exchange rate flexibility, adequate foreign exchange reserves and foreign capital flow management, including tax on capital flows, a holding period, prudential external debt and others. This is the buffer that we need to build.
We have to have a lot of friends to be called upon when needed.
Through the Bilateral Swap Arrangement among central banks, through the Chiang Mai regional financial arrangement, like the Chiang Mai Initiative, and at the same time, if needed, we call big brother. Maybe in normal times we do not like it but in the bad times, if needed, then call big brother, which is the stigma involved in calling the IMF but we need to be strong, have a lot of blankets and have a lot of friends. This is the concept we implement in Indonesia, especially after the Fed’s Taper Tantrum.
After the Fed’s Taper Tantrum, we made a lot of macroeconomic adjustments, along with fiscal tightening, monetary tightening, macroprudential tightening and introducing a lot of prudential regulations and the result was that we quickly recovered our economic stability in 2013–
2014. Of course, economic growth was slowing but when we maintained our stability in 2014 and 2015 we relaxed the regulations. After restoring stability, we introduce our steam rollers on the fiscal side, thanks to the Government’s
subsidy reforms, accommodative monetary policy, macroprudential policy, exchange rate flexibility, financial market deepening as well as structural reforms.
Recovery is underway even though it is a bit sluggish but we have already recovered since 2015. Governor Agus has already given us an assessment of the recent developments. As I recall, for example, we expect economic growth this year at 5–5.4%, next year 5.1-5.5%, inflation is very low, falling from 8.3% to 3.02% last year, now inflation is 3.9% and we expect about 4% this year and next year below 3.5% within our target. The exchange rate is quite stable and our external debt is being maintained.
This is the policy mix we coordinate with the government, we coordinate fiscal policy stimuli, accommodative monetary and macroprudential policy and structural reforms. From the central bank policy mix we introduced relaxation, reducing interest rates. Since 2016, and now with the latest cut we already got 1.75%, to 4.5%. We introduced greater exchange rate flexibility, financial market deepening and we relaxed our macroprudential loan-to- value ratio to support bank lending as well as the payment system. With the stability achieved since 2014 we have enjoyed more room for accommodative monetary policy to support growth from the central bank along with fiscal stimuli to complement structural reforms.
I think our external sector is being strengthened. The current account deficit has declined from 4.2% in the middle of 2013. Now it is very low, this year we expect our current account deficit to be 1.5-2% of GDP. Next year about 2-2.5% of GDP. For Indonesia, Prof Hal Hill has shown that as long as the current account deficit is below 3% of GDP it is ok. We are an emerging market. It is in our policymaking. Governor Agus already updated us regarding the position of reserve assets, hitting an all-time high of USD127.8 billion, even though we introduced greater exchange rate flexibility we have to have an adequate blanket in the form of FX reserves as well as a line-up of friends that we can call on. We have bilateral swap arrangements with Japan, South Korea and Australia. We are in the process of renewing the bilateral swap arrangement with China and so on. We have also reformed the Chiang Mai Initiative as well IMF’s global financial safety net as necessary. We are building layers of defence.
Maintaining Resilience and Momentum of Growth in the VUCA World We have also strengthened our risk mitigation of external debt. Indonesia is one of the few countries that has strengthened risk mitigation of external debt. For the public, we have a limit of 3% of fiscal deficit, for the banks there is a ceiling on their external debt but for non-financial corporations we introduced policy in 2014. We still have an open capital account, meaning that anybody can borrow abroad, including nonbank corporations but we require them to employ better risk mitigation. They have to borrow with prudence. In 2014, we therefore introduced a regulation requiring nonbank corporations to maintain a hedging ratio of 25% of net external debt that is due within three or six months. They have a liquidity ratio as well as minimum credit rating of one notch between investment grade. We have introduced sanctions and expanded law enforcement. We remind violators once, twice and if they do not comply with our regulations the third time, we will send the CC of their non-compliance to the creditor. So far, compliance has been quite good, about 2,500 companies already report to us, and close to 90% are compliant with our hedging ratio. Better risk mitigation.
Our banking industry is quite resilient, even though lending is very slow but NPL is manageable and the Capital Adequacy Ratio (CAR) is high.
Our problem now is bank lending is quite low and this is why Governor Agus is very strict and supporting us to further facilitate financial market deepening. While bank lending is quite low, nonbank financing in terms of corporate bonds, medium-term notes (MTN) and Negotiable Certificates of Deposit (NCD) is rising. There are diverse figures in our economic financing but we also have strengthened our crisis prevention and resolution protocol.
Last year we issued a new act on financial stability prevention, involving coordination with the Minister of Finance, Central Bank, OJK, IDIC on how to create early warning exercises, crisis prevention protocol and crisis resolution protocol under the Financial Stability Crisis Prevention and Resolution Act.
After the fiscal policy was introduced in line with energy reforms, tax revenues remained quite low but the Government was already able, with the subsidy reform, to adjust the expenditure to now being directed into building infrastructure for future development. There is a lot of progress everywhere in the country, a lot of progress on the infrastructure, on the roads, airports, seaports, energy and so on. Last year, for example, about eight or nine airports were built along with around ten or eleven seaports and so on. There are
fiscal stimuli from the Government but because of the economic decline of tax receipts there are problems we are facing but the policies are there.
We have introduced structural reforms to the investment infrastructure to be more productive going forward. I think we are quite happy. Coordination between the central bank and government is on course. The monetary, macroprudential, fiscal as well as structural reforms are being implemented and we are building resilience through buffers and we also maintain close cooperation with other central banks so we are quite confident our economic recovery will continue to progress and become more positive. We expect, as I said, 5-5.4% growth this year and 5.1-5.5% next year. Starting in 2019, however, the impact of productivity in infrastructure investment will start to kick in. We expect, starting in 2019, that our economic growth will accelerate because of the positive impact of productivity as well as other structural reforms. In 2019, we expect 5.3-5.7% and moving forward to 6% in the longer term. Inflation will be coming down to our target of 3% over the medium term if we maintain a healthy current account deficit.
As I said, we are trying to build stronger economic fundamentals with structural reforms, we are building a lot of buffers and I think we have enough friends to call on if something is needed. This is what we are doing in the VUCA world.