RaboResearch - Economic Research

Indonesia: Uncertainties hinder quick economic recovery


  • Indonesia is being hit relatively hard by COVID-19 infections compared to other Asian Emerging Markets
  • The lingering effects of the pandemic put a brake on a swift economic recovery. We expect a contraction of GDP of 2.6% in 2020
  • The independence of the central bank is being questioned by investors and analysts
  • Uncertainty on the institutional front, combined with increased global uncertainty in the coming months, is putting downward pressure on the value of the Indonesian currency
  • In the longer run Indonesia can profit from the diversification of supply chains by companies with improving their ease-of-doing-business ranking
  • The government’s planned labor market reforms to attract international investments are facing resistance from investors and protesters

Battling the coronavirus

Figure 1: Indonesia is still fighting COVID-19
Figure 1: Indonesia is still fighting COVID-19Source: Macrobond, University of Oxford

Indonesia is hit relatively hard by the coronavirus in terms of cases and deaths (Figure 1), compared to other ASEAN countries. The relative rise in cases is second only to the Philippines. While Malaysia is also suffering many new cases, Thailand and Vietnam have contained the virus relatively well with (almost) no new cases. Although the curve of new cases is flattening again in Indonesia, the war against the pandemic is certainly not won. Hence, the lingering virus is putting a brake on a quick economic recovery.

Economic impact

The economy of Indonesia took a major blow in Q2 when the economy contracted by 5.3% y/y. The Q2 figures (Figure 2) are negative in all categories: private consumption, investment, exports and imports. Zooming in on private consumption (which represents about 54% of the economy), we observe that the Transportation and Communication sector and the Restaurant & Hotel business were impacted heavily (Figure 3). They contracted by more than 15% y/y in Q2.

Figure 2: Economic contraction across the board
Figure 2: Economic contraction across the boardSource: Macrobond
Figure 3: Transportation and restaurants face largest blow
Figure 3: Transportation and restaurants face largest blowSource: Macrobond

Looking ahead, the economy seems unlikely to bounce back right away. Although restrictions that were imposed on the Jakarta region in the beginning of September are slowly winding back down, this second lockdown in the Jakarta region and the ongoing spread of the virus are putting a brake on a quick rebound. And the damage to the economy of the second (partial) lockdown is also visible in Q3.

At the time of writing, essential business is allowed to resume to full capacity while non-essential business activity is allowed to return to 50% of capacity. Looking at the mobility data in Figure 4 we observe that weekday mobility patterns have not returned to pre-corona levels, although the levels are somewhat higher than during the first lockdown. The time spent at the workplace is well below the baseline[1] (-30% on weekdays) while the time spent in residence (at home) is 10% higher.

Put simply, people are still spending more time at home and less at work. When people are at home they generally consume less, which shows through in lower consumption patterns. The lower level of time spent in workplaces is an indication of hampered business activity. This does not bode well for the Transportation and Restaurant & Hotel sectors which account for about 30% of private consumption. Reduced business activity puts pressure on new investments, but also increases unemployment.

The negative outlook on consumer spending and business activity is corroborated by consumer confidence levels and the PMI manufacturing index. Figure 5 shows that consumer confidence is still at levels well below 100, which indicates a pessimistic outlook among consumers. The manufacturers PMI, an indicator for sentiment among manufacturers, has dipped into sub 50 (negative sentiment) territory, against the backdrop of measures in the Jakarta region.

Figure 4: Mobility remains way below baseline
Figure 4: Mobility remains way below baselineSource: Raboresearch, Macrobond, Google
Figure 5: No rebound in confidence just yet
Figure 5: No rebound in confidence just yetSource: Macrobond

Economic forecasts

The signs so far are not pointing to a swift bounce back. We therefore expect an economic contraction of 2.6% in real GDP for 2020. This contraction is smaller in Indonesia than in other ASEAN countries. Explanations of this can be found in the structure of the economy. For example, since Indonesia is less dependent on tourism than other ASEAN economies, the travel restrictions have fewer negative consequences for the Indonesian economy.

The economy of Indonesia is, however, driven by domestic demand. And domestic demand (the sum of consumption, government expenditure and investments) will remain negative y/y through Q3 (-6.4%) and Q4 (-4.4%). With regard to trade, we expect exports to pick up on the back of China’s economic recovery, Indonesia’s main trading partner, but they will still be negative compared to 2019. Imports will stay on the back foot due to lower domestic demand in the form of private expenditures and lower business investments. Inflation will remain on the lower end of the BI target, even though the policy rate has been cut by 100bps since March and because we think demand weakness will dominate the effect of the rate cuts. The largest downside risks for the economy are associated with a new wave of COVID-19 infections which would lead to increased lockdowns and a larger economic contraction than anticipated.

Table 1: Forecast Indonesia
Table 1: Forecast IndonesiaSource: RaboResearch


[1] Baseline: is median value for the corresponding day of the week, during the 5-week period Jan 3- Feb 6, 2020.

Short term: Economic stimulus

Fiscal stimulus

Figure 6: The fiscal package of Indonesia is relatively small
Figure 6: The fiscal package of Indonesia is relatively smallSource: RaboResearch based on international sources

The economic headwinds that Indonesia faces since the outbreak of the pandemic are clear. A quick economic recovery is unrealistic without additional government stimulus. The government of Indonesia has announced a fiscal stimulus package of RP695 trillion (4.5% of GDP) to counter the negative impact of the virus on the economy. The additional stimulus will be used to support the medical sector, social protection, labor programs and specific sectors and regions. Although the package seems large at 4.5% of GDP, it is quite meagre in a global context (Figure 6). In this paper we compare global packages and elaborate on the drivers behind these differences.

Unconventional measures during unconventional crisis

What struck us most about the fiscal stimulus package is how much of it (the RP400 trillion which is reserved for public goods) is financed. Indonesia’s government issues securities on the market which are directly bought by the Bank of Indonesia (BI). The BI and government agreed to split the interest in half, meaning the government has an interest rate of 1% below the repo rate, while the BI compensates for the difference between the market rate and the repo rate, according to minister Sri Mulyani. This clearly is unconventional monetary policy by the BI. Although unconventional monetary policy has become more mainstream since the start of the pandemic, there are downside risks associated with such policies.

Given that the government securities are directly bought by the Bank of Indonesia, essentially this means that Indonesia is ‘printing money’. The deal between the government and the BI raised questions among global investors about the independence of the central bank. A downside risk associated with printing money in the longer term is rising inflation. A central bank that is not independent fuels the fear of more money printing, and increased inflation. Higher inflation leads to eroding yields for investors, who could then shift away from Indonesian investments. Consequently, the capital outflows and decreasing demand for IDR-denominated assets could cause the Rupiah to plunge.

Any depreciation of the IDR against the USD puts extra pressure on government finances and economic potential since a sizable part of government debt (32%) and corporate debt (38%) is denominated in foreign currency. Hence, a drop in the value of IDR is certainly something the government wants to prevent as it contends with the COVID-19 crisis and an already challenging financial and economic situation.

The government and the BI are aware of the risks of this way of financing and the damage it could do to the value of the Rupiah. Minister of finance Sri Mulyani and president Joko Widodo have stressed that this was a single package for 2020 to battle COVID-19 and they will not use these measures again. As a former World Bank executive, Sri Mulyani is likely well aware of the risks entailed in these measures and the potential consequences of any erosion of Indonesia's credibility among financial markets players.

Central Bank reforms

In view of the above it’s easy to imagine raised eyebrows among global investors at the start of September when word got out of a possible reform of the mandate of the Bank of Indonesia. The reform would supposedly add ministers to the board of governors of the BI and expand the BI's mandate to generate jobs and support economic growth. Such a reform will bring the BI closer to the government and entails realistic risks to the central bank’s independence, with other associated risks looming on the horizon.

In the meantime the central bank governor Perry Warjiyo has expressed the desire to delay the reforms to 2021. He also noted that the president and finance minister have made clear that: “monetary policy must remain credible, effective and independent”. So we haven’t heard the last on this. Investors will continue to watch the situation closely over the coming period and any events pointing to less independence, for example a draft bill that hints on government interference with decisions of board of governors, will put pressure on the value of the Rupiah.

The effect on the Rupiah

Linking the described fiscal packages and reforms to the performance of the Rupiah we can distinguish a depreciation of around 2 % following the meeting on 31st of August of the legislative committee with the panel of experts, who proposed the possible changes to the BI’s mandate. This is a clear signal from the market that it fears government interference in central bank policies. But as mentioned, the rumors were countered by some of the leading policymakers and the subsequent normalization seems to reflect that there is still confidence in the Indonesian policy makers, for now. However, the downside risks are clear.

Figure 7: Indonesia has the worst FX performance in the region against USD
Figure 7: Indonesia has the worst FX performance in the region against USDSource: Raboresearch, Macrobond

The broader picture shows that, after a turbulent few months since the outbreak of the pandemic, most ASEAN currencies were able to recover lost ground against the USD (Figure 7). This was mainly on the back of a global ‘risk on’ sentiment partially caused by the enormous flow of extra capital injected by central banks in the G10. In addition, exports recovered relatively well compared to imports, increasing value of local currencies.

Although IDR has also recovered much of its value since the huge depreciation in March (Figure 8), it is still the worst performer in the region in 2020 (Figure 7) and remained volatile over the last couple of months (Figure 9). This can be partly attributed to the uncertainty surrounding some policy decisions as described above but also due to uncertainty around COVID-19.

Figure 8: Rupiah recovered much of lost ground since March…
Figure 8: Rupiah recovered much of lost ground since March…Source: Macrobond
Figure 9: ..but remains volatile over last months
Figure 9: ..but remains volatile over last monthsSource: Macrobond

Looking ahead, the value of IDR remains volatile. IDR is very sensitive to the USD, which we expect to strengthen in the coming months. Mainly because of downside risks related to the increased volatility surrounding the US elections fueling a risk off sentiment among investors and a second wave of COVID-19 infections. Therefore we expect IDR to depreciate against USD in the coming months (Table 2).

Table 2: FX Forecast USD/IDR
Table 2: FX Forecast USD/IDRSource: RaboResearch

At the time of writing, we don’t know who will win the US presidential elections. If Biden wins, IDR could benefit from a relief rally in the short run, along with other emerging markets. If Trump wins the opposite will happen.

Long term: Increase in competitiveness

The global pandemic is a catalyst for change. Trends that were already visible before the outbreak are being accelerated. Manufacturers and countries were already confronted with the implications of the US-China trade war. Due to the pandemic they are now facing risks of supply chain dependencies on single suppliers or countries. The shift from a ‘just-in-time’ towards a ‘just-in-case’ approach will result in more diversified supply chains, for instance the use of a ‘China plus One’ strategy. This strategy aims at decreasing manufacturing single supplier dependence by, for example, using a supplier in China and one other (Southeast) Asian country. Indonesia could become one of the beneficiaries in the medium- to long term: for example by seducing manufacturers in the electronics sector to invest in Indonesia, which would lead to increased employment and exports for Indonesia.

Nevertheless, Indonesia is facing competition in South-East Asia from countries like India, Vietnam, the Philippines and Thailand. In an earlier study on relocation as result of the US-China trade war, Indonesia was ranked behind these countries in our Where-will-they-go index. The main reasons for this lower ranking are that Indonesia has lower institutional quality, a lower ease-of-doing-business ranking and its export basket is not as similar to China’s, compared to other ASEAN countries.

Cutting the red tape: ‘Omnibus’ labor reform law

Indonesia needs to bolster its attractiveness as an investment destination to capitalize on the opportunities created by the recent economic global turmoil and increase inward FDI from current levels (Figure 10).

Cutting red tape and decreasing bureaucracy is often applauded by international investors and can lead to increased ease of doing business (Figure 11). But the positivity might be washed away quickly if it triggers protests and anti-climate sentiment.

Figure 10: FDI similar to most EMs in the region
Figure 10: FDI similar to most EMs in the regionSource: Macrobond
Figure 11: Improvement in the Ease of doing business has come to a halt
Figure 11: Improvement in the Ease of doing business has come to a haltSource: Macrobond

On 5 October the Indonesian parliament passed a labor reform law, called the ‘Omnibus’ law. It will replace a whole set of laws and regulations that were imposed over the last 5 years but lacked effectiveness. The new labor law aims to increase the ease of doing business (target 40, current rank 73) by eliminating numerous restricting labor regulations, such as high severance pay, and by restructuring minimum wages.

The main advantages for companies are that it will be easier to contract workers without risking high lay-off costs, for example. Subsequently, hiring will be more flexible and less costly for companies, giving them more agility. Advantages for Indonesia are decreased friction on the labor market and an increased level of employment (the latter due to additional international investments and because rolling temporary contracts might be replaced by more fixed contracts).

Workers, on the other hand, mainly see short-term implications of increased risks of losing their jobs or getting pay cuts, especially amidst the pandemic. Therefore workers protests increased after the bill was passed on 5 October. The law will become official from November onwards. As a reaction, labor confederations demand cancellation of the new law and have scheduled new protests for the coming month.

Besides labor reforms, the Omnibus bill also loosens environmental standards. These changes triggered reactions among a few large global investors. For example by a group of companies, managing USD 4.1 trillion in assets, which sent an open letter to the government. They call for a dialogue on how to increase international investment without the risk that deregulation will negatively impact forests and biodiversity. So although the relaxation of standards increases ease of doing business, it might not attract the kind of business that helps sustainable growth, in a broad sense, in the longer term.

One step back, two steps forward

Summarizing the above, the government and Bank of Indonesia are currently facing severe health and economic challenges. But in every challenge lies an opportunity. From a positive perspective, it seems like policy makers are taking the longer term into account by using the current crisis to reform parts of the economy.

However, before the new situation is achieved, the wild waves of uncertainty will first have to be tamed. Indonesia faces headwinds due to the lingering effects of new COVID-19 cases and protests (which obviously do not help the current health situation), both of which are posing real financial and political problems. This is a threat to swift economic recovery and limits GDP growth in the short term (Table 1).

In the longer term, the new labor reforms can enhance the competitiveness of Indonesia. Which could in turn put Indonesia in a more competitive position among ASEAN economies looking to benefit from diversification strategies, like the China + one strategy, of firms. Subsequently Indonesia can attract additional international investments, supporting economic growth.

Wouter van Eijkelenburg
RaboResearch Global Economics & Markets Rabobank KEO

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