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Country Report Indonesia

Country Report

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Indonesia vlag

The third free presidential elections in Indonesia’s history (1H2014) will bring a new president into office, as Yudhoyono is barred from participating after completing two terms. There is no clear favorite, increasing policy uncertainty. Also, the external position is weakening.

Strenghts (+) and weaknesses (-)

(+) Favorable demographics and growing middle class

Indonesia has a young and growing population (currently 246 million people). While the average income is still relatively low (USD 4,904 in PPP terms in 2012), the middle class is growing fast.

(+) Strong government finances

Indonesia has a rather low public debt (less than 25% of GDP) and posts only limited fiscal deficits. This is due to rather tight control of spending, consistent strong economic growth in the past, but also due the (bureaucratic) inability to fully execute capital spending plans for, among others, infrastructure.

(-) Weak business environment

Indonesia scores poorly on governance indicators such as the Ease of Doing Business, Corruption Perception and Press Freedom. Also, the infrastructure of the country (roads, electricity) is poor.

(-) Large energy and food subsidies

Fuel and (to a lesser extent) food is heavily subsidized in Indonesia, which not only contributed to the current account falling into deficit, but also reduces the efficiency of the economy and results in fiscal inflexibility. About a quarter of the central government budget is spent on subsidies.

Key developments

1. General and presidential elections in 2014 determine policy agenda

Next year is a busy electoral year in Indonesia, as parliamentary and presidential elections will take place. A peaceful transition of power is expected after the second term of the first freely elected president ends, which would support Indonesia’s democratic credentials. The parliamentary elections will be held in April 2014. Several corruption scandals in the past months have affected the popularity of the main ruling parties, including President Yudhoyono’s Democratic Party (DP). The opposition party of Megawati Soekarnoputri seems to benefit from this. However, no party is expected to win an outright majority and a coalition is the most likely outcome. Based on the outcome of the parliamentary elections, the list of presidential candidates will be formed, as it is likely that only parties with 20% of parliamentary seats or 25% of the popular vote can nominate candidates (similar to the rules in the previous election). With much power in Indonesia concentrated in the presidential office, the focus will be on the presidential elections in July 2014.

As the current President Yudhoyono cannot participate anymore after completing two terms and there is no clear successor, the political maneuvering and speculation about possible candidates is intensifying. A popular name is Joko Widodo, the governor of Jakarta. Joko is a newcomer in the political scene, but he has become very popular in the past year. He is not a former general – unlike most other candidates – and takes a strong stance against corruption. Other candidates are more traditional and have closer ties to the business community. They are generally not openly against corruption and, if elected, more likely to take a more nationalist approach. Even though the policy direction is uncertain after the elections, there seems to be a general consensus about the basic policy mix, which includes a conservative fiscal policy and free market ideas with a touch of nationalism. Moreover, the new president is expected to be backed by a coalition in parliament. On the positive side, this limits the room for unexpected major policy shifts, but on the negative side, it will make it more difficult to implement the structural reforms that Indonesia needs, such as cutting back on subsidies, reforming the power industry, improving infrastructure, enhancing education, making labor laws more flexible, addressing corruption, etc. In the run up to the general and presidential elections, no major reforms are expected and some additional spending is likely. For example, a minor change to the fuel subsidies is expected to keep the budget spendings in check, but a structural reform of fuel and food subsidies is not in the cards. While the ruling DP of President Yudhoyono fears to lose votes over such a reform, the opposition suspects that a cash compensation to the poor (which is likely to be an element of a big structural reform) could increase the popularity of the DP. Hence, policy inaction is expected.

2. Growing vulnerability of external position

Indonesia’s external position was a strength of the country after the recovery of the 1990s Asian crisis. Indonesia posted healthy current account surpluses and enjoyed (and sometimes struggled with) ample foreign investment inflows. However, the external position of Indonesia has been weakening in the past years on the back of two important trends. First, the current account balance fell into deficit in 2012 for the first time since the Asian crisis and is expected to post 2-3% of GDP deficits in the coming years (see our Country Report of May 2013 for more background information on this trend). Second, private sector external debt has doubled in the past five years, on the back of low interest rates for foreign currency loans and the desire to find an alternative for the shallow bond market. As this has been partly offset by a reduction of foreign debt by the government, the overall level of external debt is still moderate at about 25% of GDP. The private sector has, however, become more vulnerable to changes in investor sentiment and exchange rate volatility. These factors also help to explain why Indonesia came into the spotlights when the financial markets in May 2013 started to anticipate tapering by the US Fed. Indonesia was among the emerging markets that witnessed a withdrawal of capital and therefore a strong depreciating pressure on its currency over the course of the summer. The combination of the central bank’s efforts to support the currency, the deficit on the current account and the decline in foreign investment had a negative effect on the foreign exchange (FX) reserves of Indonesia. The FX reserves are expected to be about 20% lower at the end of 2013, compared to the start of 2013. This also affects the import cover (down to about 4.5 months) and the debt service cover (down to 105% by end-2013). While these figures are not alarming and the short-term debt is less than 20% of the already rather low total external debt, the external position of Indonesia is something to be watched.

3. Slightly slower, but still solid economic growth

Indonesia’s economy is expected to continue to grow at a steady pace. GDP growth is forecast to slow from 6.2% in 2012 to a little over 5% in 2013 and pick up somewhat again in 2014. Robust private consumption growth remains the main driver of growth, supported by strong investment growth. With four policy hikes (total 150bps) since June, Bank Indonesia, the central bank, has started an aggressive tightening cycle, which is expected to temper both consumption and investment growth in the coming months. Bank Indonesia took these measures partly to support the rupiah and partly to stem inflation expectations. Meanwhile, rather high inflation is depressing spending power. Inflation is expected to be close to 8% in 2013 on the back of a fuel price increase in June and rupiah depreciation. On the upside, a slightly lower level of economic growth will be supportive of the external position, as it would temper imports.

Factsheet of Indonesia
Factsheet of IndonesiaSource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Background information

In 1945, Indonesia declared independence from the Dutch. For almost fifty years since, power was in the hands of two men: first Soekarno, a leader in the fight for Indonesia’s independence, 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, followed by the first free presidential elections in 2004. Yudhoyono defeated Megawati, the daughter of Sukarno, in presidential elections.

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. 

Economic indicators of Indonesia
Economic indicators of IndonesiaSource: EIU
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