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The World in Economic Crisis:

What are The Causes and Impacts to Asia, Particularly Indonesia?

Reny Fitriana Kaban SYLFF Fellow from University of Indonesia

Abstract This paper attempts to put some points of view about the world‟s economic crisis, precisely the causes and the impacts that have occurred after the economic crisis in Europe. It appears to have made specific problems for Asia and other countries, particularly Indonesia. The causes of world‟s economic crisis are divided into two circumstances, first the global financial crisis in 2008 and second the sovereign debt crisis of the euro area. Illiquidity, ratio of reserves to short- term external debt, a larger stock of lending from advanced countries, higher ratio of current account deficits to GDP and higher ratio of private credit to GDP, are the causes of the global financial crisis in 2008 from the financial aspect. While from the trade aspect, unexpected trading-partner growth and emerging market economies with higher dependence on demand from the advanced economies experienced are the causes of this crisis. There are some causes of European Union debt crisis such as recession, bank bailouts, sluggish growth, housing slump, and tight monetary policy. There are three key channels through which the impact of the European debt crisis is likely to spill over into the Asia region. The first is the impact on the cost of sovereign debt financing for Asia economies. The second is the trade channel, driven by the effect of reduced growth in some European countries on import demand for Asia goods and services. The third is the impact of the debt crisis on the global financial sector. Overall, the debt crisis in European countries remains worrisome and will have an impact on Asia exports. Indonesia‟s economy has not been too affected by the euro crisis, as Europe is not the country‟s main export destination. The statistics show that Indonesia has good economic fundamentals amid the global economic uncertainty. Still Indonesia must be careful in facing the risks that arise from the European crisis because this crisis is still growing and creating uncertainties. Indonesian must remain cautious.

Keywords : Economic crisis, global financial crisis, European Union debt crisis, Asia, Indonesia

Introduction Movies have been made; natural disasters have taken place, all for the year 2012. What about the unnatural disaster economies fallen, displaced workers countries rocked by economic debt. What is the price to the people of the world? Yours and mine! What were the causes of this economic demise? Is it the greed of banks and credit facilitators? Countries surviving by the use of credit cards and hire purchase agreements, buy now pay later. Well, bad economics mean loss of jobs, no increases in salaries etc. well, how do they pay their credit agreements, mortgagees etc, now they become just bad debts. Asia, particularly Indonesia is beginning to feel the affects of the European recession. But more interestingly, before we can put right wrongs done, we must understand where, how the wrong began? Where did it begin? Was it in the start of the world‟s natural disasters? No it was before that the American crisis in 2008 over the value of the dollar! All currencies are equated to the dollar. There is fighting between the euro and the dollar also the edging of other currencies to them. International monitory loans to countries riddled with debt. Previous loans cancelled unpaid new loans given. Why is this? Where is the money going? The outrageous cost of bombs‟ and arms and the cost of armies dwelling in other counties are destroying countries economics outrageous credit facilities are making people believe their life styles will last the way it is! All are leading to false hope end false idealism. Countries‟ exports are linked to credit systems of payment, followed by unpaid accounts higher interest rates to banks. Where are the days when we bought what we could truly afford to buy? Look at any car on the road you can‟t tell if it was paid for in cash or by credit! Yes it‟s true, electronics, cars, and household goods we can by all on credit, and can we truly afford it? I‟m sorry but I worry about the affects that are waiting to hurt Indonesia. It is a developing country with many wide ranges of resources for exportation. We don‟t want this unnatural disaster to hurt Indonesia. At this time, education, sports, facilities, roads are still undeveloped, but malls, hotels, anywhere with credit facilities are booming just like America and Europe was before the recession. This is a paradox, and must be solved with full efforts from many parties, from top to down in each level of stakeholders in this world.

The causes of economic crisis 1. The Global Financial Crisis in 2008 The causes of the global financial crisis in 2008 have been discussed similarly from two kinds of aspect, financial and trade. First from the financial aspect, illiquidity is one of causes as in the Asian financial crisis in 1997. Lane and Milesi-Ferretti and Blanchard, Faruqee, and Das found that the “ratio of reserves to short-term external debt” is significant in explaining the severity of the crisis. However, Blanchard et al added that the effect comes mostly from short-term debt rather than from reserves. On the other hand, Llaudes, Salman, and Chivakul and Lane et al found that reserves helped dampen the impact of the crisis on emerging market economies. Other than short-term debt, Berkmen, Gelos, Rennhack and Walsh showed that “a larger stock of lending from advanced countries contributed to a more severe downward revision of the growth forecast”. The similar results were indicated by Lane et al and Llaudes et al. As was in the Asian financial crisis, the fact that the ratio to current account deficits to GDP are significantly correlated with the crisis was proved through the regression analyses by Lane et al and Blanchard et al. In the domestic economies, similar to the Asian financial crisis, Berkmen et al, Lane et al and Llaudes et al found that a higher ratio of private credit to GDP and a larger increase in that ratio affected the severity of a crisis. Berkmen et aland Llaudes et al found in addition that the severity was more pronounced for countries with fixed exchange rate regimes. Second, from the trade aspect, Blanchard et al determined from their regression analyses for 29 countries that the variables of “unexpected trading-partner growth” were significant in explaining “unexpected GDP growth” in emerging economies. Llaudes et al found that “emerging market economies with higher dependence on demand from the advanced economies experienced sharper falls in output during the crisis.” Berkmen et al and Lane et al further found that the share of manufacturing products in total exports (or in GDP) is correlated with worse growth performance 1 . 2. The Sovereign Debt Crisis of the Euro Area The most immediate consequence of the Euro area debt crisis is the trust crisis that befalls on the national debts of the member States of the zone with together with its impact on mechanisms set

1 M. Kanaoka. Have The Lessons Learned from The Asian Financial Crisis Been Applied Effectively in Asian Economies? International Journal of Economics and FinanceVol. 4, No. 2; February 2012. pp 2

up by the European Union to mitigate that crisis and the European Financial Stability Fund

(EFSF). In effect, the AAA note of this fund depends on that of the countries which support it,

and in this case, Germany and France. It allowed the affected countries (Portugal, Greece, and

Spain) to borrow on the same conditions as Germany (2%) or France (3%). Since January 13th,

2012, Aid plans in these countries have become more expensive. It may thus have a reverse

effect on the sustainability of anti-crisis measures griped in September 2011. In so far as it

continues to weaken the European currency position, and consequently a domino effect is to be

feared. Banks had announced the events of January 13th, 2012 when they suspended negotiations

with Greece on the modalities of the restructuring of its national debt which meant that they

could come back on their promise to reduce Greece‟s debt by half! 2

Base on the Source data from the CIA World Fact book, as of December 11, 2011 the

GDP figure (figure 1) used is at official exchange rates. Current account balances refer to the net

import or export activity of a country. A trade surplus is when exports exceed imports. A trade

deficit is when imports exceed exports. Germany has a significant trade surplus, meaning it is a

net exporter. The other countries often mentioned in this crisis all have trade deficits. Trade

deficits have goods and services components. A country that is a net importer of goods and

services must borrow capital to fund this activity. This is referred to as the balance of

payments identity. It may be helpful to think of it as a form of vendor financing, with the surplus

country taking the wealth it receives in exchange for goods and lending it back to the deficit

country. 3

The debt to the GDP ratio is calculated for each quarter using the sum of GDP for the last four quarters. Data on GDP are the most recent transmitted by the EU Member States. The highest ratios of government debt to GDP at the end of the first quarter of 2012 were recorded in Greece (132,4%) , Italy (123,3%), Portugal (111,7%) and Ireland (108,5%), and the lowest in Estonia (6,6%), Bulgaria (16,7%) and Luxembourg (20,9%). 4 The complete chart can be seen in Figure 2.

2 I. Tamba. Euro Area Sovereign Debt Crisis: What Economic Policy Consequences and Implications for the Franc

Zone African Countries? International Journal of Economics and Finance; Vol. 4, No. 8; 2012 pp 2

Figure 1. Current Account Balances of EU Countries in 2010

Figure 1. Current Account Balances of EU Countries in 2010 Figure 2. Source : Eurostat news

Figure 2.

1. Current Account Balances of EU Countries in 2010 Figure 2. Source : Eurostat news releases

Source : Eurostat news releases 111/2012-23 July 2012

Causes of European Union Debt Crisis

There are some causes of European Union debt crisis as follows 5 :

Recession. In recession tax revenues fall, and governments spend more on unemployment . In recession tax revenues fall, and governments spend more on unemployment

benefits, therefore the deficit raises increasing total debt levels.

Bank Bailouts. In the case of Ireland, the majority of the rise in public sector debt was In the case of Ireland, the majority of the rise in public sector debt was because

the government took on the debt of private sector banks which had failed. In 2010, the Irish

government spent 45bn Euros (£39bn), causing the government to run a budget deficit equivalent

to 32% of GDP in 2010. The Irish bank bailout cost roughly 30% of Irish GDP, compared to the

UK bank intervention which cost roughly 6% of GDP Irish Bank bailout at BBC

Sluggish Growth. Countries with sluggish growth forecasts worried bond markets because with . Countries with sluggish growth forecasts worried bond markets because with

low growth prospects it becomes difficult to pay back the debt.

Housing Slump. Countries like Spain and Ireland are facing a prolonged slump in house price. Countries like Spain and Ireland are facing a prolonged slump in house price.

This is exacerbating bank losses and diminishing prospect for growth.

Tight Monetary Policy. Many of the peripheral EU countries lack the ability to devalue their currency because . Many of the peripheral EU countries lack the ability to devalue their currency because they are in the Euro. Therefore to regain competitiveness there is a need to pursue deflationary policies (cutting wages etc). These damages growth and makes bonds less attractive.

The European debt crisis: implications for Asia 6

Asia economies are increasingly concerned about the impact of the public debt crisis in a number

of European economies. In recent months, the scale of public debt in Greece in particular, but

also in Ireland, Portugal and Spain, has led to credit downgrades and increases in the debt

servicing costs of those countries. In response, their Governments have pledged to close their

fiscal deficits and decrease their levels of debt in the coming years through stringent programs of

budget cuts, as affirmed recently by the G-20.1 Further compounding the fiscal gap are ageing

societies and decades-old weak economic growth which will require additional resources as well

as leading to declining tax proceeds. Consequently, the global financial markets have yet to be

convinced that the affected countries will be able to reduce budget deficits sufficiently to lower

6 S. Banerjee, The European Debt Crisis: Implications for Asia and the Pacific. “MPDD Policy Briefs”, No. 4 August 2010, pp. 1-6

public debt to the level required. The worst-case scenario of sovereign debt defaults in one or more European countries at some point remains a concern. For Asia economies, two questions arise:

(a) To what degree will these difficulties translate into reduced growth prospects as the region

continues its V-shaped recovery from the global economic crisis? While some impact on Asia is inevitable given the global linkages of economies in this region, it is important to establish

whether the impact will be restricted to a limited moderating of their otherwise robust ongoing recovery, or whether the impact will threaten a downturn in Asia akin to a double-dip recession;

(b) As the crisis has exposed policy tensions inherent to the European integration process, how

will the Asia region evolve its exchange rate and fiscal policy coordination? Impact of the crisis There are three key channels through which the impact of the European debt crisis is likely to spill over into the Asia region. The first is the impact on the cost of sovereign debt financing for Asia economies. The second is the trade channel, driven by the effect of reduced growth in some European countries on import demand for Asia goods and services. The third is the impact of the debt crisis on the global financial sector, and the consequent effect on the provision of credit to the regional banking and private sectors. Public debt financing in Asia less at risk The most immediate pressure point for European Governments with public debt pressures will come from the financing of upcoming debt issues. Global financial markets are pricing in the risk of default, with yield spreads on sovereign debt rising up to and even beyond the levels last seen during the subprime crisis in some countries (figure 3). The countries most affected have been those with persistently large public debt stocks as a proportion of their economies, high budget deficits, and consequently profligate public spending. In an effort to allay future questions of debt sustainability, these countries are also committing to sizeable deficit reduction programs in the coming years.

Figure 3. Spreads between selected European long-term sovereign bond yields and 10-year German sovereign bond yields, January 2008 to May 2010

German sovereign bond yields, January 2008 to May 2010 Sources : ESCAP analysis based on data

Sources: ESCAP analysis based on data from EIU online, accessed on 10 June 2010; and OECDStat Extracts

The risk for Asia Governments lies in the possibility that financial markets might harbor similar concerns about their management of public debt. This would manifest itself in similar increases in the funding cost of new sovereign debt issuance. Such a situation would not only increase the budgetary impact to governments of new debt issuance, it would also increase the private sector‟s cost of issuing debt. This crowding out effect is due to the fact that interest rates on private sector debts are usually set on the basis of a risk premium over and above that of the economy‟s sovereign bond rates. However, as it appears, the European debt crisis remains contained. No evidence of „„herding‟„ has emerged, suggesting that financial markets are adopting an increasingly sophisticated and differentiated view of global emerging economies. The spread on credit default swaps for Asian sovereign bonds, the cost to insure against default on such bonds, has remained fairly steady and is far below the levels seen during the subprime crisis (figure 4). This means that the markets currently do not view significant risks for sovereign debt issued from the region.

Figure4. Sovereign bond credit default swap spreads for selected developing Asian economies, January 2007 to June 2010

developing Asian economies, January 2007 to June 2010 Source: ESCAP analysis, based on data from ADB

Source: ESCAP analysis, based on data from ADB AsianBondsOnline, accessed on 11 June 2010

Overall, the debt crisis in European countries remains worrisome and will have an impact on Asia exports, but this will be somewhat offset by demand from the United States and from within Asia. The more pressing concern for growth in this region is the possibility that the debt crisis will spill over to the rest of the European Union and the global economy through the financial channel Systemic implications for macroeconomic coordination in Asia and the Pacific The global crisis, and subsequently the European debt crisis, continues to strengthen the region‟s resolve to search for new sources of economic growth from within. To achieve this, the political will to boost regional economic integration through, inter alia, enhanced macroeconomic policy coordination, has gained momentum. In this regard, coordination on fiscal spending and exchange rate management are two key areas in which policymakers agree that policy action will be needed in future. Indeed, the pros and cons of a coordinated currency management system have been heavily debated for quite some time, a key concern being the need to avoid competitive devaluations of currencies in the region as a means of boosting trade during downturns. In parallel, the integration of the European economic community and the birth in 1999 of its common currency, the euro, as the most visible manifestation of a European Union, and now

its debt crisis have all provided Asia policymakers with a fascinating study of what is an extraordinary experiment in regional governance and common policymaking.

What might be some of the immediate policy implications for Asia and the Pacific arising from the European debt crisis and its common currency? Or, put differently, can currency unification function without organized fiscal coordination among countries sharing the same currency? Going further, can fiscal coordination exist without political union? To what extent do monetary goals need to be balanced with fiscal policy to ensure the desired direction of a region‟s macro economy? As the debt crisis evolves and continues to challenge the very future of the euro, these questions remain as vexing to European policymakers as they were a decade ago. While it is beyond the scope of this particular policy brief to address these issues in depth, there are a few key points that are of importance to the Asia region:

(a) The debt crisis and subsequent decline in the value of the euro, nearly 15 per cent this year,

revealed the tensions inherent in a monetary policy that is centralized by the European Central Bankstatutorily the most politically independent central bank in the worldand a fiscal policy that remains decentralized at the national level and is therefore much more politicized;

(b) The crisis also revealed that the European Stability and Growth Act, which was designed

precisely to overcome the disconnect identified above, is, despite its convergence criteria rules, too blunt an instrument, particularly in times of severe recession, to ensure stability in the Union. As of today, the fiscal deficit in the euro area stands at -7 per cent;

(c) Instead, a deeper, shared fiscal governance system carries with it the distinct advantage of

enabling automatic stabilizers to transfer fiscal resources from one area to another, without acrimonious debates over how to distribute resources from one country to another. However, the extent to which countries must relinquish sovereignty in matters of taxation and spending has made this perhaps the most politically contested aspect of economic governance in the European Union and would suggest that any form of fiscal federalism in future may be politically untenable;

(d) Historically, most currency unifications or monetary unions that were not accompanied by

fiscal and political unions folded when exogenous shocks hit. Currency union member countries should therefore share an understanding of how to deal with shocks and, when national interests give rise to conflicts, these costs should be accepted in the name of solidarity;

(e) Politically, a shared monetary policy is more palatable during a downturn if there is a shared

federal fiscal system in place.

In charting its way forward, the Asia will necessarily evolve its own forms of policy

coordination while drawing on the lessons and experiences emerging from the European Union.

At this point, the European crisis underlines the need for policy coordination over exchange rates

to move in parallel with some form of fiscal policy cooperation and deep political will to

maintain solidarity in the face of what could otherwise be untenable disconnects. The Act defines

the conditions and levels at which deficits and public debts (-3% and 60% of GDP, respectively)

may be subject to corrections and the sanctions and penalties that would prevail on non-

compliant members of the European Union.

The Euro crisis and its impact on Indonesia’s economy Overall, Indonesia‟s economy has not been too affected by the euro crisis, as Europe is not the

country‟s main export destination. Indonesian exports mostly go to Asian countries, such as

China and Japan. The share of Indonesia‟s exports in terms of gross domestic product (GDP) is

also relatively small compared to other export-oriented countries like China or Singapore. In

addition, Indonesia can rely on its domestic market, thanks to its huge population. Indonesia

proved its resilience when it survived the 2008 crisis, which was triggered by the Lehman

Brothers‟ shock.

At least, the statistics show that Indonesia has good economic fundamentals amid the

global economic uncertainty. Nevertheless, the main issue might come from the financial sector,

as reflected by the falling stock exchange (JSX) in May 2012. At the beginning of May, the JSX

reached its highest level (4,226) but since then it has been on a progressive downturn, reaching

its lowest level since March 2012, at 3,902. Moreover, the bond market has also been affected

since most government bonds showed sharp corrections last week. Further, the rupiah is also

depreciating against the US dollar, which hit Rp 9,600 to the dollar on May 29, its weakest level

in 30 months. 7

Similar with this, Finance Ministry's Debt Management Directorate‟s director-general,

Rahmat Waluyanto said on Wednesday as quoted by Antara news service that he was optimistic

7 A.F, Raz, The Euro Crisis and Its Impact on Indonesia’s Economy

European financial crisis would not have a big impact on Indonesia."Our domestic finance market is quite good and therefore the current crisis in Europe won't have much effect on Indonesia. If there are fluctuations in the stock market then the investors will turn to the government bonds (SBN) as a safe haven." 8 On the other hand, according to World Bank Managing Director Sri Mulyani, Indonesia may be affected by the second round of the European Union debt crisis because its export destinations are highly diversified. The impact of the European Union`s financial crisis would spread to other countries in different parts of the world through multiple pathways, such as trade, capital flows and remittances. But Indonesia would not feel the impact of the European crisis through the flow of remittances. Still Indonesia must be careful in facing the risks that arise from capital in and outflows because they were related to risk perceptions that could cause turmoil. This is more than just sentiment, and it should really be maintained. The sentiment is associated with risk perceptions, so volatility or turbulence in capital in and outflows become very important. Indonesia still needs to carefully manage its budget because the European crisis was still growing and creating uncertainties at the global level. Indonesian must remain cautious, perhaps that is the most important thing to do. 9

Conclusion Having some times to study the world economic failures, and reading various theses by distinguish scholars, it becomes relevant that each educated scholars all agree that the financial world that we know is decaying and not getting better. It leads to the important questions the countries of Asia to make these decaying situations right. Without doubt the points that the scholars have made, all is having a different solution to this demise. No one scholar has the perfect answer. Therefore the solution is to face the true reason for the failures of world government to deal with the situation. Asia‟s government mustn‟t follow the examples of

European counter part. I believe we must find our own answer to these problems and not be the puppet of other powerful countries. Asia must take a dominant role in finding these solutions. There are many questions that I do not have the answers. Because whilst research I found that the necessary data is very difficult to find or may be in reality is hidden, namely the data of country‟s expenditure on arms and the protection of other countries in their alliances. The bail out of other countries in their alliances has a knock back effect. Money spent is not directed in the necessary direction needed to support the country‟s financial progress. The more affluent countries are made poor by the demands off others in their alliances which has a roll on situation occurring. The money they borrow can never be paid back, because the money are not paid back and discarded as bed debts and written off. How can the more affluent countries such losses without having some bad effects of them selves making an economic system that is not fully inactivation or sustainable?

References

I. Tamba. Euro Area Sovereign Debt Crisis: What Economic Policy Consequences and Implications for the Franc Zone African Countries? “International Journal of Economics and Finance; Vol. 4, No. 8; 2012 pp 2

M. Kanaoka. Have The Lessons Learned from The Asian Financial Crisis Been Applied Effectively in

Asian Economies? “International Journal of Economics and Finance” Vol. 4, No. 2; February 2012. pp 2

S. Banerjee, The European Debt Crisis: Implications for Asia and the Pacific. “MPDD Policy Briefs”,

No. 4 August 2010, pp. 1-6

A.F, Raz, The Euro Crisis and Its Impact on Indonesia’s Economy