Cablegate: Financial Crisis Impact On Average Indonesian Rising

VZCZCXRO4675
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #2247/01 3471052
ZNR UUUUU ZZH
R 121052Z DEC 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 0956
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2846
RUEHBJ/AMEMBASSY BEIJING 5730
RUEHBY/AMEMBASSY CANBERRA 3403
RUEHUL/AMEMBASSY SEOUL 5229
RUEHGP/AMEMBASSY SINGAPORE 6394
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 04 JAKARTA 002247

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS, EAP/EP AND EEB/IFD/OMA
TREASURY FOR IA/MALACHY NUGENT AND TRINA RAND
COMMERCE FOR 4430/KELLY
DEPT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
DEPARTMENT PASS EXIM BANK
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER
DEPT PASS USTR WEISEL, EHLERS

E.O. 12598: N/A
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: FINANCIAL CRISIS IMPACT ON AVERAGE INDONESIAN RISING

REF: A) Jakarta 2206 B) Jakarta 2207 C) Jakarta 2104 D) Jakarta
2157

1. (SBU) Summary. To date the global financial crisis has affected
primarily Indonesia's wealthy population, as middle and low income
Indonesian have few or no stock or bond investments and the
Indonesian banking sector has remained stable. The concurrent
reduction in food prices and increase in government anti-poverty
programs have also eased pressure on middle and low-income families
in recent months. Yet analysts are predicting a sharp slowdown in
growth, tighter credit conditions, rising unemployment, and pressure
on wages through early 2009, increasing the likelihood that the
effects of the financial crisis will spread to average Indonesian
households.

2. (SBU) Turmoil in global financial markets has reduced the
government of Indonesia's (GOI) ability to increase fiscal spending
and ease monetary policy to blunt the impact of slower growth.
Corporate and consumer credit quality is also set to decline,
limiting the local banks' appetite to extend significant new loans.
As the impact on middle and low-income Indonesians intensifies,
confidence in the government may begin to wane. End summary.

Lower Food and Fuel Prices Boost Purchasing Power
--------------------------------------------- ----
3. (SBU) To date the global financial crisis has largely affected
Indonesia's wealthy population, as middle and low-income Indonesian
have few or no stock or bond investments. The concurrent slowdown
in overall and food price inflation have eased pressure on middle
and low-income families. Overall food prices fell 0.12% between
October and November 2008 and the price of rice, which comprises as
much as one-third of the total household spending in Indonesia, is
down almost 7% from its 2008 peak (ref A). The government's recent
reduction in the price of subsidized gasoline will also help offset
transportation costs for Indonesian families. [Note: Although poor
and middle-income families receive some benefit from lower gasoline
prices, the bulk of the benefit accrues to wealthy, automobile
owning Indonesians. End note.] In addition, the government's direct
cash transfer program and subsidized rice scheme have successfully
boosted poor households' purchasing power this year.

4. (SBU) These benign trends helped increase consumer confidence and
reverse some anti-government sentiment that had built up earlier in
the year. Danareksa's Consumer Confidence Index rose for the fifth
straight month in November, and Roy Morgan's consumer confidence
barometer jumped 5.6 points between the second and third quarters
this year. The gains in consumer confidence where attributed in
large part to improved confidence among households earning less than
IDR 500,000 per month ($45.50). Danareksa's Confidence in
Government Index also rose in November increasing 2.2% over the
previous month, reflecting respondents' view that overall economic
conditions had improved. Despite improved consumer confidence, the
number of respondents that stated job scarcity was a major problem
rose from 23.3% in October to 24.7% in November.

Growth Set to Slow Significantly
-------------------------------
5. (SBU) While lower price levels have supported improved standards
of living for many low-income households, a slowdown in the real
sector resulting from the prolonged global financial crisis will
likely undermine these trends. Analysts have significantly reduced
their growth forecasts for Indonesia in 2009, in some cases from
6.0% to less than 4.0%, as exports and investment show significant
signs of weakening. The sharp slowdown in overall world demand, as
well as the sharp decline in the prices of many of Indonesia's
primary commodity exports will continue to put downward pressure on
the value and volume of exports in the coming months. Export growth
slowed significantly in October (ref A) and anecdotal information
from the business community suggests this trend will intensify in

JAKARTA 00002247 002 OF 004

November and December. The sharp drop in commodity prices has also
delayed payments to Indonesian commodity exporters, as buyers seek
to renegotiate prices and bankers seize shipments that producers put
up as collateral for loans, according to recent press reports.

6. (SBU) Limited access to financing also threatens to undercut
export and investment growth over the medium term. The Indonesian
corporate sector is significantly healthier now than in the years
leading up to the 1997-98 financial crises, with debt-to-asset
ratios of companies listed on the stock exchange declining 30
percentage points between 2000 and 2007, according to the IMF.
However, even healthy firms are having difficulty accessing
short-term trade finance due to a reduction in USD liquidity in the
domestic banking system and rising risk aversion among foreign
banking organizations, according to bankers at ING Jakarta. Bank
Indonesia (BI) has announced plans to guarantee trade finance
extended by banks with high credit ratings, but the effectiveness of
the new program, initiated on December 5, remains unclear. The
price of USD credit has more than doubled since June, according to
the ING bankers, making loans cost prohibitive for all but the
strongest Indonesian firms. According to bankers from UBS Jakarta,
several prominent Indonesian firms with strong balance sheets have
approached them to provide funds to refinance maturing USD debt in
excess of $100 million, raising concerns of large refinancing
requirements in the corporate sector that have not been met by local
or foreign banks. A growing number of local firms have cancelled
all expansion plans in the near term in an effort to preserve cash,
further diminishing the outlook for investment, according to ING.

Job Losses Begin to Mount
-------------------------

7. (SBU) Formal unemployment is set to rise significantly in
Indonesia as economic activity slows, tempering the outlook for
robust domestic demand growth. In particular, reduced global demand
is likely to adversely impact Indonesia's labor-intensive export
industries, such as garments, footwear, and electronics.
Unemployment rates have already begun to rise, with over 60,000
workers in the formal sector either terminated or laid off this
year. Analysts expect these trends to intensify during the first
half of 2009, with as many as 1,000,000 people in danger of losing
jobs (ref B). Rising job losses among middle class workers in the
formal sector may flood the informal sector, as middle class
families shed household staff. While the informal sector can absorb
many of the workers, the rise in the number of individuals seeking
work will drive down already low wages in the sector.

8. (SBU) Anton Gunawan of Bank Danamon noted in a recent
presentation that layoffs and wage reductions in the commodities
sector outside Java have already lowered consumption levels in those
regions. Many small palm oil plantation holders who enjoyed
windfall profits this spring when palm oil prices reached their peak
are now drastically readjusting their spending patterns, according
to a recent World Bank survey. In line with these trends, car sales
in Indonesia dropped to over 47,000 units in November from that of
54,000 units in the previous month, according to the Indonesian
Automotive Industry Association. ING representatives in Jakarta
warned of significant asset quality and liquidity problems in the
consumer finance sector as job losses increase. These weaknesses
may result in a sharp contraction in the availability of consumer
credit and the failure of a number of subprime consumer credit
firms, further depressing consumption patterns in 2009.

Financial Market Turmoil Limits GOI Ability to Respond
--------------------------------------------- ---------
9. (SBU) Although the GOI and BI have been proactive in addressing
the global financial crisis to date (ref C), higher funding costs
and ongoing pressure on the currency limit the GOI's ability to
blunt the impact of the global financial crisis on the real sector.
In terms of fiscal policy, the yield on 10-year IDR denominated

JAKARTA 00002247 003 OF 004

government bonds eased recently to roughly 12.0%, but had risen to
over 20.0% as recently as late October as global risk aversion to
emerging market debt intensified. The GOI has made significant
efforts to secure funding from multilateral organizations (ref C),
reducing the need to secure financing from the private sector to
maintain spending levels. The reduction in oil prices has also
reduced the size of the government's subsidy bill, creating
additional space for spending. The GOI has stated plans to increase
pro-poor and infrastructure spending in 2009, but few observers
expect these initiatives to yield significant new jobs. A new
large-scale spending program capable of creating long-term job
growth will require private sector funding that is increasingly
difficult to secure in a climate of rising risk aversion. In
addition, the potential for corruption in large-scale infrastructure
and disputes over land use continue to hinder the GOI from moving
more quickly on job creating public works programs.

10. (SBU) In terms of monetary policy, Bank Indonesia (BI) eased its
overnight policy rate by 25 basis points on December 4, but ongoing
pressure on the Indonesian rupiah (IDR) limits the central bank's
ability to ease monetary policy at a rapid pace. Indonesia's
currency continues to trade near the IDR/USD 11,000 level, up from
9,500 just three months ago, and rose above IDR/USD 13,000 during
the month of November. Analysts expect pressure on the currency to
continue given the risk of further capital flight amid global
uncertainty and Indonesia's deteriorating balance of payments
position. Indonesia's balance of payments turned negative during
the third quarter of 2008, despite an improvement in the current
account deficit. The negative balance resulted from a significant
decline in the capital account balance. Net portfolio flows fell
from $4.3 billion in the second quarter to negative $58 million in
the third quarter. Analysts expect both the current account and the
capital account to deteriorate further in the fourth quarter, as
export growth and portfolio flows continue to decline, putting
additional pressure on the IDR.

Banking Sector Vulnerabilities Rise
-----------------------------------
11. (SBU) The rapid increase in credit recent years provided
considerable support for economic growth in Indonesia, but
deteriorating credit quality and tighter liquidity conditions will
temper banks' appetite to extend new loans and spur economic growth.
Credit growth remained high through October 2008, with year-on-year
growth reaching 37%, but signs of a slowdown are emerging. While
recent official figures are unavailable, anecdotal information from
the business community suggests a deceleration of credit growth in
November. In addition, as the global crisis spreads to the real
sector, credit quality will likely deteriorate. While overall
nonperforming loans in the banking sector remain low, at 3.9% as of
October 2008, analysts expect an increase in nonperforming loans in
the commodities and transportation sectors, as well as small and
medium-sized enterprise (SMEs) and consumer segments. Loan
concentrations in the mining, agriculture, and transportation
sectors have increased in recent years; these sectors comprised 28
percent of total bank loans as of September 2008.

12. (SBU) Indonesian banks' cost of funds also continues to rise,
putting additional upward pressure on lending rates. Deposit growth
has improved but has not kept pace with credit growth and remains
low, at a rate of 18% (yoy) in October 2008. Moreover, the lack of
a blanket guarantee on deposits raises the risk of depositor flight
to neighboring countries such as Singapore that have imposed a
blanket deposit guarantee. At the same time, tighter liquidity
conditions in the interbank market have increased the need for banks
to attract additional deposits. Interbank lending rates remain
roughly 100 basis points above the level recorded six months ago, as
concerns about counterparty credit risk among banks persist,
particularly in the wake of the failure of Bank Century. Deposit
rates at some banking institutions have exceeded 13% in recent
months, up from 9-10% in July and August. As a result, lending

JAKARTA 00002247 004 OF 004

rates have risen to close to 18% and are unlikely to fall until
confidence and liquidity in the interbank market returns.

Government Approval Ratings Unaffected, Yet
-------------------------------------------
13. (SBU) Approval ratings for President Susilo Bambang Yudhoyono's
administration have increased in recent months, largely in line with
the easing of price pressures on average Indonesian households (ref
D). As the impact of the global financial crisis spreads, these
ratings trends may begin to weaken. The outlook for job creation
and the cost of living have been significant drivers of confidence
in the government in recent years, according to researchers at
Danareksa. While lower global commodity prices and slower inflation
will continue to boost purchasing power among the poor, the
anticipated acceleration in job losses and decline in nominal wages
could significantly dilute the impact of lower inflation. Spending
associated with the 2009 election cycle and pro-poor government
programs should help alleviate the immediate spending needs of
Indonesian families. Yet the GOI's ability to create a significant
number of long-term jobs and spur economic activity in the near term
remains questionable.

HUME

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