Economic Resilience and Fuel Subsidies
By: Prof. Ari Kuncoro, Ph.D., Rector of UI and Professor of FEB UI
KOMPAS – (23/8/2022) The United States central bank has voiced that it will raise the benchmark interest rate for the third time in September, although it is possible that it will not reach 75 basis points. This amount is smaller than market expectations that had previously predicted an increase of 100 basis points. This expectation arises because some early indicators, such as housing, have signaled that the recession in the US will arrive early.
US economic growth for the second quarter of 2022 was negative 0.9 percent. Technically, the US has entered a recession because two consecutive quarters recorded negative economic growth. If the choice is a rate hike of less than 75 basis points, inflationary pressures eased from 9.1 percent in June to 8.5 percent in July.
However, positive employment data in July, with the creation of 528,000 job opportunities, keep the chances of the US central bank, the Fed, raising interest rates at a high dose wide open.
Global Impact
The above situation had caused euphoria in the world oil futures market as the less hawkish Fed reduced fears of a world recession. WTI oil prices, which had fallen from USD 108 per barrel at the end of June to USD 94, rose again. However, it could not stay above the psychological limit of $100 per barrel for a long.
After reaching US$98, it fell below the psychological limit of US$90 per barrel, then fluctuated at this price level. This happened due to the reality of recession in the US and growth in China which was disrupted by the Covid-19 lockdown.
The fall in oil prices was also followed by a fall in the prices of other global commodities, reducing global inflationary pressures. Regarding wheat, the agreement between Ukraine and Russia to open an export corridor from ports in the Black Sea to Turkey for export to the rest of the world also impacted the price decline.
In five weeks, wheat prices fell from US$9 per bushel to US$7.48. Another example is crude palm oil (CPO). The price dropped from 5,000 Malaysian ringgit per ton at the end of June to around 4,000 ringgit in mid-August 2022.
The prospect of a Fed rate hike and less attractive investments in oil and other commodities caused portfolio investors to seek safe financial assets denominated in US dollars. The US dollar index, which had dropped to around 105.8 in the first week of August, rebounded to 108.3 in the third week of August.
As a result, the rupiah exchange rate against the US dollar, which had strengthened to around Rp14,600 per US dollar, weakened back to around Rp14,800. The US dollar index resembles a sizeable global pool that affects the rupiah exchange rate. However, some domestic things support the rupiah from depreciating too quickly towards IDR15,000.
Bank Indonesia reported a net buy for Indonesian stocks of around Rp900 billion by foreigners resulting in the JCI rising 0.26 percent to 6,968.78. Foreign funds were also active again in the Government Securities (SBN) market after almost two consecutive months of net selling.
In the fourth week of July 2022, coinciding with the announcement of the second Fed rate hike, incoming funds were recorded at IDR3.28 trillion. This combination made the rupiah quite resilient.
The resilience of economic growth
Indonesia recorded annual growth of 5.44 percent in Q2-2022 amid global uncertainty. This growth rate is the second highest since the second quarter of 2021, which recorded 7.07 percent.
Despite the pandemic, world recession, and suppressed global inflation due to the energy and food crisis, this growth rate means that for three consecutive quarters, Indonesia has been able to stay on a long-term growth path since the commodity boom ended in 2012.
As predicted by the Philips Curve, with higher growth than in previous quarters, inflation will also be higher, as evidenced by July inflation which reached 4.94 percent.
In addition to exports growing by 19.74 percent, public consumption growth of 5.51 percent is inseparable from the domestic purchasing power of Indonesia’s middle class, which has been locked in big and medium cities in Indonesia. With toll roads across Java and Sumatra, the demand and production sides are more integrated. Industries can be located almost anywhere with access to the toll road.
Not to forget, micro, small and medium enterprises (MSMEs) located in remote areas can now physically sell their products to cities through online platforms or to urban middle-class buyers who come to production/tourism locations. This is consistent with the development of the gross domestic product in terms of production and expenditure.
Consumption was driven by spending on leisure services like travel, hotels, and restaurants. The highest growth on the production side was recorded in mobility-based sectors, such as transportation and storage (21.27 percent). This was followed by commoditization and eating and drinking second place (9.76 percent).
This phenomenon illustrates the preferences of the middle class after two and a half years of pandemic confinement. Tourist trips to remote areas of the country have potential linkages with sectors dominated by MSMEs, such as trade, accommodation, culinary, and light manufacturing.
Policy dilemma
The problem is that the growth based on mobility above is supported by fuel oil (BBM) subsidies amounting to Rp502 trillion, which burdens the state budget. Thus, there is a trade-off between growth and budget resilience. Another question is how much the fuel subsidy should be reduced to avoid demand destruction in mobility-based sectors.
Every policy will always have a dilemma or trade-off. If the policy of reducing fuel subsidies due to socio-economic considerations cannot be done in the short term, non-price rationing can be used. This separating equilibrium policy can be carried out based on the type of two-wheeled vehicle, public transportation and logistics, brand, engine CC, and others.
The policy is a strategic waiting game with the possibility that oil prices will hover around USD 80 to USD 90. Due to the US and world recession, there is a possibility of below USD 80, as predicted by Citigroup (Cheong, Bloomberg, July 2022).
The Fed’s plan to keep raising the benchmark interest rate many times in the future increases the chance of a prolonged recession. It should be noted that the resilience of the state budget determines the time frame for moving to the next option (pivotal point), which is to raise domestic fuel prices if the world oil market equilibrium turns out to be above US$90 per barrel again.
Source: https://www.kompas.id/baca/opini/2022/08/22/resiliensi-pertumbuhan-dan-subsidi-bbm
Economic Resilience and Fuel Subsidies
By: Prof. Ari Kuncoro, Ph.D., Rector of UI and Professor of FEB UI
KOMPAS – (23/8/2022) The United States central bank has voiced that it will raise the benchmark interest rate for the third time in September, although it is possible that it will not reach 75 basis points. This amount is smaller than market expectations that had previously predicted an increase of 100 basis points. This expectation arises because some early indicators, such as housing, have signaled that the recession in the US will arrive early.
US economic growth for the second quarter of 2022 was negative 0.9 percent. Technically, the US has entered a recession because two consecutive quarters recorded negative economic growth. If the choice is a rate hike of less than 75 basis points, inflationary pressures eased from 9.1 percent in June to 8.5 percent in July.
However, positive employment data in July, with the creation of 528,000 job opportunities, keep the chances of the US central bank, the Fed, raising interest rates at a high dose wide open.
Global Impact
The above situation had caused euphoria in the world oil futures market as the less hawkish Fed reduced fears of a world recession. WTI oil prices, which had fallen from USD 108 per barrel at the end of June to USD 94, rose again. However, it could not stay above the psychological limit of $100 per barrel for a long.
After reaching US$98, it fell below the psychological limit of US$90 per barrel, then fluctuated at this price level. This happened due to the reality of recession in the US and growth in China which was disrupted by the Covid-19 lockdown.
The fall in oil prices was also followed by a fall in the prices of other global commodities, reducing global inflationary pressures. Regarding wheat, the agreement between Ukraine and Russia to open an export corridor from ports in the Black Sea to Turkey for export to the rest of the world also impacted the price decline.
In five weeks, wheat prices fell from US$9 per bushel to US$7.48. Another example is crude palm oil (CPO). The price dropped from 5,000 Malaysian ringgit per ton at the end of June to around 4,000 ringgit in mid-August 2022.
The prospect of a Fed rate hike and less attractive investments in oil and other commodities caused portfolio investors to seek safe financial assets denominated in US dollars. The US dollar index, which had dropped to around 105.8 in the first week of August, rebounded to 108.3 in the third week of August.
As a result, the rupiah exchange rate against the US dollar, which had strengthened to around Rp14,600 per US dollar, weakened back to around Rp14,800. The US dollar index resembles a sizeable global pool that affects the rupiah exchange rate. However, some domestic things support the rupiah from depreciating too quickly towards IDR15,000.
Bank Indonesia reported a net buy for Indonesian stocks of around Rp900 billion by foreigners resulting in the JCI rising 0.26 percent to 6,968.78. Foreign funds were also active again in the Government Securities (SBN) market after almost two consecutive months of net selling.
In the fourth week of July 2022, coinciding with the announcement of the second Fed rate hike, incoming funds were recorded at IDR3.28 trillion. This combination made the rupiah quite resilient.
The resilience of economic growth
Indonesia recorded annual growth of 5.44 percent in Q2-2022 amid global uncertainty. This growth rate is the second highest since the second quarter of 2021, which recorded 7.07 percent.
Despite the pandemic, world recession, and suppressed global inflation due to the energy and food crisis, this growth rate means that for three consecutive quarters, Indonesia has been able to stay on a long-term growth path since the commodity boom ended in 2012.
As predicted by the Philips Curve, with higher growth than in previous quarters, inflation will also be higher, as evidenced by July inflation which reached 4.94 percent.
In addition to exports growing by 19.74 percent, public consumption growth of 5.51 percent is inseparable from the domestic purchasing power of Indonesia’s middle class, which has been locked in big and medium cities in Indonesia. With toll roads across Java and Sumatra, the demand and production sides are more integrated. Industries can be located almost anywhere with access to the toll road.
Not to forget, micro, small and medium enterprises (MSMEs) located in remote areas can now physically sell their products to cities through online platforms or to urban middle-class buyers who come to production/tourism locations. This is consistent with the development of the gross domestic product in terms of production and expenditure.
Consumption was driven by spending on leisure services like travel, hotels, and restaurants. The highest growth on the production side was recorded in mobility-based sectors, such as transportation and storage (21.27 percent). This was followed by commoditization and eating and drinking second place (9.76 percent).
This phenomenon illustrates the preferences of the middle class after two and a half years of pandemic confinement. Tourist trips to remote areas of the country have potential linkages with sectors dominated by MSMEs, such as trade, accommodation, culinary, and light manufacturing.
Policy dilemma
The problem is that the growth based on mobility above is supported by fuel oil (BBM) subsidies amounting to Rp502 trillion, which burdens the state budget. Thus, there is a trade-off between growth and budget resilience. Another question is how much the fuel subsidy should be reduced to avoid demand destruction in mobility-based sectors.
Every policy will always have a dilemma or trade-off. If the policy of reducing fuel subsidies due to socio-economic considerations cannot be done in the short term, non-price rationing can be used. This separating equilibrium policy can be carried out based on the type of two-wheeled vehicle, public transportation and logistics, brand, engine CC, and others.
The policy is a strategic waiting game with the possibility that oil prices will hover around USD 80 to USD 90. Due to the US and world recession, there is a possibility of below USD 80, as predicted by Citigroup (Cheong, Bloomberg, July 2022).
The Fed’s plan to keep raising the benchmark interest rate many times in the future increases the chance of a prolonged recession. It should be noted that the resilience of the state budget determines the time frame for moving to the next option (pivotal point), which is to raise domestic fuel prices if the world oil market equilibrium turns out to be above US$90 per barrel again.
Source: https://www.kompas.id/baca/opini/2022/08/22/resiliensi-pertumbuhan-dan-subsidi-bbm