POLICIES FOR A SUSTAINABLE
CURRENT ACCOUNT
Petar Vujanovic
Head of Indonesia Desk
Economic Department
Outline
Session 1 established that there has been a rapid deterioration in
the current account which continues to be perceived as a
macroeconomic vulnerability.
Outline of this presentation :
•
What does economic theory say?
•
What measures have been implemented and canvased by
Indonesian government?
•
What is the OECD’s response to these policies?
•
What should Indonesia be doing?
2
Economic Theory
Economic theory suggest a number of policy options for making
adjustments to the external balance:
1. Expenditure-switching :
Change the relative prices of exports and imported goods and services,
causing consumers to change the pattern of their spending away from
imports to domestically produced goods. And exports more competitive.
2. Expenditure-reducing :
Reduce aggregate demand and therefore lower the demand for imports.
3. Supply-side adjustment :
Improve the supply-side of the economy through structural and
industrial policies
3
Expenditure Switching
Change the relative prices of exports and imported goods and
services, causing consumers to change the pattern of their
spending away from imports to domestically produced goods.
Make exports cheaper in an overseas market and make imports
more expensive in the home (domestic) market.
•
Depreciation of the exchange rate.
•
Export subsidies.
•
Import tariffs.
•
Policies to lower the rate of inflation in
the home economy.
4
Expenditure Switching:
Depreciation and the J-Curve
“Expect thing to get worse before they get better - but keep the faith!”
A depreciation of the exchange rate can have the effect of
increasing the current account deficit in the short-run :
•
For a devaluation to be successful in terms of reducing a current account
deficit, the sum of the elasticity of demand for exports and the elasticity
of demand for imports must be greater than one.
•
In the short run – the elasticity of demand for imports might be very low,
as local substitutes are not available. And therefore the sum of the
elasticities might be less than one and the current account might initially
deteriorate after a depreciation.
•
Hard to know the direction of causality – is the large deficit causing the
depreciation?
•
There is now some signs of a turn around in Indonesia’s current account.
5
Expenditure Reducing
Reduce aggregate demand and therefore lower the
demand for imports.
• Higher taxation.
• Reduce government spending.
• Higher interest rates or a fall in the availability of credit.
• Macro-prudential?
6
Structural determinates of CA
The literature finds a number of fundamental
determinates of the current account :
• Fiscal stance (Richardian equivalence isn’t complete).
• Demographics.
• Relative per capita income (capital flows from rich to poor).
• Oil prices.
• Financial openness (conditional on income).
• Initial net foreign asset position (eg. Switzerland).
7
Structural reforms
Structural reforms aimed at improving the international
competitiveness of the economy.
• Kennedy and Sløk (2o05) find no robust link between structural
policy and imbalances for 14 OECD countries.
• Kerdian, Koske and Wanner (2010) use a panel 117 countries.
Find indirect links to savings, investment and thus current
account. Also find social spending lowers CA; stricter employment
protection lowers CA.
• Vogel (2011) suggests that structural policies aimed at supply-side
may help to improve competitiveness but will be offset by income
effect on imports.
• Ivanova (2012) finds strict credit regulations, high business taxes,
lower minimum wage and lower EPL, all increase the CA.
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Where does this leave Indonesia?
• Labour market.
– Employment protection
– Minimum wage
• Credit markets & financial openness.
• Relative per capita income (capital flows from rich to poor).
• Oil prices.
9
Employment protection
Going for Growth 2008 : A rigid labour code provides
strong protection to employees in the formal sector. This
undermines productivity and competitiveness.
Employment protection legislation, 2012
Index scale of 0-6 from least to most restrictive
4.5
Regular contracts
Temporay contracts
4.0
4.5
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
Indonesia
India
China
OECD
10
Unit labour costs
Unit labour costs in selected Asian economies
Index = 100 in 1997, national currencies
4.5
4
3.5
3
4.5
INDONESIA
China
Singapore
Thailand
2.5
4
3.5
3
2.5
2
2
1.5
1.5
1
1
0.5
0.5
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Source : OECD calculations using national sources
11
Minimum wage
Minimum wage is determined at the provincial level.
12
Minimum wage in USD
Average minimum wage
Rupiah and US$
1,400,000
140
1,200,000
120
1,000,000
100
800,000
USD; end 2013
exchange rate
600,000
Rupiah (LHS)
400,000
US Dollar (RHS)
200,000
80
60
40
20
0
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2013*
Source : CEIC and OECD calculations.
13
Competitiveness
Competitiveness in manufacturing sector
2000 to 2010
Growth in
manufacturing
wage : local
currency (%)
Growth in
manufacturing
wage : USD
(%) [A]
Productivity
growth (%)
[B]
B - A (%)
Average salary
manufacturing
sector 2010
Indonesia
5.2
4.4
3.2
-1.2
142
Malaysia
3.0
4.8
4.7
-0.1
298
Philippines
1.8
1.6
1.9
0.3
176
Singapore
2.6
5.1
1.7
-3.4
1250
Thailand
2.3
4.8
2.4
-2.4
263
Vietnam
6.2
3.5
4.5
1.0
105
China
8.6
10.9
9.4
-1.5
276
Source : National statistics and SER calculations.
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Financial Openness
Reinhardt, Ricci and Tressel (2010) find that, when
accounting for the degree of capital account openness, the
prediction of the neoclassical theory is confirmed: less
developed countries tend to experience net capital
inflows and more developed countries tend to experience
net capital outflows, conditional of various countries’
characteristics. The findings are driven by foreign direct
investment, portfolio equity investment, and to some
extent by loans to the private sector.
15
Oil price
Oil price, oil (net) exports and the current account balance
US dollars (millions for export and current account)
6,000
-20
4,000
0
2,000
20
0
40
-2,000
60
-4,000
80
-6,000
100
-8,000
120
-10,000
Current Account Balance
-12,000
2004:Q1
Net Oil Exports
Oil Price (Inverted)
140
2005:Q1
2006:Q1
2007:Q1
2008:Q1
Source : OECD Economic Indicators database.
2009:Q1
2010:Q1
2011:Q1
2012:Q1
2013:Q1
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Proposed measures in Indonesia
Most measures are aimed at promoting domestic valued-added:
• Ban ore exports (with exemptions but with profit tax penalties
over time).
• Promote firms for import replacement – in particular imported
intermediate goods for industry.
• Relax the tax facility on imported goods for export purposes to
stimulate growth in the export-oriented domestic industry
• Increase taxes durable consumer goods (502 types of goods) from
2.5% to 7.5% (applies to only 3% of all imports).
• Reduce fuel subsidy (first stage implemented).
• Plan for fiscal incentives against profit repatriation.
• Revising the negative foreign investment list.
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What should be done?
Depends on the diagnosis :
• If the deficit is purely cyclical (terms of trade shock) then have
faith hold tight – the flexible currency with help.
• If it is a permanent change in the terms of trade – then it is
structural. A permanent depreciation will help. But lower
national income.
• If it is related to trend decline in relative competitiveness - then
it is structural. A permanent depreciation will help. But lower
national income.
My assessment : both cyclical and structural.
• Fundamental structural reforms are required – and these in
large part are no different to those that have been proposed by
the OECD over recent years.
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Structural reforms (1.)
• Product market reform – pro-competition:
– Lower public ownership in some sectors – including monopolies.
• Improve business climate:
– Reduce FDI rules.
– Infrastructure bottlenecks.
– Corruption.
– Business regulations by local governments can be onerous.
– Address capacity constraints for service delivery in local
government.
• More flexible labour markets :
– Bureaucratic hire and fire rules and severance payments.
– Restriction on short-term contracts.
– Minimum wage & social protection.
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Structural reforms (2.)
• Education :
– Improve quality of compulsory education.
– Increase enrolment at secondary education, including through
greater financial support for disadvantaged students.
– Improve the quality of teaching including regular assessment.
• Fiscal : More efficient tax system and free resources to finance
infrastructure, education, and social programmes.
– Fuel subsidies
– Taxation of self-employed.
– Improve enforcement of personal income tax.
– Move to a resource rent tax.
– Remove VAT exemptions.
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Thank you
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