Stable and high economic growth continues in Indonesia

As the economy is not excessively dependent on exports, the Indonesian economy seems to be largely resilient to global uncertainties triggered by the Eurozone debt crisis.
Analisis Credito y Caución
Madrid - 20-jun-2013

The actual Indonesian president is the first directly elected in the country. In July 2009 he won a second term with a convincing 60% of the votes. However, his cabinet is reliant on a coalition of six parties. The inability of the coalition to act cohesively has seriously undermined the administration’s decisiveness and decision-making, and derailed president initial reform agenda. The three main parties all endorse the Pancasila principle, and thus the secular character of Indonesian politics. But the influence of radical Islam on society has increased gradually in the last couple of years, leading to intolerance against the Ahmadiyah sect and the Christian minority.

In recent years the Indonesian police force has taken effective action to combat terrorism. The Islamist terrorist organisation Jemaah Islamiah seems to be effectively suppressed since the government’s successful crack-down on Islamic radicals following the Bali terrorist attack in October 2002. However, other smaller terrorist groups are still active, and the risk persists of Islamic-inspired terrorist attacks against tourist resorts and Western diplomatic representatives. Despite major improvements, Indonesia remains vulnerable to separatism: there are still problems with separatist movements in West Papua.

As the economy is not excessively dependent on exports, with domestic consumption accounting for around 60% of GDP, Indonesia weathered the 2008/2009 global credit crisis relatively well. The economy also seems to be largely resilient to global uncertainties triggered by the Eurozone debt crisis, as dependence on exports remains relatively low compared to its South East Asian neighbours.

Since 2010 annual growth has exceeded 6%, driven mainly by private consumption and investments. In 2013 the economy is forecast to grow 6.2%. Telecommunications, agriculture, auto sales, and food & beverages are driving this upsurge.

In February 2012, Bank Indonesia lowered its benchmark interest rate by 25 basis points - to 5.75% - to support the economy amid signs of weakening global economic growth and the decelerating trend in inflation. Since then the benchmark interest rate has remained unchanged. In May 2013, the year-on-year consumer price increase was 5.5%. After 4.3% in 2012, inflation is expected to increase 5.7% in 2013, due partly to the planned price increases of subsidised fuel.


The exchange rate has stabilised

The Indonesian banking sector is quite small, domestic credit provided by the banking sector amounts to around 40% of GDP, but has improved significantly over the last decade. State-owned banks account for only a third of the total banking sector and the percentage of non-performing loans has decreased over the last couple of years: to 6%. However, state- owned banks are still highly exposed to state-owned enterprises.

The exchange rate of the rupiah has been very volatile in the past - and came under serious pressure in 2008 and the first half of 2009 - but has stabilised since then, thanks also to frequent interventions by Bank Indonesia to support the currency.


Planned cut of fuel subsidies to tackle rising budget deficits

The yearly budget deficit has increased since 2010, to 2.2% of GDP in 2012, due in large part to costly fuel subsidies  which account for more than 15% of the national budget. These subsidies also eat into public spending for investment and endanger fiscal sustainability in the long term. The Finance Ministry has said that spending on fuel subsidies could reach US$ 23 billion in 2013, compared to about US$ 20 billion last year. Total subsidies for electricity and fuel could end up costing about US$ 32 billion, or 20% of the 2013 budget. Annually, there is more public spending on fuel subsidies than on social programmes and capital expenditure combined.

In April 2013 the government finally decided to raise subsidised fuel prices this year, but the key decisions on when and by how much are still to be made. President has made increasing gasoline and diesel prices conditional on parliamentary approval of a compensation package for the poor - to be included in the 2013 revised budget. Fuel prices are a very sensitive issue in Indonesia, where about 100 million people live on US$ 2 a day or even less. In April last year, the government already failed in an unpopular attempt to raise fuel prices by 33%, when, amid massive public protests, parliament rejected the proposal.


A lack of structural reforms still weakens the business environment

Despite the satisfactory growth rates, deep structural problems remain, with red tape, widespread corruption, a poor legal system, an inflexible labour market and poor infrastructure all continuing to limit growth. During his first term, presi dent Yudhoyono made some promising progress on economic reforms but failed to do so in 2012. Reductions of subsidies and reforms in the labour market were regularly postponed following popular pressure and political resistance. Despite Yudhoyono’s repeated promises to combat corruption, this remains widespread in society and business alike.

Poor infrastructure has become one of the most significant barriers to sustainable economic growth. In particular, rural areas outside Java and the major cities suffer from either non-existent infrastructure or non-stop congestion, and the government has been undecided on the urgent need to tackle transport problems. This month, however, the construction of a mass rapid transit [MRT] system in Jakarta has started. A land acquisition law passed in December 2012 should also speed up infrastructure development over the next few years.

There are still too many barriers to foreign direct investment [FDI], which is severely hampered by the poor infrastructure and energy supply, so it is no surprise that investment in oil extraction capacity and infrastructure remains disappointing. Although Indonesia has made significant progress in reforming its tax system, observing international trade rules and dealing with licenses, a further improvement in the still very poor business environment is needed to attract more FDI.


Balance of payments

After more than a decade of current account surpluses, the current account balance turned negative in 2012, and this deficit is expected to remain for the coming years, due mainly to rising imports of consumer goods and increasing repatriation of dividends to foreign investors. Nevertheless, the foreign debt level remains at a manageable level and liquidity is more than  adequate.


General elections in 2014

Parliamentary elections are scheduled for April 2014, while the presidential elections will take place a couple of months later. A continuation of the rather fragmented political landscape and a broad ruling coalition are the most likely outcomes. Ahead of the election campaigns, i.e. in late 2013 and early 2014, significant structural reforms to improve the business environment cannot be expected. The possibility of further fragmentation of the political landscape following 2014’s elections, leading to gridlock, could undermine prospects of economic growth in the coming years.

Within South East Asia, Indonesia will continue to be the outstanding economic performer in 2013-2014, with GDP growth forecast above 6% per annum, driven by private consumption, investments and net exports. Indonesia’s relatively low reliance on external demand combined with strong domestic consumption means that it should be largely unaffected by a possible slowdown in global growth. Increasing income levels – the result of years of good economic performance - have contributed to the rise of the middle class in Indonesia estimated at more than 30 million in a country of 242 million, and this will additionally bolster domestic consumer spending in the short and medium term.

However, in the short term at least, Indonesia will continue to struggle with the need for structural reforms. Infrastructure and the business environment need to be improved, corruption combated, fuel subsidies reduced and the labour market made more flexible – otherwise the economic growth rate will remain below its potential. It remains to be seen if the current [unpopular] initiative to cut fuel subsidies will be put into practice in a way that can relieve the public budget and enable more infrastructure investment. Despite continuing strong solvency and liquidity, Indonesia’s external position is now more vulnerable than in the past because of its current account deficit and increasing private sector external debt.


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