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Country report Indonesia

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The reform process in Indonesia is not expected to speed up markedly under the new government, as president Widodo faces a difficult political environment. GDP growth is expected to accelerate somewhat, but Indonesia remains vulnerable to deteriorating financial markets sentiment.

Strengths (+) and weaknesses (-)

(+) Favourable demographics and growing middle class

Indonesia has a young and growing population (currently 248 million people). Average income (USD 9,524 in PPP terms in 2013) is rising steadily) and the middle class is growing fast.

(+) Sound government finances

Indonesia has a rather low public debt (31% of GDP) and posts only limited fiscal deficits. This is due to rather tight control of spending, consistent strong economic growth, 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

Although fuel subsidies have been somewhat reduced, fuel and food are still heavily subsidised, which puts pressure on the fiscal balance (and increases fiscal inflexibility) and current account.

Key developments

1. Indonesia under the rule of president Joko Widodo

Indonesia’s new president, Joko Widodo, assumed office on October 20th. Despite his track record as a reformer, we do not expect a major acceleration of the reform process, as Widodo faces a difficult political environment. The fact that the elections were peaceful, despite the narrow (5%) margin of Widodo’s victory over Prabowo Subianto (a long-time member of Indonesia’s political elite), are testimony of Indonesia’s maturing democracy. Widodo has climbed the political ladder through local-level politics, first as major of Solo (Surakarta) and as governor of Jakarta. Although he lacks national-level political experience, Widodo is known as a down-to-earth and reform-minded leader that has compassion for the poor. Not unimportant, he has a clean past when it comes to corruption. In line with his focus on good governance, Widodo voluntarily submitted the list of possible cabinet members to the Corruption Eradication Committee, which led to 8 persons being removed from the list. The final selection of the 34-strong cabinet indicates policy continuity. Experienced technocrats will man the Ministry of Economic Affairs and the Ministry of Finance while people with ample corporate management experience will run the Ministry of Transport and Ministry of State-Owned Enterprises. The influence of Indonesia’s political establishment is also visible. Vice-president Jusuf Kalla is a former leader of the Golkar Party (the Golkar party was the ruling party during Suharto’s regime). Also, relations of PDI-P (Widodo’s party) leader Megawati Sukarnoputri were appointed in the new cabinet. Indonesia’s reform process is unlikely to speed up markedly under the new government. The PDI-P has formed a minority coalition in parliament (representing 247 out of 560 seats) and Widodo thus has to gather support not only within his own party and coalition, but also from opposition parties to pass reforms. That said, another fuel subsidy cut – one of the most pressing and at the same time politically difficult reforms - is expected in the near term, even though the anticipated cut in October was delayed.

2. Economic growth expected to pick up

After years of deceleration, real GDP growth is estimated to speed up to around 5.6% in 2015, up from an estimated 5.2% this year. Investment growth is expected to rise on the back of regained confidence, as political uncertainty has been reduced. As the recently installed new government will get up to steam in 2015, government spending growth is estimated to rise. Private consumption growth, however, will continue to suffer from weaker credit growth, which is estimated to ease to around 15% in 2015, down from 22% in 2012, on the back of tight monetary policies. The Indonesian central bank started hiking its policy interest rate in June 2013, following the announcement by the US Fed that it would start to ease its monetary stimulus (tapering), and had brought the rate up from 5.75% to 7.5% by November 2013. Afterwards, rates remained high to counter increased consumer price inflation following a fuel subsidy reduction. Although inflation has eased to around 4.5% since July (due to base effects), the central bank is reluctant to lower the policy rate, as another fuel subsidy cut is expected in the near term that will once again push up inflation. Even so, the subsidy cut is welcome. It should support investor confidence and allow for more, much needed, infrastructure investment, as it will free up room in the government budget.

Figure 1: GDP growth expected to pick up again
Figure 1: GDP growth expected to pick up againSource: EIU
Figure 2: Inflation has eased, but rates still high
Figure 2: Inflation has eased, but rates still highSource: Macrobond

3. Indonesia still vulnerable to changing financial markets sentiment

Indonesia’s macroeconomic policies have improved since mid-2013, when the prospect of tapering by the US Fed led to a steep depreciation of the rupiah. The economy has stabilised since and the Indonesian stock market has recovered. However, both the fiscal balance and the current account balance remain in the red (twin deficits). Also, the Indonesian currency has not recovered and even depreciated markedly in October (2014) following the news that the Fed will fully stop its support programme and the delay of a new fuel subsidy cut in Indonesia. Indonesia thus remains vulnerable to deteriorating international financial market sentiment.

Figure 3: Current account remains in the red
Figure 3: Current account remains in the redSource: EIU
Figure 4: To recover or not to recover
Figure 4: To recover or not to recoverSource: Macrobond
Factsheet Indonesia
Factsheet IndonesiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

In 1945, Indonesia declared independence from the Netherlands. For almost fifty years since, power was in the hands of two men: first Sukarno, a leader in the fight for Indonesia’s independence, and then Suharto, who had removed Sukarno from power in the 1960s. In 1998, when Sukarno was finally toppled, the first free legislative elections took place, followed by the first free presidential elections in 2004. In 2014, Joko Widodo was elected president in elections that passed peacefully even though Widodo beat a member of Indonesia’s political elite by only a very small margin. This was testimony of Indonesia’s maturing democracy.

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 its largest industry, though. 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, Indonesia’s middle-class is growing quickly while there is plenty of remaining upside potential, as a large part of the population is still relatively uneducated and poor.

Economic indicators of Indonesia
Economic indicators of IndonesiaSource: EIU
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