RaboResearch - Economic Research

Country Report Indonesia

Country Report


The Indonesian economy has slowed down due to lower commodity prices and the inability of President Widodo to implement reforms and planned infrastructure investments. Meanwhile, he has resorted to populist policies to boost popular support. 

Strengths (+) and weaknesses (-)

(+)      Favourable demographics and growing middle class

Indonesia has a young and growing population (currently 253 million people). Average income (USD 10,538 in PPP terms in 2014) is rising steadily) and the middle class is growing fast.

(+)      Sound government finances

Indonesia has a rather low public debt (25% 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.

(-)       Dependence on foreign capital

Due to a persistent current account deficit, the net international investment position equalled -47% of GDP at the end of 2014. Due to high domestic interest rates, larger corporates often depend on foreign lending for financing, which is risky when international financial conditions deteriorate.

Key developments

1. Economy is slowing down

The Indonesian economy is performing disappointingly. It grew by only 4.7% yoy in the first half of 2015, which was the slowest growth recorded in 6 years. The slowdown was fairly broad-based. Both the external sector and domestic demand slowed down. Real exports contracted marginally in the first half of the year despite a boost to competitiveness by the sharp depreciation of the rupiah. Headwinds for the external sector are lower demand from China and lower commodity prices. The contribution of net exports to GDP growth is still positive, since imports decreased by 4.6% yoy in the same period. Together with a sharp slowdown in domestic demand growth, it signals that the Indonesian economy is currently performing very weakly.  Domestic demand growth decelerated in 2015H1 to 3.9% yoy compared to an average 4.8% annual growth in 2013 and 2014. This is mainly the result of slowing investments that slowed down to average 3.9% yoy in the first two quarters. This is the weakest figure since the great recession (2009) and is far below the long-term average (8.5% over 2004-2012). Finally, private consumption remained relatively solid, despite the temporarily higher inflation rate due to the abolishment of most fuel subsidies.

Going forward, we expect that GDP growth will slowly accelerate again in the second half of this year on the back of the government’s infrastructure investment plans. The Asian Development Bank expects the Indonesian economy to expand by 5.0% in 2015 and 5.6% in 2016. A downside risk to this growth outlook is any negative spill over of an interest rate increase in the United States. Indonesia was part of the ‘fragile five’ economies that were hurt most by the tapering announcement by the FED in mid-2013 and Indonesia is still vulnerable to a deterioration of international financial conditions, since the current account and the fiscal balance are still negative. Moreover, since the Rupiah is already under pressure (figure 2), this reduces the possibility of monetary easing by the Indonesian central bank (Bank Indonesia, BI). It even reported a slight decrease in their foreign exchange reserves (minus USD 40m USD, total FX reserves were USD 107.6bn in July 2015) to support the rupiah. BI also prohibited the use of foreign currencies for domestic transactions.

Figure 1: GDP growth remains slow
Figure 1: GDP growth remains slowSource: EIU
Figure 2: Rupiah under pressure
Figure 2: Rupiah under pressureSource: Macrobond

2. Fuel reforms saves budget for much needed infrastructure investment

In his first major policy reform, President Joko Widodo cut fuel subsidies in October 2014 that led to an increase in fuel prices by about 30%. In January 2015, the president even scrapped all gasoline subsidies and limited the diesel subsidies at IDR 1,000 per litre. Thanks to the declining world oil prices, fuel prices have moderated, though. It was a good signal that the president was willing to introduce politically difficult reforms, and the reforms were badly needed since fuel subsidies pose a big risk to the government budget when oil prices are elevated. It also saves up government budget for badly needed public investment. In the government budget, 60% of these saved funds have been reallocated to extra infrastructure spending. This is welcome, since Indonesia’s investments in infrastructure have been comparatively low, which constrains economic growth. According to the World Bank’s Logistics Performance Index, goods take longer to arrive at its destination in Indonesia than in any other country in the region. Implementation of the project will, however, be delayed by red tape and land acquisition issues. It is widely expected that the government will only be able to spend roughly two thirds of the allocated infrastructure budget. The cabinet reshuffle of August 2015 might be a positive. Former central bank governor Nasution, with many years of policy experience, will lead the economic policy team.

3. Joko Widodo loses public support due to inability to implement promised policies

After being in power 1 year, President Joko Widodo is quickly losing popular support due to the weak state of the economy, a volatile and sharply depreciating currency, both partly due to a prolonged commodities slump. The latest poll from consultant SMRC shows that his approval rating is only 40.7%, while the satisfaction level of the previous president, Susilo Bambang Yudhoyono (SBY) was at 70% after his first year in power. Moreover, during its 10 years presidency, SBY’s rating never fell below 50% for a significant period of time. Widodo is Indonesia’s first President from outside the political and military elite, which provided hope that he would be able to improve governance and introduce the necessary reforms. But without full support from his own party and coalition the president keeps struggling to implement reforms. He also lacks a majority in parliament and needs to search for a majority for each and every reform. To regain popular support, Widodo is introducing many populist and protectionist measures that are harming international relations. Whereas his decision to execute foreign drugs smugglers was well received domestically, it put his international reputation under fire. To help ailing domestic producers, the Indonesian government has raised the import duties on food, clothes, alcohol and many other consumer goods. Finally, Widodo is actively pursuing a strategy of self-sufficiency for food. But instead of focusing on increasing the domestic supply, it is mainly restricting imports. This policy will not increase food security, but rather increase food price inflation. 

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

Background information

Indonesia declared independence from the Netherlands in 1945. 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. The first free presidential elections followed 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 IndeonsiaSource: EIU

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