The post-pandemic recovery has been marked by widening inequality among households

Source: BCA Big Data, calculations by BCA Economist -1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

-20% -15% -10% -5% 0% 5% 10% 15% 20% 25%

AVERAGE POSITION, Q1-20 to Q4-20

AVERAGE POSITION, Q3-21 to Q2-22

Top Segment (98+ percentile)

Upper-Mid Segment (90-98^thpercentile)

Lower-Mid Segment (67-90^thpercentile)

saving rate

nominal gap individual accounts

Lower Segment (67- percentile)

38

Part D – A high-pressure economy?

•

In theory, such uneven recovery provides rationale for the authorities to continue running expansive policies, both monetary and fiscal. Credit and fiscal transfers are both means by which liquidity can be redistributed to

“deficit sectors” (those with negative saving rates and/or negative nominal gap), especially in situations where the windfall either flows abroad or are often left unspent as we have outlined.

•

Unfortunately, this logic does not mesh with the challenging global situation, where we are seeing not just a potential weakening of the Rupiah (Part B)but also a dramatic rise in global inflation. Similar to the exchange rate, Indonesia’s inflation is quite modest compared to other emerging countries. However, this comes at considerable cost, and Indonesia has also caught some lucky breaks along the way which might not persist in the future.

The three most consequential items to

inflation have so far stayed mostly stable

•

Much of the uptick in inflation during recent months has been caused by the so-called volatile foodstuffs(Exhibit 23), such as chili peppers which has been hampered by bad harvests and cooking oil due to high CPO prices. However,

these items account for relatively small parts of the consumption basket, while the three most consequential items by far – rice, fuel, and electricity – have stayed mostly stable(Exhibit 24).Rice, of course, has been much less affected by the Ukrainian War compared to other staple cereals.

Meanwhile, low fuel and electricity prices are sustained by subsidies, and price adjustments thus far have been limited to items that are typically consumed by the relatively few high-income households.

•

Minimizing inflation, then, would involve pairing expansive fiscal policies with monetary tightening (Table 3).

The latter is crucial not only to stabilize the Rupiah, but also to curtail the expansion in money supply while money velocity continue to rise as the economy recovers(Exhibit 26).To this

The Rupiah has been among the stronger commodity currencies in

real terms during the past decade

inflation “dampener” for its trade partners. But despite this, imported inflation – particularly on raw materials – have been in double-digits in the past year (Exhibit 23). Local producers and importers had been reluctant to pass on this higher cost to consumers, but this may be changing, as evident from the gradual increase in core inflation. We should emphasize, too, that such high imported inflation has happened despite limited depreciation, so core inflation could rise even further if the Rupiah weakens anew.

end, BI could reduce base money growth by selling its SBN holdings, and also reduce the money multiplier by discouraging bank loan growth. Given the policy changes that we have mentioned, it seems that BI is actually doing both, albeit sans BI7DRR hike.

•

Unfortunately, this policy setup could also lead to “Dutch disease” in the long-run, as it maintains a strong Rupiah while subsidizing consumption at the expense of productive investment. Indeed, the Rupiah has been among the stronger commodity currencies in real terms during the past decade(Exhibit 27), and BI may be open to changing that to restore the competitiveness of Indonesia’s manufacturing sector.

•

We would argue that such tradeoff – substituting government CAPEX for subsidies – may actually detract from growth, even in the short-run. Except for the pandemic, consumption (basic and discretionary) has been very resilient, consistently contributing about 2.8% to GDP growth even amid a series of fuel price hikes in 2013-14(Exhibit 30).Now, with

40

Maintaining energy prices at current levels through the next fiscal year might

require cuts in other expenditures

•

The opposite setup – tight fiscally, loose monetarily – is the policy combo that can best prevent Dutch disease, but it would also cause a sharp (but potentially brief) spike in inflation. The case for subsidy reduction is nonetheless quite clear: the budget deficit is expected to return to its usual legal limit at 3% of the GDP in 2023, while interest payment increases due to rising rates. Energy subsidies are very expensive at more than 2.6% of the GDP (Exhibit 28), and as oil prices may remain elevated (i.e. above USD 80/barrel) in the medium-term, expecting an “organic”

reduction in outlays without letting fuel prices rise is a dubious prospect.

•

Meanwhile on the revenue side, expecting this year’s strong growth to continue into 2023 is also questionable, as the strong nominal GDP growth and highly favorable commodity ToT index might not be replicated next year(Exhibit 29). Maintaining energy prices at current levels would thus require cuts in other government expenditures, including potentially on infrastructures.

consumption’s contribution back to pre-pandemic norms (2.92% in Q2-22), keeping subsidies no longer adds much to growth, but would instead limit contribution from government spending and fixed-asset investment.

•

As such, the situation in the next few months might resemble what some have called “high-pressure economy”. This is where the authorities let the economy run slightly hotter than what might be deemed prudent, in the hope that it will bolster employment and improve competitiveness (by weakening the currency). There is no “grand unified theory” for this kind of policy, but some recent leaders – notably Donald Trump and Turkey’s Recep Tayyip Erdoğan – has been claimed as its exponents.

(TF/TM) is certainly the most negative for growth, especially for the deficit sectors as we have discussed.

•

Short-term political concerns might eventually lead us towards LF/TM, but for the time being the situation can still be described as LF/LM. Aside from the lack of BI7DRR hike, there are multiple reasons why BI’s posture is still basically accommodative, including relaxation of loan-to- value (LTV) rules for consumer loans (until year-end) and also continued moral suasion for banks to lower their benchmark lending rates.

The situation in the next few months might

resemble what some have called “high- pressure economy”.

•

But perhaps the policy that is most decidedly accommodative is the requirement (RPIM) for banks to increase lending for small/medium enterprises (SME), where it has to comprise 20% of their portfolio by the end of 2022. As a result, SME loans have grown very rapidly, to the

point where they comprise 30% of all loan growth in the past year.

Hiking BI7DRR now may thus be akin to stepping one foot on the gas pedal and the other on the brakes at the same time, with the RPIM serving to counteract BI’s effort to control the money multiplier.

42

Global recession and continued QT would

lead to a much less benign situation for

Indonesia

•

The success of such policy, however, greatly depends on context. If we disregard the sound and fury of his tariff wars, Trump actually succeeded in attaining very low unemployment rates before being derailed by the pandemic. Erdoğan’s version, however, led to a spiral of depreciation and inflation which Turkey has not gotten out of. Of course, Erdoğan has two disadvantages relative to Trump, namely that the Lira is not a reserve currency and that Turkey is an energy importer(Exhibit 1)– meaning that once energy prices started to spike in Q4-21, the Lira’s value cratered.

•

So what is the context for Indonesia?

Unlike Turkey, Indonesia is a commodity exporter, and thanks to BI’s reforms in the mid-2010s, it is a less heavily Dollarized economy. Thus, while high commodity prices and strong USD are very disadvantageous for Turkey, it is much less punishing for Indonesia.

However, if the world is plunging into a recession and the Fed does not pivot fast enough – or its quantitative tightening (QT) outweighs a pivot in rates – we might be entering a much less benign situation for Indonesia (Exhibit 31).

•

In a way, we see some parallel between the current “Powell shock” and the old “Volcker shock” of 1980-81. Thanks to higher debt levels and an older US/global demographics, Powell may not need to raise rates up to 20% (like Volcker) to fight inflation and to trigger a recession. The Volcker shock, we should recall, led to the slowest growth rates in the Suharto era prior to the 1998 crisis (Exhibit 32), as the economy came off the sugar high of the oil/gas boom. The New Order government had to reform the economy in order to attract FDI, which would eventually usher an era of industrialization in the early 1990s.

tightening at such a moment would necessarily lead to a painful period of adjustment and a sharp growth slowdown. A more preferable scenario would be for the authorities to begin a gradual adjustment process, while putting finishing touches on Jokowinomics’ earlier wins in infrastructure and structural reforms. That way, we may be better placed to weather the short-term uncertainty, while capitalizing on the opportunities of shifting global supply chains in the long-run.

-50 -40 -30 -20 -10 0 10 20 30 -15

-10 -5 0 5 10 15 20 25

Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 Nov-15 Jun-16 Jan-17 Aug-17 Mar-18 Oct-18 May-19 Dec-19 Jul-20 Feb-21 Sep-21 Apr-22

-5 0 5 10 15 20 0 2 4 6 8 10

Exhibit 23

44

Source: BPS, BI, Bloomberg, BCA Economist

11.5 2.9

6.5

16.7 YoY %

4.9

-2.7