Indonesia is navigating safely through uncertain times

Indonesia is navigating safely through uncertain times

IMF, the International Monetary Fund Mission Chief for Indonesia, Luis E. Breuer, credits good economic management and timely reforms, particularly on fuel subsidies, for Indonesia’s favourable prospects. The country is also well positioned to cope with a challenging external environment

But he noted that sustaining strong growth and development will require the government to push on, and even expand, its ongoing reforms in areas such as infrastructure investment and trade. 

Indonesia’s macroeconomic performance was good in 2015. Despite the weaker external environment, economic growth remained among the highest in emerging market economies at 4.8 % in 2015. Inflation fell to within the central bank’s target range (3- 5 %), and the current account deficit narrowed. Over the past few years, sound monetary management and a prudent fiscal stance have reinforced macroeconomic stability and supported growth.

For 2016, we expect growth to pick up moderately to around 5 %. The recovery will be driven by increased investment, especially, public sector spending on transport and energy. Inflation will likely remain within the target band, while the current account deficit is projected to increase moderately. The fiscal deficit is expected to widen somewhat but remain below the 3 % of GDP statutory ceiling.

Indonesia

For the medium-term, Indonesia’s prospects are very favourable. Economic fundamentals are set to continue to improve, building further on Indonesia’s many assets—a young population, low public debt, large domestic markets, natural resource endowment, and a participatory and stable political system.

Like many emerging market economies, Indonesia is facing pressures from the current shifts in the global economy, notably lower growth and rebalancing in China, sluggish commodity prices, and the beginning of monetary policy normalization in the U.S.

These shifts have impacted the Indonesian economy through three main channels: commodity prices, trade, and capital flows. They have led to a slowdown in growth in recent years—from the high rates during the commodity boom years—and tighter financing conditions. As a result, risks and vulnerabilities have increased.

Government revenues, in particular oil revenues, have dropped significantly. Foreign direct investment and portfolio inflows have slowed, as foreign investors’ appetite for emerging market assets in general has weakened, even as inflows to Indonesia so far in 2016 have been more favourable than to regional peers. Although from low levels, foreign currency denominated borrowing by firms has increased rapidly in the past few years, while corporate performance has weakened somewhat and banks’ non-performing loans have begun to creep up.

Nonetheless, Indonesia has ample experience in handling such turbulence, as the economy weathered well the global financial crisis and the so-called “taper tantrum” in 2013. The economy’s adjustment to the changing world economy was facilitate by sound policies, including flexible exchange rate and government bond yields, and ample international reserves. Indonesia is certainly better able to handle this kind of turbulence than in the past.

Indonesia needs to manage short-term risks and, at the same time, increase potential growth in the medium-term. On the fiscal side, the government needs to increase revenues to create space for infrastructure and other priority spending such as well-targeted social programs. Higher public investment should be combined with sound public financial management and governance reform of state-owned enterprises, and monitoring of potential fiscal risks.

Indonesia will greatly benefit from reforms in infrastructure, investment, and trade. In a country made up of more than 17000 islands, a modern and efficient infrastructure is crucial to connect people and markets both within the country and with the world. Yet Indonesia’s infrastructure gap remains large compared to its peers. Let me give an example: logistics costs account for 24 % of GDP in Indonesia, compared to only 13 % in neighbouring Malaysia.

To attract more investment, Indonesia needs to remove constraints that shackle the private sector, including the complex regulations. President Jokowi’s commitment to jump-start investment is very encouraging, especially the implementation of the revamped Land Acquisition Law and a one-stop services shop. The recent changes to the foreign direct investment regime, which, in the aggregate, led to a partial liberalization is further progress in the authorities’ reform agenda.

The government has laid out an ambitious plan for infrastructure development. The plan sets a target of around USD 480 billion (around 50 % of GDP) during 2015–19, financed by both the public and private sectors. The authorities have made progress by accelerating government capital spending in 2015 and enhancing the institutional framework, especially the setup of a coordinating body (KPPIP) to focus on top priority projects.

Nonetheless, efforts are required on several fronts to successfully implement the ambitious plan. The government needs to mobilize additional revenue to create fiscal space for capital spending, including with an increase in excise taxes on fuel, tobacco, and vehicles.

In addition, the increase spending in infrastructure should be complemented with an improvement in public investment management, and the strengthening governance at state- owned enterprises and capacity at local governments.

www.imf.org


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