Risks Lurk in Asia's Most Upbeat Economy
Travels over the past week through India and Indonesia yielded very different perspectives. There was a sense of grave concern and urgency among market participants and policymakers in India, where high inflation, low growth, an under pressure currency, and regulatory uncertainty have combined to create difficulties unseen in many years.
Indonesia, in contrast, seemed relaxed, marked by minimal concern about growth, overall comfort with the inflation situation, and a broad-based perception that the economy was capable of withstanding the stress in global markets better than it had been in decades.
Some were concerned about the state of politics, slow pace of reforms and infrastructure investment, rising nationalism in the area of mining, and heavy handed intervention in the bond and currency markets, but no one saw high risk of market or economic dislocation. The general sentiment seemed to be that the country was primed for strong growth for years to come.
The Indonesian economy continues to be characterized by exceptionally strong consumption and investment demand. Benign inflation during the past year, helped by a broad range of subsidies on energy products, and substantial intervention by Bank Indonesia, has pushed down the structure of interest rates considerably, leading to a boom in consumption and imports. There is little sign of that boom abating in the near term.
The policy strategy appears to boost investment by pushing interest rates to exceptionally low levels, while keeping consumption under some modicum of control through sectoral lending limits - banks now face some restrictions in the areas of real estate, auto, and credit card lending.
The biggest focus is on foreign exchange market stability, with the central bank imposing repatriation requirement on exporters and opening a dollar deposit facility for banks this year. The former has yet to gain traction, while the latter has received positive response from banks, although the amounts are small.
At times the market has been overwhelmed by heavy handed intervention by the central bank, causing the spread between domestic and off-shore forex rates to spike. The authorities seem to think that the market has broadly stabilized in recent weeks, which appears misaligned from the market's perception.
Indonesian policymakers are keen to prevent disorderly adjustment in bond yields or financing crunch if external risk aversion spikes. A bond stabilization fund is in place to use state owned enterprises' "excess" cash to purchase bonds, although the fund has not been needed thanks to Bank Indonesia's aggressive bond buying program in the past year. A $5.5 billion standby credit line has been arranged to handle emergency budget financing risks.
The central bank has a multi-billion dollar swap line with the central banks of China and Japan, in case balance of payments are stretched.
While these contingencies help deal with external risks, they are not comprehensive. Corporates have considerable external leverage, much of it in short term liabilities, which could still face stress. Exceptionally low fuel prices continue to cause excess consumption and distortion, which would likely result in particularly poor current account figures if exports remain weak and imports stay sticky.
Rising judicial activism on investment related regulation is a source of discomfort among foreign investors. New laws on mining suggest rising protectionism and economic nationalism.
Still, confidence among Indonesians, whether they are consumers or government officials, remain high. Indonesia has been long dormant, a product of the aftermath of the 1998 financial crisis. There are many reasons why its growth rate may not soar in the coming years, and why a boom-bust cycle could ensue in a couple of years, but for the time being, it may well be the most buoyant economy in Asia.
Taimur Baig is the Chief Economist for India, Indonesia and Singapore, Global Markets Research at Deutsche Bank AG. He is a regular guest on CNBC TV.