Indonesia’s economy continues to surprise

Author: Thee Kian Wie, Indonesian Institute of Sciences

The Indonesian economy continues to surprise with its very healthy growth rate through the period of global financial crisis. The growth rate, driven by consumer spending, investment, and exports, has surpassed most predictions at 6.2 per cent during the second quarter of 2010. Domestic consumption is robust, investment figures are encouraging and exports are expanding at least as fast as global growth. While monetary policy and financial regulatory concerns remain, Indonesia is well-positioned for broad-based economic growth.

Perception indicators increasingly support the view that Indonesia’s economy is on an upswing. The Japan Credit Rating Agency has upgraded Indonesia’s investment grade from BB+ to BBB; the first in 13 years. Other credit rating agencies, including Fitch, Standard and Poor’s and Moody’s, have also upgraded Indonesia’s sovereign rating. Last year Indonesia was the only member of the G20 to lower its public debt-to-GDP ratio: a very positive economic management indicator.

What is responsible for Indonesia’s surprising growth performance?

Prices have been reasonably stable although inflation is still a worry. Even so, the inflation rate in August 2010 was lower than previously estimated, at 0.76 per cent month-on-month, or 6.44 per cent year-on-year. A major factor accounting for Indonesia’s generally higher inflation was the increase in electricity tariffs in July. And here, even though the direct impact of this increase was higher than expected, the indirect impact appears to have been relatively mild so far.  For this reason, the Bank of Indonesia’s decision to keep the policy interest rate at 6.5 per cent for the time being seems sensible.

Meanwhile, Indonesia’s banking sector is in good shape and has successfully weathered the global financial crisis (GFC). It was protected by prudential guidelines and sound banking practices, and is strongly solvent, with contained risk exposure, and solid profitability.  The most recent World Bank and International Monetary Fund assessment of Indonesia’s financial system concluded that it is generally healthy, as demonstrated by its success in recovering quickly from the GFC.

On the trade side, there is good news too. Indonesia’s balance of payments during the second quarter recorded a big surplus of US$ 5.4 billion, $6.6 billion during the first quarter. This was due to the good performance of non-oil and gas sectors, a positive natural gas balance, and a surplus in the capital and financial account due to inflows of FDI and portfolio investment.

More specifically, Indonesia’s exports to the developed nations have not substantially weakened, despite apparent signs of a slowdown in these markets. Indonesia also increased its level of imports, with higher capital goods (machinery, mechanical and electrical appliances, and aircraft) inflows.

Unfortunately, green field investment in manufacturing has not mirrored the performance of other sectors. Foreign direct investment (FDI) amounted to US$ 3.7 billion the second quarter of 2010. Near-zero FDI was directed towards manufacturing.

FDI predominantly flowed into the transport, storage and communication sectors (US$ 1.5 billion); mining (US$ 0.6 billion), trade (US$ 0.4 billion) and electricity, gas, and water supply (US$ 0.3 billion). While this is good, more direct investment into the manufacturing sector would lead to higher employment and a faster reduction in absolute poverty. Government estimates identify $210 billion of infrastructure development over the next 5 years, of with almost $100 billion to be funded by the private sector. Strong foreign investment flows are vital Indonesia’s economic expansion plans.

The IMF and World Bank report identified two major issues that urgently need government attention: protection and support of financial regulators, and weak creditor rights.

The creditor rights issue is seen in the ability of large corporate borrowers to challenge contracts through long and arduous court battles. This in turn leads banks to focus on small and medium-scale (SME) lending. Indonesia is ranked 146 out of 183 countires surveyed in the 2010 Ease of Doing Business Index, with outstanding claims taking 570 days to enforce, for 120 per cent of the claim’s cost.

The financial regulator issue specifically refers to the political decision earlier this year to bail out the corruption-tainted Bank Century (now Bank Mutiara). It culminated in the ‘resignation’ of then Finance Minister Sri Mulyani Indrawati, now a World Bank Managing Director). As a result, the pending adoption of the Financial System Safety Net law, which would clarify the responsibilities of various regulatory agencies, is crucial to achieving greater financial stability.

All in all, Indonesia’s economy is in a solid position. While inflationary and regulatory issues remain, with robust growth of the economy  Indonesia is poised for increased economic and political influence within Southeast Asia.

Thee Kian Wie is a senior economist at the Indonesian Institute of Sciences (LIPI) in Jakarta and will be presenting the Economics Update at the Indonesian Update, to be held at the ANU, September 24-25.

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