Welcome Back Sri Mulyani - Now About Indonesia's Economy

It was a black day for Indonesia when in 2010 Finance Minister Sri Mulyani Indrawati was hounded out of government over her handling of the Bank Century rescue of late 2008.   For she is, by some distance, one of the most impressive politicians/financial technocrats to have come from Southeast Asia in recent memory. Consequently, when on 27th July President Jokowi announced that he had lured her back from the World Bank to resume office at the Ministry of Finance, it was easy to feel renewed optimism about Indonesia.  

Financial markets anticipated it, with: 
the Jakarta Composite Index up 12% since the end of June, a move which has been largely attributed to the advance rumours of Sri Mulyani’s imminent return;  
10yr government bond yields falling to 6.85%,  the lowest since June 2013, whilst
the currency has remained stable against the dollar. 

But Sri Mulyani would be the first to acknowledge that there is a limit to how much difference one person can make - no matter how clear eyed and determined they may be. What is the state of Indonesia’s economic fundamentals which greet her? At best, they are modestly encouraging, but they have not yet fulfilled their promise of breaking through to something better.  

The details of 2Q GDP show some of the promise. In real terms, 2Q GDP rose 5.2% yoy, which was the fastest since 4Q13, but this was flattered by a relatively weak base of comparison. Growth was entirely domestically-led, with private consumption rising 5% yoy, accounting for 2.71pps of growth, gross fixed capital investment rising 5.1%, accounting for 1.61pps of growth, and government consumption rising 6.3% yoy, accounting for 49bps of growth.  Exports of goods and services fell 2.7% yoy and imports fell 3%, with the result that net exports made effectively no contribution to growth. 

In industry terms, growth was led by finance/insurance which rose 13.5% yoy, infocomms +8.5%, business services +7.6% and ‘other services’ +7.9%. Meanwhile, manufacturing rose only 4.7% yoy, agriculture expanded 3.2% and mining/quarrying actually fell 0.7% yoy. 

All of this is unexceptionable - goodish without suggesting any great underlying momentum. And the same is true of trends in return on capital. In nominal terms, Indonesia grew 7.6% yoy in 2Q or 8.4% on a 12ma, with the underlying rate still slowing. Meanwhile, by my estimate (generated by depreciating all nominal gross fixed capital formation over a 10yr period), Indonesia’s capital stock is currently growing by 12.7% yoy. This means that asset turns, and most likely return on capital, are still slowing, as they have been consistently since late 2008. More, in the absence of a very sharp surge in nominal growth, there is no realistic expectation that my ROC directional indicator will bottom out in the short or medium term. 

Once again, there are hints that progress might be possible: the fall in monetary velocity (nominal GDP/M2) which has been ongoing since 2011, does appear to have bottomed out. However, this is almost entirely a function of slowing monetary growth, with M2 slowing to 7.8% yoy in 2Q16. This is the slowest growth since 2004, and contrasts with the persistent double digit M2 growth seen between 2005 and late 2015.  Whilst this new stability in monetary velocity suggests improved monetary discipline, it does not necessarily suggest any imminent acceleration in nominal GDP growth. 

On the other hand, this improved monetary discipline has tamed Indonesia’s inflation: by July, CPI had slowed to 3.2% yoy, and whilst this looks likely to be about as low as it will get in the coming year, current trends point to inflation remaining contained at or just under 4%. As a result, current 10yr yields of around 6.85% still look generous. 

The biggest fillip for bond yields would be for Indonesia’s private sector finally to run a savings surplus, which would oblige Indonesia’s banking system to be net purchasers of government bonds.  Indonesia’s private sector developed a minor savings deficit in 2012, which widened to a deficit worth 2.7% of GDP in 2013. Since then, the private sector’s net call on the financial system to generate a cashflow for them has lessened, but never quite disappears. In the 12m to 1Q16, that deficit narrowed to just 0.7% of GDP. By my estimate, it remained there in the 12m to June 2016. 

It is not just that these fluctuations have not yet been sufficient to allow the private sector to develop a savings surplus, but in addition, it seems that those fluctuations continue to reflect movements in the commodity cycle, and, specifically in Indonesia’s overall terms of trade. Whilst these are no longer deteriorating, as they were as the commodities super-cycle waned, there is no sign yet that they are improving, or, indeed, are likely to improve any time soon.  In fact, if commodity prices are thought once again to be falling, we should expect Indonesia’s terms of trade to deteriorate slightly, and the longed-for arrival of a private sector savings surplus to be delayed once more. 

None of this is to counsel despair about Indonesia’s prospects: in many ways Sri Mulyani returns to an economy which is in significant respects more stable than in recent history. But from stability to a new tempo of economic growth requires more, and at present the fundamentals of economic growth do not suggest it.