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Cablegate: Indonesia: Divergent Views On Impact of Global Economic

VZCZCXRO1954
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0671/01 0940805
ZNR UUUUU ZZH
R 030805Z APR 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8546
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/USDA WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 1745
RUEHBJ/AMEMBASSY BEIJING 4867
RUEHBY/AMEMBASSY CANBERRA 2255
RUEHUL/AMEMBASSY SEOUL 4496
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 000671

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
COMMERCE FOR 4430/KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
DEPARTMENT PASS EXIM BANK
USDA/FAS/OA YOST, MILLER, JACKSON
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER
USDA/FAS/OGA CHAUDRY, DWYER

E.O. 12598: N/A
TAGS: EFIN EAGR ECON PGOV ID
SUBJECT: INDONESIA: DIVERGENT VIEWS ON IMPACT OF GLOBAL ECONOMIC
INSTABILITY


1. (U) Summary: The U.S. economic downturn will decrease Asian
economic growth prospects, according to Morgan Stanley Asia Chairman
Stephen Roach, who spoke to Indonesian business executives on March
31. Lower U.S. consumption will likely reduce Asian exports to the
U.S., a significant driver of growth. Roach also warned that
growing protectionist sentiment in the United States could result in
higher world inflation and tighter monetary policies. In contrast,
the World Bank Chief Economist for East Asia predicted only a modest
slowdown in the United States and limited impact on Asia. Both
economists raised concerns about the severe effect of rising food
prices on the world's poor. Nehru warned governments not to respond
with market distorting price controls and subsidies. Indonesia's
large domestic economy and diversified export base reduce the
repercussions of a global economic slowdown, but poverty and the
risks to economic growth are rising. Recent bond and equity market
movements in Indonesia reveal increased investor concern. End
summary.

Morgan Stanley: Worst yet to Come
---------------------------------
2. (U) The simultaneous collapse of the housing and credit markets
in the United States will lead to a prolonged period of economic
retrenchment in the United States and around the world, according to
Morgan Stanley Asia Chairman Stephen Roach. Roach identified three
rounds of impacts: the first in financial markets, the second in U.S
homebuilding and consumption, and the third in reduced growth in
world trade and capital flows. According to Roach, the first-order
impacts may have reached their peak, but the second and third round
effects will pull down world growth for the next few years. Easy
credit access and the wealth effect of higher housing prices spurred
unprecedented U.S. consumer spending in recent years, Roached noted.
U.S. wages have grown at a significantly slower pace than
consumption for the past five years.

3. (SBU) Roach rejected both decoupling - the notion that Asia will
be unaffected by a U.S. economic slowdown - and the theory that
consumption in China and India could compensate for significantly
lower U.S. consumption. Growth in Asia as a region over the past
twenty years has been dependent on exports, particularly to the
United States, according to Roach. Exports comprise 45% of GDP in
Asia in 2006, compared to less than 20% in 1980. In 2006, 21% of
China's exports, 23% of Japan's exports, and 14% of ASEAN's exports
went to the U.S. Roach said that Japan will enter a recession soon,
given the high proportion of Japanese exports destined for the
United States. While intra-regional trade and internal consumption
are rising across Asia, these sources of growth are relatively small
when compared to the United States market. Combined personal
consumption in China and India in 2006 was less than $2 trillion,
while annual U.S. personal consumption was more than $9 trillion.

4. (U) Roach's greatest concern is that the current economic crisis
in the U.S. will result in a new era of anti-globalization,
characterized by protectionist trade policies, which prompt higher
inflation and interest rates and lower investment returns. Labor
compensation as a share of national income has remained steady or
declined over the past ten years, despite significant gains in
productivity, lending support to views that globalization has not
improved the lives of average people. High oil and food prices also
put pressure on middle- and low-income households around the world,
and have already prompted governments to erect trade barriers.
While Roach anticipates a decrease in world oil and mineral prices
over the next year, he predicts agriculture prices will remain high
due to demand from emerging markets and alternative energy
producers.

World Bank: Asia positioned to weather the storm
--------------------------------------------- ---
5. (U) World Bank Chief Economist for East Asia Vikram Nehru expects
the United States economy to recover over the next 12-18 months and
believes the United States' economic problems will have a minimal
affect on Asian growth rates. Asia's high savings rates, strong

JAKARTA 00000671 002 OF 002


productivity growth, large current and capital account surpluses,
and fiscal capacity to respond to slower export growth will provide
a sufficient cushion to absorb slower U.S. demand for Asian exports.
In contrast to Roach, Nehru said that the importance of the U.S. to
world growth has receded significantly. U.S. share in world imports
dropped from over 18% in 1999 to roughly 15% in 2005, while
developing countries outside Asia now consume more than 20% of world
imports. Nehru believes that domestic demand will be a key force
behind economic growth in Asia.

6. (U) Rising global food prices are a serious risk to Asia and the
world, according to Nehru. High food prices could erase the
reduction in poverty in the region achieved over the past 20 years
of high economic growth in Asia. Asian governments must avoid
widespread use of price controls and subsidies to dull the impact of
high global prices. These policies tend to be regressive, lead to
significant economic distortions and encourage black market
activity, according to Nehru. Instead, Nehru encouraged governments
in Asia to use progressive policies, such as targeted cash transfers
to the poor, which directly improve the purchasing power of
low-income households.

Indonesia: Risks Increasing
---------------------------
7. (SBU) Indonesia's large domestic economy and diversified export
base reduce its vulnerability to a significant slowdown in world
growth. However, risks to economic performance are rising, based on
Morgan Stanley and World Bank analysis. High food prices are
straining household budgets and contributing to higher overall
inflation rates, which will curb domestic consumption. Indonesian
headline inflation jumped to 8.17% in March, as food, tobacco, and
clothing prices soared. If metal and mineral prices decline in line
with Roach's predictions, Indonesia's export growth rate could slow
markedly. In addition, while only 11% of Indonesian exports go
directly to the United States, 13% of the country's exports go to
Japan, which is also facing slower growth, reducing the scope for
growth in Indonesian exports. Indonesia also has less flexibility
to respond to declining internal and external demand with
expansionary fiscal policy. The overall subsidy bill - estimated at
25-30 percent of the overall budget - has reduced the scope for
other spending.

8. (U) Investor concern about Indonesia is mounting, according to an
April JP Morgan report. A growing number of asset managers are
nervous about the ability of the Indonesia government to maintain
the FY08 projected budget and funding plan in light of increasing
fuel subsidies. The 10-year local bond price has decreased by 9%
since the end of February. The Jakarta Composite Index also
declined this week on concerns that Bank Indonesia will maintain
interest rate levels despite growing inflation, raising the risk of
negative real interest rates, which could prompt an exodus of "hot
money." JP Morgan analysts have recommended that investors reduce
holdings in banking institutions with large exposures to the
consumer market or large bond portfolios.

HUME

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