Indonesia: Rebalancing for growth
The next few months will be crucial for Indonesia’s economy: the country faces rising global headwinds in the form of potential contagion from concern about emerging markets in the post-QE era, and a worsening trade war between some of its biggest trading partners, as well as a degree of uncertainty over the 2019 general election.
However, these are principally short-term factors. In our view Indonesia’s fundamentals remain sound and the opportunities good for the country to pursue structural reform. With the aim to rebalance the economy away from a reliance on low value-added sector such as commodity, efforts to build out infrastructure, bolster human capital, develop value-added export-oriented sectors and raise foreign direct investment should in the longer term put its economic growth model on a more robust footing.
We expect Indonesia’s economy to grow 5.1% in 2018 and 5.1% next year: although tighter monetary policy, cautious private investment and moderating exports is likely to weigh on growth, 5%-plus is still a comparatively good performance.
Importantly, Indonesia’s position is relatively sound compared to other emerging markets that have come under pressure in recent months from monetary policy normalisation in the US. While it is true that Indonesia has been scrutinised for twin current-account and fiscal deficits (forecast at 3.0% and 2.1% of GDP this year) and maintains a degree of reliance on external funding (short-term external debt is USD 57bn, around 16% of total external debt), its vulnerability remains modest. For comparison, the short-term external debt to total external debt ratio stood at 43% in India, 65% in Malaysia, and 49% in Thailand.
Relatively strong FDI inflows, a commitment by the government to prudently manage its fiscal policy and reduce current account deficit (for instance, expediting a programme to increase biodiesel blend to reduce fuel imports by estimated around USD 2bn and delaying some infrastructure projects that has not reached financial closure), combined with co-ordinated and responsive monetary policies by Bank Indonesia to tackle currency weakness have helped to support country’s resilience. Inflation remains well under control, even accounting for some pass-through of higher fuel prices.
The risks of a potential trade tension with the US, meanwhile, appear to be moderating. In April the US Trade Representative’s Office said it was reviewing Indonesia’s inclusion on the US’s Generalised System of Preferences (GSP), covering around USD 2 billion of Indonesia’s USD17.8 billion worth of exports to the US. While no decision has been made on the GSP, it emerged recently that the US has decided to exempt 19 Indonesian steel products from its 25 percent tariffs.
Of course, the indirect impact of the US’s trade dispute with China could yet be significant, both in terms of supply chain disruption and investor sentiment. However, as we analyse elsewhere, the ASEAN region is well placed to benefit both from diverted investments should manufacturers seek to reduce their exposure to China, as well as from robust demand in China and diversifying trade links via the Belt & Road (B&R) programme.
Rebalancing the economy
Encouraging such investment and developing broader trade links are part of the government’s bid to diversify exports and rebalance the economy away from a reliance on commodity shipments. During the commodity “supercycle” that lasted until around 2011, almost two-thirds of Indonesia’s export earnings came from commodities, while around quarter of the government’s revenue was also related to extractive industries. While this has dropped quite a bit, to around two-fifths and one-tenth respectively, Indonesia remains exposed to volatile commodity prices.
The good news is that given the size and importance of domestic demand – accounting for around 60% of the economy – and the policies undertaken by the government, the country has rebounded from a period of low commodity prices and is set to put growth on a more sustainable footing.
The drive to bolster FDI and diversify exports encompasses a variety of initiatives from building out infrastructure, developing the country’s human capital through education, simplifying investment rules and promoting different sectors such as manufacturing, maritime sectors, e-commerce, and tourism, (for instance through initiatives like President Jokowi’s “10 New Balis” campaign.)
Building the future
Infrastructure underpins much of this drive: improved transport links are vital to raise competitiveness and attract the kind of foreign investment in tourism, technology and value-added manufacturing that is necessary to rebalance the economy. Progress under the Jokowi administration has been significant, since the government first identified 226 “national strategic projects and programs” involving roads, railways, bridges, power stations and other projects. Of these, 123 are under construction and over 20 have been completed. The strategic projects include a total of 28 special economic zone and industrial zone across the country that set to become new economic hub.
The infrastructure spending is expected to continue. Infrastructure spending for 2019 is budgeted to increase to IDR 421tn, up 4% y/y. This consists not only of direct spending, but also of investment in the government’s infrastructure arms (including capital injections to state-owned companies and land funds) to speed up infrastructure development.
Building the future needs more than just pouring concrete. To realise Indonesia’s potential the country must also upgrade its workforce. Currently, the government is allocating more to non-physical spending such as education, social assistance and subsidies. In 2019 the budget for education spending was increased substantially to IDR 487tn (up around 10% y/y), with the aim of improving access and quality of education.
The effects of this drive are already being seen in terms of FDI flows toward projects that are helping restructure Indonesia’s growth profile. Chinese investment for B&R projects is perhaps the epitome of these trends. Significantly, over two-thirds of Chinese investment into Indonesia during 2015-17 (which totaled USD6.7bn) was in secondary (metals, machineries, and electronics) projects; primary sector activity accounted for just 4%.
The multiplier effect
Completing the planned infrastructure build-out will take time and focus. For the policy makers challenging external conditions mean the need to reprioritise spending and policy is all the more pressing. When ambitious infrastructure plans were first formulated money was still cheap and commodity prices expensive: these trends have both reversed (though oil is on another upward curve.)
With a concomitant reduction in financing to emerging markets, the imperative to be selective and focus on those investments and sectors that will truly have a multiplier effect is more acute, particularly on higher value-added exports sectors that will not only to boost growth but also strengthen country external position. The good news is that despite some challenging headwinds, Indonesia is still on track to achieve its objectives and realise its economic potential.