Energy Crisis, US Dollar, and Recession

Energy Crisis, US Dollar, and Recession

By: Prof. Ari Kuncoro, Ph.D., Rector of Universitas Indonesia

For countries with a better chance of facing the prospect of a world recession, mitigating the impact of the global energy and food crises is still not easy. For Indonesia, the policy design will not be the same as in the last two years.

KOMPAS – (14/6/2022) The World Bank, in its Global Economic Prospects launched on June 7, 2022, warned of the prospect of a world recession coupled with high inflation (stagflation) as a result of the Russia-Ukraine conflict. The World Bank cut its global growth forecast from 4.1 percent to 2.9 percent.

This figure is expected to remain for the next two years as the war in Ukraine disrupts investment flows and international trade, especially in food and energy.

The current situation is similar to the 1970s when accommodative monetary policies in developed countries preceded persistent supply-side disruptions.

The prospect of a world recession comes as the US, the world’s locomotive, recorded negative growth of 1.5 percent in the first quarter of 2022, while inflation reached 8.6 percent in May. Annualized auto sales in May were recorded at recessionary levels or 12.8 million units, 14.6 percent lower than the previous month. Weekly mortgage applications ending June 3 were the lowest in 22 years.

Meanwhile, Eurozone growth stood at 0.2 percent in Q1-2022, down from 0.3 percent in the previous quarter.

Encouragingly, with an adequate policy mix, countries with large populations and diversified economies in agriculture, manufacturing, services, and export products seem to have a better chance of weathering the recession. For example, China has just relaxed the lockdown for the city of Shanghai. Its growth in the first quarter of 2022 exceeded expectations at 4.8 percent, exceeding all estimates of 4.4 percent annually.

In contrast with the 1970s recession

The Russia-Ukraine conflict produces an exciting phenomenon. In the 1970s recession, the US dollar was weak, but now it is vital. Not only because of the Fed’s policy of raising its benchmark interest rate by 50 basis points in early May but also because of the exodus of capital from economically sanctioned Russia.

The US dollar index had reached 107, although it is now at 104. Usually, the strength of the US dollar is inversely related to international oil prices, but currently, both are rising.

This development is a double whammy for net importers of energy and food. Developing countries and emerging markets now face a dilemma.

The first alternative is to let these price increases be borne by society. By doing so, budget priorities can be allocated towards sectors with long-term impact—education, health, energy transition, climate change, food, and others.

The consequence is the risk of a decrease in people’s purchasing power, which will lead to an economic slowdown, in addition to potentially causing social unrest. Another option is to increase the allocation of subsidies for food and energy at the risk of reducing the budget for long-term competitiveness through human resource capacity building and infrastructure.

In the 1970s, Indonesia was a net exporter of oil and gas. The world energy crisis brought the US and other industrialized countries to the brink of stagflation. However, for Indonesia, it was a bonanza period. The proceeds from oil and gas exports were then injected into the domestic economy through programs to improve irrigation, infrastructure, and other development programs.

The current energy crisis is more complex as an economic slowdown preceded it due to the Covid-19 pandemic. Indonesia is in the process of recovering growth due to pandemic-disrupted mobility.

The energy crisis and world recession can potentially hamper economic recovery due to price increases on the production side and the disruption of fossil energy-based mobility. In addition, it also undermines the demand side of society because prices are too high.

Mobility stimulus

Last week the price of West Texas Intermediate (WTI) oil reached USD 122 per barrel, although it later fell back to around USD 120. As a bit of a consolation, wheat prices, which surged to nearly US$12.7 per bushel after India banned its wheat exports, fell significantly, though they remained high at US$10.5 per bushel. This price drop came on news of a bountiful harvest in Australia.

For countries that the World Bank says have a better chance of weathering the prospect of a world recession, the job of mitigating the impact of a world energy and food crisis remains daunting. For Indonesia, the policy design required may not be the same as in 2020-2021, when Covid-19 was rampant with massive allocations to the health sector and maintaining the purchasing power of vulnerable groups.

One of the new strategies is to capitalize on the purchasing power of the middle class, who are looking for a new atmosphere after being confined for two years due to the pandemic.

Amid high fuel prices, the phenomenon of delayed flight schedules in developed countries in the northern hemisphere in early June is interesting to observe. That happened due to the limited number of airport staff and flight capacity in the face of people’s high interest in spring travel.

Such services are a factor that explains why growth in the Eurozone and the UK, which slowed down, did not enter hostile territory. This phenomenon was also seen during the Lebaran homecoming holiday in May, followed by crowded tourist attractions, especially during the holiday weekend.

The World Bank’s projection for Indonesia’s growth in 2022 remains at 5.1 percent, not far from the 5.01 percent growth rate in the first quarter supported by mobility-based sectors.

Recent observations show that, in addition to classic stimulus policies such as cash transfers for vulnerable groups, the Pertalite subsidy policy seems to maintain growth momentum by using the spending leverage of the middle class.

Indonesia’s middle class is estimated at around 57 million, or 21 percent of the population. The relaxation preference of the middle class through travel to remote areas of the country has potential linkages with sectors dominated by micro, small and medium enterprises, such as trade, accommodation, culinary, and light manufacturing.

Every policy will always have dilemmas or trade-offs, moral hazards, and free-riders. The significant price difference with Pertamax causes some luxury cars to fill their tanks with Pertalite.

In this regard, a wise saying goes, it is better to do something imperfectly than not to do something perfectly. The most important thing is to pay attention to sustainability, feedback, and continuous improvement.