Indonesia Economic Quarterly

June 2016
Resilience through reforms

Ndiam Diop
Lead Economist, Indonesia

June 20, 2016

Introduction
Global economy: weaker than expected
The world recovery is yet to be realized;
Hence, external conditions remain
unsupportive.

Indonesias resilience stands out

Private consumption has held up in the
aggregate;
But is private investment recovering?

Further reform momentum is needed

Sound monetary policy, but rigid bank interest
rates;
Higher public investment despite fiscal
constraints;
Trade policy and the real incomes of the bottom
40 percent;
Long-term policies to improve manufacturing
competitiveness and reduce inequality.

Indonesia: growth resilience

Macroeconomic outlook and risks

Further reform momentum

Global economy: no recovery yet

Annual growth, percent

2015e

4.0

2016f

3.5
3.0
2.5
2.0
1.5
1.0
0.5

0.0
Advanced

Emerging market and developing

Source: World Bank, June 2016 Global Economic Prospects

4

Gloomy global trade and investment:

a drag in Q1
USD billion
Non-oil and gas exports

Direct investment in Indonesia, RHS

45

8
7

40

35

4
30

3
2

25

1
20
Mar-14

Sep-14

Mar-15

Sep-15

0
Mar-16

Source: BI; World Bank staff calculations

5

But Indonesias economy remains resilient

Annual growth, percent
6
Indonesia
5

4
Commodity-exporting
developing countries

3
2
1
0

2013

2014

2015e

Source: World Bank, June 2016 Global Economic Prospects

2016f

2017f

2018f

Private consumption holding up in the

aggregate, although not for all
Paddy farmers income and costs,
indices 2012 = 100

Private consumption growth yoy,

percent
6.0

130

5.5

125

5.0

120

4.5

115

4.0

110

3.5

105

Cost of production and

investment (food
crops)

3.0
Mar-14

100
Mar-14

Mar-15

Mar-15

Source: BPS; World Bank staff calculations

Mar-16

Price received by
paddy farmers

Mar-16

Source: BPS; World Bank staff calculations

7

.Private investment recovering?

Business confidence indicators,
indices

Estimates of the public

investment multiplier:

60
50
PMI Manufacturing

40
30

Business activity:
expectation

20

- 0.4 in short term and

1.4 in medium term in
advanced countries
(IMF, 2015);
- 0.6 in short term and
1.6 in long term in
developing countries
(Ilzetzki et al., 2010)

10
Business activity:
0
Mar-14

Sep-14

Mar-15

Sep-15

Mar-16

Note: A PMI value above 50 indicates improving economic activity.

Source: BI; Nikkei/Markit; World Bank staff calculations
8

Indonesia: growth resilience

Macroeconomic outlook and risks

Further reforms

Baseline outlook
2015

2016f

2017f

Real GDP (annual % change)

4.8

5.1

5.3

Consumer prices (annual % change)

6.4

3.9

4.4

Current account balance (% of GDP)

-2.1

-2.3

-2.5

Budget balance (% of GDP)

-2.6

-2.8

n.a.

Source: BPS; World Bank staff projections

10

External risks and uncertainties

Monetary
policy in
the US
Trajectory
of
commodity
prices

UK
referendum
on EU
membership

External
uncertainty

Global
growth and
trade

China
rebalancing
and
deleveraging

11

Domestic risks

Limited fiscal
space

Weak credit
growth

Domestic
Risks

Tax amnesty

SOE capital
injections

12

Indonesia: growth resilience

Macroeconomic outlook and risks

Further reform momentum

13

Hence, Indonesia needs to work harder

This was
supposed to get
me there faster

Thats counting
without headwinds
and reform impact
lags!

Monetary easing but rigid bank interest

rates
Cumulative change since December 2014, percent
0.0
Investment lending rate
-0.2

BI rate

-0.4
-0.6
-0.8
-1.0
-1.2
-1.4
Dec-14

Mar-15

Jun-15

Sep-15

Dec-15

Mar-16

Jun-16

Source: BI; World Bank staff calculations

15

Why are Indonesian interest rates higher

than in peer countries?
Percent per year

Bank interest and expense structure:

High overhead costs;

Low fee income;

High capital ratios;

Low loan loss provision.

Structural factors:

High inflation;

Underdeveloped financial markets;

Crowding out by government

borrowing.

Thailand
Philippines

Malaysia
Indonesia

Lending
rate
Deposit
rate
5yr gov.
bond yield

Inflation
0

10

Source: WDI; World Bank staff calculations

20

Public investment maintained within limited

fiscal space
Central government capital spending, IDR trillion

Fiscal deficit at 2.8%

of GDP and cuts to
non-priority spending

200
180

215

160

183

140
120
100

WB
forecast

135

80
60
40
20
0
Mar-14

Sep-14

Mar-15

Sep-15

Mar-16

Sep-16

Source: Ministry of Finance; World Bank staff projections

17

Fiscal policy could better target inequality

Reduction in the Gini coefficient
due to fiscal policy

What can be improved?

The Government spends the least

on the most effective programs
(e.g. direct cash transfers);

Compliance and the size of the

tax base must be increased.
What has already worked well?

Fuel subsidy reform,

accompanied by compensation for
the poor, has had a positive
impact on both poverty and
inequality reduction.

0
-2
-4
-6
-8
-10
-12
-14
-16
-18
-20

Source: Various; World Bank staff estimates for Indonesia

based on Susenas 2012

Trade policy can hurt the people with the

lowest incomes
Difference in value added per unit of output compared to a free trade
scenario in 2015, percent

90
70
50
30
10

-10
-30

Source: Ministry of Finance; World Bank staff projections

19

The good news: an emerging trade

liberalizing trend
Number of trade measures

Until last year, Indonesia was

among the worlds top users of
trade barriers.

Restricting

40

37

35
30

Over the last four quarters, the

Government has introduced
fewer trade restrictions and
more trade liberalizing
measures. In Q1 2016, the
number of liberalizing measures
exceeded the number of
restricting.

Liberalizing

28

25

21
19

20

18
16

15
10

10
5

12
6

4
1

0
Mar-14

11

9
5

Sep-14

Mar-15

Sep-15

Mar-16

Source: Global Trade Alert; World Bank staff calculations

Reviving manufacturing competitiveness

Share in global manufacturing,
percent

What can be improved?

Partnership with private sector;

Sustainably low inflation;
Focus on promising sectors.

What reforms have already begun

but need to gain momentum?

Better fiscal budget allocation,

including higher infrastructure
spending;
Regulatory reform to improve
competitiveness.

Indonesia
Vietnam

Malaysia
China (RHS)

20
16

12
2
8
1

0
1990 1995 2000 2005 2010 2015

Source: UN COMTRADE; World Bank staff calculations