Petar Vujanovic Head of Indonesia Desk Economic Department Outline 2 Session 1 established that there has been a rapid deterioration in the current account which continues to be perceived as a macroeconomic vulnerability ID: 233703
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Slide1
Policies for a sustainable current account
Petar Vujanovic
Head of Indonesia Desk
Economic DepartmentSlide2
Outline
2
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?Slide3
Economic Theory
3
Economic theory suggest a number of policy options for making adjustments to the external balance:
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.
Expenditure-reducing :
Reduce
aggregate demand and therefore lower the demand for imports
.
Supply-side adjustment :
Improve the supply-side of the economy through structural and industrial policiesSlide4
Expenditure Switching
4
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.Slide5
Expenditure Switching:Depreciation and the J-Curve
5
“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.Slide6
Expenditure Reducing
6
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?Slide7
Structural determinates of CA
7
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)
.Slide8
Structural reforms
8
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.Slide9
9
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.Slide10
Employment protection
10
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 Slide11
Unit labour costs
11
Unit
labour
costs in selected Asian
economies
Index
= 100 in
1997,
national
currencies
Source
: OECD calculations using national sourcesSlide12
Minimum wage
12
Minimum wage is determined at the provincial level.Slide13
Minimum wage in USD
13
USD; end 2013 exchange rate
Average minimum wage
Rupiah and US$
Source
:
CEIC
and OECD calculations.Slide14
Competitiveness
14
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
8.610.99.4-1.5276
Competitiveness in manufacturing sector2000 to 2010
Source
: National statistics and SER calculations.Slide15
Financial Openness
15
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. Slide16
Oil price
16
Oil price, oil (net) exports and the current account balance
US
dollars (millions for export and current account)
Source
: OECD Economic Indicators database.Slide17
Proposed measures in Indonesia
17
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.Slide18
What should be done?
18
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.Slide19
Structural reforms (1.)
19
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.Slide20
Structural reforms (2.)
20
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.Slide21
Thank you
21