Project Syndicate : Navigating Economic Perfect Storms Dec 12, 2022 SRI MULYANI INDRAWATI

 Navigating Economic Perfect Storms

Dec 12, 2022

SRI MULYANI INDRAWATI

The global economy has been beset with a combination of supply and demand shocks that has generated stagflationary pressures and greater debt distress. But, owing to sound countercyclical policy responses and other factors, a few economies have managed to sustain growth.

JAKARTA – During the opening of the summit of G20 finance ministers and central-bank governors on October 12, 2022, I warned that the world is facing increasing and compounding risks from high inflation, weak growth, energy and food insecurity, climate change, geopolitical fragmentation, and rising debt distress. Low-income countries will bear the highest burden, but also middle-income and even advanced economies face the prospect of substantial pain.

The global economy has been heading into a perfect storm. The COVID-19 pandemic has left scars on all our economies, precipitating a drop in aggregate demand and then aggregate supply. The symptoms are similar to those of a “liquidity trap,” with third-party funding in the financial sector remaining high while the real economy stagnates. To solve this problem, the great twentieth-century economist John Maynard Keynes proposed countercyclical fiscal policy. If the economy works well, the annual budget deficit should be reined in; but if the economy is slowing, deficits should be permitted to grow.

Indonesia, under a 2003 law, disciplined its fiscal policy by limiting annual budget deficits to less than 3% of GDP, and total public debt to 60% (using the same parameters as the European Union’s Stability and Growth Pact). But when COVID-19 caused the economy to contract, the annual budget deficit was expected to rise above 3% of GDP to create room for stimulus. To enable that flexibility, the government waived the budget-deficit limit.

Within weeks of the World Health Organization’s March 11, 2020, declaration of a pandemic, the Indonesian government revised the budget law to allow for an expanded deficit. Indonesia’s annual deficit then grew to 6.5% of GDP in 2020, before falling to 4.6% in 2021 as the economy recovered. In Keeping Indonesia Safe from the COVID-19 Pandemic, a book published by the Indonesian Ministry of Finance in 2022, we detail how Indonesia managed to be one of the few countries in the world that sustained its economic performance even through a global aggregate demand shock.

By expanding the deficit, the Indonesian government kept growth from shrinking by more than 2.1% in 2020, and created the conditions for 3.7% growth in 2021, with consumer price inflation remaining low, at 1.7% in 2020 and 1.9% in 2021. Moreover, in 2021, economic output increased by around 1.6%, exceeding its level in 2019. This year, the annual budget deficit is expected to be around 4.5%, reflecting the government’s response to the latest wave of global supply-side shocks. But starting in 2023, the deficit should return to below 3%, barring another crisis.

After the initial economic storm that COVID-19 whipped up, the global economy is now in the midst of a second tempest. Mobility restrictions and other public-health measures from the height of the pandemic disrupted services, snarled supply chains, and curtailed production in key sectors such as semiconductors (which are used in many other manufactured products, including new cars). The total value added in global manufacturing has decreased by 4% from 2019 to 2020, as did the number of mother vessels shipping freight between major ports.

Unlike the first storm, this second one brought both weaker growth and high inflation, owing to rising costs of global production and transport, which were pushed even higher in 2022 by the spike in hydrocarbon and food prices. The Indonesian Crude Price rose above $100 per barrel and settled around a consensus forecast of $105 per barrel, on average. As food prices have risen, tens of millions more people have fallen into food insecurity. Unfortunately, regardless of what happens in the geopolitical domain, food prices are likely to remain high as a result of ongoing climate shocks.

These food and energy supply pressures have left a heavy burden on the global economy, which is still struggling to heal from the wounds that the pandemic inflicted on global value chains (GVCs). Nonetheless, Indonesia’s economy remains relatively resilient, for several reasons.

For starters, Indonesia’s own connections to GVCs are weighted more heavily toward food and beverage products than automotives and electronics. Second, the country generates a healthy share of its electricity from renewable-energy sources. And third, Indonesia has a greater comparative advantage in raw materials than intermediate goods, which means it is less exposed to semiconductor shortages. It also means that it benefited from windfall income and a current-account surplus when the prices of primary products (including palm oil, coal, rubber, and nickel) rose in 2021. Looking ahead, however, Indonesia still aims to boost domestic manufacturing by producing more intermediate goods, particularly for major GVCs such as automotives and electronics.

In 2022, the pandemic shock to aggregate demand met new shocks to the supply of food and energy stemming from the war in Ukraine, resulting in forecasts of global stagflation and recession in 2023. Yet Indonesia’s economy continues to move in a positive direction, with significant improvements both in aggregate demand, as measured by the consumer confidence index (CCI), and aggregate supply, as measured by the purchasing managers’ index (PMI).

A higher CCI allowed Indonesia to maintain robust growth in the second quarter of 2022, when year-on-year household consumption growth exceeded total economic growth for the first time since the start of the pandemic. With the CCI still rising from July at 123.2 to August at 124.7, and the PMI increasing in the third quarter of 2022 from 51.3 in July to 53.7 in September, Indonesia’s economic performance continued to improve as the year progressed.

Against the backdrop of an increasingly gloomy global economy, Indonesia and a few other countries have become exceptional. The same advantages that have helped shield it from the storms of the past few years should continue to do so again in 2023.

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Sri Mulyani Indrawati

SRI MULYANI INDRAWATI

Writing for PS since 2011

13 Commentaries

Sri Mulyani Indrawati, Finance Minister of Indonesia, is Chair of the Coalition of G20 Finance Ministers for Climate Action.