Indonesia: Economic Growth Rate, Although High, Remains Below the Government’s Expectation

Euromonitor International’s Indonesia Economy, Finance and Trade Country Briefing focuses on one of the key emerging markets with immense growth potential. To accelerate economic growth amidst numerous global challenges, Indonesia has been implementing various reforms. A series of interest rate cuts was carried out by the central bank to stimulate credit growth. Additionally, the government has been announcing large fiscal spending plans, with an aim to achieve an economic growth rate of over 7.0% annually, which it has not yet achieved, given soft commodity prices and a slowdown in China. Although, the economy grew at a robust pace of 5.0% year-on-year in real terms in 2016, which is expected to rise to 5.2% in 2017, it is not sufficient to generate enough revenue for the government’s ambitious plans, including eradicating all slums across the nation by 2019, amidst a high budget deficit and weaker than expected public revenue.

Medium- to long-term economic outlook remains strong, but the high budget deficit is a concern

• Indonesia will continue to perform better than most emerging markets. Annual real GDP is expected to grow by 5.2% in 2017, mainly driven by final private consumption and the government’s drive to improve infrastructure. Stronger commodity prices, along with low interest rates, should help boost investment. However, exposure to natural disasters, coupled with growing income inequality, might weigh on its economic potential;
• Foreign direct investment (FDI) inflows surged in the 2010-2014 timeframe, owing to a favourable economic outlook and major initiatives taken by the government in easing FDI policies. However, in 2015, annual FDI inflows contracted by 24.8% in real terms (latest data available), owing to increased political tension in the country before the elections;
• Gross fixed capital formation surged by 26.7% in real terms over 2011-2016, thanks to the government’s focus on enhancing the country’s overall infrastructure. China Railway International Co. Ltd and a consortium of Indonesian state companies will build a 142 km-long railway line, costing US$5.1 billion that will link Jakarta and West Java’s capital Bandung in the southeast;
• Despite cuts in fuel subsidies, Indonesia’s general government net budget deficit deteriorated over 2011-2015, finishing the period at 2.5% of GDP in 2016, mainly owing to increased government spending on infrastructural projects and lower than expected tax revenue received from the tax amnesty bill;
• Indonesia is a youthful country, but those aged 65+ accounted for 5.3% of the total populace in 2016 and their share is expected to increase to only 8.4% by 2030. The old-age dependency ratio will accordingly rise from 7.8% in 2016 to 12.4% by 2030, highlighting a gradually ageing population. Thus, Indonesia’s public finances are not under pressure from ageing-related costs, but instead should profit from a potential rise in tax revenues.

The government continues to implement major monetary and economic reforms

In a bid to accelerate the economic growth rate, the country’s central bank, Bank Indonesia (BI), slashed its key interest rate six times from a high of 7.5% in 2015 to a record-low of 4.75% in 2016, and became the biggest rate cutter in Asia in 2016. However, given a rising trend in inflation and likely hikes in interest rates in the USA, Indonesia remains exposed to potential large capital outflows. To avoid this, the BI has left its key interest rate unaltered since October 2016; thereby causing a lag in credit growth. However, to address this issue, the central bank has eased guidelines on the proportion of cash that commercial creditors must reserve, offering them more freedom in managing liquidity. In July 2017, the quantity of total deposits kept by the banks with BI on a daily basis was further cut to 5.0% from 6.5%. On the fiscal front, the government has been promoting public private partnership (PPP) infrastructural programmes and its current medium-term development plan for 2015-2019 focuses on attaining inclusive and environmentally sustainable growth, which is a part of its broader National Long-Term Development Plan (2005-2025). Additionally, in order to boost Indonesia’s industrial sector, the government has introduced fiscal stimulus and deregulation measures through a series of economic policy packages since September 2015. The above measures have helped the real economy grow at a healthy pace of 5.0% year-on-year in 2016, but this remains below the government’s expectations.