Indonesia: Economic challenges facing the new government - September 2014
Published 9 September 2014
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The markets responded positively to the election in July of the reform-minded Joko Widodo ( referred to by all as ‘Jokowi’) as Indonesia’s next president and the dismissal of the Constitutional Court challenge by Jokowi’s opponent, Prabowo Subianto, provided a further boost. Market participants are now watching closely for evidence of how the President-elect plans to address the economic challenges facing Indonesia and deliver his ambitious reform agenda.
Recent economic data highlight the challenges awaiting the new administration: slowing economic growth, widening current account deficit, and pressures on the state budget. The country’s current account deficit expanded to 4.3% of GDP in the second quarter of this year. Cyclical factors usually increase the current account deficit in the second quarter of each year. But the substantial increase in the deficit came despite an overall cooling of the Indonesian economy, which should have been good news for the current account. GDP grew by 5.1% in the year to the second quarter, the slowest rate since the end of 2009.
The government’s ban on the export of unprocessed minerals, which was implemented in January, has not helped tackle the current account deficit. The main cause, though, is the persistently large trade deficit in the oil and gas sector, which in turn is exacerbated by fuel price subsidies. Oil imports have continued to rise despite some reform of fuel price subsidies in July 2013.
The ballooning fuel subsidy bill, combined with a low and declining tax take, mean the new administration will also inherit a more challenging fiscal environment. The new President will have to ensure the budget deficit does not exceed the constitutional limit of 3 percent of GDP. That makes fuel subsidy reduction an urgent priority, as is boosting government revenue – without which the new President will be unable to fund his promised development and growth generating programmes.
The President-elect has indicated that reducing the fuel subsidy is a priority (it currently accounts for 21 percent of total central government expenditure). Owing to the political and social challenges in drastic fuel price adjustment, not least securing Parliamentary approval, gradual reform is the most likely option. As well as, reducing subsidies the government also needs to find a way to increase revenues. The growth rate of government revenue has fallen significantly over the last three years (2011: 21.6%, 2012: 10.5%, 2013: 6.8%), mainly as result of weaker revenues from the oil and gas sector. Broadening the tax base and identifying new sources of revenue are therefore critical. Improving the quality of local government spending is another priority. Transfers to local governments account for 32 percent of total public spending and most goes on routine expenditure. During the presidential campaign, Jokowi said he intended to use transfer funds as a tool to involve local governments in his economic reform agendas.
The President-elect is clearly seized of the importance of improving infrastructure to achieve his growth goals, top priority is marine infrastructure. He plans on improving the business environment He knows this is essential to improve the competitiveness of manufacturing and to boost non-commodity exports. His public statements have so far have focussed on improving the environment for local businesses, including the possibility of favouring them over foreign businesses. But privately Jokowi and his team have been more pragmatic and accepting of the need to attract foreign investment to achieve their economic growth and infrastructure development targets. But he will need to persuade a nationalist leaning Parliament.
Comment
Delivering on this programme will also require a 2015 state budget that fits with the new priorities. The proposed state budget for 2015, just submitted to Parliament by the current President for scrutiny and approval, maintains the status quo of continuing fuel subsidies and leaves limited fiscal space for development programmes. Jokowi needs to secure changes but will have little opportunity to do so before he takes office on 20 October.
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