RaboResearch - Economic Research

Indonesia: Widodo is turning the tide

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Economic growth in Indonesia slowed down in 2015 to a post Global Financial Crisis low, mainly due to weak external demand. We expect a gradual economic recovery in 2016, driven by rising infrastructure investments due to a more decisive government. 

Strengths (+) and weaknesses (-)

(+) Favourable demographics and growing middle class

Indonesia has a young and growing population (currently 256 million people). Average income (USD 11,097 in PPP terms in 2015) is rising steadily and the middle class is growing fast.

(+) Sound government finances

Indonesia has a rather low public debt (28% of GDP) and posts only limited fiscal deficits. This is due to rather tight control of spending, with a constitutionally set cap on the deficit of 3% of GDP. It is, however, also due to 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. Economic growth is bottoming out

Economic growth slowed down in 2015 to a post Global Financial Crisis low of 4.7%, according to a preliminary estimate by the Indonesian Ministry of Finance. This is primarily due to slowing demand for Indonesia’s mining commodities and palm oil, which also negatively impacted the commodity prices. Moreover, the slow implementation of infrastructure investments in the first half of the year slowed down the economy. Going forward, we expect growth to slowly accelerate to about 5%-5.5% in 2016 (figure 1). Weak external demand will remain a drag on the economy, but domestic demand will likely strengthen, thanks to increasing government investments (in infrastructure). For the longer-term we stress that a successful implementation of Widodo’s reform agenda and infrastructure investments is necessary to reduce the economy’s dependence on commodities driven in order to make its growth model more sustainable.

Figure 1: A slow recovery of economic growth
Figure 1: A slow recovery of economic growthSource: EIU
Figure 2: Sharp drop in headline inflation
Figure 2: Sharp drop in headline inflation Source: Macrobond

2. Low inflation provides an opportunity to ease monetary policy

Indonesia’s central bank (BI) cut the interest rate by 25 bps to 5.25% in January. So far, BI had kept the rate on hold waiting for the effects of the first US FED rate hike. The Rupiah, however, remained stable afterwards and global financial uncertainty decreased according to the BI. Given that inflation was down to a six year low of 3.4% y-o-y in December (figure 2) and inflation is expected to remain around the lower end of the target inflation range (3%-5%) in the near future, further monetary easing is possible.

3. A further depreciation of the Rupiah poses a risk to Indonesian corporates with FX-debt

Over 2015, the Rupiah depreciated by 11% against the USD and compared to 2012 by 50% (figure 3), which made it one of the worst performing currencies in Asia. Since a large share of Indonesian corporate debt is denominated in foreign currencies (figure 4), a further depreciation of the Rupiah is undesirable. This restricts the central bank from easing monetary policy too quickly. A study by the Asian Development Bank[1] shows that most of these companies do not have matching FX revenues. Moreover, in comparison to other corporates in the ASEAN, Indonesian corporates have relatively weak fundamentals[2]. Out of the ten weakest corporates within the ASEAN, seven are headquartered in Indonesia. Sector wise, companies in the mining and energy sector are the most fragile, and are currently also most affected by low commodity prices. Luckily, overall corporate indebtedness in Indonesia is still relatively low (23% of GDP).

4. Joko Widodo increased his political authority

The tide seems to have changed for Widodo’s government with the cabinet reshuffle of last August. The President appointed technocrats as ministers to help him implement bureaucracy reducing reforms and appointed, Lembong, who has a large amount of international business experience, as trade minister. Furthermore, the PAN party joined Widodo’s coalition in September, providing Widodo with a majority in parliament. After these two key events, policies have become more market-friendly and outward looking. Widodo has also been able to implement more public investments (in particular in infrastructure) during 2015H2 than was widely expected. Public support also increased considerably: according to the latest poll by political consultant SMRC, the approval rating for the President was 63% in December, compared to 41% in July. Moreover, Widodo’s party (PDI-P) won the regional elections of 9 December, possibly reducing local resistance to the government’s investment plans. Another positive is that Widodo’s own party is becoming more supportive, and in particular, resistance by Megawati weakened significantly.

Figure 3: Rupiah stabilized at the end of 2015
Figure 3: Rupiah stabilized at the end of 2015Source: EIU
Figure 4: FX-corporate debt load is big
Figure 4: FX-corporate debt load is big  Source: Macrobond
Factsheet of Indonesia
Factsheet of IndonesiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Footnotes
[1] Asian Development Bank, Asian Development Outlook Update 2015 (pp.18-22)

[2] A. Garcia-Herrero, Indebted ASEAN companies will feel Fed’s rate rise, Bruegel blog, 2015

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. The oil and gas industry remains its largest industry and in January 2016 Indonesia rejoined OPEC. 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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