Research and analysis

Indonesia economy: structural challenges - June 2014

Published 15 June 2014

0.1 Detail

Indonesia unexpectedly chalked up a large, $1.96 billion, (goods) trade deficit in April. This was the largest trade deficit since July last year and in most of the months since then the country has been running trade surpluses. Imports fell in April by 1.3% on the same month in 2013, but exports fell more sharply, by 3.2%, resulting in the trade deficit.

The key change was in non-oil and gas trade, which recorded a $900 million deficit in April after 8 continuous months of surpluses. Non-oil and gas trade has in recent months masked the gaping structural deficit in the oil and gas sector, which remained broadly stable at $1.1 billion in April (Indonesia runs a trade surplus in gas, the deficit comes from oil, especially refined oil products). January’s ban on the export of unprocessed minerals may have been a factor but that did not prevent Indonesia from running trade surpluses in February and March. April’s figures showed exports weakened in a number of sectors, including vehicles, oils and rubber. Weaker international commodity prices may have been a factor and the data suggest trade with the slowing Chinese economy accounted for a large chunk of the deficit. Indonesia also ran a trade deficit with Japan and Thailand – the latter’s economy has stalled as a result of political tensions.

Arguably of more significance is the strengthening of imports, especially in sectors such as machinery, mechanical appliances, and electrical goods. This suggests that domestic demand, in particular investment, is rebounding despite multiple interest rate hikes by Bank Indonesia, the central bank, to cool the economy and reduce the country’s large current account deficit. HSBC’s Purchasing Managers Index (PMI), which surveys managers’ views on changing output/demand, seems to confirm this, reaching a record high in May. The PMI suggests the pick-up in new orders is coming mainly from the domestic market, rather than for export.

In March the PDI–P announced that popular Jakarta Governor Joko Widodo would be their presidential candidate, should the party meet the qualifying criteria in the legislative elections on 9 April. In fact, two parties (the PDI-P and Gerindra) have formed coalitions to enable them to put forward Presidential candidates (Widodo and Prabowo) for the elections on 9 July. This has helped to reduce political uncertainty and boost investor confidence, although both Presidential candidates have supported a protectionist approach to the economy should they be elected.

Other official data released this week showed that inflation is broadly stable, with consumer prices rising by 7.3% in May on the same month in 2013.

Policy implications

Signs of a recovery in domestic demand – although only based on one/two months’ data – would normally be good news, and indeed is for those UK exporters supplying products used by investors/producers in Indonesia. But the government has been trying to cool the domestic economy (to reduce imports) after a record 4.4% of GDP current account deficit in the second quarter of last year sparked financial market volatility. If the rebound in domestic demand continues, Bank Indonesia may be forced to tighten monetary policy further. The current account deficit shrank to 2% of GDP in the final quarter of 2013 and first quarter of this year, winning the government praise for their policy response. But the latest goods trade data raise the risk that the current account deficit widens again (although that also depends on what happens to services trade and income transfers). The deficit is unlikely to return to the levels seen in the middle of last year, but even a modest increase could harm the relative stability Indonesia’s currency and stock markets have enjoyed so far this year – although the authorities might be able to argue that the current account deficit is usually larger in the second quarter of the year (ahead of Ramadan).

A step backwards on the current account deficit would increase the pressure for further reform of fuel prices. Last July’s 44% hike in domestic fuel prices has failed to make a dent in the large, structural, trade deficit in the oil and gas sector – partly because vehicle sales have continued to rise, partly because the Rupiah fell sharply against the dollar (making the Rupiah import price more expensive as international oil products are priced in dollars), though it has subsequently recovered some ground. The cost to the government of fuel subsidies has therefore not fallen (though would have been worse without the reform) and the 2014 Budget currently being discussed by Parliament does not envisage a reduction in government spending on fuel in the near future.

A number of commentators, have wondered whether the government might try to make progress on fuel price reform ” between April’s parliamentary and July’s presidential elections. But this issue may be left for the next government, with the added benefit that inflation would likely have subsided further by then. In the meantime the country could be stuck in a vicious cycle – fuel subsidies worsen the current account deficit, which puts downward pressure on the currency, which in turn increases the cost to government, reducing the funds available for other priorities..

The latest trade data also serve as a reminder of Indonesia’s other major challenge – boosting non-commodity exports so its current account, and therefore external vulnerability, is less subject to the whims of international resource prices (not just oil and gas but also palm oil, rubber etc).

0.2 Disclaimer

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