Author: FLY: Malaysia

Introduction

You may remember the story of Evergrande Group, a property developer that threatened the collapse of the Chinese Financial Sector due to it’s overexposure (Click here to read more about it) – and a year on it seems to have been the tip of the iceberg. While many know China as a manufacturing, industrial, and services powerhouse – this article aims to dive deeper into exploring how a property crisis could affect China’s Economy. An overview of The Chinese Economy can be seen in Figure 1:

Figure 1. Breakdown of China’s Economy 

Source:https://www.visualcapitalist.com/visualizing-chinas-18-trillion-economy-in-one-chart/ | Visual Capitalist

According to Figure 1, Real Estate contributed a whopping 7.8 Trillion ¥ (RMB) in 2021 (or 1.2 Trillion USD), making up 6.9% of China’s Total GDP in 2021. However, ever since the Covid 19 Pandemic, the once booming sector has contracted greatly – and as of July 2022, Real Estate Value has fallen by 12% Year on Year (YoY) (Munjal, 2022).

The Context.

Before we explore a potential collapse, it’s important to understand the ‘pre-sales’ mechanism that is the bedrock of the real estate industry where properties are sold before they are built. This was put in place way back when there was a lack of properties in the market (Wu, 2022), hence this mechanism allows property developers to use deposits for construction (leaving demand to create supply). A Senior China Economist at Capital Economics attributes that 70-80% of properties are sold under this mechanism (Tewari, 2022). A majority of individuals pay for mortgages (a housing loan) even without stepping foot on the property. 

Chinese Banks and Regulators play a vital role in monitoring how these funds are utilized, however in practice, keeping track of how funds are used is easier said than done – namely if the developer abandons the project due to financial difficulties, there is no safety net in place to ensure the deposits. With economic and financing conditions taking a turn for the worse as a result of the pandemic – the system flaws are beginning to come to light where this system is starting to be questionable as the current state of China’s economic and financing conditions are beginning to tighten…

According to The Conversation, more than 300 groups, as of late August, are refusing to pay home loans with values between 150 billion USD and 370 billion USD as part of their protest against unfinished residential projects (Ou, 2022). These numbers are based on various informal surveys published online, hence, they should only be taken lightly. When the citizens of a nation begin to protest knowing the likely consequences of the actions under an authoritarian government – it’s a telling sign of the direness of the situation. As quoted by The Business Times Singapore, the mortgage payments strikes could have a detrimental effect on the Chinese economy. A recent research report published by ANZ group supports the statement as their findings have shown a payment boycott could affect approximately 222 billion USD worth of home loans sitting in banks, translating to about 4% of outstanding mortgages.

Aside from that, this issue has also indirectly resulted in an overall decrease in demand for properties in China. Consumers have lost the confidence to purchase, in addition to the fact that some have still yet to recover from the economic downturn fueled by the COVID-19 pandemic. The renowned American Credit Rating agency, S&P Global, forecasted a fall in market confidence in July 2022. Their reports have shown that China’s property sales will likely drop by about 30% in 2022, which is supposedly twice as worse than their initial estimates. This forecasted decline can unquestionably be classified as an “outlier” in terms of trends over the past 20+ years as reflected in Figures 2 and 3 below :

Figure 2 shows the Sales revenue from residential real estates sold in China from 1998 to 2020 (in billion yuan).

Figure 2. Source:www.statista.com/statistics/243239/revenue-from-residential-real-estate-sold-in-china/  | Statista

Figure 3 shows the number of apartments sold by real estate developers in China between 2005 and 2020 (in million units).

Figure 3. Source: www.statista.com/statistics/244523/number-sold-in-million-units-in-china | Statista

By analyzing the graphs on sales revenue from residential real estates sold in China (1998 to 2020) to the number of apartments sold by real estate developers in China (2005 and 2020), we can conclude that the trendline shows positive growth – excluding the sharp decline in 2008 caused by the Global Financial Crisis.  However, if S&P Global’s forecasts come to fruition, we would see a significant decline in both sales revenue and the number of apartments sold. This would go against the flow of the trend in the past 20 years. The predicted 30% drop would be even worse than the fall in 2008’s property sales in China which was 20% according to Ester Liu, director at S&P Global Ratings (Cheng, 2022).

However, the Chinese government has been finding ways to counteract mortgage strikes. China has recently made a move to cut down the one-year loan prime rate (LPR) from 3.7% to 3.65%. Moreover, the five-year LPR, which is a reference rate for mortgages, was reduced by 15 basis points or 0.15%. LPR can be simplified as the interest rate commercial banks charge their customers for purchasing the property. The country’s central bank will set the federal funds overnight rate which acts as the basis for these prime rates. Hence, these rates will affect the lending rates for both corporate and household loans in the country. Although the cuts may not seem that significant, a continued trend will reduce the price of mortgages in the long run which should drive up housing demand again. 

The Three Red Line Policy introduced in August 2020 reins in property developers to reduce overexposure. The policy states that developers should:

• Have a liability to asset ratio of less than 70%
• A net gearing ratio of less than 100%
• Cash-to-Short Term debt ratio of more than one times

The intended aim of this policy is to control house prices and protect consumers and lead to deleveraging among developers (UBS Asset Management, 2021). Moving on, another key issue that could have contributed to this property crisis in China is the involvement of local land politics as highlighted by Diksha Munjal in The Hindu’s article on China’s Property Market. Dexter Roberts, a senior fellow at the Atlantic Council shared that there was a unique political system behind the growth model of China’s real estate sector (Munjal, 2022). They speculated that local governments worked well with big developers and often gave them the green light to continually develop new commercial and residential properties at breakneck speed. The reason was simple: money. More development projects meant more revenue for the local government council as they would sell more land-use rights to local developers. In fact, the sale of land-use rights is the largest source of non-tax revenue for local governments (Guo, 2022). Thus, with the help of local governments, local developers were able to grow faster and faster, reaching an unsustainable pace where they couldn’t fund their own development projects. This led to breakdowns and abandonment of housing projects, thus finally resulting in angry citizens and mortgage strikes. 

Another key factor that may have contributed to this crisis worth examining is the role of local land governments. Dexter Roberts, a senior fellow at the Atlantic Council noted that there was a unique political system behind the growth model of China’s real estate sector (Munjal, 2022). Big developers were given the greenlight by local governments to continually develop new commercial and residential properties at breakneck speeds – and the motivating factor was money. More development projects meant more revenue for the local government council as they would sell more land-use rights to local developers. In fact, the sale of land-use rights is the largest source of non-tax revenue for local governments (Guo, 2022). Thus, with the help of local governments, local developers were able to grow faster and faster, reaching an unsustainable pace where they couldn’t fund their own development projects. Ultimately leading to the abandonment of housing projects and the unrest we see today.

Effects 

A development project, be it residential or commercial, does not only involve the developer but many other parties, such as those that supply the raw construction materials and the workers that provide the labor. Hence as things operate in a circular fashion, the stall and collapse of property projects would not only hurt the developer and the citizens paying the mortgage, but also the suppliers of raw materials. For instance, raw materials such as metals and iron ore will experience a decreased demand in China, where the resulting shift of the demand curve would cause prices to fall. Since China is one of the top importers of iron ore, their change in iron ore demand would definitely have an impact of a larger magnitude on the world prices of iron ore. In fact, this was clearly depicted when the property crisis in China worsened in 2022, particularly in July when it slumped by 8% as seen in Figure 4.

Figure 4 shows a graph on Iron Ore (USD/T) in 2022.

Source: https://tradingeconomics.com/commodity/iron-ore | Trading Economics

Adding on, the slowdown in property development would indirectly reduce demand for hard labor. In the long run, this would increase unemployment rates, which would decrease the standard of living and subsequently have adverse effects on consumer demand and purchasing power.

Furthermore, this property crisis would bring about negative effects on Chinese banks. S&P Global Ratings estimated in a worst-case scenario that 356 billion USD of mortgages would be at risk, while Deutsche Bank AG warned that at least 7% would be in danger, triggered by the mortgage boycotts across China (Bloomberg, 2022). Hence, the banks are now stuck at crossroads, where helping or not helping property developers would both bring adverse impacts; helping via cutting loan rates and providing longer grace periods would support the developers but increase the probability of more delayed real estate projects. In contrast, they might end up losing more if they do not decide to provide aid, as the developers would default on debts. 

This would not only affect smaller-scale banks such as state-owned rural banks but also larger Chinese banks. In fact, some major Chinese banks are already showing worrying signs of distress. According to Reuters, 5 of China’s largest banks recorded huge increases in bad debts linked to real estate in the first half of 2022. China Construction Bank Corp (CCB) and Bank of China Ltd reported 68% and 20% increases respectively in bad real estate debts in the first half of 2022, whilst the Industrial and Commercial Bank of China Ltd (ICBC), famous for being the world’s largest commercial lender by assets, recorded a 15% rise in the same period (Tang et al., 2022). 

However, in the same report, Chief Liu Jin of the Bank of China states that the state council and respective regulators will continue to push banks to increase lending to the property sector. This would undoubtedly increase the immense pressure and burden that the banks are already experiencing. Bad debts or loans in large volumes would result in banks encountering problems with their capital adequacy and earnings. Unsustainable levels in the long term would lead to bankruptcy. This would indirectly affect the financial stability of China as it could worsen China’s overall debt-to-GDP which is projected to skyrocket to a new record. According to the director of the National Institution for Finance and Development, the overall debt ratio is projected to increase by 11.3 percentage points to around 275% in 2022.

As mentioned earlier on how the property crisis would affect iron ore prices negatively, we can speculate that this property crisis could spill over and bring down other economic sectors in China, such as the steel production industry. According to research by Fitch Ratings, construction accounts for 55% of steel demand in China. Hence a downfall of the property sector might bring down steel producers that are highly dependent on local demand along with them. Sectors that are highly dependent on local consumer demand such as SMEs may also experience similar effects in the long run. The mortgage strike suggests that consumers may be in a situation of financial hardship and hence, may not have the purchasing power to consume as much as before, hurting these businesses. However, in the short run, risks may not be too prominent as Chinese households historically have very high rates of savings. All in all, this property crisis will remain a huge drag on the Chinese economy as quoted by Shuang Ding of Standard Chartered in a recent interview (early August’22 with CNBC).

Although the situation looks pretty bad, a full-blown financial crisis in China and it affecting the world economy significantly is unlikely, given the fact that China has historically pulled itself out of major financial difficulties before and foreign investors do not have much exposure to assets owned by China. Thus a ripple effect in the economy has low chances in the near future. In fact, according to the Guardian, less than 5% of Chinese equities and bonds are held by foreigners (Jin, 2022). However, due to the staggering size of numbers involved in this crisis, the world at large will definitely feel its effects. One example we can look at is furniture. China is now also one of the biggest importers in the world in terms of foreign furniture, thus some pre-sold properties may include fittings of furniture and appliances from foreign countries. So, if the property developers default on debt and are unable to continue with their planned property development, Western furniture manufacturers’ sources of income would be affected, ultimately losing their exports and profitability opportunities in China.  

If the property crisis continues to drag China’s economy down over the next few years without any signs of economic upturn, other countries may start to experience adverse effects as well given how the world is interconnected due to international trade. In a 2019 study by the United States Federal Reserve, economists estimated that an 8.5 percent fall in China’s GDP would result in a 3.25 percent drop in advanced economies and nearly 6 percent decline in emerging economies (Power, 2022). 

What has been done so far and what should be done?

The property crisis in China has been an ongoing crisis for several years but worsened in 2022. Despite the Chinese government’s introduction of the “Three Red Lines” policy in August 2020, most property developers failed to cope and comply with its terms. However, that was not their only initiative. 

The Chinese government has also undergone interest rate cuts and allowed the local councils to relax restrictions on purchasing property in China (The Economist, 2022). The government also rolled out a stimulus worth 44 billion USD in new credit through its state-run policy banks. These steps were taken in the hopes to spur an increase in consumer confidence and stimulate a rise in demand for property. However, these can be considered as temporary, short-term solutions that fail to tackle the issue’s root causes and build-up of past, unresolved crises. On another note, reports suggested that Beijing may allocate a 29.3 billion USD windfall in loans to help complete unfinished housing projects and reduce the burden on parties involved.

In my opinion, I believe that the structure of China’s property system is fundamentally flawed and needs to be redesigned. There should be some form of restriction or introduction of tighter policies on pre-sales of property in China in order to protect the purchasers of that specific property. For instance, relevant government agencies and authorities could perform thorough background checks, in terms of the developers’ liquidity, efficiency and stability during the specific period of time in which they decide to launch a new property project. This should be followed up with frequent checks to ensure the developers’ financial ratios and level of financing remain at a sustainable level and that there is a low risk of project abandonment. Also, the Chinese government could take the initiative to undergo a property market reform. One of the first few steps that can be taken is to approve and implement a property tax, tax paid on property owned by a specific individual or any other legal entity to the local government. This is relevant as China remains one of the few countries that do not impose a property tax on private residential property ownership. However, I believe that property tax will help improve the deformation of the economy of properties in China as it will discourage citizens from seeing properties as “investments”. At the same time, it will increase revenue for local governments, thus expanding their budget and reducing their dependence on selling land use rights to local developers. If the local government’s said dependence decreases due to an increase in tax revenue, it would place less pressure on the local government to sell them to local property developers; hence, decreasing the overpopulation of development and allowing sector growth at a sustainable pace. This reform would also align with President Xi JinPing’s idea of property as he often quotes that “houses are for living in and not for speculation”.

References:  

Bloomberg. (2022, August 1). China banks may face US$350 billion in losses from property crisis. The Edge Markets. Retrieved September 16, 2022, from https://www.theedgemarkets.com/article/china-banks-may-face-us350-billion-losses-property-crisis

Cheng, E. (2022, July 27). China’s property sales are set to plunge 30% — worse than in 2008, S&P says. CNBC. Retrieved September 16, 2022, from https://www.cnbc.com/2022/07/27/chinas-property-sales-set-for-a-worse-plunge-than-in-2008-sp-says.html

The Economist. (2022, September 15). China’s property crisis hasn’t gone away: it is getting worse. The Economist. Retrieved September 17, 2022, from https://www.economist.com/leaders/2022/09/15/chinas-property-crisis-hasnt-gone-away-it-is-getting-worse

Guo, Y. Z. (2022, July 7). China’s plunging land sales threaten local governments. Nikkei Asia. Retrieved September 16, 2022, from https://asia.nikkei.com/Spotlight/Caixin/China-s-plunging-land-sales-threaten-local-governments

Jin, K. (2022, August 23). China’s property market is in freefall. What does this mean for the world economy? | Keyu Jin. The Guardian. Retrieved September 17, 2022, from https://www.theguardian.com/commentisfree/2022/aug/23/china-property-market-world-economy

Munjal, D. (2022, 8 30). Explained | How bad is China’s property crisis and how did it get here? The Hindu. Retrieved 9 11, 2022, from https://www.thehindu.com/news/international/explained-how-bad-is-chinas-property-crisis-and-how-did-it-get-here/article65826898.ece

Ou, Z. (2022, August 23). China property crisis: why the housing market is collapsing – and the risks to the wider economy. The Conversation. Retrieved September 11, 2022, from https://theconversation.com/china-property-crisis-why-the-housing-market-is-collapsing-and-the-risks-to-the-wider-economy-189082

Power, J. (2022, August 30). As China’s property crisis grows, is the global economy at risk? Al Jazeera. Retrieved September 17, 2022, from https://www.aljazeera.com/economy/2022/8/30/what-chinas-property-crisis

Tang, Z., Yu, X., & Tham, E. (2022, August 31). China’s largest banks show wounds from property sector crisis. Reuters. Retrieved September 16, 2022, from https://www.reuters.com/business/finance/top-china-bank-icbc-worlds-largest-posts-49-h1-profit-rise-2022-08-30/

Tewari, S. (2022, August 9). China property crisis: Why homeowners stopped paying their mortgages. BBC. Retrieved September 11, 2022, from https://www.bbc.com/news/world-asia-china-62402961

UBS Asset Management. (2021, January 11). China’s Three Red Lines Policy on Property. UBS. Retrieved September 16, 2022, from https://www.ubs.com/global/en/assetmanagement/insights/thematic-viewpoints/apac-and-emerging/articles/china-three-red-lines.html

Wu, S. (2022, 7 14). China’s Housing Presales Model Needs Fixing as Many Projects Go Unfinished, Experts Say. Yicai Global. Retrieved 9 11, 2022, from https://www.yicaiglobal.com/news/china-housing-presales-model-needs-fixing-as-many-projects-go-unfinished-experts-say-

Researcher(s): Edwin Oh Chun Kit

Reviewer(s): Nasir Ali

Editor(s): Maryam Nazir Chaudhary (Article), Julia Yazid (Infographic)

As the war between Russia and Ukraine rages on, our increasingly volatile economy faces new challenges daily. One unmistakable event has been the sudden inflation of nickel prices leading to the suspension of trades on the London Metal Exchange, a decision that has drawn widespread criticism.

Continue reading our article to explore how a Chinese nickel company lost $8 Billion (RM35 Billion) in a matter of days.

On 8 March 2022, the price of nickel on the London Metal Exchange doubled in a matter of hours and skyrocketed to $100,000 per metric ton – a record high. While high prices may be like a win for buyers, short sellers will have to brace for unlimited losses. 

Before we talk about the nickel company’s misfortune, let’s first discuss why nickel prices surged. Russia is a major nickel exporter, accounting for 7% of the global production of nickel. In light of the Russo-Ukrainian conflict, economic sanctions were imposed on Russia to restrict trade as a financial penalty for the aggression on Ukraine. This meant that already low global inventories of nickel were further disrupted, significantly driving up prices for the metal.

A side note: a similar trend of inflation could be observed in products such as oil, vehicles and wheat.

Consequences and Aftermath

In response to the sudden nickel price surge, the London Metal Exchange (LME) was forced to halt a day’s worth of trades in order to restabilise the market. Ever since restarting nickel trading, LME has implemented daily price limits on outright contracts, demonstrating a first in its 145-year history.

Meaning, once the commodity price hits a certain level, it can’t go any higher. The exchange cancelled all 5,000 nickel trades that had been executed on Tuesday, which might’ve been a nearly $4 Billion payday. 

It is estimated that the exchange had wiped out $1.3 Billion of profit and loss on the cancelled deals. Market participants accused LME for picking sides on Tsingshan Holding Group (a Chinese company) and their parent company Hong Kong Exchanges and Clearing having influenced its decision. 

Closing the market allowed Tsingshan Holding to realise a gigantic loss.The decision to close the market by LME, was arguably damaging to their reputation and investor confidence in executing trades. 

What do high nickel prices mean for you:

Nickel being one of the key components of lithium-ion batteries, is central to the production of electric vehicles and battery storage systems. Higher prices of nickel could mean pricier electric vehicles and renewable energy storage systems, reducing its attractiveness to consumers.

This in turn leads  to a lower adoption of electric vehicles and renewable energies, which may worsen the climate crisis. In spite of the higher prices, governments could consider offering higher subsidies to lower the prices of electric vehicles and encourage adoption. 

But are consumers willing to pay higher taxes?

Nickel is also used in the production of stainless steel, which has various use cases across multiple industries for industrial and consumer applications. As such, nickel price is positively correlated to stainless steel price. A price hike in nickel may have a spillover effect on the industries where stainless steel is used extensively.

How to Keep Nickel Prices Lower? : Supply-Side Reforms

• Increase nickel production by offering incentives to open new nickel mines.
• Increase investment, adoption, and production of nickel-free batteries. By adopting nickel-free batteries or increasing investment in nickel-free battery research to make them more efficient, we can reduce reliance on nickel to meet our battery demands. 
• Increase investment in recycling nickel-based batteries and stainless steel to reduce dependency on mining new nickel.

Now, back to how a Chinese nickel company lost $8 Billion in a matter of days.

You don’t have to “buy low and sell high” to profit from the asset market. Anyone who firmly believes an asset is overvalued can engage in short selling. To illustrate the idea of short selling, let’s say there are two investors, Tim and Dave. Dave owns some gold, which is currently worth RM10.

Tim believes that gold is overvalued and thinks it will go down in the future. To act on his thesis and make a profit, he would borrow the gold from Dave and sell it.

Suppose the price of gold does go down to RM5, Tim still owes Dave gold, so he would then purchase the gold at RM5, and return it to Dave. Tim pockets the difference of the gold prices, thereby making a profit of RM5.

Asset price goes up: Tim has to buy the asset at a higher price and return it to Dave who not only enjoys the increase in value, but additional interest on the loan as well. Asset price goes down: Tim earns a profit from the price difference, and Dave still earns some interest, but loses out as his asset has fallen in value.

How the Chinese company lost so much: when trading an asset, you stand to lose 100% of your investment, but when you engage in short selling, there is infinite risk.

If we go back to the example of Tim and Dave, suppose the gold price were to jump to RM100, Tim would have to add more money out of his pocket to purchase the gold (remember, he has borrowed the gold and has to return it).

In short, the inadequacy in risk management led to Tsingshan holdings suffering a huge blow from the nickel price surge, in addition to the effects of geopolitical tension on nickel supply

References:

Shalaba, Z., 2022. LME watching nickel after price soars on Russia supply concerns. [online] Reuters. Available at: <https://www.nasdaq.com/articles/lme-watching-nickel-after-price-soars-on-russia-supply-concerns> [Accessed 27 June 2022].

Meredith, S., 2022. Systems error triggers fresh chaos as LME suspends nickel trading once again. [online] CNBC. Available at: <https://www.cnbc.com/2022/03/16/metals-lme-suspends-nickel-trading-once-again-on-systems-error.html> [Accessed 27 June 2022].

Reuters. 2022. LME nickel soars by a record 30% on Russia supply concerns. [online] Available at: <https://www.reuters.com/business/london-nickel-rises-25-after-market-open-2022-03-30/> [Accessed 27 June 2022].

Iaconangelo, D., 2022. Nickel shortage spells trouble for EVs — report. [online] Energy Wire. Available at: <https://www.eenews.net/articles/nickel-shortage-spells-trouble-for-evs-report/> [Accessed 27 June 2022].

Researchers: Umar Fazlan, Calvin Kwa, Lee Shuen

Reviewers: Muhammad Bahari, Marcus Wee

Editor: Marcus Wee

Indonesia, the next Asian Tiger and Economic Powerhouse?

Indonesia seems to be in the news a lot lately, with some of the most well-known companies investing in Indonesia; Facebook building a cable connecting Singapore, Indonesia, and North America, and Amazon investing 5 billion dollars in Cloud Services, to name a few. You may also remember the viral photo of Indonesia’s President Jokowi visiting Elon Musk at Tesla’s factory.

When you think of influential economies in the Asian Market, countries such as Singapore, China, Japan and South Korea likely come to mind. However, the Emerald of the Equator, better known as Indonesia, is catching up and maysoon move to the forefront of the financial market in Asia. The outlook was less than favourable post 1997 Asian Financial Crisis, which, due to the large devaluation of the rupiah, had led to a period of economic crisis as well as political instability. They have since recovered strongly and gone through a steady economic growth over the last 20 years, as seen in Diagram 1 below. This year’s economic projection shows a robust 5.4% real GDP growth for Indonesia, further solidifying their economic boom (International Monetary Fund (IMF) , 2022).

 Diagram 1 : Indonesia’s Gross Domestic Product (GDP) (Billion USD)

(Source: tradingeconomics.com | World Bank)

What perhaps worth considering are the various reforms implemented by Indonesia that helped bolster this renewed economic resurgence and growth. While it may be hard to extrapolate which reforms directly contributed to this growth, these reforms in the supply side all undoubtedly played a key role.

Infrastructure Spending

Since its inception, the geographical challenge faced by Indonesia is that the country is a collection of islands.  Part of what possibly hampered Indonesia’s economic growth in the past was its lack of connectivity between not only rural and urban areas, but its islands (which would be a tall feat to connect all given that there are over 11,000 inhabited islands).  The lack of connectivity was particularly hard on those in areas with low accessibility as their goods were more expensive due to the higher transportation costs. The construction of a 5000-km sea highway, a supply side reform, would help reduce this disparity in prices by reducing logistical issues. 

For some nations, highways may be taken for granted but they play a significant role in promoting growth; allowing for greater connectivity between rural and urban areas as well as reduced journey times. Furthermore, highways also reduce the risk of accidents, as one doesn’t need to navigate hazardous back roads. 

To give a sense of scale to the scope of the connectivity projects, in 2018, 616 kilometres of toll roads were built, which was double the entire amount of road building in the past 35 years. 

This growth in infrastructure was beneficial to all age groups, as large businesses gained from easier transport and a wider market access, while small and medium enterprises were also taken into account as rest areas were developed that would allow access to these enterprises to share culture and small buisness. The infrastructure spending did not only extend to roads, but airports, ports and railways as well.

Bolstering Lower Income Groups

Part of the reforms under the Jokowi era included various initiatives that would bolster lower income groups; such as free infrastructure upgrades and healthcare inclusivity. 

For instance, installation of new power grids was done to underprivileged neighbourhoods (prior to this, 200,000 in West Java did not have electricity, and those who connected their outlets to their neighbours who did, had to face unreliable connections). These new power grids would help alleviate the burden and also induce more economic activity; an anecdote mentioned in, Jokowi and the New Indonesia highlighted how a 52 year trader would now be able to continue trading into the night- something she wasn’t able to do earlier due to the lack of electricity. 

Furthermore, Indonesia embarked on a project of healthcare reforms and introduced universal healthcare coverage in 2014. This would greatly benefit the lower-income groups as occasions where they fell sick took a larger toll on them, not only because of the treatment and medical costs,but also the loss of earnings. With these new healthcare policies, a worker with a desk job would still get paid and be able to claim for sick leave, and furthermore, would be covered under their firm’s health insurance. Currently JKN, or Kesahatan Nasional, covers 83% of Indonesia’s population.

A healthy economy

Aside from the positive GDP growth trend over the years, there are many other economic indicators that can solidify the fact that Indonesia’s economic outlook is incredibly positive. The country’s unemployment rate has fallen from 8.06% in 2007 to just 4.28% of the total labour force in 2020, which has led to a decline in poverty rates (headcount ratio at $1.90 a day) from 19.3% of the population in 2007 to just 2.3% in 2020 (International Labour Organisation, 2022) 

This positive change in the unemployment rate has definitely impacted Indonesia’s economy positively as the increase in wage output  indirectly increases money in the circular flow of the country’s economy. As a result, there is increased spending and economic growth, leading to a thriving business cycle and consequently more employment.

In addition to that, low unemployment would also benefit the government by providing additional revenue from income taxes and taxes on expenditure.

On a separate note, there’s no denying that the role of digital industries has become more significant to a country as we have seen a huge increase in digitalization, from banking to e-commerce, and Indonesia has great potential in this sector. As of February 2022, it boasts the largest population of internet users in Southeast Asia at 204.7 million (Statista , 2022), and according to the World Economic Forum, Indonesia ranks among one of the most competitive countries in terms of its digital technology capabilities for the year 2021. 

In fact, in late 2021, the Finance Minister of Indonesia, Sri Mulyani Indrawati stated at the 3rd Indonesia Fintech Summit that Indonesia’s digital economy had the largest value in its region with its total gross merchandise value (GMV) reaching approximately US$70 billion (Agatha O Victoria, 2021). Gross merchandise value tracks the total value of merchandise sold over a certain period of time, making a good metric to gauge the health of an e-Commerce business. 

Diagram 2 below shows how Indonesia dominates the digital economy in Southeast Asia with its GMV projected to reach approximately US$120 billion in 2025, which would give this G20 country a huge economic boost.

Diagram 2: Southeast Asia’s Digital Economy Gross Merchandise Value (US$ billion)

Source : e-Conomy SEA 2020 report by Google, Temasek and Bain&Company | Graph first seen on the ISEAS EDU SG webpage.

The Indonesian Digital Economy 

As seen in the statistics here, the digital economy industry has a huge potential to become a key component in Indonesia’s economic success in the years to come. The digital economy has been characterised by Deloitte as an economic activity that runs on online connections among people, businesses, devices, data, and processes. All in all, the digital economy is basically an economy based on advanced computing technology which transforms business processes by undergoing digitalization. An example would be conducting businesses via the Internet. Arguably, for a digital economy to be successful, the need for seamless connectivity between people, organisations and machines is undoubtedly essential, which translates to a strong internet and mobile technology infrastructure, and one that utilises the internet of things (IoT). IoT is the concept of connecting electronic devices to the Internet and to other connected devices, essentially forming a widely linked network and indirectly a connected community where data can be easily shared, stored and accessed.

A country would need to digitise and increase R&D spending in terms of improving its technology to support the ever-growing digital economy. Some may argue that there may be better industries for a country to invest in, but statistics such as those shown in Diagram 2 regarding Indonesia’s projected GMV in 2025 can further solidify the fact that an advanced digital economy enables a country such as Indonesia to reap the benefits in monetary terms.

The digital economy is a big one in Indonesia with loads of potential, having already produced seven start-ups with the “Unicorn Status” (Unicorns are startups valuing more than US$1b). Examples of these Unicorns are Tokopedia, Bukalapak, Traveloka and Gojek, which are all in the digital economy sector. Although this is a respectively good number (joint highest with Singapore in the ASEAN region), they are still a long way from the largest Asian economy, China, with a whopping 301 ‘Unicorns’. 

MSMEs are picking up in the digital economy thanks to the Government 

MSMEs (micro, small and medium enterprises) are the strong foundation for Indonesia’s growing economy), accounting for about 60% of Indonesia’s GDP making them an invaluable asset to the country.

Prior to the COVID-19 pandemic, only 13% of MSMEs had their operations digitised, which was particularly worrying, as they may be less efficient and less competitive without the advent of digitalisation. Given that 60% of Indonesia’s GDP is contributed by this sector, the government has thus initiated various policies to increase MSME adoption. 

There were promising signs as Deloitte estimated roughly 15-20% of MSMEs migrating online due to the pandemic but this wasn’t enough. Let’s take a look at some initiatives the Indonesian Government has taken to help push MSMEs into digitalization and further scale them upwards.

1. The government has drafted the Indonesia Digital Roadmap for 2021-2024 which acts as a guide to strategise its goal of achieving national digital transformation. According to the Communication and Informatics Minister, Johnny G.Plate, the plan aims to provide guidelines for digital infrastructure, digital government, digital economy and digital citizens. He added that at least 100 main initiatives within 10 priority sectors have been sketched out within the road map to realise inclusive digital transformation. “These sectors comprise digital transformation and tourism, digital trade, digital finance service, digital media and entertainment, digital agriculture and fishery. They also include digital real estate and city, digital education, digital health, industry digitalization, and government institution digitalization,” as explained by Plate.
2. Pasar Digital (PaDi): Established by the Ministry of State Owned Enterprises, PaDi (SoEs) aims to encourage four SoEs (State Owned Enterprises) which are PT Telkom Indonesia (Persero) Tbk, PT Pertamina (Persero), PT Waskita Karya (Persero) Tbk, and PT Wijaya Karya (Persero) Tbk to utilise their budgets on expenditures with 540,000 MSMEs in Indonesia. PaDi was established in August 2020 and its marketplace is currently divided into B2B and B2C with the categories of products ranging from manufacturing, catering, advertising services and many more. B2B which is business-to- business are any transactions between 2 businesses whereas B2C  is business-to-consumer where the transactions occur between a business and a consumer where the consumer will be the end-user of the service or product sold by the business
3. Belanja Pengadaan (BELA) is another initiative launched by the National Public Procurement Agency (LKPP). According to their official webpage, BELA aims to act as an E-Purchasing Platform for procurement of government goods & services in collaboration with PPMSE ( business actors who provide electronic communication facility (e.g. platform) for trade/commercial transactions) to increase the use of domestic products and  MSMEs involvement in the procurement of government goods & services. This initiative should encourage the development of micro and small businesses throughout Indonesia and is a mutually beneficial development for both the development of E-Marketplace procurement of goods & services while providing opportunities to MSMEs. As of 9th May 2022, total transactions were worth 247.4B rupiah (74 million Ringgit).
4. Laman UMKM (MSMEs portal): Introduced by the Ministry of Cooperatives and Small and Medium Enterprises, this initiative consists of an e-catalogue portal  designed to support MSMEs’ operating digital businesses. This initiative can help widen the potential target audience of MSMEs since it is able to target a larger group of individuals. This could help generate more leads which can boost sales, thus scaling up the MSMEs.

An industry with potential growth

Software as a service (SaaS) sector

Software as a service (SaaS) essentially allows individuals to connect to and use cloud-based apps over the Internet. Examples are Outlook or Google Calendar you use for work where you can see your team’s scheduled meeting.

The SaaS sector in Indonesia is still considered to be in its infant stage, but has a promising future ahead. Indonesia’s software spending in 2020 is estimated to be US$900 million, a 33% increase from 2017’s estimated US$672.5 million with the two major parts of the SaaS market being point-of-sale systems (27.8%) and human resource information system software (16.7%). Moreover, 58.3% of SaaS startups are currently in the seed stage,a stage where entrepreneurs approach investors to obtain financial support to fund their concept or product. Ultimately, the seed stage could develop into a strong and robust industry that becomes a major contributor to Indonesia’s economic growth. 

Another solid reason as to why Indonesia has the potential to be an economic powerhouse is its rapid growth in the manufacturing industry, with production ranging from textiles and garments to F&B, electronics, chemicals and electronics. According to the latest data available by the United Nations Statistics Division, Indonesia was ranked as the top country in Southeast Asia in terms of its global manufacturing output which stands at 1.6% (Ritcher, 2021). The contribution of the manufacturing industry to Indonesia’s GDP has risen significantly over the years as seen in Diagram 3 below. 

Adding on to this, its neighbour, China, who is a global manufacturing powerhouse has been shifting towards high-tech manufacturing with its average growth in high-tech manufacturing surging to 13.2%. This scenario will definitely benefit the Indonesians as labour costs would be lower and more competitive compared to China. Thus, we should not be surprised if we see Indonesia increasing its share of global manufacturing output in the next decade or so.

Diagram 3: Indonesia’s GDP from Manufacturing. 

Why the future is looking bright

A huge population which is relatively young, Indonesia boasts approximately 276 million individuals (Population Pyramid, 2021) and a median age of 29.7 in 2020. This potentially results in a large labour force which is both tech-savvy and adaptable. With the digital world shaping our future, this young generation could give Indonesia an edge over its neighbours such as Singapore, which has a median age of 42.2 and Japan at 48 years of age. Many critics may argue that a young population does not necessarily guarantee a digitally literate workforce, but many reports and studies have pointed out that the Gen-Zs are digital natives merely due to the fact that they grew up in a technologically advanced era.

Indonesia has also been experiencing a rise in foreign direct investments (FDI). Increased FDIs will not only improve capital flow but also result in economic growth through multiple channels, such as increasing government revenue via increases in tax revenues. This, in turn, triggers a positive multiplier effect and encourages improvements in technology which would drive advancements in productivity. Data by The World Bank shows a steady increase in FDI net inflows into Indonesia (% of GDP); numbers having risen from -2.57% in 2000 to 1.81% in 2020 with Singapore, China and Japan being among the largest contributors.

Furthermore, education expenditure has increased significantly, with the 2022 allocation currently valued at 541.7 trillion Rupiah, which is a 53% increase compared to the Pre-Jokowi budget of 353 trillion Rupiah. Some of the educational policies pursued include increasing scholarship recipients and funding vocational programs (pg.160, Prasdojo, 2020).

A potential area of risk

A potential area of concern with Indonesia is their incurrence of debt. As a developing economy, it is no surprise to see that Indonesia’s gross external debt has been on a sharp rise over the last 20 years due to an increase in foreign direct investments into the country. A closer look at these worrying statistics show how influential China is to Indonesia. It’s no secret that there are a large number of poorer countries in danger of falling into a “debt trap” with China. According to data from the World Bank International Debt Statistics, countries like Laos, Zambia and Kyrgyzstan have debts with China  equivalent to approximately 20% of their annual GDP. and there are a few situations that could drag Indonesia into a similar plight. Indonesia already has US$4.95 billion of sovereign debt exposure to China and US$17.28 billion in what’s known as a “hidden” public debt due to it being incurred by state-owned companies (Mcbeth, 2021). Adding on to that, Indonesia’s construction of the Jakarta-Bandung high speed railway, which is reported to be at an 80% completion status as of April 2022, has a price tag of more than US$8 billion and unfortunately Indonesia has reportedly allowed the sharing of the cost of this project with the government and will seek financial aid worth 75% of the total cost from the Chinese Development Bank  according to Radio Free Asia. This would only add fire to the already growing amount of Indonesia’s “hidden debt” with China. If Indonesia does not manage these external debts sustainably, it could mean trouble for them and further hinder the country’s economic development in the future.

Indonesia will definitely face many challenges in pursuit of sustainable economic growth. However, the government has taken some initiatives such as the construction of the Jakarta-Bandung high speed railway, and another US$400 billion into other infrastructure projects according to KPMG. However, as explained above, their method of financing could bring about some issues. Overall, their weak infrastructure foundation could bring many complications which would disrupt Indonesia’s plans to be a global economic powerhouse. For instance, poor city planning and lack of infrastructure has indirectly contributed to the sinking capital of the country, Jakarta. According to The Organization of World Peace (OWP), Jakarta is sinking up to 25cm per year, making it the world’s fastest sinking city. This scenario would disrupt businesses, social welfare and impede potential investments from MNCs and other countries. In addition to that, increased expenditures to solve problems caused by bad planning would reduce the government’s funds which could have been used to spearhead other economic developments.

Furthermore, remember how earlier in the report we lauded Indonesia for the construction of highways that offered greater economic activity? There was a fair amount of criticism surrounding the “5000km sea tunnel” as while the program did reduce costs, it still fared worse compared to its neighbours – shipping would cost more than $1400 compared to $100-200 in neighbouring countries, and port utilisation remained dismal with only 20% in use. While the initiative was carried out with good intent, governance and policy making are ultimately not a magic wand to cure economic challenges.

Conclusion

All in all, Indonesia undoubtedly has an abundance of economic potential to be at the forefront of the Southeast Asian financial market as the next global superpower. However, all countries will definitely face challenges in their pursuit of development and Indonesia is no exception. Nevertheless, the various reforms that promote greater connectivity and increase in human capital have certainly helped propel Indonesia to the front line of ASEAN economies. 

References: 

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Researcher: Edwin Oh Chun Kit 
Reviewer : Muhammad Bahari
Editor: Julia Yazid