Watching Indonesia

Last week at New Economist I posted about the apparent fragility of Indonesia's financial situation. I was partly put in mind of this by a post by the New Economist himself on Buttonwoods interest in emerging market risk.

Basically the idea is that demography is a context, economic theory explains the details. To see what I am getting at, lets go back to the idea (which isn't correct, but some state) that I am 'putting it all down to demography'. Obviously you can't do this, and this isn't really my intention. What I do suggest is that we can get onto the economics later when we understand the demographic settings better.

What do I mean? Well the thing is we could take the difference between stable and unstable equilibrium. Now when economies move from one 'local state' to another, then they move from one more or less stable equilibrium to another, and it is during this process that the danger of 'crisis' is high, and policy is terribly important.

Look at the median ages of some of the societies which have had notorious crises in the last 15 years: Mexico, Argentina, Thailand, Turkey.(For the record they are currently: 24.93, 29.42, 30.88, 27.77 respectively).

What is interesting is that all these countries have had crises as they moved from being child societies to becoming young adult ones. Once they have firmly made the transition they become a lot more stable. (China will, of course, be the big test here). My guess is that Turkey is firmly ontrack, Argentina would be if someone would lend them some money and Thailand is now also following a much more solid trajectory. Mexico is still rather on the young side, and prehaps still vulnerable.

So what about Indonesia? Well Indonesia's median age is 26.8, whioch means it is making the transition now, and is in the high risk area: which is why this piece in the Morgan Stanley GEF again caught my eye:


We have been quite concerned about the Indonesian situation as the rupiah and the market lost substantial ground over the past month (Between a Rock and a Hard Place, August 26, 2005). The move by Indonesia on August 30 in raising short-term interest rates and reserve requirements for banks, and tightening foreign exchange market regulations in my view will not fundamentally address the current woes confronted by Indonesia.

In the face of a structurally weak economy, high debt, a lack of fiscal latitude, a weak rupiah and soaring oil prices, we think difficult policy trade-offs will be required. The government has chosen to raise short-term rates and impose restrictions on the banking system and the foreign exchange market. As the banking system and consumers are quite interest-rate sensitive, a substantial rise could torpedo the economy. Yet, raising short term interest rates and putting restrictions on the banking system and the foreign exchange market is not a permanent policy solution. Tackling the root of the problem — the inefficient fuel subsidies — is the ultimate solution. However, such a subsidy removal would also pose considerable social-political risks as a significant segment of the population relies on this subsidy and it could also torpedo private consumption. Indeed, it is an ugly policy trade-off as the current administration may risk social and political-economic instability, but hopefully a rational policy move would win the support of the Indonesian people.

I would say this is the quite a clear statement of the classic child to young adult policy dilemna. Be careful Indonesia.

Moving up to the next level, Japan's 1989 crash came as she was moving from mature adult to elderly dynamics. Does that tell us why the shock was so severe, and the results so enduring? I've not quite got there yet, but this type of argument is definitely getting me someway along the road.