Indonesia: prospects for growth in the economy
Published 25 November 2014
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This article is no longer current. Please refer to Overseas Business Risk - Indonesia
Summary
Indonesia’s new President faces slowing economic growth, increasing the urgency of his structural reform agenda. Cutting fuel subsidies in November a positive step forward. His new economic team is arguably well placed to deliver on reform but the relationship with parliament will be a constraining factor on the pace of progress. So far, positive noises on strengthening an open economy that welcomes FDI.
Detail
Growth versus stability?
Recently released economic data highlight the challenges facing Indonesia’s new President, Joko Widodo. GDP growth slowed to 5% in the third quarter (on a year earlier) and the need to tighten fiscal belts means it may slip further in the fourth quarter. Bank Indonesia (BI) expect growth to recover to around 5.5% next year, in line with the IMF’s forecast. But Indonesia won’t return to 6% growth until 2016 at the earliest. Widodo has consistently stressed his ambition to see the economy grow to 7% by the end of his term in 2019.
The authorities are constrained in loosening monetary policy to support growth, given the need to tackle the current account deficit, contain inflationary pressure and guard against potential capital outflow triggered by changes in US monetary policy. As a first step of reform, Widodo announced on 18 November fuel prices would go up by IDR 2000 per litre¢16 US ; an increase of approximately 30%.This is lower than the anticipated IDR 3000 increase, likely due to the recent drop in the global oil price creating more breathing space. Markets have responded positively and the rupiah also strengthened against the dollar.
The reduction in the fuel subsidy burden should generate much needed fiscal space with savings of approximately US$9 billion to the state budget, nearly 6% of the 2015 budget. The majority of the savings are likely to be redirected towards infrastructure development, with the rest focused on reducing the fiscal deficit and funding poverty alleviation programmes (including to support social welfare programmes in health and education).
On the same day, BI unexpectedly increased its benchmark interest rate by 25 basis points to 7.75%, to help counter inflationary pressures brought about by the fuel price increase. In their view the full impact of the higher fuel prices on the economy will only be felt early next year and economists are predicting a spike in inflation over the next six months. BI’s Governor has reiterated the Bank’s intention to remain focused on stability over growth in the near future.
What’s next?
Indonesia’s relatively tight fiscal position (budget deficit of 2.4% of GDP) means cutting fuel subsidies alone will be insufficient to fund increased spend on infrastructure and other priorities. Beyond the fuel subsidy reform, Widodo is also prioritising the need to boost domestic production of major staple foods, oil, and manufacturing products through “supply-side” reforms. Rapid progress in addressing the country’s woeful infrastructure, including energy supply, will be critical to improving the economy’s productive capacity. In addition to increased spending, Widodo is keen for the central government to expedite land acquisition for infrastructure projects, one of the main blockages. Improving tax revenue, one of the lowest relative to GDP in the region, and addressing government waste, streamlining regulation and business licensing processes and corruption are also essential. There is clearly already substantial focus on tackling both the streamlining of regulation and business licensing, the Coordinating Minister for Economic Affairs, Sofyan Djalil, has been tasked with implementing a one-stop shop for business licensing at national level within 3 months with all provinces to following within a year.
The appointment of former Corruption Eradication Commission Vice Chair, Amien Sunaryadi, to lead Indonesia’s oil and gas regulator, SKKMigas, together with the appointment of respected economist, Faisal Basri, to lead an Energy Sector Reform Commission reporting to the new Energy Minister, bodes well for a much needed overhaul of practices in the sector. Potentially good news for British companies with large investments in Indonesia.
Comment
This week’s fuel price increases have been long anticipated. As one prominent economist put it the President is finally ‘walking the talk”. The subsidy reform was essential, not just to enable the spending to deliver the President’s election promises on public services and infrastructure, but to demonstrate his ability to secure a tough reform. Combined with the serendipitous drop in global oil prices, this gives him sufficient space to launch his pro-poor health and education programmes, and has boosted investor confidence. The major challenge in the new year will be defending his reform agenda with a difficult, opposition dominated Parliament.
President Widodo’s appearance at Bank of Indonesia’s recent “Bankers Dinner”, the first for an Indonesian President, where he emphasised his commitment to working closely with the monetary authority is a good sign. He stressed the importance of FDI to Indonesia’s growth.
Disclaimer
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