Try the CSQ on your own. But for the following 2 questions, please post your comments as a group (leader - please co-ordinate)
3(a) Evaluate the possible impact of rising oil prices on the Indonesian economy. (8)
- Since the question is asked with regards to the Indonesian economy at large, one way of structuring your answer is via the 4 macro goals.
- Review the case evidence to ascertain if Indonesia is a net exporter or net importer of oil. That will be important for your analysis.
- Try to support your points with evidence from the case as far as possible. For this question, Table 1 will be particularly helpful.
4. Assess how the measures taken by the Indonesian government will affect the rupiah. (8)
- Identify the measures from the case.
- An assessment would require you to explain how each measure impacts the currency as well as the extent of the impact.
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ReplyDelete=.=
ReplyDeleteQuestion 3a. Rebecca;Serena;Daren;Tracy
ReplyDeleteOil is a relatively price inelastic good. Rising oil prices in the Indonesian economy will increase the cost of production where oil is used as a raw material in production of goods. The immediate consequences is the retrenchment of employees as the firms try to cut costs. This can increase the unemployment rate as more and more people become retrenched.
Moreover, the increase in price will lead to uncompetitive prices of oil-dependent Indonesian exports (export which use oil in the process of production). If the price is elastic for those goods, the increase in price will lead to a more than proportional decrease in quantity which will mean a decrease in export revenue. If the price is inelastic, the increase in price will lead to a less than proportional decrease in quantity. This will then translate to an increase in export revenue. In either case, the Balance of trade is affected and the balance of payment of Indonesia will therefore be at a disequilibrium.
The oil prices will also affect the prices of domestic goods as well. This will thereby make imports appear cheaper, which will mean that import expenditure will increase. The increasing import expenditure coupled with the decreasing export expenditure will result in the lower AD since (X-M) will decrease. Hence economic growth will decrease.
Rising oil prices may also cause demand pull inflation as it is an important commodity.
Question 4. Rebecca;Serena;Daren;Tracy
ReplyDeleteIncreased interest rate will increase the MEI (Marginal Efficiency of Investment)thereby increasing FDI. Therefore AD will shift to the right. Also, the increase in FDI will bring about technological improvements that will affect employment. The technology brought in by FDI will increase employment by creating a demand for jobs. Indonesia's AD will increase through the multiplier effect. The increase in national income may cause the Indonesian people to demand more foreign goods and services. Therefore, the supply of Indonesian rupiah will increase as the rupiah is used to purchase foreign currency in order to buy foreign goods and services. This will cause a depreciation of the rupiah.
The increase in FDI will also lead to potential growth of Indonesia's economy.
The decreased subsidies for fuel will increase cost of production as prices increase. The G component of AD will be lower since the government does not have to spend so much on fuel subsidies, thus the AD will decrease. However, the decreased fuel subsidies will mean that consumers have to pay more for fuel. And since fuel is an inelastic good, the price increase will be met with a less than proportional decrease in quantity. Therefore, overall, the C component will increase more than the G component in AD. Therefore the net effect on Indonesia's AD is that the AD will shift to the right. Moreover, the increased cost of production arising from higher fuel prices would mean that Indonesia will be less attractive for firms. FDI will thus decrease and capital flight will take place. The long term capital outflow from Indonesia will imply that the supply of Rupiah will decrease. Hence, the rupiah will depreciate.
In conclusion, the increased interest rate as well as the higher cost of production arising from the lower subsidies would lead to the depreciation of the rupiah.
The occurrence of rising oil prices will have a significant impact on the different sectors of the economy such as manufacturing and transport sectors as well as the well-being of it. Pertaining to that, the 4 macroeconomic goals namely sustainable economic growth, price stability, state of balance of payment (BOP) and unemployment level will be addressed to analyze the effect of rising oil prices has on them.
ReplyDeleteWith the rise in oil prices, the government has reduced fuel subsidies and the central bank raised the interest rates. With the fall in interest rates, it can attract more domestic investments and foreign direct investments (FDI) which causes investments, a constituent of Aggregate demand (AD) to increase. Therefore when AD increases, it will cause aggregate expenditure to increase and national income to increase by multiplied times, boosting actual economic growth. Not only that, with an increase in the level of investments, it can enhance the productive capacity of the country, causing aggregate supply (AS) curve to shift to the right, boosting potential economic growth. This can be supported by an overall increase of 49.2% in net investments from year 2002 to 2005 and an increase of 21.5% from year 2002 to 2005, thus showing economic growth.
However, reducing fuel subsidies has led to a decrease in production as the reduced fuel subsidies made it more expensive for firms to produce the same amount of goods. Due to the decrease in supply, the costs of goods and services would increase, making domestic products relatively more expensive to the Indonesians. They will choose to consume cheaper imports rather than the more expensive local products, taking the assumption that the demand for goods is price elastic. The firms would find that they are unable to sell their current level of output at the current price level, and would hence cut down on production. Since labour is a derived demand, firms will also begin to cut back on the amount of labour they employ. This will therefore lead to the increase in unemployment rate. This is supported by the overall increase in unemployment rate from 2002 to 2005, from 9.1% to 10.3%.
(con't Q3a)
ReplyDeleteAs mentioned above, reducing fuel subsidies has increased the cost of production for the producers, causing the producers to reduce the quantity supplied and resulting in a rise in price. Not only that due to high volume of imports, Indonesia may suffer from imported inflation which will further push up the price. In addition, with increasing affluence of the country, people have more disposable income in their hands to consume more goods and services. Therefore there will be an overall increase in consumer expenditure on goods and services, including consumer imports. So with that net exports will fall as import expenditure may increase more than export revenue as shown by table 1 where current account fell by 77.3% from year 2002 to 2005. However this may not appear AD substantially as it is not the only component of AD, thus the increase in consumption and investments may offset the fall in net exports, causing all overall rise in AD, promoting economic growth. With the growing affluence of the consumers and their increasing amount of disposable incomes, they will demand for more goods and services which can give rise to demand-pull inflation when the economy is near or at the full employment level, which is by extract 2 last paragraph “demand that more than doubled to about 6.38million barrels”. Thus both imported inflation and demand-pull inflation can push up the prices, resulting in price instability as shown by a 25.2% in the inflation rate from year 2002 to 2005.
Due to the inflation caused by the rise in fuel prices in Indonesia, the current and capital accounts of BOP would be affected. Taking the assumption that the demand for goods traded are price elastic, there would be reduced exports out of Indonesia as they are relatively price uncompetitive compared to other countries. Thus export revenue decreases, leading to a fall in current account. This is supported by the fact that the current account has fallen from US$6900m in 2002 to US$1564 in 2005. However, the increase in interest rates as well as the demand-pull inflation has boosted foreign direct investments, as explained above. This resulted in the rise in capital account, which is the transfer of capital to and from abroad. The fall in current account should overall outweigh the rise in capital account balance leading to a decrease in inflow and increase in outflow. Therefore, the BOP of Indonesia would deteriorate, and may even lead to a deficit if the outflow exceeds the inflow to a large extent. This is supported by the overall fall in goods balance from US$22696 in 2002 to US$20152 in 2005.
Xecons: Jasper, cc, calvin, hweeyin, Si'en :)
ReplyDelete3(A)
For the first macro goal of inflation, rising oil prices will lead to imported inflation as Indonesia is now an oil importer(due to fall in output). Hence this will in turn lead to cost push inflation. This is because cost of production rises e.g. in factories. Hence, prices of goods and services may increase to offset the rise in cost of production. Therefore, workers may ask for higher wages through trade union. This may result in a wage spiral. This further leads to a wage push inflation causing prices to soar.This could lead to a drop in investments as investors will source for countries with cheaper cost of production. Consumption will rise as the real value of savings fall.This increases Aggregate Expenditure which will cause a rise in GDP due to the multiplier. However Indonesian may have a weak multiplier due to its high imports (high MPM). As Indonesia is now an importer of oil, GDP falls because of lowered production of oil.
Oil, being an inelastic good, may cause revenue to increase as although prices rise, quantity demanded decrease less than proportionately.
Being exporters, they were processing and producing oil, when they became importers, the oil industry begins to become a sunset industry, thus, lower production means cutting jobs.
The loss of investments will also worsen structural unemployment as workers are not versatile enough to enter other trades. Hence, the government will have to spend more on the retraining of workers to reduce structural unemployment and improve factor mobility.
Furthermore, older workers will be more reluctant to undergo retraining.
BOP worsens as current account worsens. Imports (M) rises causing a net deficit in (X-M). Capital account also worsens due to the drop in investments.
Xecons: Jasper, cc, calvin, hweeyin, Si'en :)
ReplyDeleteBy raising the interest rates through the central bank, the government has appreciated its currency in the forex market. As interest rates are raised, the MEI (Marginal Efficiency of Investment) is raised as well. This will raise the amount of international ‘hot money’ that flows into Indonesia. Hence, this raises the level of Foreign Direct Investment (FDI) in Indonesia, due to higher expected yield from the investments in Indonesia. The rise in FDI creates more jobs and provides technological advancement in Indonesia. As more jobs are created, the incomes of people will rise, people will also consume more. With the multiplier effect, there would be a significant rise in aggregate demand (AD). Thus, the Indonesian government is able to raise the incomes of the people, so that they can overcome the heightened oil prices. With an increased in the demand for the rupiah to purchase investments in Indonesia, the rupiah is appreciated.
By reducing the subsidies on oil, government need not spend as much. As mentioned in the source, the Indonesian government which has been giving subsidies on oil is being weighed down by the rising oil prices as this increases their spending on the oil subsidies. As oil is an inelastic good, a rise in its price will lead to a less than proportional fall in the quantity demanded for the good, ceteris paribus. Thus, the rise in oil prices resulted in a significant impact on the Indonesian government’s budget. Hence, the Indonesian government now has a budget deficit. Therefore, by reducing the subsidies on oil and eventually eradicating it, the government can raise and regain its reserves. The money used on oil subsidies can be used on other developments in Indonesia such as infrastructural developments and economic developments. This will result in Indonesia being more like an economic hub. This will attract investors and as more rupiah is demanded by investors to purchase investments in Indonesia. Thus, the rupiah will appreciate. However, with heightened oil prices and the lack of subsidies, Indonesian consumers will have to pay more for oil. This results in lower quantity demanded and consumption of oil. The consumption component of AD decreases. Government expenditure also falls, thus, AD falls. As the quantity demanded for foreign oil falls, less money is spent on import expenditure. There will be lesser rupiah available in the Forex market, thus, this appreciates the rupiah.
Indonesia being mainly an importer now, has a BOP deficit as its import expenditure is more than its export revenue. Thus, the BOP deficit will also result in the appreciation of the rupiah as there will be more rupiah available in the forex market.
In conclusion,the measures employed by Indonesian government will result in an overall appreciation in the rupiah.
Pei wen, Yijie, jesselyn and eric
ReplyDeleteQ4. Reduction in fuel subsidies will reduce the strain on the government’s budget. Currently, the fuel subsidies are draining Indonesia’s finances as the government subsidizes fuel costs for its 238.5 million people. By reducing fuel subsidises, it would help to relieve the government’s budget deficit and thereby improve the country’s economy. This would help to restore confidence in investors as they are less apprehensive about investing in Indonesia. The demand for the rupiah would then increase as investments increase, causing the strength of the rupiah to increase, and less of the rupiah will be sold off.
However, the implementation of this measure might have negative impacts on other aspects of the society. Reducing the fuel subsidies might cause social unrest. The lower-income people in Indonesia might find it harder to cope with their lifestyle without the subsidies, and may protest or have demonstrations in response to the reduction. Political unrest would cause investor’s not to have confidence in Indonesia’s economy as the situation is not stable, therefore decreasing the demand of the rupiah and causing more to sell off the rupiah. This may cause the situation of the decline of the rupiah to even worsen.
Furthermore, there are concerns that this measure may hurt bilateral ties with Singapore, hindering trade between the countries, and thereby also causing a decrease in the demand for the rupiah.
The Government has raised the interest rates of foreign funds through the central bank, thus appreciating its Rupiah in the Forex Market. As a result, the increased interest rate will also increase the MEI (Marginal Efficiency of Investment), hence increasing Foreign Direct Investment (FDI) in Indonesia, and also reducing short term outflows of ‘Hot Money’.
However, many other factors have to be considered for such funds hence an increase in interest rate may be ineffective if economic outlook of Indonesia continues to worsen. Besides, a high interest rate would deter foreign investment as it would increase opportunity cost for foreign companies looking to invest, hence leaving the Indonesia’s Rupiah weak.
On the other hand, a rise in FDI would create more jobs and provide I.T. investments in Indonesia, proving beneficial for the people and also the Government.
In conclusion, the measures may be able to help strengthen the rupiah. However, the Indonesian government has to consider the economic outlook of the country and implement other measures to deal with the negative impacts that accompany the measures e.g. measures to appease the people and prevent social unrest and improve bilateral ties.