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Monthly Report - DossierÀlex Ruiz, Carlos Martínez Sarnago
Indonesia and Malaysia are back on track after coping with the taperingIndonesia and Malaysia are back on track after coping with the taperingIndonesia and Malaysia are back on track after coping with the tapering

The emerging countries of Asia make up a multifarious group, both in terms of the structural conditions of each economy as well as the economic policies adopted. Two neighbours, Malaysia and Indonesia, are a case in point. Both are becoming increasingly important thanks to favourable but clearly different economic advantages.

Malaysia is a country which, with an average per capita income of around 16,000 euros (in purchasing power parity) and in the midst of shift towards a much more services-oriented economy, is in a position to become an advanced economy within less than one generation. This position has led to a range of highly ambitious government programmes to reform its economy. The two main levers are support for investment in technology, telecommunications, nuclear energy, etc. and the modernisation of its business environment, reducing corruption and improving education. Its size, relatively small by Asian standards (30 million inhabitants) and the open nature of its trade (exports of goods and services account for 82% of GDP) make this aspiration feasible.

In comparison, Indonesia is a less prosperous country (its per capita income is less than one third of Malaysia's, around 4,700 euros in purchasing power parity) with an economic model that still depends greatly on the primary sector and commodity exports. However, the contribution of these last two areas does not prevent its economy from being relatively closed (total exports represent just 24% of GDP) considering its substantial size (it has more than 251 million inhabitants and, after China and India, is the third largest economy of emerging Asia). Nevertheless, the country still has a lot of potential. According to a recent study by the IMF, its long-term growth trend is around 6%.1 At this rate, the country could see a significant increase in the segment of its population with a standard of consumption befitting that of an emerging middle class: according to a study by the McKinsey Global Institute, by 2030 135 million people would make up this group, compared with 45 million in 2010.2

However, such attractive prospects need to be achieved without taking any shortcuts that may be tempting in the short term but harmful in the long run. The recent episodes of financial stress affecting the emerging economies are a warning that should not go unheard. Let us recall the chain of events. In May last year, the Federal Reserve Chairman at that time, Ben S. Bernanke, announced, by surprise, the Fed's intention to start gradually reducing its monthly bond purchases (tapering) at the end of 2013, provided the economy continued to make good progress. International investors reacted sharply: rapid rises in long-term interest rates on US government bonds and a strong upswing in global risk aversion, which hit the financial markets of a large number of countries from emerging Asia particularly hard. The region's financial environment deteriorated dramatically due to heavy capital outflows during the second half of 2013, affecting the currencies and most asset prices (sovereign bonds, corporate bonds and stock markets). There was a further outbreak of tension at the beginning of 2014, this time caused by factors such as the devaluation of the Argentine peso and the Ukraine crisis.

The Asian continent had already suffered several episodes of financial tension in the past but these latest ones were different insofar as there was clear discrimination in the punishment inflicted on various countries. This can be seen by comparing the nominal depreciations in their respective currencies throughout the last year. In this respect, Indonesia and Malaysia are a case in point: today the Indonesian rupiah is 20% below its value against the dollar in May 2013, while the Malaysian ringgit has depreciated little, merely 6%. Similarly, the trend in the implied volatility of the exchange rate for each of these currencies against the dollar (an indicator of the risk perceived by operators in the foreign exchange market) provides a similar conclusion: systematically, during the episodes of financial stress last year, the volatility of the Indonesian rupiah was at a higher level than that of the Malaysian ringgit.

What is this disparate risk assessment telling us? The episodes of financial turbulence were quickly interpreted as the result of excessive macroeconomic imbalances, both external (current account) and internal (inflation, fiscal balance). The most vulnerable countries in these areas were considered to be fragile and more susceptible to capital outflows, with the consequent drop in the values of their currencies and risk assets. According to this interpretation, the punishment meted out to Indonesia is understandable: in 2012, in the run-up to the crisis, its current account had a deficit of 2.8% and inflation was around 4%. However, Malaysia, with a current account surplus of 6.1% and inflation at 1.2%, had a lower risk profile. Nonetheless, in the Malaysian case, the poor state of its public finances was a downside (its public deficit in 2012 was –3.6%, more than double that of Indonesia). A dynamic evaluation of these same indicators of vulnerability helps to improve our diagnosis; but it also complicates it. During the period 2010-2012, both economies had exited the global recession of 2008-2009 with an important feature in common: considerable economic dynamism (after China and India, Indonesia was the country from emerging Asia with the fastest growth during this period and Malaysia the fourth) which aggravated the aforementioned imbalances. In particular, the combination of the real appreciation of their currencies and growth in domestic demand worsened the external position of both economies: Malaysia went from a current account surplus of 15% of GDP in 2009 to 6.1% in 2012 while Indonesia went from a current account surplus of 2% of GDP to a deficit of 2.8%. Together with these crucial elements, analysts also highlighted other imbalances, particularly serious in the case of Indonesia, such as strong stock market gains and the significant rise in private credit. As mentioned previously, these all pointed to excessively fast growth. After the episode of the financial crisis, Indonesia suffered an initial stage of rising inflation. Fortunately, in the last few months this has started to fall again. Another imbalance starting to correct itself is the external deficit. The strong nominal depreciation of the rupiah and the reduction in the inflation differential with its main trading partners is helping to adjust the current deficit. For its part, Malaysia has also started an incipient correction in inflation and, more visibly, has seen its current surplus increase after years of decline.

The financial upsets of the last few months and the inevitable need to redress imbalances are threatening to jeopardise the growth of these countries over the coming years. The IMF's World Economic Outlook published last April predicts average growth over the next five years of 5.0% for Malaysia, while Indonesia is expected to grow by 5.9%. In April 2013, a few weeks before the turbulences erupted, the forecasts given by the IMF were 5.2% and 6.4%, respectively. The price paid by Malaysia for these tensions has therefore been relatively modest, while Indonesia has paid a higher price due to its relative weaknesses. But this is far from being a dramatic scenario. When we look back, with hindsight, at the episode of 2013 and the tail-end of the tensions in 2014, we will probably tend to minimise their importance. In no way has this been a crisis such as the one affecting Asia in 1997. In fact, the lessons learned from that episode are still present today (as witnessed by the high accumulation of reserves and prudential management of external debt by Asia's economies) and have prevented the recent crisis from being any greater. Nonetheless, we should not forget that, on the road to prosperity, it is advisable to avoid any shortcuts.

1. Rahul, A., Cheng, K., Rehman, S. and Zhang, L. (2014), «Potential Growth in Emerging Asia», IMF WP 14/02.

2. McKinsey Global Institute (2012), «The archipelago economy: Unleashing Indonesia's potential».

Àlex Ruiz and Carlos Martínez Sarnago

International Unit and
Financial Markets Unit,
Research Department, "la Caixa"