OECD Economic Outlook, Volume 2022 Issue 2

Indonesia

Favourable commodity prices and still buoyant capital inflows are helping Indonesia to resist strong global headwinds. However, domestic demand and private consumption growth is being held back by high headline inflation. With foreign investors recognizing the progress made towards macroeconomic stability and enhanced structural reforms, and expanding their reach in Indonesia, GDP growth is projected to average around 5% in 2022 and 2023 and strengthen slightly in 2024. Persistent tensions on energy, fertiliser and food markets and social unrest ahead of the February 2024 presidential elections are the main downside risks.

Fiscal and monetary policies should remain tight, while support for vulnerable households should be maintained. In the medium run, the overarching imperative remains to spur productivity growth through appropriate human capital policies, the removal of obstacles to business activity and the restructuring of state-owned enterprises (SOEs). It is also important to reinforce the independence and professionalism of the Indonesia Investment Authority, the recently-established sovereign wealth fund. On the upside, the impact on potential output of reforms enacted in recent years to liberalise labour markets may turn out to be larger than expected.

Recent developments provide mixed signals

Growth accelerated in the first three quarters of the year: domestic demand was buoyant as mobility restrictions to curb COVID-19 cases were withdrawn and external trade was supported by the rise in global prices for commodities such as coal, palm oil, and nickel (a critical component in electric vehicle batteries). In US dollars, exports over the year to September 2022 were 36% higher than in the previous year. A recovery in tourism is underway (boosted by the broadening of visa-on-arrival procedures), although the number of visitors remains below pre-pandemic levels.

Indonesia 1

Source: CEIC; and OECD Economic Outlook 112 database.

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Indonesia: Demand, output and prices

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Indonesia 2

1. In total there are 43 subgroups. The cumulated share of the subgroups with inflation exceeding 4% in the total inflation basket is calculated with the constant weights (Index 2018 = 100).

2. 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: Statistics Indonesia; Ministry of Energy and Mineral Resources; and World Bank Commodity Markets Outlook.

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Price pressures continue to build, with annual CPI inflation reaching 6% in September and core inflation settling at 3.2%. The number of product categories in the consumer basket experiencing high inflation has also grown. Bank Indonesia started increasing its policy rate (seven-day repo reverse rate) in August 2022. Since the summer, most high-frequency indicators and sentiment surveys have stalled, but there have not been any major capital outflows: foreign multinationals have maintained their expansion plans, the stock market is the best performing in the Asia-Pacific region this year, and currency depreciation against the US dollar has been less pronounced than in other emerging Asian economies.

Indonesia, the world's largest thermal coal exporter, has gained considerable market share in new overseas markets following the introduction of EU sanctions on Russian energy exports. At the same time, oil and gas imports have almost doubled in value since the Russian invasion of Ukraine. The government is considering purchasing oil from Russia at a discount. The principal tool used to cushion the impact of the crisis has been the universal fuel subsidy, with additional resources equal to IDR 502 trillion (4.5% of 2021 GDP). In addition, direct cash assistance (BLT) and wage subsidies (BSU) targeted programmes now reach 21 and 16 million citizens, respectively.

Fiscal and monetary policies should remain tight

The 2023 Budget aims to bring down the deficit to the 3% of GDP ceiling set in the Constitution. The main forces acting are increasing tax revenue (+30% from pre-pandemic levels) and declining spending (-4% from the 2022 Budget, with most cuts in healthcare). Nonetheless, various socio-economic groups, such as youth, women, remote villagers, and people with disabilities, remain vulnerable to post-pandemic scarring effects and the rise in inflation. It is therefore opportune to provide them with sufficient welfare support, to make it well-targeted, and to improve the social assistance delivery system.

Over the years, thanks to its legal independence, Bank Indonesia has acquired the necessary credibility to pursue front-loaded, pre-emptive, and forward-looking monetary policy normalisation at a more gradual pace than in other emerging market economies. From 5.25% at end-2022, the policy rate is expected to rise by 25 basis points in early 2023 and to remain unchanged throughout the projection period. So far, most financial indicators point to greater resilience than during previous episodes of global turmoil and banks have built an adequate level of provision against non‑performing loans, which are likely to see an increase once most regulatory forbearance is phased out early next year. However, interest payments on public debt absorb a relatively high share of Indonesia’s budget, reflecting Indonesia’s low tax effort, and the Treasury is exposed to foreign-exchange fluctuations.

Steady growth is projected to persist

External demand for commodities and pent-up consumption will support growth. In 2023, despite heightened global uncertainty, demand for export commodities is projected to remain brisk. Although macroeconomic policy support is set to wither as real interest rates turn positive and fuel subsidies are trimmed, domestic demand will benefit from pent-up consumption and a gradual increase in capital spending. The 30% increase in fuel prices due to reduced subsidies is contributing to the initial acceleration of core inflation as higher energy costs spread through the economy. With monetary tightening and the base-year effect of higher inflation in the first half of 2022 wearing off, inflation expectations will eventually decrease. This will allow consumer price inflation to fall to the upper value of the target band of 3±1% in the second half of 2023.

Risks remain tilted to the downside and include a slower-than-projected taming of inflation, with the ensuing purchasing power losses weighing on household consumption and political turbulence and social unrest in the run-up to 2024 Presidential elections which might distort international investors’ perception of the strengths of the Indonesian economy.

Sound macroeconomic policies and structural reforms can boost productivity

The fiscal-monetary synergy approach that authorities have adopted since 2020, consisting of large private placements of government bonds with Bank Indonesia and the central bank's purchases of Treasury paper in the primary market, should be progressively wound down to avoid fiscal dominance and crowding out private investment. Indonesia’s productivity level remains stuck at a fraction of the OECD average and state-owned enterprises – given their sheer size and reach – could make a greater contribution in this regard. The consolidation of 108 companies into 41 in 12 business clusters, where they may develop sufficient size and efficiency to compete in global markets, and the planned partial privatisation of operating subsidiaries of the national oil company are encouraging. The Indonesia Investment Authority can also play a positive role in attracting foreign capital and therefore accessing high-productivity technologies, provided it remains immune from political interference. For Indonesia to reach the 2060 net zero goal, clean energy investment needs to nearly triple by 2030. Greenhouse gas emissions can be lowered through a consistent strategy to reduce reliance on cooking with inefficient heat sources.