OECD Economic Outlook, Volume 2022 Issue 1

Indonesia

GDP growth is projected to strengthen to 4.7% in 2022 and 2023, as the improving health situation underpins the rebound of domestic demand, exports of raw materials increase and tourism slowly restarts. The rise in inflation, however, is already damping consumers’ purchasing power and demand for durable goods. The output gap will remain considerable, limiting at least initially the pass-through of higher global commodity prices to consumer prices. However, the current account deficit will rise.

The government plans to reduce the budget deficit progressively in order to comply with the 3% of GDP constitutional ceiling by 2024. The normalisation of monetary policy will be gradual and geared towards currency stability. Following the enactment of major investment and tax administration reforms, it is important to complete the process with coherent implementation measures. Geopolitical tensions highlight the urgency of improving energy security through investment in renewables and higher energy efficiency.

The recovery is taking hold

Mobility restrictions introduced to contain successive waves of COVID-19 infections have been largely lifted, although a shortage of vaccines, logistical challenges and vaccine hesitancy are still impeding quasi‑universal coverage. Real GDP grew by 3.7% in 2021 and accelerated to 5% (year-on-year) in the first quarter of 2022: nonetheless output remains well below the path expected before the pandemic. Household consumption, corporate investment, and net exports each accounted for a third of 2021 growth. Sentiment indicators, such as the Mandiri Spending Index and the manufacturing PMI, suggest the rebound is taking hold, and the April stock market debut for Indonesia’s biggest start-up bucked a global decline in technology stocks. The pass-through of higher global prices into consumer prices was initially limited, although headline inflation has accelerated this year and core inflation has reached a level last seen at end-2017. Transport services and food and beverages are the fastest-growing CPI items. The unemployment rate declined in 2021, but almost half of household primary breadwinners report earning less than before COVID-19. Sales of consumer durables such as scooters have slowed in the first quarter of 2022.

Indonesia: Economic activity and inflation indicators

1. The price indices for individual commodities (palm oil, coal, iron ore and gold) are aggregated by using weights based on the share of each commodity in the total 2020 exports of these commodities.

Source: OECD Economic Outlook 111 database; Ministry of Energy and Mineral Resources; and World Bank Commodity Markets Outlook.

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Indonesia: Demand, output and prices

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Indonesia: Fiscal and inflation indicators

Source: OECD Main Economic Indicators database; and IMF World Economic Outlook, April 2022.

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Indonesia imports a considerable share of its energy needs and is also far from self-sufficient in selected food staples such as wheat (a quarter of domestic needs is sourced from Ukraine). This is making the country vulnerable to war-related supply disruptions and weighting on households’ purchasing power. Russian visitors also accounted for a considerable share of foreign tourists. On the other hand, Indonesia is among the largest global suppliers of commodities such as palm oil, thermal coal, nickel, gold and ferroalloys that have recorded considerable global price surges since mid-February.

Policy normalisation will reflect global developments

Fiscal and monetary policies have supported activity through the COVID-19 crisis and are now set to normalise gradually in parallel with the recovery. Bank Indonesia is projected to bring the policy rate to 4½ per cent by late 2022, thus moving from an accommodative towards a neutral stance before accelerating inflation expectations take root. The financial system is in better shape than during previous episodes of global turbulence and uncertainty: sovereign and corporate exposure to external financing is now relatively small, the current account deficit is low and manageable, the rupiah’s fluctuation has been relatively mild and international reserves are ample. Indonesia has resorted to export bans on commodities for which it ranks among the world’s largest producers, palm oil in particular. This approach should be very limited in time and coverage, as the potential short-term benefits (securing supply in the domestic market and limiting price increases) are likely to be offset by the proven medium-term costs of distortions. These include lower hard currency earnings, currency depreciation and therefore higher import costs, damage to reputation in global markets, and disincentives to farmers.

The 2021 fiscal performance was driven by improved tax revenue collection, supported by high commodity prices and tax reforms. In this context, there is space to protect the purchasing power of the most vulnerable groups through direct income support without jeopardising fiscal consolidation plans. Spending performance also improved, focusing mainly on healthcare and social programmes. The carbon tax, initially planned for April 2022 and postponed to July, includes a floor rate of IDR 30 000 (EUR 1.9) per tonne that will initially apply to coal power plants. This would be an important step to containing greenhouse gas emissions, which are currently the highest relative to GDP among G20 countries after accounting for land use.

Growth is set to return to its medium-term trend

Real GDP growth for 2022 and 2023 is projected to be 4.7%. Forces driving the return to the growth pattern that prevailed before the pandemic include a release of pent-up demand for consumer goods and personal services, a cash transfer programme for cooking oil, job creation, new investments made possible by recent reforms and trade agreements, the return of foreign tourism and strong, albeit decelerating, world demand for Indonesian raw materials. Annual headline inflation will be close to the 4% ceiling during 2022 and 2023. The current account is projected to record a modest deficit.

The forecast is subject to both idiosyncratic risks weighing on investors’ confidence, such as continuing uncertainty surrounding the date of the next presidential elections, and a broad-based deterioration of financial conditions in emerging markets. Enduring increases in global energy and food prices would pose additional risks, including for public finances due to the large size of subsidies, as well as to food security and livelihoods. On the upside, the benefits of the 2020-21 reforms of labour markets and tax administration will be felt through a better business and investment climate, increased employment, and improved private physical and human capital.

Structural reforms can steer Indonesia towards energy security

Through Vision 2045, the government has set the goal of making Indonesia one of the world’s five largest economies by the time of the 100^th anniversary of independence. Achieving this ambition must be consistent with the target of reducing emissions by 29% with its own efforts, and 41% with international support, by 2030. The 2014 National Energy Plan targeted a 2025 energy mix where oil and coal account for 55% (against 72% in 2019), gas for 22% (19%), and new and renewable energy for 23% (9%). The government is working to cut subsidies that encourage the use of coal. Indonesia has an abundance of renewable energy resources, but complex procurement and project implementation inhibit greater uptake. To attract the necessary investment, the reliability of official energy data should be enhanced, the regulatory review process strengthened to ensure regulatory consistency, and policies that have made fossil fuels more financially attractive than less emission-intensive energy sources withdrawn. Fiscal and non-fiscal incentives should be considered to accelerate the shift to electric vehicles and the necessary infrastructure should be expanded.