Indonesia is currently experiencing its most sustained stretch of current account deficits (CADs) since the Asian Financial Crisis. This fact has generated much discussion within policy circles.
Yet CADs are not inherently harmful – Australia has sustained CADs for much of the past 150 years with little harm to the economy. As in Australia, Indonesia's CAD is structural in nature. This reflects the fundamental features of the Indonesian economy, such as a relative abundance of investment opportunities. As such, short-term, ‘tactical' policies designed to counter the CAD may inadvertently generate long-term distortions. Where they increase the risk of investing in Indonesia, they may even reduce the stability of the external position.
This paper highlights how, through a long process of reforms, Australia has improved the stability of its external position while also running a persistent CAD. Indonesia can also continue to promote stability and economic growth more broadly through further structural reforms that would liberate it from short-term management of its CAD.
The paper was prepared collaboratively by officials from the Indonesian Fiscal Policy Agency and the Australian Treasury and finalised in January 2015.
Indonesia is experiencing its most sustained stretch of current account deficits (CADs) since the Asian Financial Crisis, with twelve consecutive quarters of deficits. Even so, this series of deficits is relatively brief compared to its stretch of CADs before the crisis. Since then Indonesia has undertaken significant reforms aimed to mitigate some of the vulnerabilities that affected it so severely in the Asian Financial Crisis. Those reforms likely contributed to its comparatively robust performance during the Global Financial Crisis.
Australia, by comparison, has run a CAD for the majority of the statistical record, weathering both the Asian and Global Financial Crises without significant capital flight or serious impediments to real economic performance. The perception of Australia's CAD has changed over this time. Australia's current account position in recent decades was not a significant concern, due to the move away from a fixed exchange rate and a trade deficit that was unmatched by capital inflows. Empirical experience suggested that under a fixed exchange rate regime with limited capital mobility, large and persistent CADs were unsustainable, and left the economy vulnerable to changes in market perceptions of risk.
During the 1980s, various arms of macroeconomic policy in Australia were partly targeted toward managing the CAD, under the assumption that foreign borrowings were unsustainable. These policies ultimately proved to be an inefficient means of managing the economy. After the floating of the dollar, academics such as Makin (1988), Pitchford (1989) and Corden (1991) challenged the view that Australia's persistent CAD was ‘unsustainable'. Instead, they argued that the CAD was a result of optimal consumption and investment decisions made by ‘consenting adults'.
In considering Indonesia's current account position, Indonesia's policymakers today face many of the same concerns that Australian policymakers faced in the 1980s. The continued normalisation of global monetary policy is likely to see markets re-evaluate Indonesia's external position. At worst, a possible consequence of this normalisation would be a sharp reversal of capital flows. The Indonesian government recently demonstrated its commitment to managing currency stability during periods of volatility, at least in the short run.
This paper, posits that a CAD itself is not necessarily ‘bad'; rather it is the fundamental factors that drive a CAD that determine whether or not it is a ‘sustainable' position for a country. Moreover, considerations of the stability of the external position are more relevant to Indonesian policymakers than notions of sustainability. The paper begins by outlining some key concepts characterising the CAD, followed by a description of the makeup of Indonesia's recent stretch of CADs. It then examines the drivers of the stability of the external position – especially its financing – and the relevance to Indonesia.
Maintaining stability is a function of managing perceptions of the riskiness of investing in a country. Frictions between theoretically stable long-run CADs and the realities of perceptions about Indonesia's CAD mean that there is a short-term role for mitigating risks to stability. It is widely acknowledged however that such measures have a limited effective lifetime and come at a direct cost to economic growth.
Indonesia's and Australia's current account positions are viewed differently by markets today (and indeed there is ample research on the vulnerability of emerging market economies running CADs to volatility). It is not the purpose of this paper to outline a series of ‘tactical', short-run responses to threats to the stability of Indonesia's CAD, and indeed, Indonesia has been proactive in managing the risks to the stability of its external position brought about by recent global monetary policy changes. In this paper, lessons are drawn from Australia's experience in running prolonged CADs, while maintaining high investment flows—an experience that highlights the importance of a commitment to long-term reforms, as a way of promoting the stability of the external position over a long horizon. In this vein a series of policy recommendations for Indonesia are outlined towards the end of the paper.
1 From the Macroeconomic Group of Australia's Department of Treasury.
2 From Fiscal Policy Agency (Badan Kebijakan Fiskal) within the Indonesian Ministry of Finance.
3 The views in this article are those of the authors and not necessarily those of the Indonesian Fiscal Policy Agency or the Australian Treasury. The authors would like to thank Yoopi Abimanyu and Rudi Handoko of Indonesia's Fiscal Policy Agency, Michele Savinizangrandi, Elitza Mileva, Masyita Crystallin and Alex Sienaert of the World Bank, Helmi Arman of Citibank, Roland Rajah of the Department of Foreign Affairs and Trade, and Natalie Horvat, Joanne Evans, Jenny Wilkinson, David Gruen, Sandra Roussel, Jason Allford, John Swieringa, John Burch, Iyanoosh Reporter, Nathan Wonder, Alex Beames and Moira Byrne of the Department of Treasury, for their comments and contributions to this paper.