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Middle East turmoil poses major economic risk

Tan KW
Publish date: Wed, 17 Apr 2024, 07:21 AM
Tan KW
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JAKARTA: Further escalation in the Middle East conflict could pose multi-layered economic risks to Indonesia, ranging from further capital outflows to weaker gross domestic product (GDP) growth, according to analysts and some former government officials.

Speaking at an online event held by the Eisenhower Fellowships on Monday, former finance minister Bambang Brodjonegoro said Indonesia’s economic growth this year could end up between 4.6% and 4.8% if further escalation occurred, short of the government’s target of 5.2%.

“Perhaps, if the escalation is more severe and longer ... maybe the 5% target will be challenging,” Bambang said.

Iran launched over 200 drones and missiles in a military strike on Israel late last Saturday, AFP reported, in retaliation for an Israeli attack on an Iranian consulate building in Damascus on April 1.

The strike was the first direct attack Iran has launched on Israel in their decades of contestation.

In response, Finance Minister Sri Mulyani Indrawati held a meeting last Sunday discussing the global economic and financial situation amid the heightened geopolitical tensions.

Coordinating Economic Minister Airlangga Hartarto said in a press statement on Monday that the government would “not stand still” and emphasised that market trust in Indonesia “must be maintained”.

He also urged market players to “remain calm and not take speculative steps”.

The conflict between Iran and Israel could pose “serious external challenges” for Indonesia, Bambang said, noting that some four trillion rupiah (US$249mil) of foreign capital left Indonesia’s bond market when the Israel-Hamas conflict began in October of last year.

“That’s just between Israel and Hamas. The nature of that conflict was still local, an internal issue in the Middle East. This Iran-Israel issue is bigger than that,” said Bambang.

Investors tend to put their money in lower-risk assets such as the US dollar or gold during times of conflict, drawing their funds out of emerging markets such as Indonesia’s, whose assets are riskier.

An outflow could further strengthen the greenback against the rupiah. One US dollar bought 16,120 rupiah last Sunday after Tehran’s strike, breaching 16,000 rupiah per US dollar and extending a trend that began last Thursday.

Bank Indonesia (BI) would have to intervene to stabilise the rupiah, Bambang said, but he encouraged caution because exhausting foreign exchange reserves in such an intervention could result in “fatal” consequences.

“Even if BI increases its interest rates, the effect may not be that strong since what’s going on is the US dollar strengthening against all currencies,” said Bambang.

The central bank will hold its monthly meeting next week after which it will announce policy rates.

Businesses have also urged BI and the government to work quickly to stabilise the rupiah against the US dollar, citing risks of inflation and input costs, Kumparan reported.

Bambang warned that the escalation could risk increases in oil prices, fuelling global inflation that could corner the US Federal Reserve into keeping its interest rates higher for longer, further weakening the rupiah in the process.

Speaking at the same event, Energy and Mineral Resources Ministry oil and gas director-general Tutuka Ariadji said Jakarta was currently focusing on the short-term effects of the conflict as longer-term predictions “would be inaccurate” given the complexity of the matter.

Jakarta uses the Indonesia Crude Price (ICP) as the benchmark for its energy policy-making along with the rupiah exchange rate, with baseline assumptions of US$82 per barrel and 15,000 rupiah per US dollar in this year’s state budget.

Tutuka said that for every US dollar increase in the ICP, the government had to spend 1.78 trillion rupiah more in energy subsidies and 5.34 trillion rupiah more in energy compensation, paid to state-owned energy companies that sell their goods or services below economic prices.

Likewise, for every 100 rupiah weakening of the rupiah against the greenback, the government needed to spend 1.2 trillion rupiah more in energy subsidies and 3.9 trillion rupiah more in compensation.

As of March, the ICP was US$83.79 per barrel, and the exchange rate as of April 5 was 15,873 rupiah per US dollar.

 - ANN

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