Muhamad Chatib Basri: The Long Road towrad Economic Recovery
Nino Eka Putra ~ FEB UI Public Relations Officer
DEPOK, Wednesday, 8/7/2020 – Kompas.id published an article written by Muhamad Chatib Basri, lecturer at the Faculty of Economics and Business, Universitas Indonesia, in its opinion section – Economic Crisis – entitled The Long Road toward Economic Recovery. Below is the article.
The Long Road toward Economic Recovery
The economy will not automatically bounce back unless the government interferes to boost demand. The government must take all measures to ensure the safety of the people and restore the economy until a vaccine is found.
He took off his helmet. Sweat drenched his face. The online ojek (ojol) driver then handed me the food package I ordered. “Thank you,” I said. He nodded. I had no idea what was on his mind. Maybe he was worried or hoped economic activity would resume and an economic recovery would follow.
He could be one of the those people whose voice was represented in a survey conducted by Saiful Mujani Research and Consulting (SMRC) on June 18-20. The survey revealed that an increasing number of citizens thought the economic situation would improve next year. There is hope even though the threat of an outbreak is looming. Is that right? What is the path for economic recovery? What must be done?
Sources of recovery
There are several things that must be considered. First, what are the sources of economic recovery in the next few years? The Organization for Economic Cooperation and Development (OECD) wrote a grim report: in the next two years, the global economy is not expected to return to 2019 levels.
In the case of China, production indicators have started to improve after economic activity resumed. However, demand is still weak. This is easy to understand. As a global player, China’s economy will depend heavily on the recovery of the world economy, particularly the United States.
China’s and India’s economies have remained weak, putting pressure on the prices of mining products and commodities, particularly coal and palm oil. In fact, our exports still depend a lot on natural resources. The implication is that Indonesia cannot rely on external sources of growth such as exports.
Second, then what is the alternative? Focus on domestic sources of growth, ideally private investment. However, we need to be clear, the economic shutdown and sluggish demand have put tremendous pressure on the business world. In addition, new investment will increase only if there is demand and consumption.
The decision to resume economic activity can indeed drive production. However, if demand is sluggish, why increase production if sales are still low? Perhaps the only sector that still has the engine to move at this point is the government, not the private sector. This is where the role of fiscal policy is very important to boost people’s purchasing power.
Social restrictions are clearly needed to overcome the pandemic, but they can have a bias toward the upper middle class if social protection for the lower middle income groups is not sufficient. Members of the upper middle income group who have savings have the luxury of choosing to stay at home, avoid the pandemic, or resume activities. On the other hand, the lower middle income group does not have many choices. They must return to work unless they receive sufficient social assistance.
My argument is consistent with the results of the SMRC survey that showed that most of the respondents who want economic activity to resume are primary school graduates who work as street vendors and ojol drivers, and who earn less than Rp2 million per month.
On the other hand, those who think that the new normal policy needs to be postponed mostly earn Rp4 million and more per month and have university and professional backgrounds with fixed income. That is why social protection is very important to increase the purchasing power of the lower middle class.
The jump start (initial policy) must be started by providing broader direct cash assistance (BLT), as well as a cash-intensive program, the Family Hope Program (PKH). Social protection needs to be extended to the aspiring middle class. The World Bank (2020) predicted that 115 million people are in the aspiring middle class category (middle class candidates).
If this group is to be the target group, social assistance will need to be provided for an estimated 30 million households. If the value of the benefit is Rp1 million per month and is given for four months, Rp120 trillion or about 0.75 percent of the gross domestic product (GDP) is required for this program.
The real sector
Third, the government stated that there is a risk of an economic contraction in the second quarter. Economic recovery is expected to occur in the third quarter. However, if demand remains sluggish and contraction persists, we will fall into a recession. We all know that these economic difficulties have caused the real sector to stagnate. If this happens, bad credit will increase, and the impact can affect the banking sector.
To avoid this, banks will be very prudent and will even reduce loan provision or stop lending money. It reminds me of my experiences at the G-20 in 2008-2009. At that time, due to the global financial crisis, world trade was paralyzed. There were hardly any commercial banks willing to extend credit to exporters.
The risk of bad credit was too great. The G-20 meeting in London in 2009 agreed to provide US$250 billion worth of trade financing for two years. Multi-lateral institutions also agreed to provide working capital loan and credit guarantees as well as export insurance so that exports could resume. The business world needs this kind od policy.
Banks are of course worried about lending money to the real sector unless there is a guarantee from the government. Therefore, the credit guarantee as well as credit restructuring programs must be executed. On the other hand, because economic activity has stalled, there are practically not many requests for new credit. This explains why the main problem today is actually a credit crunch (banks’ reluctance to provide credit due to bankruptcy risk), not a liquidity issue.
The government has prepared this scheme. This is the right move. However, the government should ensure that: the rules for credit guarantee and interest subsidies must be made simple, easy to implement and do not pose major risks in the banking sector, including credit risk, legal risk, or operational risk. If they are too complex, there is a risk that the program will not be effective.
Banking liqyuidity is generally quite good, as indicated by a decrease in the loan to deposit ratio (LDR) of third-party funds.
We also need to appreciate the Financial Services Authority (OJK) for issuing a loan relaxation policy that is valid until March 2021. However, we should bear in mind that the real problems may only arise after March 2021 when loan relaxation ends. Only then we will know the amount of bad loan unless the OJK extends its relaxation policy. That’s when banking problems will arise as banks may face various problems, from bad credit, profitability, to capital and liquidity.
It is important to understand the path of this problem and how to anticipate it. Other central banks play an important role in providing liquidity support for banks and non-bank financial institutions, particularly those providing loans to small, micro and medium enterprises (MSMEs). Take a look at the policy packages issued by the Reserve Bank of Australia, the Monetary Authority of Singapore, the Bank of Thailand, the Bank of England, The Fed, and various other central banks.
Economic recovery policy
Fourth, after activities return to normal with the resumption of economic activity, the recovery policy can start with fiscal expansion to boost people’s purchasing power, to be combined with monetary stimuli, such as lowering interest rates and statutory reserves (GWM), and policy relaxation for the real sector.
The problem is, is there a fiscal space for this? Law Number 2 of 2020 states that the state budget deficit must return to below 3 percent by 2023. I understand and support this precautionary stance. However, it might be worth looking into our fiscal framework until 2023.
The government’s projections within the macroeconomic framework of the Ministry of Finance show that tax revenues will be in the range of 8.4-9.1 percent of GDP in 2023. On the other hand, the debt to GDP ratio will be in the range of between 36.5 and 37.4 percent in 2023. Given the rising debts, the loan to interest ratio to the total state expenditure is expected to increase from 12 percent in 2019 to 16-17 percent in 2023.
On the other hand, we know that there are mandatory expenditures, such as education funds (20 percent of total expenditures), fund transfers to regions (around 30 percent), village funds (10 percent) out of funds transferred to regions and so on. At the same time, the tax ratio is projected at a mere 9.4-10.1 percent to GDP.
The low tax revenue, combined with an ever increasing expenditure and a budget deficit target of 3 percent by 2023 has signifcantly reduced the room for fiscal expansion. In fact, for the time being, we need fiscal expansion to support economic recovery. Therefore, the government should make careful calculation and base its decision on economic conditions (data dependence), whether an exit from fiscal expansion is too fast or not.
Another alternative is to improve the quality of the expenditure allocation so that every rupiah spent is productive and can encourage economic growth. The fiscal stimulus also needs to be re-evaluated. For example, to what extent are tax incentives effective in this situation, are they being widely used?
If they are not effective, shouldn’t they be used to expand social protection or increase credit guarantees or interest subsidies to support MSMEs? If you look at the data on budget absorption, the social assistance program, especially BLT, despite its drawbacks, still seems to be the most effective program. What must be done is to improve recipient data and overcome overlapping aid schemes so that they are optimal.
The economy will not automatically bounce back unless the government interferes to boost demand. And this has the implication of increasing the budget deficit. I fully understand the risk of a large budget deficit. However, the theme of fiscal policy around the world today is whatever it takes.
The government should take all the necessry measures to ensure the safety of the people and restore the economy. And let’s not forget that the economy won’t fully recover until a vaccine is invented. Therefore, although fiscal discipline is very important, perhaps it can wait until the crisis subsides.
If economic recovery runs at a slow pace, the debt to GDP ratio will not decrease. Conversely, if economic growth can be spurred, the debt to GDP ratio will decrease. A hastened exit can worsen the economic situation. We have to be careful. If there is no second wave of the pandemic, hopefully our economy will hit its lowest point in the second quarter.
The question is, will it be an L-shaped recovery or will it be a U-shaped recovery? We want a quick (V-shaped) recovery. I remember the ojol driver who handed me the food package. He’s certainly not talking about it, but I think he has hope. And that’s our hope too. (hjtp)
Source: https://kompas.id/baca/opini/2020/07/08/jalan-panjang-pemulihan-ekonomi/