Economic Ramifications and Rupiah Exchange Rate Dynamics Amidst the Israel-Palestine Conflict

Oleh: Ronald Sofyan Ganda Sari Sipayung *)

Introduction
In the crisp dawn of October 2023, the Israel-Palestine conflict reignited, casting a long shadow with profound economic consequences—both across the embattled lands and reverberating through the intricate web of the global economy. The undercurrents of this conflict have unleashed ripples of uncertainty and volatility, transcending borders. This paper ventures into the heart of these economic tempests, dissecting the multifaceted impact of the Israel-Palestine conflict. Specifically, it delves into the intricate nexus of global oil and gas supplies, offering tailored recommendations to navigate these treacherous waters. Moreover, it casts a discerning eye on the tumultuous tides of the Rupiah exchange rate, driven by capricious foreign capital flows, and lays the groundwork for the transformational role of data transparency in steering through these turbulent times. In the following pages, we invite you to embark on a journey of economic exploration, where every insight uncovered promises a deeper understanding of the world’s most pressing economic issues, today and beyond.

Economic Impacts of the Israel-Palestine Conflict
The Israel-Palestine conflict has far-reaching impacts, especially on global oil and gas supply. World crude oil production is estimated to drop by up to 1 million barrels per day if the conflict spreads to Iran, the largest OPEC oil producer. Global oil prices could rise by around $6 per barrel if Iran’s production is disrupted. Moreover, distribution of gas from Israel’s offshore Tamar field to Europe is also under threat, while involvement of Iran and the United States would increase the risks around the strategically important Strait of Hormuz, through which a third of the world’s oil shipments pass.

If the Strait of Hormuz is blocked due to the conflict, oil prices could skyrocket to $150 per barrel, especially if the conflict spreads and involves other Gulf nations. The global Brent crude price has already risen around 8% since the war began, reaching $91 per barrel. This increase has been more driven by speculation and geopolitical uncertainty in the Middle East, although fundamentally global oil supply remains in surplus. This would significantly impact the global economy, given over 30% of global crude oil production passes through the Strait of Hormuz daily. Disruption to the Strait would severely affect major oil importing countries like China, India, Japan and South Korea.

The impact of this conflict is not limited to energy supply, but also has broad ramifications on global economic growth. World economic growth is projected to slow by around 0.1-1% if the conflict escalates, and global inflation would rise by around 0.1-1.2 percentage points.

A weakening global economy would reverberate through international trade volumes and potentially trim growth in various countries. Additionally, the spike in global crude prices would depress purchasing power and household consumption in oil-importing nations, which would ultimately hamper post-pandemic economic recovery.

Impacts on Indonesia
As a developing country heavily reliant on imported crude oil (net importer) and subsidized fuel, Indonesia would feel direct impacts from this conflict. The rise in global oil prices would increase the cost of importing fuel (BBM) for Indonesia. In 2022, Indonesia’s total imports of crude oil and fuel reached $26 billion. If oil prices continue to surge sharply to $100-120 per barrel, Indonesia’s burden of importing fuel would swell considerably. The prices of subsidized fuels like Pertalite and Solar have the potential to rise significantly if following the upward trend in global oil. Calculations estimate every 10% increase in Pertalite’s price is predicted to add 0.27% to Indonesia’s inflation rate, while a 10% hike in Solar’s price would add inflationary pressure of 0.05%. This would certainly affect Indonesia’s inflation rate and people’s purchasing power.

High inflation would provide further justification to keep raising the benchmark interest rate. Bank Indonesia’s 7-Day Reverse Repo Rate has now reached 6.0%, the first hike since January 2023. This interest rate hike is deemed necessary to strengthen efforts to stabilize the rupiah exchange rate amid heightened global uncertainties. The rupiah has hit its lowest level since 2020, impacted by the Fed’s tight monetary policy and tensions in the Middle East. On the other hand, there would also be impacts in the form of higher financing costs for businesses, potentially dampening investment appetite and business expansion.

The rupiah exchange rate against the US dollar has also weakened 0.64% since the war began, reaching Rp15,138 per USD. This depreciation has been driven by capital outflow as global investors shift to safe haven assets like gold and US bonds. A weaker rupiah will make imports from overseas more expensive in rupiah terms. This adds inflationary pressure in Indonesia, especially on imported goods like electronics, automotive, etc.

Overall, the economic impact of the Israel-Palestine conflict on Indonesia remains limited as long as it does not escalate to major oil producing nations. However, vigilance and preparedness to take policies to curb potential inflationary and currency volatilities are still warranted. Macroeconomic stability remains key amid global geopolitical uncertainties.

Policy Recommendations to Respond to Israel-Palestine Conflict
Like many countries, Indonesia faces the challenge of adapting to unfolding economic changes. Here are some recommended policies to mitigate the economic impacts of the Israel-Palestine conflict, including export market diversification, boosting domestic economic growth, infrastructure investment, Rupiah exchange rate protection, and enhancing economic resilience. These all aim to strengthen Indonesia’s economic stability and reduce vulnerabilities to external shocks.

Safeguarding the Rupiah Exchange Rate
The Israel-Palestine conflict has caused fluctuations in global oil prices, which can adversely affect the Rupiah exchange rate. Efforts to maintain Rupiah stability should focus on accumulating sufficient foreign exchange reserves and adopting prudent monetary policies. This approach will mitigate the Rupiah’s exposure to global economic shocks, ensuring its stability amid global economic uncertainties.

Maintaining Fuel Subsidies and Compensation
To a certain extent, providing subsidies and compensation to Pertamina needs to be maintained even as global oil prices rise. This is necessary so that increases in global oil prices do not get immediately passed on to domestic fuel prices, thereby reducing inflationary pressure. Budgets for fuel subsidies and compensation need to be maintained in the 2023 state budget (APBN).

Enhancing Monetary and Fiscal Policy Coordination
Coordination needs to be enhanced between monetary authorities and fiscal authorities to curb inflationary pressure and exchange rate volatilities through a mix of monetary policy (interest rates) and fiscal policy (fuel subsidies, stimulus spending). Good coordination will support policy effectiveness.

Export Market Diversification
The Israel-Palestine conflict has exerted pressure on international trade, which could potentially affect Indonesia’s export markets. To mitigate this risk, Indonesia needs to reduce dependence on export markets directly affected by the conflict. Diversifying export markets will build economic resilience by lessening dependence on a limited number of trade partners. By expanding the breadth of export markets, Indonesia can mitigate the impact of external economic shocks.

Strengthening Domestic Economic Resilience and Growth
Sustained economic growth is crucial for Indonesia’s development. To achieve this, economic stimulus that spurs investment and stimulates domestic economic activity is needed. Pro-growth fiscal policies, such as tax reductions for businesses, investment incentives, and higher public spending on high-multiplier sectors should be implemented. These measures can invigorate the domestic economy, create jobs, and encourage growth in consumer spending.

Enhancing Indonesia’s economic resilience is imperative amid geopolitical tensions like the Israel-Palestine conflict. This involves diversification of products and markets, improving industry competitiveness, adaptability to global condition changes, and developing economic sectors with high potential. By implementing these strategies, Indonesia can strengthen its economic foundations and become more resilient to external shocks.

Rupiah Exchange Rate Developments
At the same time, the rupiah exchange rate is also facing turmoil amid fickle capital flows.

One study shows through regression analysis that trade surpluses and foreign direct investment (FDI) are statistically insignificant in bolstering foreign exchange reserves. In contrast, inflows into government bonds have a statistically significant positive correlation with forex reserves. This means claims that trade surpluses and FDI are the main determinants of rupiah stability need to be re-examined for validity.

This is especially as despite trade surpluses being recorded positively for 35 consecutive months, BI keeps issuing new instruments like forex time deposits from export proceeds and rupiah-denominated central bank securities to attract foreign currency.

Simply put, the explanation is that trade surpluses only record the value of exported goods, not the actual foreign currency proceeds repatriated back into the country. Exporters still keep most of their export earnings abroad, thus not contributing maximally to forex reserve accumulation.

For instance, the value of coal exports reached $32 billion in January-September 2023. However, forex time deposits from export proceeds channeled through BI were only around 2% of total export value. This means export proceeds are not repatriated and deposited offshore instead of onshore.

Comparisons with other natural resource exporting countries show, the lower the contribution of natural resource exports to total exports, the larger the forex reserves. Russia with 85% natural resource exports, has forex reserves of $581 billion (19 months of import cover). Meanwhile, Indonesia with 52% natural resource exports, has forex reserves of $135 billion (6 months of import cover). This means Russia is more effective in ensuring export proceeds are repatriated. The opposite happens in Indonesia.

So how can exporters be compelled to repatriate export proceeds back to Indonesia?

Data Transparency as a Solution
Data transparency can be key in mitigating risks of rupiah exchange rate fluctuations. Publish data on export-import values and volumes per company per commodity monthly, to reveal the net surplus of each company and how much has been repatriated back in foreign currency.

This data transparency is needed because the public has a right to know how natural resources are managed, as mandated in the 1945 Constitution Article 33. With openness, the public can ensure export proceeds are repatriated to benefit the people. Broadly, the public can support BI in maintaining forex reserves and mitigating the impact of the Israel-Palestine conflict. Exchange rate stability and economic benefits can be enjoyed by the Indonesian people.

Without repatriation of export proceeds, the exchange rate will potentially keep weakening and the full economic benefits of trade surpluses are not enjoyed domestically. Data transparency can compel corporate compliance due to pressure from investors and banks.

In this intricate web, to encourage exporter compliance, banks can also play a role by not extending credit (loans) to non-compliant companies. This needs to be done as current sanctions for non-compliant companies as stipulated in BI Regulation No. 7 of 2023 are only administrative fines, hence enforcement can still be encouraged.

With transparency, the public can be involved in helping buttress forex reserves so that ultimately, exchange rate stability and economic benefits can be enjoyed by the Indonesian people.

Conclusion
In conclusion, the Israel-Palestine conflict looms as a critical factor with far-reaching economic implications, profoundly affecting global oil and gas supply dynamics and the stability of the Rupiah exchange rate. Amidst these complex economic challenges, the imperative of data transparency emerges as a compelling solution. Open and comprehensive disclosure of company-specific export-import data, categorized by commodities, on a regular monthly basis not only serves as a pragmatic means of managing the intensified economic consequences but also stands as a beacon of accountability and equity for the Indonesian populace. This proactive approach is poised to safeguard the repatriation of export earnings, bolster economic stability, and ultimately pave the path for an equitable distribution of economic advantages among the citizens of Indonesia.

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*) Pegawai pada Kedeputian Bidang Perekonomian Setkab