In a fashion similar to what became known as the “Asian Contagion” in the late 90s, the current stress in emerging economies has been spreading.
One of the nations to experience financial stress recently has been Indonesia, Southeast Asia’s largest economy.
The impact of capital outflows from emerging economies on Indonesia’s financial markets has been swift and severe.
Here are the key financial indicators:
1. Indonesia’s equity markets are down 17% in the past 3 months (note that the market peaked in late May, corresponding to this event) -
2. The government bond market (sell-off also started around the same time) -
3. Currency (the exchange rate went vertical last week) -
4. Sovereign CDS isn’t very liquid but is still showing signs of financial stress.
The question some are asking is whether this is just a contagion-driven panic or are there fundamental flaws in the economy? Just as the case with India (see post), trade imbalance in Indonesia is behind some of this adjustment. In the past, foreign investment covered up the problem, but the party is now over. Investors – not surprisingly – have become uneasy with the chart below:
A massive structural problem like this is an invitation for a punishment from the markets. Indonesia (just as Brazil and others) is trying to plug the trade gap hole.
NYTimes: – Indonesia announced a package of policy measures on Friday to reduce imports and bolster investment in labor-intensive industries as it struggles to revive confidence and consumer spending in its economy, Southeast Asia’s largest.
The intervention by President Susilo Bambang Yudhoyono comes after a punishing week for emerging markets, with currencies from Brazil to India hit hard by fears of higher global borrowing costs and a reduction in cheap cash from the United States.
Indonesia has faced sell-offs in the rupiah, stocks and bonds after an unexpectedly large second-quarter deficit in its current account — a measure of foreign trade and investment — prompted fears that the weak global economy would only further erode exports at a time when a surge in inflation is crimping domestic demand.
The country’s chief economic minister, Hatta Rajasa, said the government would increase the import tax on luxury cars, seek to reduce oil imports and provide tax incentives for investment in agriculture and in metal industries.
With China being one of the large clients for Indonesia’s natural resources, fixing the trade balance issue is going to be easier said than done. A few tax adjustments are simply not going to do the trick – at least not in the near-term. The nation remains vulnerable to further market pressure.