Economic Stabilization Policies in ASEAN Countries 9789814345842

Table of contents :
CONTENTS
LIST OF TABLES
LIST OF FIGURES
CONTRIBUTORS AND EDITORS
ACKNOWLEDGEMENTS
I. OVERVIEW
II. ASEAN STABILIZATION EXPERIENCES
III. ECONOMIC STABILIZATION POLICIES IN INDONESIA
IV. ECONOMIC STABILIZATION POLICIES IN MALAYSIA
V. ECONOMIC STABILIZATION POLICIES IN THE PHILIPPINES
VI. ECONOMIC STABILIZATION POLICIES IN SINGAPORE
VII. ECONOMIC STABILIZATION POLICIES IN THAILAND

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I5EA5

INSTITUTE OF SOUTHEAST ASIAN STUDIES

The Institute of Southeast Asian Studies was established as an autonomous organization in May 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the multi-faceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer. The ASEAN Economic Research Unit is an integral part of the Institute, coming under the overall supervision of the Director who is also the Chairman of its Management Committee. The Unit was formed in 1979 in response to the need to deepen understanding of economic change and political developments in ASEAN. The day-to-day operations of the Unit are the responsibility of the Co-ordinator. A Regional Advisory Committee, consisting of a senior economist from each of the ASEAN countries, guides the work of the Unit.

ECONOMIC STABILIZATION POLICIES IN ASEAN COUNTRIE S

dtt db

and FLORIAN A. ALBURO niver it of th

Ph,uV~nJ~s

Field R port Sed o. 17 ASEAN ECO OMIC RESEARCH U IT INST ITUTE OF SOUTHEAST ASIA STUD I ES 1987

Published by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Panjang Singapore 051 I All rights reserved. No part of this publication may be reproduced , stored in a retrieval system, or transmitted in any form or by any means , electronic , mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies.

© 1987 Institute of Southeast Asian Studies The responsibility for facts and opinions expressed in this publication rests exclusively with the authors, and their interpretations do not necessarily reflect the views or the policy of the Institute or its supporters. Cataloguing in Publication Data Economic stabilization policies in the ASEAN countries I edited by Pradumna B. Rana and Florian A. Alburo . (Field report series/ Institute of Southeast Asian Studies ; no . 17) I. Economic stabilization-- ASEAN . 2. ASEAN -- Economic policy . I. Rana, Pradumna B., 194711. Alburo, Florian A., 1947III. Institute of Southeast Asian Studies. IV. Series. DS50l 1594 no. 17 1987 ISBN 9971-988-48-8 ISSN 0217-7099 Printed in Singapore by Kim Hup Lee Printing Co . Pte. Ltd.

OOHTENTS

List of Tables iv List of figures vii Contributors and Editor Acknowledgemcnu ix

vm

Overview Prddumruz B. Raruz an.d Florian A . A lburo IJ

ASEAN Stabilization Policies Pradumruz B. RaM

III

Economic Stabilization Policies i:n lndone Polin L. R . Pospos

IV

I7

13

Economic Stabilization Policic in Malay ' 13

M. Semudram

52 79

v

Economic Stabilization Policic1 in the Phihpptne• Noel Lim

VI

Economic Stabilization Policies in angaporc Lee (Tsao) Yuan

Vll

Economic Stabilization Policies in Thailand Direlc Patmasin.wat

lll

12~

154

IACs except Tha i land due to the emerging recovery of the world economy. but the current account deficit still stood at 20 per cent of total exports. To sum up. during the post-shock period both the inflation rate and the current account deficit deteriorated in each of the r«>ACs and this was associated with a lower growth rate of GOP. Inflation rates were particularly high during the 1973-74 period and again during 1977-80; current account deficits were high during 1974-75 and 1977-82. Indonesia is the only ASEAN country which recorded an improved payments position and a higher growth rate during the post-shock period relative to the pre-shock period. The inflation rate in Indonesia also increased during th is period, indicating a failure of that country to sterilize its BOP. Sources of Stabilization Problems If better policy measures for dealing with the stabilization problems outlined in the previous section are to be designed, the source (or cause) of these problems must be identified. A cause is classfied as external if it is due to externally-generated changes in trade volumes or trade prices, or to fluctuations in the volume of international capital

flows

classified

(including interest rates); otherwise it is as internal or domestic. Such a system of

classification must be expressed in broad terms only since there may be significant linkages between the two types of causes. For example, capital inflows could be related to domestic pol;cies, and failure to respond to external factors could in some sense be classified as internal. The external factors that influenced the ASEAN countries during the 1970s and early 1980s were the com-

28 Pradumna B. Rana modity price boom of 1973, the first oil shock of 1973 and 1974, the worldwide recession of 1974 and 1975, the mild recovery which lasted from 1976 to 1978, the high interest rates of the late 1970s, the second oil shock of 1979 and 1980, the world recession and the oil glut which started in 1982, and the emerging recovery of 1983. These factors were transmitted to the domestic economy through three channels. Firstly, they affected the ability of a country to import essential intermediate goods. Secondly, they influenced the macro-economy through the Keynesian foreign trade multiplier. Finally, they had a direct effect on the price of traded goods, wages and the cost of capital. Together with external factors, internal factors ha~e These comprised primarily domestic also been important. crop failure and expansionary demand management policies. The poor harvest in Asia in 1982 fuelled inflation and increased food imports in the ASEAN countries. The data in Table 2.5 indicate that in four of the five ASEAN countries the money supply increased at a faster rate in the postshock period than during the pre-shock period. The increase was particularly pronounced in 1973 and 1974 and again during the 1976-80 period. It was only Indonesia that was able to reduce the rate of growth of its money supply during the post-shock period. On the fiscal side, performance by the ASEAN countries was better and the budget deficit increased in the post-shock period only in Malaysia and Thailand (see Table 2.6) . • In the case of the Indonesia the pre-shock deficit was reduced during the post-shock period, in the case of the Philippines the pre-shock deficit turned into a surplus, and in Singapore the budget surplus increased Political factors were also in the post-shock period. important in some countries, particularly the Philippines. Sources of Balance of Payments Problems The four major factors that influenced the current account

Table 2.5:

Countries: Growth Rate of Narrow (Per Cent Per Annum)

~EAH

Average 1967-72

Average 1973-83

~ney.

1967-83

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

198}

77.1

29.7

34.6

40.5

37. 1

29.6

29.5

18.9

31.4

4}.4

}2.6

25 .5

4.1

7.2

16.9

35.9

20.8

7.9

14.5

18.5

17.9

18.0

17. 1

1:3.3

11.0

11.}

Ph I I I pp I nes

12.2

15. 1

27.9

20.9

14.4

15.4

21. 1

16.5

11.9

14. 1

11.0

1.8

11. 1

Singapore

12.3

13.8

24.7

7.4

8.6

8. 1

10 .5

1.6

3. 1

14. 2

11.9

12.9

9.l

8.3

12.2

20.2

14.7

7.6

n.o

II. 9

15.3

16.6

15.8

5. 1

6. 5

7.5

Indonesia M!llaysla

Thailand

Source:

1FS Yeerbook 1984, I W.

Teble 2.6:

ASEAN Countries:

Budget Deficit as Percentage of GOP, 1963-83

Average 1967-72

Average 1973-83

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

Indonesia

-2.7*

-1.6

-2.0

-0.9

3.2

-1.5

0.9

-0.5

-0.5

-2.4

-1.5

-2.4

-1.4

Malaysia

-4.1

-6.8

-3.7

-2.7

-4.7

-4.4

-5. 1

-4.2

-5.2

-9.6

-15.6

-11.5

-7.6

Philippines

-0.9

0.2

2.9

2.5

-0.8

1.7

-1.8

0.2

1.7

0.6

-1.1

-0.9

0.4

2.5

6.3

6.3

6.8

8.1

5.3

3.8

3. 1

3.9

4.9

6.8

9.9

0.4

-2.2

-2.8

-2.4

0.8

-2.5

-4.8

-3. 1

-2.8

-2.4

-3.8

-2.7

-4.8

-2.5

Singapore ThaI land

*

Average for 1969-72.

Sources:

IFS Yearbook 1984,

I~;

IFS Tape.

ASEAN Stabilization Experiences

31

positions of the ASEAN countries in the post-shock period were: o

deterioration in the tenns of trade due primarily to the oil shocks,

o

the post-oil shock recession in industrial countries,

0

sharp increase in interest rates in the major capital markets towards the end of the 1970s, and inadequate

0

insufficient

or

domestic

adjustment

signalled by an appreciation of the real effective exchange rate (see Table 2.7, note 4 for a definition of the real effective exchange rate). While this list is not exhaustive

(for example, domestic

supply shocks such as poor harvests are not included), it covers the major factors. In a broad sense, the first three factors (deterioration of tenns of trade, the recession in the industrial countries and the increase in interest rate in major capital markets) were external factors because they were beyond the Similarly, control or influence of small open economies. the fourth factor is a domestic factor because decision makers have some control over the major policy variables (that is, money supply, budget deficit and nominal exchange rate) which influence the rea 1 effective exchange rate. We can then write, CA/ X = where CA

=

f (TOT, GY IC , FIR, RER, T)

current account balance (excluding official transfers) nominal exports of goods and services

X

tenns of trade index

TOT GYIC

=

growth of real GIJ> in industrial countries

FIR

=

foreign interest rate

( 1)

Table 2. 7:

AS EAN CountrIes: Current Account B&lance, Terms of Trade Changes, Foreign Interest Rate, Real Effective Exchan~e Rate, and GNP Growth Rate of Industrial Countries, 1973-82 (Percentage) 1973

1974

1975

1976

1978

1977

1979

1980

1981

1982

Current Account 2 8& lance

-o.4

-9.6

- 13.7

-11.2

-11.5

-13.1

-14.2

-15.7

-20.7

-21.6

Terms of Trade Changes

15.3

-1.7

-14.9

-o.3

-1.:5

1.9

7.5

-7.5

-3.:5

-7.7

9,2

11.0

7.0

5.6

6.0

8.7

12.0

14.4

16.5

13.1

108.0

120.2

115.4

112.3

109.4

10:5.7

106.5

105.2

108.0

112.9

6.0

0.7

-o.4

5.0

:5.9

4.0

:5.2

1.3

1.5

-0. 5

Foreign Interest Rate 3 Rea I Effect I ve 4 Exchange Rate (MI!y 1970=100) Growth rate of Industrial countrIes

Rows 1, 2 and :5 are arithmetic averages for Melaysla, the Phi llpplnes and Singapore; Indonesia was not Included because of data problems.

Notes:

2

Excluding official transfers and as percentage of total exports of goods and services.

:5

Three-month Eurodollar rate.

4

RER

1

( L wjrj/Pjl I (rl/Pll where rm for mz l, j Is the price of the US dollar In terms of

J

t. I

\

country l's or j 1 s currency relative to May 1970; Pm for mzl, j are wholesale price Indices In local currency for count r y I and j relative to MDy 1970; and wj's are the 1970-7:5 average Import weights. These Indices were computed by the author using mont~ly data from IFS.

ASEAN Stabilization Experiences RER T

33

real effective exchange rate index, and time trend

Other things equal, we would expect an improvement in the terms of trade and an increase in the growth rate in industrial countries to have a favourable effect on the current account positions of the ASEAN countries. Similarly, we would expect an increase in the foreign interest rate and an appreciation of the real effective exchange rate to have an adverse effect. Since the time trend variable captures the effects of variables which are not included in the equation, it can be either positive or negative in sign. While equation (1) is a simple model of the current account balance, it can be viewed as a reduced form equation of a full structural model consisting of an import equation, an export equation and net service trade equation. For estimation purposes we used the following semi log linear approximation: (CA/X)t

a1 log TOTt + a2 GYICt + a3 FIRt + a4 log .RERt + a5 T + ut

(2)

where ut is a random variable, which is normally distributed with mean o and variance 1, and is homoskedastic. Equation (2) and a restricted version of the latter (which sets a5 = 0) were estimated using data from four ASEAN countries; Indonesia was excluded because of a lack of c0mplete time series data fJr the terms of trade variable. 7 Annual data for the four countries for the period 1973 to 1982 were pooled to yield a sample of forty observations. 8 In order to account for cross-country differences in the behaviour of the current account we inserted intercept dummies. We did not, however, use slope dummies; thus, the results pertain to an "average" ASEAN country rather than to any individual country included in our sample.

34

Pradumna B. Rana The

results

of

the

estimation

equations 2.1 and 2.2 in Table 2.8. have

the

expected

sign

and

the

equations is quite satisfactory.

are

presented

as

All of the variables

goodness-of-fit

of the

However, the sign of the

trend variable is a bit surprising. Given the increase in global protectionism during the 1970s one would expect this variable to be negative in sign. The positive sign probably indicates that the industrial restructuring policies (that is, policies promoting efficient industries and reliance on the market as a means of allocating resources) in the ASEAN countries

offset the adverse effects of the increase in

protectionism. The results show that changes in the terms of trade had a significant effect on the current account ba 1ance of the ASEAN countries: they suggest that a one percentage point improvement in the terms of trade leads to approximately a one-half percentage point increase in the current account ba 1ance (as a proportion of tota 1 exports). The foreign interest rate variable is not significant; this suggests that on the whole, the debt service burden was not very great for the ASEAN countries during the period under study. The growth rate of the industrial countries variable was not significant at the 5 per cent level.

This is not

surprising because this variable captures only the direct effect of the growth rate in industrial countries. The indirect effect is captured by the terms of trade variable. Changes in the rea 1 effective exchange rate had a si gnificant effect on the i nd i vi dua 1 current account ba 1ances of the ASEAN countries. The results suggest that this effect is similar in magnitude to the terms of trade effect. In estimating equation (2) with the countr-y intercept dummies,

we

assumed

that

the slope coefficients of the

variables were identical for the seven countries included in the sample. assumption

A simple way to test the validity of this is

to estimate the correlation

co-efficients

Table 2.8:

ASEAN Countries:

Inter-country Regressions of Current Account Balance

Dependent Variable = CA/X

Explanatory Variables (t values in parentheses)

Equation

Log TOT

GYIC

FIR

LOG RER

2. 1

0.444*** (3.876)

0.008 (0. 734)

-0.00 7 (-0.089)

-0.449*** ( -3. 108)

2.2

0.406*** (3. 154)

0.009 (1.677)*

-0.004 ( -0.405)

-0. 414*** (-3.365)

***

Significant at 1 per cent.

*

Significant at 10 per cent.

T

-0.00 7 ( -1.064)

R2

Number of Observation

0.655

38

o. 786

38

36

Pradumna B. Rana

between the actual and estimated current account balances of The resu 1ts of this each country using equation ( 2. 2). exercise (see Table 2.9) show that only in one case (Singapore) could the simplifying assumption have contributed to serious in-sample prediction errors. For the other countries the correlation coefficient is greater than 65 per cent and is significant ~t traditional levels. The results thus far indicate that both external and domestic factors had a significant effect on the current account balances of the ASEAN countries. In order to assess the relative contribution of the two factors, however, we need to consider the actual changes in the variables as

Table 2.9:

Correlation Between Actual and Predicted Values of Current Account Balances, 1973-82

Country

Correlation Coefficient*

Malaysia

0.735 (0.015)

Philippines

0.845 (0.002)

Singapore

-0.054 ( 0.897)

Thailand

0.686 (0.005)

*

Levels of significance in parentheses.

ASEAN Stabilization Experiences well.

37

Table 2.10 shows the causes of the changes in the

current account of the countries under study.

The data in

column 3 suggest that deterioration in the terms of trade accounted for the greater part of the decline in the current account positions of the ASEAN countries.

Next in impor-

tance (although not statistically significant) are the two rema1n1ng

external

factors:

increase

in

the

foreign

interest rate and the slowdown in the growth rate of the industrial countries. the real

The domestic factor, appreciation of

effective exchange rate, was the least important

variable in relative terms.

Table

2.10:

ASEAN Countries: Sources of Changes in Current Account Deficit, 1973-82

Mean in Sample

Parameter from Equation 2.2

Contribution to Current Account2

b.

( 1og TOT)

-0.047

0.406

-0.019 (61)

t:..

GYIC

-0.718

0.009

-0.007 (23)

t:..

FIR

0.386

-0.004

-0.002 (6)

b.

(log RER)

0.001

-0.414

-0.001 ( 3)

t:..

T

0.429

-0.007

-0.003 (10)

t:..

Residua1 1

b.

( CA/ X)

Notes:

0.001 (-3) -0.031

1

Includes the effects of country intercept dummies.

2

Figures in parentheses are percentages.

38

Pradumna B. Rana

Sources of Inflation Although there is a considerable controversy regarding the relative significance of demand-pull and cost-push inflation in developing countries, it is commonly accepted that price equations should include both factors. Since the major cost-push variable that influenced the inflation rate in the ASEAN countries during the post-shock period was the price of imports, the relative contribution of domestic versus external factors is estimated using the following importprice augmented monetarist model of inflation:

where

P

M v

domestic inflation rate excess money supply

pf =

foreign inflation rate measured by the weighted average of inflation rates of major importing partners with import shares as weights.

pe

price expectations

NER

t

percentage change in nominal import weighted effective exchange rate, stated as the price of domestic currency in terms of importing partner currencies time.

While the foreign inflation term measure the impact of imported inflation on domestic inflation, the excess

ASEAN Stabilization Experiences

39

money supply weighted exchange rate variables measure the impact of domestic demand management po 1 i c i es. 9 The signs of a , a and a are expected to be positive since increases 1 2 4 in the money supply, foreign inflation and inflationary expectations all Since

an

lead to a higher domestic inflation rate.

increase

domestic currency, negatively

in an

influence

the

NER

increase the

implies

appreciation

in the NER

inflation

rate

of

is expected to (that

is,

the

expected sign of a

is negative). 3 Equation (3) was estimated using pooled cross-section

and time-series quarterly data from the four ASEAN countries from the fourth quarter of 1973 to the fourth quarter of

1979. 10

Since the work of other authors suggests that there

may be significant

lags

in the response of the inflation

rate to changes in the exogenous variables, we explored the lag pattern by fitting two different models.

Firstly, we

allowed lags of up to eight quarters for the excess money supply variables.

The lags with the highest t-values and

those which maximized the likelihood function of the sample were selected.

We also estimated three versions of a Koyck-

type distributed lag model, the three versions corresponding to

the

three

expectations

hypotheses

(perfect

foresight,

regress i ve expectations and accelerator hypothesis) of each model were estimated, and the equations with the highest R2 and for which the errors were unautocorrelated were as follows:

~t = 0.244

+ 0.013

(0.538) (0.546}

+ 0.407 ~~ (5.025)

R2 = 0.53

( ~t

- it) + 0.559

(7.239)

~r

-

0.085 N~Rt (-0.987) (3. 1)

40

Pradumna B. Rana

. .f . . Pt = 0.008 + 0.016 (Mt - Yt) + 0.563 Pt - 0.105 NERt (-0.878) (6.241) (0.368) (0.437)

·e

(3.2)

+ 0.494 pt + 0.145 pt-1

(4.012)

{1.001)

R2 = 0.54 All variables have the expected sign. 11 The results show that foreign inflation is by far the most powerful variable in explaining domestic inflation, and that the price expectations hypothesis that performed the best was the perfect-foresight hypothesis. They also show that while the excess money supply variable did not have a statistisignificant

cally

effect,12

inflationary

expectations

contributed significantly to the inflation rate of the ASEAN Further changes in nominal import-weighted countries. exchange rates did not contribute to the inflation rate of the ASEAN countries. Table 2.11 disaggregates the sources of the inflation observed in the ASEAN countries during the period under These data suggest that most of the inflation rate in these countries during the post-shock period is accounted

study.

for by imported inflation. Design of Stabilization Programmes The major finding of the previous section is that external factors played a greater role in explaining the BOP and inflation problems of the ASEAN countries during the period under study than did domestic factors.13 While deterioration

in

terms of trade, world

recession and high world

interest rates have been responsible for the BOP problems, imported inflation takes much of the blame on the inflation side.

ASEAN Stabilization Experiences Table 2.11:

M-

y

.f pt (NER) ·e pt

ASEAN Countries: Sources of Changes in Inflation 1973-82 Mean in Sample

Parameter from Equation 3.2

Contribution to Inflation 2

2.241

0.013

0.029 ( 1.4)

2.165

0.559

( 57.2 1.2JO

-0.140

-0.085

0.012 (0.6)

2.074

0.407

Notes:

0.844

(39.9)

Residual 1 pt

41

0.019 (0.9) 2.114

1 Includes the effects of country intercept dummies. 2 Figures in parentheses are percentages.

Since the impact of the external factors on the domest i c economy depends upon the structure of production and trade, it can a1so be said that most of the s tabil i zation problems in the ASEAN countries during the post-shock period were structural in nature. In such cases adjustment by increasing supply or by adjusting the composition of aggregate demand is more efficient than reducing the level of aggregate demand. This is because structural adjustment permits adjustment with growth, whereas adjustment by demand management is deflationary, at least in the short-run. Also, since demand responds to policy changes more quickly than supply, our analysis of the origin and cause of disequilibria ' favour longer term policies over short term policies.

42

Pradumna B. Rana

However, on both theoretical as well as empirical grounds, we do not advocate abandoning short-term demand management policies completely. This is because BOP stabil- , ization requires that absorption be reduced relative to output, and in order to ensure that absorption does not increase at the same rate as output, we need demand management policies. Also, our empirical findings indicate that while external factors have a major role to play in explaining stabilization problems in the ASEAN countries, domestic factors are also important. We, therefore, argue that given the structural nature of the stabilization problems in the post-shock period, the response of pol i cymakers should be broad-based and consis t of both supply-side and demand management policies with the former type of policies being the centre-piece. The IMF-type demand management policies although necessary are not sufficient. ASEAN 1 s Success with Stabilization The basic question we started to answer was: Why has the ASEAN region been more successful in stabilization and As already noted, growth than other developing regions? past history provides a partial but not a complete answer. Obviously, the policy responses to the disequilibria have been crucial. While the details of the policy responses of individual countries are discussed in the country papers, some broad indications are provided here. In the monetary approaches to the BOP and inflation, the growth rate of money supply is the crucial variable explaining stabilization problems. Figure 2.2a shows that the growth rate of narrow money was slower in the NOACs during the period of study than in other non-oil developing In fact, in the NOACs a declining trend in the regions. growth rate of money supply is discernible during the postshock period. Although the money supply in Indonesia grew faster than in the NOACs and on occasion faster than the

Figure 2.2:

Growth Rate of Narrow Money (a)

Non-Oil

~veloping

Countries

Per cent

lOOr---------------------------------------------------------~

80 70

60 50 40 30

20 0

············

0 1973

74

75

76

78

77

( b)

79

80

81

83

Oil-Exporting Countries

Per cent

70 r-----------------------------------------------------------,

60 ~ Oil-Exporting Countries

50

//---- ,

''

40

''

''

30 Indonesia

20

'

''

_j

10

Source:

IFS, 1984 Yearbook, IMF.

.....

,

___ -------,

Figure 2.3:

Real Effective Exchange Rate (1973 (a)

100)

Non-Oil l.eveloping Countries

140

I 130

-----

120

110 ...

_

--

··... ·········· ·····

100

90

,,

····· ...... ·· .. ~"

...

I

I

Africa

I Middle East

-_./

Western / ' Hemisphere

-----

NOACs

.... '· • • Europe

80 ~--~----~----~----~~----~----~----~--~~----~--~ 19 73 74 77 75 76 79 78 81 82 80

(b)

Oil-Exporting Countries

160

150

140

130 /

120

,. "'

110

100 1973

74

Source :

,. /

75

/

/

/

/

,,

--

/

76

77

78

79

/

/

80

/

/

/

/

/

Oil /Exporting Countries

Indonesia

81

82

Annual Report 1983, IMF; ASEAN data computed by the author.

44

Pradumna B. Rana

average for oil exporting countries, this growth was still modest compared with the developing countries of the Western Hemisphere (that is, the Latin American and Caribbean countries). Many developing countries tend to overvalue their domestic currencies, thereby subsidizing imports at the Depreciation of the rea 1 effective expense of exports. exchange rate is therefore a crucial policy measure in In this regard, the adjusting to payments disequilibria. NOACs have achieved considerable success compared with other developing regions (see Figure 2.3a). While in the short run, depreciation of domestic currency in terms of the real exchange rate affects the BOP position by reducing excess demand for tradeables, in the long run the supply effects of such depreciation must also be taken into account. The real exchange rate is a country's price level relative to those of its trading partners adjusted for exchange rate changes, hence the real depreciation that has occurred in the NOACs has allowed all of these countries to maintain a relative price structure favourable to the production of traded goods vi s-a-vis non-traded goods. Although the Indonesian rupiah appreciated rapidly during the period 1973 to 1977, since that year the rupiah has depreciated rapidly in real terms, and this has brought about rapid adjustment in Indonesia. Acountry running a BOP deficit can adjust to payments disequilibria generated by external shocks in one of four ways. It can attempt to increase export shares through aggressive export policies. It can pursue efficient import substitution policies. It can lower growth to curtail import demand. It can engage in net external borrowing. While the first two are growth-augmented or supply-increasing adjustment policies, the third is growth-reducing. A recent study by Naya et al. (1984) which measures the policy responses of the ASEAN countries to external shocks during

Figure 2.3:

Real Effective Exchange Rate (1973 (a)

100)

Non-Oil l:eveloping Countries

140

I

120

110 .....

_

··..... ······

100

90

___, ----

---

I

Africa

I

130

I

Middle East

-_./

Western / ' Hemisphere / /

_./

,,

/

... -----

······· ... "'-..,_,......· .. ··. ·· ..... ·

_NOACs

•• • • •• • • Europe

80 ~--~~--~~----~----~----~----~----~----~----~----~ 1973 74 75 76 79 82 77 78 81 8D

(b)

Oil-Exporting Countries

160

150

140

Oil

130

120

1·10

100

/

1973

/

/

/

;

74

Source:

... / , "' ...

75

/

/

/

/

/

/

"' "'

76

"'

........... /

/

/

/

/

/Exporting / Countries

-/

77

78

79

80

Indonesia

81

82

Annual Report 1983, IMF; ASEAN data computed by the author.

46

Pradumna B. Rana

the period 1974-82 found that all of the ASEAN countries responded to external shocks by increasing supply rather by reducing demand (see Table 2.12). From this we can conclude that it was a broad-based approach to stabilization consisting both of supply-side and demand management policies with greater emphasis on the former that accounts for the success of the ASEAN region in economic stabilization and growth during the period of study. Summary and Policy Recommendations During the post-1973 period, all developing countries at some time or other have faced the problem of macro-economic instability manifest either in the form of higher inflation rates or payments imbalances (or both). The ASEAN countries have, however, been more successful than other developing regions in economic stabilization, and this success has also contributed to the dynamic growth performance of these countries. While history provides a partial explanation for ASEAN's success, more important, perhaps, have been the nature of the stabilization policies pursued by these countries. This study shows that although domestic demand or political factors were important in some cases, most of the stabilization problems during the period were due to external or structural factors. A cost-effective response to such problems therefore consists of supply-side or structural adjustment policies. While the IMF-type demand management policies are necessary to ensure that absorption does not grow at the same pace as output, these are not sufIt is precisely the greater ficient for stabilization. reliance on supply-side policies that accounts for ASEAN's relative success in stability. Since supply-side policies permit adjustment at a higher growth rate, such po 1i ci es have also contributed to ASEAN's dynamic growth performance. The other major finding of the study is that changes in exchange rates during the post-Bretton Woods period have not

Table 2.12:

Balance of Payments Effects of External Shocks and Policy Responses to the Shocks (Averages of 1974 to 1982) Policy Responses (%)

Balance of Payments Effects (%)

External Shocks as % of GNP

Terms of Trade Effects

Export Volume Effects

Total

Increase in Export Market Shares

Import Substitution

Effects of Lower GNP Growth Rate

Net External Financing

Indonesia

23.6

83.6

16.4

100.0

2.3

-1.1

0.5

-101.7

Malaysia

6.4

71.6

28.4

100.0

39.9

-25.4

4.3

-118.8

Philippines

-14.5

-75.6

-24.9

100.0

17.5

2.3

-2.6

82.9

Singapore

-46.3

-98.1

-1.9

100.0

67.0

-41.8

17.5

57.2

Thailand

-15.2

-90.1

-9.9

100.0

25.5

8.6

2.6

63.4

Source:

S. Naya, D.H. Kim and W. James, "External Shocks and Policy Responses", Asian Development Review 2, no. 1 (1984).

48

Pradumna B. Rana

contributed to inflation. This contradicts the view of many policymakers in LDCs and suggests that the competitiveness gained by a country's exports through a policy of nominal exchange rate depreciation can be sustained. The exchange rate is, therefore, a powerful stabi 1i zati on too. Because of this finding, the study recommends that the countries of the region pursue an active exchange rate policy, especially since the other finding of the study is that monetary policy may not be effective in controlling moderate inflation. An active exchange rate policy implies three things. Firstly, governments should focus on the trends of the real exchange rates. Secondly, governments should choose an exchange rate regime (pegging, floating or a combination of the two) Thirdly, small but frequent changes in exchange wisely. rates may have considerable advantages over occasional large changes, not the least of which is that they help depoliticize changes in exchange rates. Notes 1.

Brunei

which

In early 1984 Is not

became the sixth member of ASEAN

Included In the study. 2.

In 1972, exports as a percentage of GOP ranged from a high of 192 per cent In Singapore to a low of 35 per cent In Indonesia.

3.

Although

Mall!lysll!l

became a

net exporter of

oil

In

1976,

since oi I

exports do not exceed two-thirds of total exports, the IMF classifies Malaysia as a non-ol I developing country. 4.

This Is the well-known "Dutch disease".

See, for example, Arndt (1983).

5.

This approach to stabilization policy

Is advocated by Kllllck (1984)

l!lnd others. 6.

There are two conceptual difficulties one faces In Identifying macroeconomic Instability or disequilibria. the proper Indicator. BOP should one use

The first lies In Identifying

For example, which of the several concepts of

In measuring BOP disequilibria?

As a matter of

double-entry book keeping, the complete BOP account sums to zero. second

difficulty

Is

Identifying

when

the

dlsequl llbrla

pose

The a

ASEAN Stabilization Experiences prob Iem.

49

For examp Ie, a zero ba Iance In the account chosen may not

Indicate a desirable state of affairs since this may not allow the government to achieve a desired Increase In reserves or reduction In external debt.

Given these two problems, It Is desirable to use more

than one Indicator. this

chapter

(excluding

we

While the country studies use this approach, In

use

official

the

trend

transfers)

In

the

current account

expressed

In

relative

balance

terms

(by

deflating by total exports of goods and services) as an Indicator of BOP disequilibria and changes In the consumer price Index as an Indicator of Inflationary disequilibria.

The justification for the choice

of these two variables Is that the current account as defined Includes more or less alI autonomous entries In the BOP account, and the consumer price Index Is highly correlated with GDP deflator or wholesale prices (see Chowdhury and Dowling 1982).

Stabilization problems occur

when eIther of these IndIcators remaIn persIstent I y above the "norma I" or the trend rate. 7.

The basic data were obtained from the IMF 1 s International Financial Statistics.

CA and X are expressed In current dollars; TOT Is the

ratio of the unit value of exports (74d) to the unit value of Imports (75d), both expressed In US dollars; GYIC Is from ..!£?_; and FIR Is a three-111onth London Eurodollar rate.

(For the definition of RER see

Table 2.7, note 4).

a.

Two observations were missing from the sample. because

Individual

country

regressions

did

The data were pooled not

yield significant

results. 9.

The assumption here

Is that changes

domestic factors alone.

In money

supply are due to

This assumption may not hold It countries are

unable to sterilize their balance of payments, In the latter case, part of the Increase In the money supp Iy may be exogenous. prepared

tor

assumption.

this

project

!Yenko

(1984)

i,

however,

A study

supports our

Yenko finds that the NOACs were able to sterll lze signi-

ficant proportions of changes In their balance of payments. 10.

The data were obtained primarily from_!£?_. were

not

aval fable,

these were

Goldstein and Kahn (1976).

Since quarterly GOP data

Interpolated

NER 1 = wjrj/rf

using

the method of

where, rm tor m = I, j Is

50

Pradumna B. Rana the price of the US dollar In terms of country I •s or j'S currency relative to May 1970; and w.•s are the 197o-73 average weights. J

These

were computed by the author using monthly data from IFS and Direction, of Trade Statistics. 11.

The corre Iat Ion coet tic Ient between the actua I and predIcted va I ues was high (0.75) and significant at 1 per cent.

This provides some

justification tor pooling the data. 12.

This finding corresponds with the findings of a number of others (for example, Saini 1982) tor Asia.

The reasons for the non-slgnl tlcance

of the excess money supply variable could be the Importance of barter In some of the NOACs and decl lnes In money velocity. 13.

Because of data problems, Indonesia was not Included In the empirical analysis sunmarlzed In the previous section.

However, the contrlbu-

tlon of the ol I shocks to changes in Indonesia's BOP Is not a subject of conTroversy.

The case Is probably also similar with respect to the

contribution of Imported Inflation to domestic Inflation.

III

ECONOMIC STABILIZATION POLICIES IN INDONESIA Polin L.R. Poepoe

Introduction When Genera 1 Suharto became Pres 1dent of the Repub 1 i c of Indonesia in March 1966 and introduced his New Order government, he brought a much needed shift in government priorities and policies. had

been

situation

too

The previous administration of Sukarno

preoccupied

following

the

with

first

the

dynamic

two decades

of

political Indonesian

independence, and as a result, the national economy had suffered from neglect and mismanagement. Sukarno had been inclined towards the subsidization of a fast-growing public sector and the construction of monuments

and

buildings

intended to

boost

instead of economic development projects.

national

prestige

Foreign exchange

had become scarce, partly due to his "Confrontation" policy with Malaysia in 1963-65 which denied Indonesia the vital transit port of Singapore for its export commodities.

Also

many foreign properties were nationalized and many foreign banks had withdrawn. The burden of financing deve 1opment came to rest with the indigenous banking system, which was effectively relegated to the function of financing the burgeoning government deficit. The resulting hyperinflation of the mid-1960s (see Table 3.1) caused real per capita

Table 3.1: Changes in Honey Supply1 and Prices 2 (Annual Percentage Changes) Year

Money

Prices

1960 1961 1962 1963 1964 1965 1966 196 7 1968 1969 1970

39 42 99 95 156 280 763 132 120 61 36

19 72 158 128 135 595 636 112 85

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

28 48 41

2 26 27 33

Notes :

40

33 28 25 24 35 37

10

9

20

14 12 7 19 16

1 Cash and demand deposits. 2 Prior to 1979 the rate is measured in terms of Jakarta cost of living index; since Ap ri 1 19 79 in terms of CPI in 17 biggest cities.

Source :

Bank lndones i a, Annua 1 Report , Jakarta (various issues).

54

Polin L.R. Pospos

income

to

plummet,

increased

barter

transaction

(which

further aggravated the tax structure and reduced government fi seal

revenues),

and

encouraged

the

growth of a

black

market in foreign exchange.

In 1966 the new republic found

itself

external

in

a

situation

of

insolvency,

with

a

national debt in excess of US$2 billion. President Suharto committed his New Order government to the stabilization, rehabilitation, and development of the Indonesian

economy.

In

order

to

achieve

this

goal

a

vigorous progranme was pursued which among others included the adoption of a balanced budget policy, the renegotiation of old

debts,

the

securing

of new

loans,

and

the

New

Investment Law. As part measures

of the

were

taken,

balanced the

budget most

policy a series of

significant

of

which

included: 0

centralization of budget decisions at the Ministry of Finance,

o 0

a system of quarterly budget progranming, IMF standby arrangements which limited government expenditures to no more than 10 per cent of national income,

0

rehabilitation

of

the

fi sea 1 administration

and

increased taxation, o

a moratorium of foreign debts,

o

the devaluation of the rupiah, and

o

the restoration of diplomatic ties with Malaysia and Singapore (Anwar 1983).

The measures proved effective, and with the help of foreign assistance, the government was able to balance its budget in 1968.

By Apri 1 1969, the economy had been restored to a

situation when the government could launch its first fiveyear development plan (REPELITA I). This paper looks at the post-Sukarno economic regime and various periods in recent hi story during which stabi 1-

Economic Stabilization Policies in Indonesia i zat ion programmes were undertaken.

55

In the course of the

next section's analysis of stabilization policies, the years in which inflation accelerated are identified, their causes and consequences traced and pol icy responses assessed.

A

final section summarizes and concludes the discussion. Stabilization Policies Ideally, stabilization policies are functions of long-range economic planning based on past experience and the ability to prognosticate with some accuracy the likely contingencies.

Due to the

lack of prior experiences the task of

Indonesia's economic planners during the decade of the 1970s was compounded by the vagaries of nature such as droughts which affected rice harvests; the volatility of the world commodity market; revenue.

and windfall

gains

in the

form of oil

Below we shall review the various periods when the

need for economic stabilization was particularly acute, and the nature,

functions, and effects of the policies imple-

mented. 1972-73 The

production

and

distribution

of

rice

had

long

been

acknowledged as a cornerstone of economic and political stabilization efforts by the various rulers of the archipelago which now comprises concern

in

the

Indonesia.

early

This became the focus of

1970s.1

Reflecting

labour-intensive nature of traditional the

decade

of

the

1970s

an

the extremely

production, during

estimated

70

per

cent

of

Indonesia's population were in the agricultural sector; rice a l so provided slightly over half of the daily calorie intake for the average Indonesian. of the

1970s

Indonesia

However, throughout the decade

remained

a

large

rice

importer.

During the preceding two decades various programmes had been designed to work towards self-sufficiency in rice production. These

programmes

included

measures

which

provided

price

56

Polin L.R. Pospos

floors for rice, price ceilings for inputs (such as urea), the introduction of improved seed and pesticides, easy credit for farmers, and various government organizations to aid the procurement of inputs and the marketing of the harvested rice.2 fhe most successful of these was the Bimbingan Massal (Mass Counselling or BIMAS), which, while encountering serious managerial and logistical difficulties three years after its implementation in 1964 (under its original name of Demonstrasi Massal --Mass Demonstration or DEMAS), showed that the concept of government assistance through low-cost package deals and advice was a viable one and one that would be continued in a modified form under the Suharto administration. Table 3.2 shows rice area, production and yield. Perhaps the most notable features in this table is the increase in per hectare yield in 1968, 1970, 1973, 1974, and 1976-78. In 1967, when the political dust had settled, Suharto established Badan Urusan Logistik (BULOG or Logistics Board), as the main component of the government's effort to maintain price stability among several basic commodities (of which the most important was rice). BULOG was made directly responsible to the President, and among its duties was the co-ordination of procurement and distribution of rice and its various inputs, to establish and enforce their respective price floors and/or ceilings, and later to manage warehouses to hold stocks which could be used as buffers during years in which harvests were poor, foreign exchange for imports scarce, or a combination of the two. With record rice harvests in 1970-71 (see Table 3.2), BULOG was able to amass some 300,000 tons of reserve stock. In 1972, however, the situation took a drastic turn for the worse as a drought swept Asia and the dry season was particularly long and harsh. 3 In that year, the volume of world rice output fell by some 8.9 million metric tons, of which about 7.2 million metric tons production shortfall was

Table 3.2:

Rice Area, Production and Yield in Indonesia, 1960-78

Year

Area Harvested (millions of hectares)

Production1 (million metric tons milled rice)

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978

7.28 6.86 7.28 6.73 6.98 7.33 7.69 7.52 8.02 8.01 8.14 8.32 7.98 8.38 8.51 8.50 8.37 8.36 8.81

8.76 8.27 8.89 7.93 8.42 8. 80 9. 34 9.05 11.67 12.25 13.14 13.72 13.18 14.61 15.28 15.18 15.71 15.88 17.50

Notes:

(10.17} ( 9. 58) (10.28} ( 9.16) ( 9.61) (10.24} (10.75) ( 10.40)

Yield (tons mi 11 ed per hectare) 1. 20

1.21 1.22 1.18 1.21 1. 20 1.21 1.20 1.46 1. 53 1.61 1.65 1.65 1. 74 1.80 1. 79 1.88 1.90 1. 99

1 Estimates shown in brackets for 1960-67 are new series estimates and are consistent with the data shown for 1968-78. 2 New series of data for 1968-78; method of estimate of output was revised by the Central Bureau of Statistics.

Source:

Mears and Sidik (1981).

58

Polin L.R. Pospos

In Indonesia production fell to from the Far East alone. 13.18 mi 11 ion metric tons in 1972, and harvested acreage of 8.32 million hectares in 1971 fell to 7.98 million hectares in 1972.4 Indonesia's planners had not become aware of the magnitude of their domestic production deficit until late August and September 1972, by which time the desperatelyneeded rice imports were expen sive and in short su pply. Domestic rice prices began to rise significa ntly in September, and by December the average price of medium quality rice in Jakarta was Rp 78.1/kg, a 72 per cent j ump from the price prevailing in December 1972 (see Table 3.3). By January 1973, the Jakart a rice price had peaked at Rp 84.35/kg. It then began to decline steadily until May; and, then skyrocketed to Rp 120/kg in June. This increase, coupled with worldwide inflation which began accele rat ing in mid-1972, had triggered the inflation rate to jump sharply from only 2 per cent in 1971 to 26 per cent in 1972 and 27 per cent in 1973 (see Table 3.1 ). The immediate response of the government to the 1972 crisis was to import rice on a commercial basis, as mentioned above, and to welcome foreign food aid. In addition, the government undertook other programmes to ensure long Emphasis was to be given to term price stability. increasing padi production yields, or "intensification", by employing the existing framework of the BIMAS and INMAS Along with adjust(Mass Intensification) organizations. ments in the inputs of BIMAS packages, these programmes concentrated on improvement of irrigation techniques and the problem of soil erosion due to seasonal flooding of rivers. The "intensification" schemes resulted in increase of padi yield by 4.6 per cent in 1973 over the previous year. "Extensification" efforts were also undertaken and given high priority; more and more acreage was brought under cultivation through BIMAS and INMAS encouragement. In connection with both the "intensification" and the

Table 3.3:

Prices of Medium Quality Rice in Selected Cities Average Price in Rp/kg

Year

Jakarta

Bandung

Surabaya

Medan

~1enado

1970

December

46.4

4 7.0

41.0

50.0

51.5

1971

December

45.3

43.0

44.5

45.4

51.5

1972

January

48.5

49.0

48.0

45.0

51.5

March

4 7. 5

44.0

43.0

40.2

48.5

June

44.0

36.0

38.0

45.0

4 7.0

Sept ember

55.0

51.0

52.5

51.0

55.0

r:ecembe r

78. 1

74.0

73.8

63.0

80.0

January

84.3

78.0

80.0

65.0

70 .o

February

80.0

77.5

6 7. 5

68.0

70.0

March

78. 1

74.0

54.8

6 7.0

57.5

April

62.5

53.0

50. 1

6 7. 5

52.5

May

65.0

55.0

59.5

82.5

65.0

June

120.0

71.2

64.6

102. 5

84.5

July

100.0

83.0

81.2

125.0

112.5

August

97. 5

.a 7.0

77.5

120.0

132.5

September

95.0

85.0

72.5

110.0

120.0

October

93. 7

81.0

76.2

110.0

110.0

November

91.2

76.0

75.0

115.0

119.5

r:ecembe r

100.0

90.5

75.0

115.0

118. 5

January

112.5

92.0

83. 7

115.0

120 .o

February

106. 7

8 7. 5

77.5

95.0

120.0

March

106. 7

81.2

70.0

10 5. 0

120.0

April

96.3

80.0

68. 7

100.0

120.0

May

93. 7

78.0

72.5

100.0

120.0

1973

1974

Source:

Bank Indonesia, Financial Reports (various issues).

60

Polin L.R. Pospos

"extensification" efforts, additional support services were also provided. Bank Rakyat Indonesia, the state bank responsible for providing agricultural credit to farmers, expanded into harvesting areas to service more farmers.5 Village units were formed, and within these, smaller organizations were created in order to oversee and co-ordinate the distribution of agricultural production inputs and the processing and marketing of the agricultural produce. The processing and marketing functions were to be the responsibility of the BUUDs (Badan Usaha Unit Desa or Village Unit Undertaking Body), which were rural co-operatives, and the KUDs (Koperasi Unit Desa or Village Co-operative Units), which were to be full co-operatives. By the end of 1973, 2,361 of the BUUD-KUD organizations had been formed. Furthermore, plans were made by BULOG to increase it s reserve stock capacity by building additional modern government warehouses. The plan called for a buffer stock capacity of one million tons, to be stored i n 120 warehouses throughout Indonesia. Finally, Indonesia embarked upon a crusade to end her dependence on foreign imports of fertilizer. Table 3.4 shows that the discrepancy between domestic supply and demand in 1973 was relatively larger. This was a precarious

Table 3.4:

Demand and Supply of Urea for Food Crops in Indonesia, 1973-77 (Thousand Tons)

Production Demand

1973

1974

1975

1976

108 678

191 632

383 676

365 666

* Estimate. Source:

Mea~s

and Sidik (1981), p. 41.

1977 787 800*

Economic Stabilization Policies in Indonesia 61 position considering the volatility of prices in the world market. This margin narrowed in succeeding years. During 1973 some 550,000 tons of urea were imported in order to help keep prices low and to encourage farmers to use yieldincreasing inputs. An attempt was made to follow the Rumus Tani (Farmer's Formula) guideline of keeping the price of rice and fertilizer at a ratio of approximate unity. Some success in this policy can be noted (see Table 3.5).

Table 3.5:

Year 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979

Source:

Padi/Urea Price Ratio, 1970-79 Floor Price (Rp/kg) 20.9 20.9 20.9 20.9 30.4 41.8 58.5 68.5 71.0 75.0

Urea Price (Rp/kg)

Padi/Urea Price Ratio

26.6 26.6 26.6 26.6 40.4 60.0 80.0 70.0 70.0 70.0

.80 .80 .80 .80 .76 .70 .73 .98 1.01 1.07

World Bank, 1979.

What was the result of the improving of old programmes and introducing new ones? BIMAS was faced with growing difficulties, and it had trouble staffing its extension services with qualified personnel, due to low wages and lack of job mobility. According to Nyoman Suwidjana (1981), "A

62

Polin L.R. Pospos

study by the World Bank revealed that about 50 per cent of the extension workers' total earnings came from sources Meanwhi 1e, other than their sa 1a ry from the government. only about 35 per cent of their working time was devoted to This explains why, although the number of farm visits. extension workers had increased almost seven times between 1973 and 1978, the area under BIMAS persistently declined, the growth rates of per hectare yield slowed down and, most This combined important, credit repayment rates fell." with BIMAS rules which effectively encouraged delinquency on loan repayments on BIMAS credit placed the organization in a solvency crisis in 1975-76.6 Nonetheless, the annual growth rate of rice production during PELITA I was an impressive 4.5 per cent, inspite of the bad year, and during PELITA II the rate was 3.5 per cent annually. Inspite of the production increase during these periods, wh i ch managed to stay

Table 3.6:

Year

1973 1974 1975 1976 1977 1978

Sources:

Extension Service, Productivity, and Rates of Credit Repayment Area under Number of Extension BIMAS Workers (000 ha)

2,946 3,058 2,993 2,494 2,203 1,514

4,157 4,764 5,097 6,549 8,734 26,144

Yield mt/ha (Pad i )

2.81 2.87 2.84 3.07 3.04 n.a.

Rate of Credit Repayment (Percentage of Total Loan) 99 91 89 81 58 10

Central Bureau of Statistics (1980); Nota Keuangan 1978/79; and World Bank {1978).

Economic Stabilization Po1icies in Indonesia

63

ahead of population increases for the same periods, imports represented increasing percentages of the total consumption -- a trend made possible by increased oil-generated foreign exchange and foreign aid. Along with these, BULOG effectively managed reserve stocks and successfully supported ceiling prices during the droughts of 1976-78. 1973-74 The need for stabilization efforts next became apparent during 1973 and 1974 when Indonesia benefited first from the world commodity boom, in general, and then from the OPEC oil price rises, in particular. As we look at Table 3.7 we note that the value of several of Indonesia's non-oil exports increased dramatically from 1972-73 to 197 3-74. The tot a 1 non-oil export earnings increased from US$974 million in 1972-73 to US$1,905 million in 1973-74, or an increase of

Table 3.7:

Selected Non-Oil Commodity Exports FOB, 1971-74 (US$ Million)

Commodity

1971-72

1972-73

1973-74

215 50 82 170 23 20 21

211 46 99 275 42 32 21

483 95 175 720 90 46 31

Rubber Palm oil products Mining products Timber Animal & livestock products Tobacco Pepper

Source:

Bank Indonesia, Report for the Financial Year 1973-74.

64

Polin L.R. Pospos

95.6 per cent. Exporting timber, rubber, and mining products posted particularly large increases. The dependence of Indonesia's foreign trade sector on the world oil market is illustrated clearly in Table 3.8. It will be observed that while non-oil exports increased in value after 1973-74, the rapid increase in the value of total exports came mainly from the increase in the export oil earnings. The increase in the oil export earnings was the result of, not only the price rise, but also volume. In 1972-73, for example, the export volume of crude oil and oil refinery products was 344.7 million barrels and this jumped to 424.5 million barrels in 1973-74. Until the 1973 oil shock, non-oil products, comprising mainly of agricultural products -- and in the late 1960s, timber -- have been Indonesia's traditional export commodities. Worldwide recession, inelasticity of supply, low income elasticities of demand by industrial countries, low degree of competitiveness due to the overva 1ued exchange rate, are among many factors contributing to the slow growth in the earnings from these products. The breakdown of the current account into oil and nonoil components show that while the oil sector has been continually on the surplus side since 1969-70, the non-oil sector is characterized by deficits. And since the size of the non-oil sector deficits together with the service sector exceeded the oil sector surplus, except for fiscal 1979-80, the current account has been continually on the deficit. On the whole, the favourahle overall balance of payment position during the decade was made possible only by increasing foreign borrowings through the capital account. In addition, oil had also steadily become the major In order to increase its source of government revenue. share of oil revenue, on several occasions, the government altered its income-sharing agreements with foreign oil companies. In 1975 oil revenue accounted for more than half of

Table 3.8:

Balance of Payments:

1969-70 to 1979-80 (US$ Million)

19691970

19701971

19711972

19721973

19731974

19741975

19751976

197ti1977

19771978

1971J1979

197919tl0

1044 384 660

1204 443 761

13 74 590 784

1939 965 974

3613 1078 1095

7186 5153 2033

7146 5273 1873

9213 6350 21:163

10860 7353 350 7

11353 73 74 3979

17945 11774 b171

-1227 -88 -1139

-1232 -94 -1138

-1381 -132 -1249

-1820 -159 -1661

-3399 -461 -2938

-5616 -1275 -4341

-6020 -930 -5090

-7920 -1753 -616 7

-8 731 - 1490 -7241

-9 254 -1 711 -7543

-10952 -1924 -9028

Oil

Excl. oil, freight

-318 -204 -114

-360 -214 -146

-441 -254 -18 7

-6 76 -40 7 -269

-970 -606 -364

-1708 -1240 -468

-1980 -1205 -775

-2095 -887 -1208

-2819 -1418 -1401

-32 54 -1653 - 1601

- 4345 -2425 - 1920

Current Balance Oil Excl. o11

-501 92 -593

-338 135 -523

-448 204 -652

-55 7 399 -956

-756 641 -1397

-138 2638 -2 77ti

-854 3138 -3992

-802 3710 -4512

-690 4445 -5134

-1155 4010 -5165

+2198 7425 -4777

35

28

30

-

-

-

-

-

64

65

Official Private

371 27

369 115

400

481

480

643 549

660 -131

1995 -10 75

1823 38

2106 176

l101 3'J2

l!ill -1315

D.

ll!bt Service

-31

-4 7

-78

-66

-81

-89

-77

-166

-lti 1

-b32

-t>'J2

E.

Total A to 0

-99

77

94

338

355

302

-11

893

831

770

Z75'l

F.

Errors & Onlnissions

56

-95

6

87

5

-311

-353

108

-180

-62

1069

G.

Monetary Movements

43

18

-100

-425

-360

9

364

-1001

-651

-i'IJII

1b90

A.

Goods and Serv1ces: Ex~ort, f.o.b. Oi Exc 1. o11

J~fort Exc 1. o i 1 , c & f Services

B.

SIRs:

c.

Capita 1 :

Source :

Suharsono ( 198 2!_), pp. 40, 42 , 44.

190

-

66

Polin L.R. Pospos

total domestic revenue, and as shown in Table 3.9, except for a slight decrease in 1977-78 and 1978-79, the share continued to rise. In response to mounting internal pressure subsequent to the oil price increases, the government was obliged to increase its expenditures. As shown in Table 3.10, during fiscal year 1973-74 government expenditures were up 52 per cent over the previous fiscal year; this i s compared to an increase of government revenue of 61 per cent in fiscal 1973-74 over 1972-73 (Table 3.11). As noted in Table 3.10, during this period the government took the opportunity to raise salaries and increase food allowances (that is,

Table 3.9:

Government Revenue and Sources, 1969-70 to 1979-80 (Billions of Rupiah)

Year

Domestic Revenue

1969-70 1970-71 1971-72 1972-73 1973-74 1974-75 1975-76 1976-77 1977-78 1978-79 1979-80

243.7 344.6 428.0 590.6 967.7 1,753.7 2,241.9 2,906.0 3,535.4 4,266.1 6,696.8

Source:

Suharsono

(1982~),

Oil Revenue 65.8 99.2 140.9 230.5 382.2 957.2 1,248.0 1,635.5 1,948.7 2,308.7 4,259.6

p. 34.

Oil Revenue as Percentage of Domestic Revenue 27.0 28.8 33.0 39.0 39.5 54.6 55.7 56.3 55.1 54.1 63.6

Table 3.10:

Central Government Expenditures, 1972-73 to 1979-80 (Billions of Rupiah) 1972-73

1973-74

1974-75

1975-76

1976-77

1977-78

1978-79

1979-80

Personnel expenditure Material expenditure Regional subsidies Debt service payments Other

197.4 92.1 94.6 49.4 10.8

258.9 109.1 113.1 73.7 149.3

408.0 167.0 306.9 69.2 149.4

565.0 292.3 256.6 67.9 65.0

639.4 325.2 311.0 180.3 154.4

880.8 356.5 469.9 227.6 185.9

1,001.6 419.5 522.3 534.5 265.8

1,419.9 569.0 669.9 684.1 718.9

Total routine expenditure

444.3

704.1

1,100.5

1,246.8

1,610.3

2,120.7

2,743.7

4,il61.8

Development expenditure

290.7

473.7

966.4

1,425.2

2,043.5

2,157.6

2,556.6

4,014.2

Total expenditure

735.0

1.117.8

2,066.9

2,672.0

3,653.8

4,278.3

5,300.3

8,076.0

Source:

Ministry of Finance, Country Economic Memorandum, Jakarta.

Table 3.11:

Central Government Receipts, 1972-73 to 1979-80 (Billions of Rupiah) 1972-73

1973-74

1974-75

1975-76

1976-77

1977-78

1978-79

1979-80

Taxes on income Taxes on domestic consumption Taxes on international trade Non-tax receipt

301.1 125.9 141.4 16.7

511.1 168.0 253.6 44.4

1,234.5 161.0 300.7 62.1

1,558.3 234.4 309.5 98.6

2,029.2 322 . 1 421.5 104.2

2,515.9 37p.2 482.7 133.4

2,996.3 491.4 587.0 191.4

5,129.3 537.2 843.0 187.3

Total domestic revenue

585.1

977.1

1,758.3

2,200.8

2,877.0

3,508.2

4,266 .1

6,696.8

Development funds

149.5

207.7

233.5

491.9

783.8

773.4

1,035.5

1,381.1

Total revenue

734.6

1,184.8

1'991.8

2,692.7

3,660.8

4,281.6

5,301.6

8,077.9

Source:

Ministry of Finance, Country Economic Memorandum, Jakarta.

Economic Stabilization Policies in Indonesia

69

personnel expend i tu res ), and to secu r e some of its debts. In t he fo ll ow i ng yea r 1974-75 expenditures increased by 76 per cen t over 197 3- 74 compared with the increase in revenues whi ch wa s 68 per cent for the same period. As t he goverr, ment pursued its de ·tel oprr.2r.t programme, it became more genero us wit h regard to domestic credit. Table 3.12 pre sen ts data on bank credits for 1973 and 1974. The data shows t ha t a ma jo r portion of short-term credit in rupiah we re recei ved by the trade and manufacturing sectors. Inflation which resulted from the overheated economy was 33 per cent in 1974. This adversely affected mostly the fixed-income class and the people living in the urban areas. However, import substitution industries with more advanced technology, new marketing methods benefited ; thus further aggravating the gap between the modern sector and the traditional sector which, by and large. consisted of the pribumi or indigenous businessmen (Salim 1981). The pribumi claimed that this deve 1opment had benefited the foreigners and the non -pribumi at their expense. The frustration finally erupted in a series of riots in January 1974, as students and pribumi took to the streets to protest their diminished economic leverage and to seek government assistan ce. The government quick ly percei ved the potentia 1 repercuss i on s of an econom i cally disadvantaged pribumi class, and quickly undertook measures to enhance their relative position through a comprehensive programme of indigenization. Foreign companies were given incentives usually in the form of reduced taxes, eligibility for low-interest government loans, and acces s to investment in fields that would otherwise be of f -limits to turn over their management to Indonesians. In certain cases, foreign-ow ned companies were simply ordered to transfer management control to their Indonesian counterparts over to a fixed time frame. The areas in which foreigners were allowed to invest became more restricted, and investment procedures and terms were revised.

Table 3.12:

Total Bank Credits* (Millions of Rupiah) 1973 II

1. 2. 3.

Agriculture Mining Manufacturing

1974 III

II

III

IV

63 ,590

62,528

78,93 7

90 '751

4,313 139,529

4,925 169,927

3 '723 195,314

7,949 218,006

6 '135 285,880

77' 10 7 733 319,952

80 '104 594 334,982

103 '75 7 10,598 289,543

290 '156 26,461

329,997

451,478 3 7,025

390,994

401,262

512,562

550,367

604,448

39,202

49,950 137,738 1,098,042

62,851

73,851

122 '977 858,065

50,295 134,571 968,894

127,099 1,155,997

166,494 1,248,691

101 '746 9,33 7

107,952

112,303

117,139

121,450

11,320

13,223 1,223,568

14' 186 1,287,322

15,547 1,385,688

4.

Trade Service industries Others Total short term (1-6)

67,935 587,754

676 '753

95,975 846,043

Investment credits

90,604

93 ,44 7

99,266

6,200

8,327 953 ,636

8.

I

59,360

5. 6. 7.

IV

34,850 73 ,464

9. 10.

local cost-project aid Sub-total credits

684,558

7,051 777,251

11.

Export - For Ex.

5,152

5,802

6,501

969 '148 6,594

1,088' 166 6,543

4,877

5,316

5,011

12.

Import - For Ex.

32,801

28,789

30,63 5

17,926

19,694

21,258

17,33 7

13.

Others - For Ex.

45,794 34,259

48,151

42,201

51,994

147,418

Sub Total - For Ex.

85,205

151,001

1,058,3 71

1,215,581

1,371,569

173.992 1,461,314

164,6 78 187,026

Total Credit

77,491 1,031,127

89,223

15.

86.754 864,005

102,946 127,415

126,430

14.

769.763

* Includes Bank Indonesia direct credits. Source:

1,572,714

Excludes interbank credits, credits to government and credits to non-residents.

Bank Indonesia, Annual Report, Jakarta (various issues).

Economic Stabilization Policies in Indonesia

71

As for the pri bumi investors, various credit schemes were developed, of which the two most important were the Small Investment Credit (Kredit Investasi Kecil or KIK) and the Permanent Working tap1tal Credit (Kredit Modal Kerja Permanen or KMKP}. Both provided attractive credit packages to encourage small and medium scale enterprises, with the KIK providing fixed capital and the KMKP providing working capital. To alleviate the pressures of inflation, the government embarked on controlling prices by increasing its subsidy on a wide range of consumer goods, such as rice, wheat flour, soya beans, salt, sugar, cotton and yarn, newsprint, fertilizers,

pesticides,

kerosene, diesel,

bunker oil,

bus

fares, electricity, drinking water, health, education, and others. Import duties on raw materials and spare parts as well as domestic sales taxes on basic necessities were also lowered (Anwar 1983, pp. 10-11). On the monetary side, a series of measures were introduced in 1974-75 which included contraction of money supply by setting higher interest rates, introduction of credit ceilings for commercial banks, and doubling the reserve requirements against the bank's time and saving

deposits to 20 per cent.

Under the IMF

standby arrangements which was in effect for the pedod 1968-73 to 1974, ceiling had been levied to control the upper limit expansion of the banking system's net domestic assets (Anwar 1983, p. 10}. The result of the above stabilization measures was a sharp decrease in both the monetary growth rate and consequently the inflation rate. The former fell from 40 per cent in 1974 to 33 per cent in 1975, while the latter fell to 20 per cent during the same period. It must be understood, however, that although these measures had successfully brought the inflation rate down, the heart of the problem remained, namely, how to sterilize the monetary impact of the oi 1 revenue increases.

Because

72

Polin L.R. Pospos

of the impact on the ba 1ance of payment and the government budget and subsequently on money supply, the windfall gains presented Indonesia with an awkward situation -- on the one hand the oil boom provided new opportunities to pursue development programmes, and on the other, the funds had to be used wisely. The government attempted to sterilize the payment This surplus by creating an "effective budget surplus". means that while a formal adherence to a balanced budget was maintained, the government refrained from spending all the extra revenue; it used the revenue to repay earlier borrowings from the Central Bank and to build up deposits In this way it offset what would with the Central Bank. otherwise have been a dramatic monetary expansion (Grenville

1981, p. 113). Although it was not a deliberate policy action, the Pertamina crisis of 1974 and 1975 also helped. In the last quarter of 1974 and again in 1975, this state-owned oil company failed to meet its short-term debts due to diversion and mismanagement of funds. The company had extended itself into non-oil operations which included, among others, cattle breeding, rice production, real estate, airlines, and tourist hotels. It had bypassed the Ministry of Finance and the proper financial authorities, and violated regulations regarding short and medi urn term foreign borrowings. As a In result, creditors refused to roll over company debts. May 1975, the government had to assume direct control over Pertamina and with it a responsibility for US$10.6 billion short term debts, or about one-third of Indonesia's GOP for that year (Anwar 1983, p. 11). 1978-79 During the last quarter of 1978 prices started rising again, and in 1979 the inflation rate reached 19 per cent as compared to only 7 per cent in 1978. This represented another

Economic Stabilization Policies in Indonesia

73

period in which Indonesia faced a stabilization problem. As in the case of the previous period, Indonesia was largely a victim of global circumstance. There were several OPEC price hikes during 1979 contributing to an increase in the oil export earnings. During the end of 1978-79 the weighted average for oil prices stood at US$13.98 per barrel, and by the end of 1979-80 it had rocketed to US$29.80 per barrel. In addition, Indonesia also enjoyed an increase in the prices and value of several of its non-oil commodity exports (Table 3.13). Because of a 54 per cent increase in export value in fiscal year 1979-80, Indonesia was able, for the first time in ten years, to experience a surplus on its current account to the tune of US$2.198 billion -- a notable improvement over the US$1.155 billion deficit in fiscal year 1978-79. Once again, through the balance of payment, government budget, and monetary channel, domestic liquidity increased, thus the

Table 3.13:

Selected Non-Oil Commodity Exports, FOB, 1977-80 (US$ Million)

Rubber Mining products Wood Animal and livestock products Textiles and handicrafts LNG

Source:

1977-78

1978-79

1979-80

608 363 943 179 17 162

774 423 1,130 212 45 516

1,025 541 1,969 252 151 1,345

Bank Indonesia, Report for the Financial Year 1979-80.

74

Polin L.R. Pospos

demand-pull type of inflation was in effect. Unlike the inflation experienced during the previous period of stabilization, the 1979 inflation also had its cost-push component resulting from November 1978 devaluation when the August 1971 peg of the rupiah was broken. This devaluation was necessary because the difference between the Indonesian and the u.s. inflation rates (and as a proxy for trading partner inflation rate) had widened considerably (Table 3.14) underlining the competitiveness of Indonesia's non-oil exports.

Table 3.14:

Inflation Rates, 1971-77 (Percentage)

Country

1971

1972

1973

1974

1975

1976

1977

2.6 3.6

26.3 3.7

27.4 9.2

33.3

19.7 7.0

14.2 4.9

11.8

Indonesia

u.s.

Source:

11.1

7.0

Suharsono (1982E_), p. 4.

Growing pressures, therefore, developed for the The government to i11111ediately adjust the exchange rate. 15 November 1978 devaluation also changed the external standard of the rupiah from its previous exclusive link to the U.S. dollar to a basket of Indonesian trading partners currencies. The timing of the devaluation was considered, by some, to be correct because in that year rice harvest was good and the country's external reserves (Table 3.15) were sound (Anwar 1983, p. 35). As a result of the devaluation, the value of non-oil exports did show an increase of about 55 per cent in fiscal

Economic Stabilization Policies in Indonesia

Table 3.15:

Net International Reserves (US$ million)

1973

782.8

1974

1472.3

1975

489.6

1976

1225.5

1977

2423.2

1978

2579.9

1979

4144.8

1981

6626.8

Source:

75

Suharsono (1982!)•

p. 48.

year 1979-80, but as was mentioned earlier it also contributed

to

the

response

to

because

the

price the

rise during

growing

required

1979.

inflation

policy

of

The government's

rate was

restraint

half-hearted

over

liquidity

expansion would conflict with the two long-term goals of continued economic development and providing special aid to the

pribumi.

With

regard

to

credit

policy,

the

total

domestic assets of the banl •

Flnanclel Reports (various Issues).

Central

Bureau of Stetlstlcs.

St!ltlstlcal Pocketbook.

Jak!lrte (various

Issues>. •

Economic lndlcetors, 1980.

FAO. Monthly Bul Jetln of Agriculture and Stetlstlcs. 11 Monet!lry

Grenvl I Je, Stephen.

(Februery 1974>.

Pol Icy end the Formal Flnanclel Sector".

In

The lndoneslen Economy during the Soeharto Ere, edited by Anne Booth and Peter McCewley. Mears,

Leon A.

Economy

end

Sldlk Moeljono.

during

McCewley.

the

Oxford University Press, 1981. "Food Pol Icy".

Ere,

edited

by

In The

Anne Booth

lndoneslen end

Peter

Oxford University Press, 1981.

Country Economic Memorendum, Jekarte.

Note Keuangan, 1978-79.

Njoman Suwldjena. 1981. Salim,

Soeharto

Kuele Lumpur:

Ministry of Finance. •

Kuale Lumpur:

11

1ndonesle's Rice Pol Icy".

Slngepore:

In Southeast As len Affairs

Institute of Southeast Aslen Studies, 1981.

Emil. "Trends In the lndoneslen Economy".

_1_1,

edited

by

Leo

Suryadlnete

end

Sharon

In Trends In lndonesle S Jdd I que.

SJ ngepore:

Institute of Southeast Aslen Studies, 1981. Suharsono

Sag Jr.

Peranan

Mlnyak

De lam Pembangunan.

Yeyasan

Jak!lrte:

ldayu, 1982~. Ekonoml Jndonesle Post-Knop 15. World Bank.

Bandung:

Alumni,

1982~.

"lndonesle Supply Prospects for M:tjor Food Crops".

Report No.

2374-IND (February 1979) • •

11

lndonesle:

Review of Support Services for FJeld

No. 20600-IND (December 1978).

Crops".

Report

IV ECONOMIC STABILIZATION POLICIES IN MALAYSIA M. Semudram

Introduction The 1970s witnessed a series of events affecting the world economy. These were the collapse of the Bretton Woods system and an associated expansion of liquidity during 1970-72; the exchange rate realignments in 1971 and 1973; the adoption of floating exchange rates by the industrialized countries; worldwide inflationary conditions in 1973 followed by the two oil price increases; and the subsequent global recessions. These developments posed problems particularly to developing countries in their conduct of stabilization policies in order to achieve low inflation rates, sound balance of payments position and balanced growth. The Malaysian economy also faced these stabilization problems in the 1970s and early 1980s. During the period between 1970-80, Malaysia registered an average growth rate of 7.8 per cent in real GOP, a performance surpassed among the ASEAN countries, only by Singapore. Malaysia has an open economy where imports and exports each constitute about 50 per cent of GOP and hence large shifts in terms of trade can be rapidly transmitted to the domestic economy. The recessionary conditions in the rest of the world and the resultant fluctuations in terms of

80 M. Semudram trade had reduced the real GOP growth rate to a mere 0.8 per cent in 197 4 t but the prudent management of the economy coupled with strong production and diversification programmes sustained a rapid development pace for the rest of In the external sector the trade account the decade. showed large surpluses in the second half of the decade, while the current accou~t showed a mixed picture during the The government decade with services account dominating. with its strong presence in the economy had an overall defiThese deficits were cit averaging 8 per cent of GNP. largely financed by domestic sources and the debt service ratio on public and public guaranteed debt at the end of the decade was a low 2.2 per cent of GNP. Inflation was kept to an average of 4 to 5 per cent per annum although there were years when prices rose rapidly. On the supply side, agriculture registered a long-term growth of 5 per cent per annum with a large contribution The estate component of Malaysian coming from palm oil. agriculture planted palm oil extensively and in the process reduced the rubber acreage. Palm oil production increased at an average rate of 20 per cent per annum particularly with contributions from FELDA schemes, and emerged as a major export crop outstripping rubber. Completion of major irrigation projects of Muda and Kemubu made the country 90 per cent self-sufficient in rice. The manufacturing sector grew very rapidly at 11 per cent per annum easily outstripping the agriculture sector. Import substitution policies of the early 1970s lay the foundation for this growth. The rise of oil production in the economy is another factor which contributed to the sustained economic growth of Production increased from 6.6 the Malaysian economy. million barrels per annum in 1970 to about 101 million barrels in 1980. This development in the oil sector and coupled with the increase in its price enormously improved foreign exchange earnings and increased the government revet

Economic Stabilization Policies in Malaysia

81

nues.

Finally, the services sector grew by over 8 per cent per annum with transport and communications and general government components growing at 12. 5 per cent and 9.1 per cent respectively. The different sectoral growth rates have altered the structure of the economy during the 1970s. In 1970 agriculture accounted for 32 per cent of GOP and by 1980 its share had fallen to 24 per cent. Industry broadly defined to include construction and utilities, in addition to manufacturing, increased its share in value added from 20 per cent to 26 per cent and the services sector also increased its share from 43 per cent to 46 per cent. A major feature of the economy in the 1970s was the rapid growth in export earnings during 1976-80. This rise can be attributed to three factors: 0 first, the rapid rise in conrnodity prices (including oil)

which

led to near doubling of export price index between 1976 and 1980;

o

the

very

rapid

growth

of production of oil

for

exports which contributed about 24 per cent of the merchandise export earnings in 1980; and o

the export divers1 fication into palm oil, electro-

nics, clothing and textiles. These factors led to a significant improvement in terms of trade and in turn, to higher income and production growth. This sudden increase in earnings had significant expenditure and exchange rate effects on the domestic economy. In 1980, gross national expenditure (demand) exceeded gross domestic production (supply) and the gap widened signi ficantly in 1981 and 1982. Also the appreciation of the exchange rate biased against the sectors producing goods for trade and assisted the sectors providing non-traded goods. This "boom" syndrome also increased the size of the public sector and led to major shifts in labour deployment. Some of the principal

features that emanated from the

82

M. Semudram

"boom"

conditions which were evident

in the early 1980s

were: (1) The overall rate of growth in the economy was higher than the underlying trend growth and this was primarily due to the rise in the export earnings. (2) Import growth was strongly associated with the high growth in incomes., This was due to growing dependence on imports of investment and intermediate goods. The proportion of consumption, investment and intermediate

(3)

goods imports increased significantly during the 1980s compared to their proportions in the 1970s. There was substantial increase in the employment since 1976

( 4)

in

non-traded

goods

sector

particularly

the

government sector. The agri cul tura 1 sector dec 1 i ned from a 6 per cent per annum growth rate in 1970-76, to 4 per cent growth rate during the remainder of the decade and this growth was largely attributed to the increase in production of palm oi 1.

On the demand side, public expenditure constituted the main source of growth and provided a counter cyclical impact on the economy during the first half of the decade. However, in the second ha 1 f, extern a 1 sector demand acce 1erated and induced a significant increase in the domestic production activity. Total

consumption

expenditures

reached

the

highest

in 1972 with 82 per cent of GNP and declined to an average of 70 per cent during the second half of the decade. But these expenditures began to rise again in the early level

1980s. The pattern of demand has changed with the rapid expansion of public sector spending by the government in the Total government consumption and investment early 1980s. expenditures as a share of GNP has increased significantly between 1970 and 1980 (see Table 4.1).

If investment in

Table 4.1:

Components of Nationa l Expenditure (As Percentage of GNP in Current Prices) Total* Government Expenditure

Gross Nation a 1 Savings

Year

Private Consumption

Private Investment

Public Con sumpt 1on

Publ1 c Investment

Total Consumption

1970

61.5

10.2

17. 7

5.9

79.3

16.2

24.8

17.9

1973

57.1

16.5

16.2

6.8

73.3

24.5

24.7

25.9

1975

60.6

16.2

18.2

9.8

78. 7

26 .o

32.6

20.9

1979

51.9

15.8

15.0

9.4

67.0

25.2

31.5

32. 7

1980

53.7

18.6

17.6

11. 1

70.2

29.7

41.8

29.5

1981

56.3

21.8

19.2

13.2

75.5

34.3

49.4

24.3

1982

56.4

20.4

19.5

15.7

75.8

36.4

47.3

24.1

Total Investment

* Total Government Expenditure includes development expenditure and current expenditure. Sources :

Statistical Appendix in "Money and Banking in Malaysia", Bank Negara Malaysia, 2nd edition. Quarterly Economic Bulletin, Bank Negara Malaysia (various issues).

84 M. Semudram petroleum is included, the share would have been higher. Savings rate, however, had steadily increased from 18 per cent in 1970 to almost 33 per cent in 1979. But it dropped during the recessionary periods to 21 per cent in 1975 and 24 per cent in 1981 and 1982. Since 1980, the savings rate has begun to decline. Therefore, in the 1980s, a savings-investment gap emerged and this was strongly associated with the resultant current account deficits due to continued high consumption and investment demand. The current account deficit and savings-investment gap required well co-ordinated stabilization policies in the 1980s. Stabilization Problems Inflation accelerated rapidly globally in 1973 and 1974. World consumer prices increased by 9.5 per cent and 15.5 per cent in 1973 and 1974 (Table 4.2) respectively. The principal reasons for the inflation were the sharp rise in international reserves flowing into developing countries in 1972, a sharp increase in prices of imported commodities in 1973 and 1974, and the pressure that poor harvest in 1972 put on food prices. These were regarded as the main causes of inflation worldwide. Malaysia being an open economy faced the full impact of this world cycle of inflation and recession. Any changes in imports and exports in terms of prices and volumes had significant effect on the domestic price level. Inflation rates reached historically high levels in Malaysia in 1973 and 1974. From a low of 1.9 per cent in 1970, it climbed to a two-digit level averaging 14 per cent in 1973-74. The trends in the components of the consumer price index (CPI) were dominated by the rise in food prices which accounted for about 70 per cent of the total increase. Most of the price increases in various components of the CPI took The index of food prices place between 1973 and 1974.

Table 4.2:

Inflation Rates: 1969-81 (Annual Percentage Change in Consumer Price Index)

Year

Malaysia

World

Industrial Countries

Oil-Exporting Countries

Non-Oil LDCs

1969

-0.4

5.1

4.8

6.9

7.1

1970

1.9

6.0

5. 6

5.1

8.7

1971

1.7

5.9

5.2

4.9

10.2

1972

3.2

5.8

4.7

4.2

12.7

1973

10 . 4

9.5

7.7

10.9

21.1

1974

17 . 4

15.5

13 . 3

6.1

25.8

1975

4.5

13.7

11.1

18.6

24.8

1976

2.6

10 . 9

8.3

16.2

21.6

1977

4.8

11.2

8.4

14 . 8

23.1

1978

4 .9

9. 5

7. 2

9.9

20.2

1979

3.6

ll.8

9.2

10.4

24.6

1980

6. 7

15 . 4

11.9

14.1

32.0

1981

9.6

13 . 5

10.0

13.2

30.7

Source :

IMF, International Financial Statistics, Yearbook 1982.

86 M. Semudram increased by 15.9 per cent and 26.1 per cent in 1973 and 1974 respectively (Table 4.3}. Other categories of the CPI which contributed to the rise in inflation were clothing and footwear (21.7 per cent and 11.7 per cent) and household equipment and furniture (12.8 per cent and 17 per cent}. There was also a substantial rise in the prices of residential homes, land, and generally all kinds of property values in the urban areas and these were not reflected in the CPl. Some portion of this price rise may have been reflected in the "rent, fuel and power" component, but its effect would have been minimal due to the small weight given to it. Besides, this had, in fact, increased from 1.3 per cent in 1973 to 6.9 per cent in 1974 and from then on, the increase was maintained at 6 to 7 per cent. The rapid rise of this component between 1973 and 1974 was due to the rise in oil prices. Two quantitative studies suggest that import prices have a large impact on domestic prices in Malaysia. Semudram (1982} using annual data from 1959 to 1977 has estimated the following price equation: t.P = -1.8988 + 0.0272RGDP + 0.3468 t.Pm + 0.0225 ( t.P) - 1 (.1737} 1PT (5.995} Pm (1.991} --P-- (1.321) R2 where

p

=

RGDP Pm

=

and t.

=

.82;

h

=

-.953

Consumer price index Real GOP in 1970 prices Import price index are changes in the variables

Although the period of estimation includes the decade before the 1970s, nevertheless the import prices appear to have the largest impact on domestic prices. Rana (1984} using quarterly data from 1973 to 1979 has also estimated the following equation:

Table 4.3:

Components of Consumer Price Index (Annual Percentage Changes) 1978

1979

1980

5.42

4.9

2.3

3.6

1.3

3.7

5.1

1.3

6.6

-0.5

2.5

3.9

3.5

6.5

6.8

6.9

6.6

5.6

6.1

5.0

6.6

9.6

12.8

17.0

4.9

2.5

3.5

4.1

3.9

7.3

2.9

2.2

9.4

6.2

4.9

3.5

5.9

3.6

6.8

3. 21

10.55

17.38

4.50

2.57

4.81

4.91

3.63

6.65

1971

1972

1973

. 1974

1975

1976

Food

0.9

3.8

15.9

26.1

3.7

2.0

Beverages and tobacco

o.o

4.1

1.3

1.9

9.5

Clothing and footwear

0.99

2.9

21.7

11.7

Rent, fuel and power

0.99

0.99

1.3

Household equipment &furniture

1.9

5.6

Transport and communications

0.97

Total

1.58

Source:

Quarterly Economic Bulletin 15, no. 4 (December 1982) .

1977

88

M. Semudram -.261 + .599 pf- .251 (WER)t- .006 (m-yh-2 (.281) (5.109) t (1. 790)

+ .004(m-y)t_ 3 - .049(WER)f

+

(1.267)

(.182)

.637 V(WER)t (1.844)

.608; Where Pt

=

pf t

IJ..J = 2.084

Percentage change in domestic prices Percentage change in foreign inflation rate

m

Percentage change in money supply

y

Percentage change in real income Percentage change in import-weighted exchange rate

V(WER )t His

Variabil i ty of import-weighted exchange rate

analysis

shows

also

that

the

in

inflation

Malaysia

during the 1970s was primarily imported. The analysis of various components of the import price index

(Table

indicates

4.4)

that

there

were

increases in all components in 1973 and 1974.

significant

The food com-

ponent increased by 26.3 per cent and 37.7 per cent respectively between

1972 and

1974.

The component of "mineral

fuels" experienced a rise of 164 per cent between 1973 and 1974 which obviously indicated the quadrupling of prices by OPEC countries in 1973.

Other components which reflected

sizeable increases between 1973 and 1974 were manufactured goods (39.3 per cent), chemicals (69.4 per cent), animals and

vegetable

fats

(39.5 per cent).

(51.5 per cent),

and

crude materials

The overall import price index therefore

Table 4.4 : Annual Percentage Changes fn

I~ort

Prfce Index, "alaysfa 1971-80 (1970 • 100, wefghts 1n parentheses)

1971

1972

1973

1974

1975

1976

1977

Food (19.4)

7.0

8.8

26 . 3

37 . 7

- 1.6

- 9.1

-2 . 9

Beverages and tobacco (2.0)

5.0

-4.4

12.7

-1.8

21.3

15.2

-12.7

5.6

12 . 5

39 . 5

-4.0

26.1

0.8

12.7

164.4

Anf.al and vegetable oil fats (0 . 6)

6.1

-6.6

22.1

Chetnfcals (8.4)

5.4

1.5

Manufactured goods (20.2)

6.5

Machinery and transport equ1piient (28 . 6)

1979

1!180

ILb

-0.4

+11. 7

2.5

16.0

0.3

9.!1

4.2

17.6

8. 1

10.11

11.7

20 .0

12.7

5.3

-5.9

24.6

71.8

51.5

-2.2

-7.4

9.8

-5.4

u.s

7.3

14.4

69.4

-1.1

-1.9

-8 . 4

0.9

14.9

12.0

4.0

17.4

39.3

-1.9

3.3

0.5

2.2

7.4

5.11

9.2

7.7

11.1

13.2

17.4

1.4

4.9

1.9

-0.2

5.5

Miscellaneous (5.0)

4.1

0.4

5.2

19.7

5. 1

7.9

8. 8

6.2

l.3

1.9

Total (100.0)

7.3

4.7

15.7

41.3

6.0

1.7

2. 6

2. 5

7.3

19.!1

Crude .aterfals (9.2) Mineral fuels (6 . 6)

Source :

Economic Report 1982-83, Ministry of Finance, Malaysia.

1978

90

M. Semudram

increased by 41.3 per cent between 1973 and 1974. the opennes s of the economy, the increases

Due to

in the import

price index had significant impact on consumer price index. The second oil price rise of 1979-80 has increased the "mi nera 1 fue 1" component of the import price inde x by 71.8 per cent and this had the major impact on import price inde x which rose by 19.9 per cent between the two years. The favourable e xport conditions in 1969 was followed by two years of slow growth in e xports ending with a trade account surplus of only M$365 million in 1972, largely due to the sharp drop in prices of the main primary commodities (namely, rubber, sawn logs and palm oil). The trade account again 1974 compared (Table 4.5). price

rise

to

the

surplus

slumped to M$672 million of M$1,594 mill i on

in

in 1973

This phenomena was due to a comb i nat i on of o i l and

the

recession

which

began

in

1974.

The

recession, in fact, had its direct effect on the Malaysian economy in 1975 when the value of e xports dropped by 9.6 per cent in the face of a general drop in pri ces and volumes of exports.

During the rest of the decade, the trade account

showed large surpluses due to buoyant commod ity prices and the increase of production and the rise in the price of oil. The high growth rate of GNP during the second half of 1970s was in part due to the terms of trade effect arising from the increase in commodities and oil prices.

Nevertheless,

there was sti 11 a rise in the underlying GNP growth rate. The second imports

half of 1970s experienced a large increase in

particularly capital

and

intermediate goods which

accounted for 80 per cent of the value of imports in 1980, compared with 60 per cent in 1970. From 1980 onwards, Malaysia has, for the first time in its

hi story,

been

running

a

merchandise

current

account

deficit in addition to the traditional services sector deficits.

The deficit increased from one per cent of GNP in

1980 to 12 per cent in 1982 (Table 4.6).

Table 4.5:

Balance of Payments 1970-80 (Millions of Ringgit)

Trade account Exports ( f.o. b) Imports ( f.o. b) Services account (net) Freight & insurance Other transportation Trave 1 Investment income Other services Trans fer (net) Current account Capital account (long term) Official Private direct investment (Private borrowings) Other Capital account (short term) Domestic financing sector Other Errors and Ministries SDR allocation (net) Overall balance Financing Change in assets (increase -) Source:

1970

1971

1972

1973

1974

1,06 7 5,020 3,953 -862 -304 -21 -105 -355 -77 -180 25

686 4,884 4,198 -878 -322 -34 -106 -363 -53 -13 7 -329

365 4,736 4,3 71 -906 -309 -35 -101 -3 78 -83 -157 -698

~,594

, 63 5,669 -1,197 -420 49 -94 -659 -73 -151 246

672 10 ,022 9,350 -1,719 -714 82 -39 -997 -51 -104

2T

395"

-mo

Tib

~

--=-.r.m

'l9T

320 173 -6

420 +46 254

-5 -506

1,3 74 -67 29 05" 36 -77

862 -18 -83 -"Tim" 25 -397

576

452

171

m

287 5 -10 -=10 +6

-260 64 132

-m -132

~

306 -15 73 bS" 5 -227 61 264

-"204

-264

T;"T9J"

-15"

9 -100 60 449

-m

-449

w

"'2"5]"

-

-!Jrb -576

-i·~~~

-

-m -452

Quarterly Economic Bulletin, Bank Negara Malaysia (various issues).

1975

1976

1977

1978

724

3 '762 13 ,330 9,568 -2,020 -726 94 -151 -985 -252 -100

3,871 14,861 10,990 -2,515 -884 158 -196 -1,272 -322 -78 1,278

2,587 16,925 13 ,338 -3 ,186 -1,072 +110 -308 -1,571 -345 -82 319

9,'0"51

8,333 -1,710 -621 98 -105 -727 -3 55 -79

-i·~~~

-

-m

-171

.

i·~ri~

r,m

~

l,~~j

757 154 -175 tiO -241 -817

1,174 -20 -1,280 --r97 -1,477 -987

-586 -1,034

2,319 -2,319 -2,319

490

625

-

-

-490

-490

858 (400) -82 -349

ID

-

-625"

-625

1979

1980

6,580

4. 776 28,060 23 ,284 -5,176 -1,934 -11 -521 -1,954 -756 -123 -523

2"3;971

17,397 -4,175 -1,362 +70 -455 -1,797 -631 -119 2,286 2,747

-m

928 {520) 87

-1.-§~~ -590 -1,165 74 1,863

-T;SOJ -1,863

2

·H6

1,275 {854) -140 939 1,751" -314 -1,713 76 1,078

-r.on -1,078

92

M. Semudram

Table 4.6:

Current Account of Balance of Payments (Millions of Ringgit)

Current account balance Goods Services Current account as a percentage of GNP

Source:

1975

1980

1981

1982

1,065 724 -1,789

-523 4,776 -5,299

-5,323 -67 -5,256

-7,298 -1,199 -6,099

4.9

-1.1

-9.6

-12.4

Quarterly Economic Bulletin, Bank Negara Malaysia (various issues).

Export prices for most of Malaysia's major export commodities began a sustained upward rise between 1976 and 1980; rubber, tin, timber and logs, and petroleum prices all more than doubled du r ing this period; thereafter certain commodity prices declined, of which rubber declined by 35 per cent in two years; tin prices have declined by 15 per cent since 1980, as have palm oil prices. The diversity of Malaysia's exports and the composition of exports with high volume performers and some with high unit value increases, has meant that in aggregate export prices have not fallen much between 1980 and 1982. However, import prices particularly of food, petroleum and chemical imports have risen. Therefore the terms of trade declined by about 15 per cent since 1980. On the trade account, the exports declined in 1980 and 1981 due largely to reduced volumes and in 1982 due to reduction in prices. On the import side, total imports have been increasing slowly, reaching high volumes in 1982.

Economic Stabilization Policies in Malaysia

93

The principal cause of payments instability in Malaysia has been the fluctuations in export earnings.

The economy

depended on the proceeds of a few primary commodities for it s export earnings and the prices of these commodities were sub j ected

to

considerable

fluctuations.

Although

it

was

difficult to offset fully the effects of external developments

on

the

applied a

economy,

the

combination of

authorities

fiscal

have

nevertheless

and monetary

policies

to

minimi ze th e effe c t s . Monetary Dev e lopment and Policy Mone y s uppl y incre ase d at a significant rat e during 1972 and 19 73 , befo re returning to their relatively low trend rate. They

incr e a se d

on cP

again

in

1976

and

since

then

have

remained at doubl e d igit levels.

Comparin g data in Tables

4.4 and 4.7 it ca n be s een that

increased monetary growth

ha s had a lagged effec t on inflation in Mal a ysia. The

c urren c y component of money supply experienced a

s ignifi cant

i nc r ea s e

during

the

latter

part of

the

first

half of 197 0s part ic ularly due to increased uncertainty and h igh

tr a nsac t io ns

de mand.

During the second half of

the

de ca de th e mo ney s upply (M1 and M2) a c celerated reflecting s t i mu la t i ve mon e t a ry po li c y to promote economic recovery. The s up p l y of mone y is generated from three main sources -- ne t fo re ig n as set s , net claims on government and credit

to

priv a t e

con s iderable 197 0s

sec tor.

The net

e xpan si onary

impact

parti c ularly the

foreign on

money

boom years of 197 2 ,

assets supply

imparted in

the

1976 and 1979.

Finan c ing of dev e l o pment expenditure by th e banking system ha s be come i mportant in this decade. always

remained

Commer c ial

ban ks

a

net have

borrower become an

term finan ce for the government.

The Central Bank had

vis-a-vis important

the

government.

sour c e

of

long

Credit to private se c tor

had been generally expansionary sometimes far ex c eeding the growt h o f Ml and M2 .

94

M. Semudram

Table 4.7: -

Money Supply (Annual Percentage Changes)

------·-- ·- - - - - - - - - - - - - - - - - -

Year

Currency

Demand Deposits

Quasi Money

M1

1970 1971

7.4 6.1

8.4 2. 7

13.8 21.9

8.2 4.9

10.8 13.1

1972

19.6

3.6

19.6

25.0

23.6

1973

35.4

39.5

25.3

3 7.6

31.1

1974

18.2

0.4

22.1

8.6

15.4

1975

10.3

4.2

20.9

7.3

14.8

1976

17.4

24.6

32.9

20.9

27.7

1977

14.7 21.5

16.0 17.6

16.5 18.2

16.4

1978

18.4 15.0

1979 1980

14.4 16.2

19.9 13.9

28.4 36.3

17.2 15.0

24.1 26.2

Source:

M2

17.9

Quarterly Economic Bulletin, Bank Negara, Malaysia (various issues).

In an open economy like Malaysia, the domestic credit created by the monetary authorities is a better indicator of economic activity than measures such as M1 and M2 which are basically affected by movements in the international serves.

re-

During 1970s, credit creation in the economy kept

pace with the

growth

in

nominal

GNP.

Domestic credit

increased by 49 per cent in 1973 in line with the increase of 30 per cent in GNP from the preceding year.

But the

events of 1973 caused inflation to rise to 17 per cent in 1974 and the authorities reduced credit creation to 21 per cent from 49 per cent in 1973. A boom in 1976 led to a large influx of foreign exchange reserves which increased

Economic Stabilization Policies in Malaysia

95

money supply substantially. Therefore credit creation was reduced to 16 per cent from the 18 per cent of 1975 so as to contain inflationary tendencies. There was a 1arge influx of foreign exchange reserves in 1979 because of the second oi 1 shock and these were effectively sterilized by monetary authorities by reducing the growth of domestic credit to 10 per cent (from 24 per The monetary stance was cent in the previous year). reversed in 1980 when domestic credit expanded by 50 per cent (Table 4.8) in order to provide stimulus to the economy in the face of falling commodity prices. This was in addition to the fiscal impulse of the previous years. Attempts were made in the 1980s to reduce the domestic credit but it remained far above the growth of nominal GNP. The large disparities between the growth of credit and nominal GNP creates excess demand and poses problems of balance of payments. This will be a stabilization problem of the In addition, there is a possibility of financial 1980s. "crowding out" of the private sector, of which there was little evidence in the 1970s. Unlike the 1960s, the 1970s were characterized by unstable international economic conditions -- breakdown of the Bretton Woods, oil price rises and crop failures. Under these circumstances, monetary and fiscal policies were directed to ensure that fluctuations in external trade did not unduly affect the domestic economy. In 1969, the effect of the export boom on the domestic economy was minimized by the Central Bank's increase of statutory reserve ratio from 3.5 to 5 per cent to dampen the growth in liquidity. The finance companies were also required to observe the minimum liquidity requirements of 10 per cent. Between 1971-72, the stance of monetary policy was changed in response to emerging recessionary tendencies. Monetary policy was eased to stimulate an expansion of busiFiscal policy, was ness activity and private investment.

Table 4. 8:

Percentage Change in Components of Money Supply

1g7o

1971

1972

1973

1974

1975

1976

1977

1978

1979

191!0

7.6

9.3

20.2

ll. 5

12.5

8.2

52.8

9.9

6.2

36.5

2. 7

Domestic credit of which : Credit to the private sector

21.8

19.3

27.2

49.3

21.1

18.5

16.5

18.3

24.2

10.2

49.9

22.1

14.6

17.1

52.2

15.1

15.2

22.9

20.1

29.6

23.6

41.6

Broad money of which:

10.8 8.2 13.6

13.1 4.9 21.3

23.6 25.0 22.5

31.1 3 7.6 25.3

15.4 8.6 22 . 1

14.8 7.3 21.3

27.7 20.9 32.9

16.4 16.5 16.2

17.9 18.2 17. 7

24.1 17.2 28.9

26.2 15.0 33.4

7.1

6.7

9.9

29.8

21.7

-1.2

25.0

15.0

11.0

25.0

14.0

-0.6

o. 20

18. 1

12.3

-3.3

13.0

7.0

5.0

14.0

6.0

2.0

3.0

11.0

17.0

5.0

3.0

5.0

5.0

4.0

Net foreign assets

Narrow money Quasi-money

Nomina 1 GNP GNP deflator Consumer price index

Sources:

2.0

Economic Rep ort, Treasury; Quarterly Economic Bull etin, Bank Negara Malaysia (various issues) .

7.0 •

Economic Stabilization Policies in Malaysia

97

also expansionary and various tax incentives were given for private investment. 1 During this period certain monetary measures were taken to stimulate the demand for loans within the context of monetary stability. (a) In 1972, the lending and borrowing rates of the commercial banks and finance companies were reduced including those on Treasury bill discount rate. (b) Statutory reserve ratio for the commercial banks was increased to 8.5 per cent in October 1972 and a 2! per cent statutory reserve ratio was introduced for finance companies. These measures were introduced to ensure that liquidity is maintained with limits in the face of fiscal expansion in the early 1970s which generated substantial amount of liquidity in the banking system. In 1972, the Central Bank initiated Credit Guarantee Corporation Malays ia Berhad (CGC) to enable small-scale enterprises to have a ready access to bank credit at reasonab 1e cost. This is to promote economic deve 1opment and enhance the effectiveness of monetary policy. The upswing in economic activity which began in late 1972 accelerated in 1973 and tapered off by about mid-1974. The consumer prices which were stable during the 1960s began to rise towards the end of 1972. With the "boom" conditions in sight, the inflationary pressures would pose a serious problem. Therefore it had become clear that the policy of fixed exchange rate was not conducive for economic stability and the ringgit (M$) was allowed to float in June 1973. In 1973, the monetary me~sures could not contain inflation and therefore some fiscal measures were introduced to stabilize prices, particularly food prices, by providing subsidies for essential food items and by removing import quotas or duties. In 1974, the contro 1 of i nfl at ion became the primary objective of the Central Bank. The monetary measures taken were to raise interest rates and 1evy cei 1i ng on growth of

98

M. Semudram

credit. Money supply was drastically cut from a growth of 37.6 per cent in 1973 to 8.6 per cent in 1974. lnfldtionuy pressures were contained, but the economic s 1owdown 0f the industrial countries affected economic activity in Malaysia. Real output in that year grew only by 0.8 per cent. In 1975-76, the objectives of macro-policies were to stimulate growth while (Ontaining inflation. Bank credit to private sector was increased and the economy recovered by the end of 1976. From a deficit in 1975, the current account showed a surplus primarily due to increases in commodity prices. In 1977 and 1978, the external sector exhibited a slower growth and, therefore, any increase in growth had to emanate from domestic sources. Stimulatory budgets were introduced in 19 77 and 1978 and monetary po 1icy took an easier stance. Money supply increased by 18.2 per cent between 1977-78 with domestic credit reaching a growth of 24.2 per cent (Table 4.8). Apart from traditional instruments of control, monetary authorities introduced in 1978-80, measures to strengthen the financial sy s tem. These measures included a more market oriented approach towards the determination of interest rates, and revision of liquidity requirements. During 1978-80, the movements in monetuy aggregates were influenced by developments in the external sector. The growth of total liquidity (broad money) averaged about 22.7 per cent largely due to the increase in quasi-money. Since 1978, market forces detennined deposit and lending rates promoting a more efficient allocation of resources. The deposit rates (one year) increased from 6.5 per cent in 1978 to 11 per cent in 1981 while lending rates increased by 3 to 4 percentage points since 1978. The domestic interest rates were below the internation a 1 rates during the decade and this difference has to some extent led to higher domestic borrowing than foreign

Economic Stabilization Policies in Malaysia

99

borrowing. The interest rate differential did not result in any capital outflow until 1979 due to the low level of domestic inflation and a strong Malaysian ringgit. In the 1980s the international rate rose and the differential increased substantially. The Central Bank offered swap facilities to the commercial banks to offset the impact of this differential on capital flows. Conclusion In the 1970s, Malaysia adopted the traditional tools of economic management to contain inflation and promote economic growth. Monetary restraint took the form of restrictions on the flow of credit to the private sector. Statutory reserve ratio, liquidity asset ratio and Credit Guarantee Scheme of the Credit Guarantee Corporation were also used in managing the flow of credit. Short-term funds were made available by the government for private investment through the introduction of two money market instruments namely the bankers' acceptance and negotiable certificates of deposits. The growth in money supply in Malaysia, is largely determined by the prevailing conditions in the external sector and also the demands of the budget deficits on the money Fiscal policy had been expansionary during the rna rket. 1970s and this counter cyclical policy has generated a substantial amount of liquid in the banking system. So the Central Bank has conducted a policy of a steady noninflationary expansion of the money supply taking the implications of expansionary fiscal policy and prevailing conditions in the external sector. This process enabled the authorities to adjust money supply to the existing stable demand for money (Semudram 1981). The 1970s did not pose many stabilization problems other than a large increase in consumer prices in 1974 which was a worldwide phenomenom. A prudent management of the economy by standard monetary and fiscal policies not only

100

M. Semudram

contained inflation but also increased the real GOP growth rate at an average of 7.8 per cent per annum. A pressing prob 1em of the government has been the achievement of the objectives of the New Economic Policy (NEP)2 by 1990 and the decade of the

1970s was an important period for restructuring the economy. In fact significant progress was made during the 1970s in achieving the targets of NEP which are income imbalances, employment restructuring, the ownership of assets and the development of a commercial and industrial community among bumiputera (indigenous population). This was

carried

out

by

increase

in

public

expenditure,

by

setting up of Foreign Investment Committee and offering tax incentives for equity restructuring.3 Worldwide recession in 1981 coupled with fall in commodity prices and increase in external borrowing for public investment pose stabilization problems for the remainder of the 1980s. One of the main difficulties will

be to minimize the

deficit of the current account of the balance of payments which began to emerge in 1980.

These deficits follow four

years of surpluses (1976-79) which averaged 4.2 per cent of GNP.

In 1981 and 1982 the deficits were particularly large

(9.6 per cent and 13 per cent of GNP respectively).

These

deficits

have accompanied weakened GOP growth rate which dropped from an average of 8 per cent in 1976-80 to 6.9 per cent in 1981 and 5.8 per cent in 1983. The international recession had a strong impact on the Malaysian economy. Export prices have declined during the early 1980s with rubber showing a significant decline in 1981 and

1982.

In aggregate the export prices

have not

fallen much because of the diversity of the exports.

Most

of the rise in import prices during 1980-82 concentrated on food, petroleum and chemical imports. While the terms of trade improved considerably during 1976-80, they declined significantly in the 1980s. Balance of payments surpluses and deficits have their

Economic Stabilization Policies in Malaysia

101

counterpart in domestic income and expenditure relationships. The increase in real

incomes in 1976-79, did not lead to

substantial expenditures and therefore savings in the economy rose to record levels particularly 33 per cent in 1979. During this period of 1976-79, savings exceeded investment. But in 1980 when gave rnment engaged in a major expenditure expansion,

public

then in the

expenditures

1970s.

expanded

far

more

rapidly

In 1981, on the assumption that OECD

would soon cl imb out of recession, public expenditures began to increase again.

It was realized in 1982 that there was

no early end to the recession and measures were taken to reduce public expenditures. (total

investment/GNP ) had

But by then investment ratio reached

36.4 per cent

in

1982

compared to 25.2 per cent in 1979 while the savings ratio had declined from 32 . 7 per cent in 1979 to 24.1 per cent in 1982. Therefore, the economic conditions of the early 1980s may suggest short-term stabilization policies.

In the light

of no signs of full recovery in the world economy, the previous ly adopted counter -cyclical policies to counteract the interna ti onal

recession and decline in terms of trade have

to be re-examined in the l ight of the level of public expenditures, the direction of spending, the structure of taxation

and

government

financing.

There

are

also

several

structural problems emerging within the economy with regard to

agriculture,

manufacturing,

trade,

labour markets

and

pub lic finances that need cr itical evaluation. The important poli cy that will have a direct impact on trade account import detailed

is to examine the structure of imports and

intensity study

of

of

public

import

investment

tariffs

and

progra11111es.

subsidies

for

A such

imports may suggest the introduction of some form of selective import substitution. On the export side, specific policies can be introduced to promote medium and long-term growth of exports.

There is

102 M. Semudram a secular decline in rubber exports and one way of promoting rubber exports is to accelerate replanting and consolidate smallholdings into larger units with improved extension and de 1i very services of government. Potentia 1 a1so exist for export diversification into fruits, vegetables, poultry and Manufactured exports largely from the Free Trade swine. Zone have to increase their domestic resource content so that the backward linkages with the rest of the economy can be initiated, so as to widen the domestic industrial development of the country. On the expenditure side, expenditure reducing policies have to be adopted. The current account deficit in 1982 was 13 per cent of GNP, corresponding to national savings at the level of 23 per cent of GNP and investment at 36 per cent of A major adjustment in expenditures is required to GNP. achieve a current account deficit of 5 to 6 per cent within This requires a drop in investment the next two years. ratio to 31 per cent of which the public sector is expected to take a greater reduction in its investment expenditures. The 1980s are crucial years for the ~1alaysian economy. Stabilization policies have to be geared not only to achieve i nterna 1 and extern a1 ba 1ance but to promote a reasonab 1e growth rate in the economy to achieve the objectives of NEP. This will be a difficult problem in an environment of slow economic recovery in the industrialized world.

Notes 1.

For further detal Is refer to the Fourth Malaysia Plan, pp. 140-42.

2.

For detal Is see the Third Malaysia Plan, pp. 1-10.

3.

See the Fourth Malaysia Plan, p. 137.

Economic Stabilization Policies in Malaysia

103

References P. Ran!!.

"lnfl!!tloMry Effects o f

ASEAN

CountrIes,

Exch11nge Rate Ch!!nges:

197:5-1974".

ASEAN

EconomIc

TheC!!se of the

Bu I I et In

1,

(Ju I y

1984). M.

Semuelr!!m.

"The Demand

Estlm~~te s

l!nd

l!n

An~~

In the 141! l!!ys 11! n Economy:

for "bne y lysis

of

Stability".

141! l!!yan

Emp I r I Cl! I

Economic

Review

2, 161.0 ( 8.4%>

542.6 ( 19.6%)

2,4 11. 2 111.6%>

683 .4 12 5.9%)

2,21 8.8 (-8.0%>

852.0 124. 7%>

2,056.6 1-1.3%>

893.8 14.9%>

2, 052 .0 (-0.2%>

335.8 (- 5.9% >

529.2 (-7.3%>

388.9 115.8%>

490.9 1-7 .2%>

514.9 132.4%>

487.1 10.8%)

646.4 125.5%>

454.8 (-6.6%)

658.8 11.9%)

425.7 (-6.4)

172.4 (9.3%>

304.0 16.9%>

185. 9 (7 .8%>

284 .6 (-6.4% )

223.5 120.2%>

273.3 (-4.0%>

269.8 120.7%>

277.3 ( 1.5%>

305.2 ( 13. 1%>

258.4 (-6.8%>

57.3 1-22.9%)

209.3 1-18.5%>

83. 2 (45.2%>

188.7 (-9.8%)

126.8 (52.4%>

179.5 (-4.9%)

162.8 128.4%>

151.9 (-15.4%)

140.8 (-13.5%>

158.8 (4.5%>

Other Construction and Works

106.1 (28.2%>

15.9 (-23.8%)

119.8 ( 12.9%>

17.6 ( 10. 7%)

i64.6 (37.4%>

34.3 (94.9%>

213.8 129.9%>

25 .6

581.7 (51.0%>

i0.4 (-3 . 7%>

662.6 (1 3.9%>

11.3 (8.7%)

504 .9 (-23.8%>

14.7 (30 .1%>

689.6 (36.6%)

11.7 1-20.4%)

821.4 ( 19. 2%>

Machinery and Eq uipmen t

106.9 (10 .5%>

143. 3 0 (34.1%>

1, 257.7 ( 19.8%>

i 57.2 (9. 7J>

1,226.8 (-2.5%>

190.9 (21.4% )

9 12.2 (-16 .4%)

22.3

Gross Domestic Fi xed Capital Formation Construction and Works

Res id e nt ia l Buildings

Non-Residential Buildings

1, 050.1 16.5% )

8.5 (-66 .8%)

Table 6,5 (contd)

Gross Domestic FIMed Cep ltel Fonnetlon Construction end Works

Resi dentlel Bul !dings

Non-Res ident lei Bul I di ngs

Other Construction end Works Trensport EQuipment

~chlnery

end EQuipment

1982

Publ lc

Pr I vete

Public

Prlvete

Public

Private

Public

Private

Public

Private

962. 1 (7 , 6Jl

2,308,4 ( 12 . 5%)

779 . 6 (-19 ,0Jl

2 ,821 . 6