Country Report Indonesia
Indonesia has outperformed most countries in the World throughout the crisis years on the back of domestic demand. However, in order to maintain that growth level, and not be faced with increasing inflation, the country will need to seek structural improvements.
Strengths and weaknesses
Indonesia has a young and growing population (currently 246 million people), with a growing middle class.
Strong government finances
Indonesia has a rather low public debt (25% of GDP), and posts only limited fiscal deficits. This is also due to the government not being able (bureaucratically) to spend.
Indonesia scores poorly on social indicators such as the Ease of Doing Business, Corruption Perception and Press Freedom. Also, the infrastructure of the country (roads, electricity) is poor.
Fuel is heavily subsidized in Indonesia, leading not only to a flip of the current account into a deficit position, but also to reduced competitiveness of the economy and fiscal inflexibility.
1. Current account has turned into deficit
Indonesia’s run of posting successive current account surpluses since the Asian crisis has come to a halt in 2012. The current account dropped to a deficit of 2.7% of GDP. One of the drivers of this movement is strong domestic demand (also: below), generating constant growth in consumer demand for imports. On the other hand, external demand for local products has dropped. Furthermore, the energy balance has also taken a turn for the worse. Indonesia already had to leave OPEC in 2008, due to it becoming a net importer of oil. Due to the vast energy subsidies, however, domestic demand for energy continues to take a carve out of potential exports, while also leading to an increase in fuel imports. The current account is unlikely to turn into the black in the near term, given the structural issues at the root of its problems. The overall external position remains acceptable though, as Foreign Direct Investments cover about 90% of the deficit. There will be increasing pressure on the rupiah however, as the current account deficit persists.
2. Domestic demand remains the main driver of growth
Domestic demand has been the main catalyst of Indonesia’s for more than a decade. Its contribution to growth has hovered between 2.5-3 percentage points (ppt) during that period. Therefore, Indonesia was less exposed to the global economic crisis of 2008 and beyond, and was still able to post growth rates of over 6%. The government is a far less important contributor to growth, although in an indirect measure (through subsidies) it allows the population a larger disposable income. It is important to note that consumption has not been boosted by exceptionally low interest rates or through the government promotion of exports and investment. Investment, though, has become a more important source of growth, as investors’ eyes are increasingly opened by the continues growth in a populous country that seems to be stabilizing in a political, social and economic sense. However, this demand-side driven growth needs to be matched on the production side in order to avoid further current account, exchange rate and inflation pressures. In that sense, investments in infrastructure and labor productivity in order to reduce unit labor costs seems indispensable to maintain this growth level for the next decade.
3. SBY will be out, who’s coming in?
Yudhoyono (PD) has won two consecutive presidential elections, and is not able to run in the 2014 presidential elections. Also in 2014, the parliamentary elections will be held. As power in rather concentrated in the hands of the executive power, these would at first sight appear to be less important. However, under Indonesian law, only parties that cross a 20% of the seats in parliament threshold may propose a candidate for the presidency. This threshold is currently under debate, with the three main parties PD, PDI-P and Golkar wanting to move the threshold up, to the dismay of six smaller parties. Especially the Gerindra party (nationalistic) wants to reduce the threshold, as this party is the only party with a strong presidential candidate. However, also PD now wishes a lower threshold, as its popularity has been undermined by several corruption scandals. As his successor is unknown yet, Yudhoyono has tightened the reins on his party in order to salvage his heritage. The other two main parties, Golkar and PDI-P still seem able to bank on sufficient support to obtain a higher threshold. Candidates for these parties are likely to be Bakrie (Golkar), the candidate for vested interests, and Megawati, former president and daughter of founding father Soekarno. However, after losing twice to Yudhoyono, she might pass up on the candidacy in favor of her daughter.
4. Inflation remains a concern
Inflation remains a stubborn problem in Indonesia, in spite of the central bank’s prudent monetary policies. The government plays a big role in limiting the central bank’s control over the inflation rate. For one, the heavy subsidies on fuel do have a downward impact on the inflation rate, while on the other hand, the resulting increase in the current account deficit leads to the fear of imported inflation through the exchange rate. Furthermore, in order to protect the local agricultural sector, the government has imposed both import and export quota. Needless to say, this leads to higher prices for the local consumer. Currently, inflation has moved to 5.9% in March, higher than the central bank’s 5.5% upper target. With the government needing to cut back on energy subsidies (that will significantly raise inflation) and needing to confront the powerful agricultural sector (through its employment) while domestic demand remains high, the central bank could be wrong about maintaining its benchmark interest rate at 5.75% based on the assumption that most inflationary pressure is temporary.
Indonesia was a Dutch colony until the Dutch government handed over sovereignty in 1949, after years of struggle. For almost fifty years since, power was in the hands of two men: first Soekarno, a leader in the fight for freedom, and then Suharto, who had removed Soekarno from power in the 1960s. In 1998, when Soekarno was finally toppled, the first free legislative elections took place, and in 2004 the first free presidential elections took place. After two consecutive turns as president, Yudhoyonu will leave office in 2014.
Indonesia benefits from its abundant natural resources, which include coal, gas, oil, timber, gold, silver and palm oil. A decline in oil production made Indonesia a net oil importer in 2005 and triggered its exit from the OPEC in 2008. The oil and gas industry remains the largest industry in Indonesia. Coal and gas have become the new strengths – Indonesia is the world’s largest exporter of coal. The export mix is dictated by commodities, followed by manufactured products.
During the Asian crisis of 1997/8, Indonesia was among the hardest hit countries. In 1998, GDP plummeted by more than 13%, inflation rose to 58%, the rupiah lost 70% of its value, and the sovereign went into default. This episode left its mark on the country’s economic policies. Consecutive governments have been fiscally prudent (with the country regaining its international investment status), and monetary policy has been able to contain inflation and the value of the rupiah within acceptable boundaries.
In socio-economic terms, there is plenty of upside potential, as a large part of the population remains uneducated and poor. Furthermore, religious strife has become more pronounced as the country rids itself of autocratic leadership to deal with the challenges of being a democracy.