"A current-account deficit is not a sin" says Indonesia's Finance Minister Sri Mulyani Indrawati, "but we are punished just the same". The minister -- former professor, former top World Bank official -- makes a telling point.
In textbook economics, it makes good sense for countries like Indonesia to run a current-account deficit, funded by foreign capital inflows. Its saving rate, at well over 30% of gross domestic product, is high but this is not enough to fund all the viable investment opportunities.
For President Joko Widodo (known as Jokowi), this is anything but a theoretical question. He needs investment and growth to provide the jobs which will ensure his re-election in April. Balancing the current account would require slower growth -- not an election-winning formula.
In good times, global capital markets have readily provided funds to Indonesia, covering current account deficits which have often been close to 3% of GDP. Just over a year ago, foreigners held 42% of government bonds on issue. At the time this was touted as a demonstration of foreigners' confidence in Indonesia.
But confidence is ephemeral. Investors change their minds and threaten to take their money out. It is not as if Indonesia's prospects have changed. Economic growth is forecast to maintain the steady 5%-plus rate seen in recent years: inflation is low, as is government debt; total foreign debt is modest; and the budget deficit is well-contained. The current-account deficit will be trimmed to 2 1/2% of GDP and all credit rating agencies give Indonesia an "investment" rating.
The issue is not at home, in the domestic economy. The problem is that global capital markets are inherently volatile, driven by factors far removed from Indonesia. When a shiver runs through global markets, the portfolio investment that surged eagerly into Indonesian government bonds does a U-turn.
Around half of Indonesia's capital inflow is in the form of stable foreign direct investment (FDI), which not only funds the current account but provides valuable technology and managerial transfers as well. But the other half is portfolio investment -- the restless money scouring the globe for yield, ready to react to the latest shift in risk-on/risk-off mood.
The most recent episode began six months ago, when America's "normalization" of interest rates put investors on edge, despite these moves being well-signalled by the U.S. Federal Reserve. Financial markets recalled the 2013 "Taper Tantrum", where Indonesia was included in the market's hit-list of 'Fragile Five' countries, with the rupiah coming under selling pressure.
Never mind the demonstrable fact that Indonesia came though this period without trauma: when global markets are shifting, they have neither time nor interest in differentiating between countries. It's "everyone for the exits". The rupiah ended 2018 7% weaker against the U.S. dollar.
The high share of foreign ownership of government bonds, previously seen as an endorsement, morphed to become an indicator of vulnerability. Foreigners' bond holdings fell to under 37% of the total.
Indonesian policymakers have learned how to handle capricious foreign sentiment. When the market turns pessimistic, they raise interest rates, tighten fiscal policy and stand ready to defend the currency from extreme movements.
They did this last year and the drama was soon over, after rates increased from 4 1/4% to 6%. But of course this policy has costs. Investment is discouraged, growth slows, important budget expenditures are delayed and financial markets are disrupted.
There ought to be a better way. If this short-term capital is so volatile, is it worth having? You can't fund longer-term investment with money that is withdrawn on a market whim. Indonesia gains little from these fickle funds, as it has to maintain substantial foreign exchange reserves -- currently $120 billion -- to cope with possible outflows. The priority should be for stable flows rather than maximum inflows.
Conventional wisdom, as promoted by the International Monetary Fund, has long seen free capital flows as a virtue, level with free trade. This doctrine survived the 1997-98 Asian Crisis, in which capital-flow reversals played the central malign role. The 2008 global financial crisis, however, brought a belated reappraisal. Doctrine shifts slowly, but it is now possible to talk about "capital flow management" (which earlier would have been condemned as "capital controls") without provoking outrage in Washington.
What might be done? First best is an increased role for FDI -- which is not only more stable, but more beneficial. By international comparison, Indonesia's FDI inflow is small, at less than 2% of GDP. In dollar terms, it is not much more than FDI to Vietnam, which is a much smaller country.
In recent years Indonesia has shifted from 129th in the World Bank's ranking on "ease of doing business" to 73rd.
But a post-colonial nationalistic sentiment is never far below the surface when the going gets tough on the hustings, so there is no quick fix here. Vigorously promoting foreign ownership, even in the cause of faster growth, will not win April's election. Indeed, Jokowi signaled his nationalist credentials with a deal in December to acquire 51.2% of Grasberg gold and copper mine, previously managed by U.S. company Freeport-McMoRan.
Among policy-wonks in Jakarta, the focus is how to make portfolio flows more "sticky", so that funds stay put when global sentiment turns.
One idea being bandied about has its origins in the half-century-old idea of a Tobin tax -- a small transaction levy on inflows to "throw sand in the wheels" of short-term transactions. A tiny tax would discourage very short-term flows, while being barely perceptible for longer-term flows.
Now that the Washington Consensus is (properly) seen as a framework rather than a dogmatic doctrine, such ideas can be discussed without derision from Washington, although financial market executives are still ready to pour cold water on any idea which limits their flexibility and profits.
The lead-up to a presidential election is no time for esoteric economic debates. Neither Jokowi nor his challenger shows much interest in macroeconomics, beyond the general notion that Indonesia needs faster growth to overcome its many challenges.
For the immediate future, Indonesia will have to accept the unpalatable deal which global financial markets offer: "we will lend you money in good times, but we'll take it back whenever we have a fit of nerves." In the longer-term, however, it could boost both FDI and domestic funding, reducing reliance on portfolio flows through carefully designed capital-flow management.
Stephen Grenville is nonresident visiting fellow at the Lowy Institute in Sydney and former deputy governor of the Reserve Bank of Australia.