20 January 2020 (closed)
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Indonesia has had to cope with a structural current account deficit (CAD) since late-2011. This deficit has been a thorn in the eye of Indonesian policy makers and investors as it makes the country - Southeast Asia's largest economy - highly susceptible to capital outflows in times of global economic turmoil. Below, we provide an analysis of Indonesia's current account balance.
What is a Current Account Balance?
The current account balance is the broadest measure of a country’s international trade. It covers transactions in goods, services, factor income (income derived from selling the services of factors of production), as well as transfers. In other words, when a country posts a current account deficit (CAD) it implies that the country is a net borrower from the rest of the world and thus needs capital or financial flows to finance this deficit.
It is important to stress that a CAD is not necessarily bad. Similar to a company’s negative cash flow, a deficit can be useful provided that funds are used for productive investment purposes (meaning they will trigger future revenue streams). Examples of productive investment purposes are industrial or infrastructure development. However, when the deficit is merely used for consumption it causes a structural imbalance as no future revenue streams are generated.
Investors (in currency and equity markets) are usually interested to learn about a country’s current account balance before investing in assets because those countries that are plagued by a CAD are highly vulnerable to capital outflows in times of global economic turmoil, particularly - as in the case of Indonesia - when a large amount of the country's assets are in the hands of foreign investors.
For example, when former Federal Reserve Chairman Ben Bernanke announced in late-May 2013 that the central bank of the world's largest economy was thinking about winding down the US quantitative easing program (hence triggering severe global uncertainty and volatility), Indonesia was one of those emerging markets that was hit most severely. Both Indonesia's benchmark stock index (Jakarta Composite Index) and Indonesia's currency (rupiah) weakened significantly in the second half of 2013 as investors pulled money out of Indonesian markets due to uncertainty about the US monetary policy. In 2014, conditions improved as the Federal Reserve started to wind down its QE program, thus providing more certainty to markets. Moreover, capital inflows occurred in 2014 due to markets' optimism about Joko Widodo's candidacy for presidency. However, Indonesian assets started to weaken again in 2015 on uncertainty about the timing of higher US interest rates.
One of the reasons why Indonesia was one of the hardest-hit emerging market economies as a result of such global economic turmoil was that it contains financial weaknesses, one of which is the current account deficit. This is also the reason why the Indonesian government and central bank (Bank Indonesia) are eager to curtail the CAD.
What Causes Indonesia's Current Account Deficit (CAD)?
Amid sluggish global economic growth, especially slowing growth in China (the largest trading partner of Indonesia), Indonesian exports have dropped dramatically since 2011, particularly due to weakening commodity prices. Indonesia, a major commodity exporter, saw its commodity export revenue fall by around one-sixth over the years 2011-2014. Revenue generated from exports of key commodities, such as coal and crude palm oil, halved. Meanwhile, Indonesia's imports grew rapidly, especially in 2010-2011, primarily on costly fuel imports (driven by the government's decades-old fuel subsidy program).
In its July 2015 Indonesia Economic Quarterly, the World Bank states that “[Indonesia’s] narrower non-oil & gas goods trade surplus accounts for about half (49 percent) of the USD $30.5 billion deterioration in the current account balance from 2010 to 2014, oil & gas trade somewhat under a third (29 percent), and higher income outflows about a quarter (23 percent, most of which occurred in 2010).”
Indonesia started to post a CAD in the fourth quarter of 2011 (and it has remained in deficit ever since). In the second quarter of 2013, the country's CAD hit a record high at USD $10.1 billion, or 4.4 percent of the country's gross domestic product (GDP). Although due to seasonal reasons the country’s CAD tends to rise in the second quarter, it was an alarmingly high level (generally a CAD at a maximum of 3 percent of GDP is considered sustainable). Most problematically, a major factor that causes the deficit was the country’s ballooning oil import bill. As such, the CAD was not used for productive investment purposes (resulting in future revenue streams) but for people’s ever-increasing fuel consumption.
Current Account Balance Indonesia 1981-2015 (% of GDP):
In a report released in 2015, the International Monetary Fund (IMF) stated that a CAD of around 1.5 percent of GDP is normal for Indonesia. However, although it can be normal it still implies that the country is accumulating net foreign liabilities and this may pose risks over time.