OECD Economic Outlook, Volume 2023 Issue 1

Indonesia

Real GDP growth will slow to 4.7% in 2023 and then reach 5.1% in 2024, once the impact of monetary tightening fades away and uncertainty about the 2024 elections abates. The economy has benefitted from strong commodity prices and will be sensitive to mounting global headwinds, including geopolitical tensions, slowing trade growth, and financial volatility. Low real wage increases and a soft labour market are holding back household consumption.

Monetary policy has become more restrictive since mid-2022, with the policy rate rising from 3.5% to 5.75%. Credit growth has weakened. Fiscal policy will become less supportive following the reinstatement of the 3%-of-GDP limit for the budget deficit. The incoming administration after the February 2024 elections should prioritise structural reforms to increase productivity and international competitiveness, while monitoring the impact of industrial and trade policies and adjusting them in case of disappointing results.

Disruptions from earlier pandemic-related lockdowns are still being felt

Output growth picked up in the fourth quarter of 2022, and was 5.0% higher than a year earlier, but moderated in the first quarter of 2023. The lifting of all remaining mobility restrictions as of 1 January 2023 is supporting the recovery in the services sector, but consumption is still significantly below its pre-pandemic trend. Demand for consumer durables was subdued in 2022. For instance, two-wheel vehicle sales were 10% lower than the pre-pandemic seven-year average, although sales picked up in early 2023. Consumers’ caution partly reflects anaemic real wage growth. Leading indicators such as cement purchases and machinery imports suggest that the contribution of investment to GDP growth remains muted, despite the expansion of the government infrastructure programme. Price pressures continued to fade as the modest jump in food and public transport prices during this year’s Eid-al-Fitr period contributed to the fall in inflation, to 4.3% year-on-year in April. Another positive signal comes from new stock market listings, with the number of listings at an all-time high in 2022, and the proceeds from listings the largest ever in the first quarter of this year.

Indonesia: Economic growth and inflation indicators

Source: OECD Economic Outlook 113 database; and CEIC.

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Indonesia: Demand, output and prices

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Indonesia: Inflation and activity indicators

1. The price indices for individual commodities (palm oil, coal, iron ore, gold and nickel) are aggregated by using weights based on the share of each commodity in total 2021 exports of these commodities.

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

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The impact of Russia’s war of aggression against Ukraine on Indonesia has been mixed. Direct trade with both Russia and Ukraine is limited. However, replacing part of crude oil imports with discounted Urals oil from Russia is helping to contain inflationary pressure. On the other hand, disruptions in global value chains and operating restrictions in energy markets have fed into domestic prices, especially for food, fertilisers and fuels. Meanwhile, as a large producer of various crops, minerals and metals, Indonesia benefited from the large global price increases for some of these items. The terms of trade improved significantly in 2022 and net trade supported growth, despite measures aimed at limiting exports of palm oil and making them conditional upon prior servicing of domestic market obligations.

Monetary and fiscal policy have moved from supportive to neutral

Bank Indonesia increased the policy rate by 200 basis points in the second half of 2022 and is assumed to raise it slightly further in 2023 to 6%, and defer the first cut to the second half of 2024. Credit supply appears ample, but higher borrowing costs weigh on business investment and household consumption of durable goods. The increased share of commercial banks’ reserves that must be invested in Treasury paper makes it important to consider how monetary policy decisions impact banks’ net interest margins and overall financial stability. The termination of primary market purchases of government debt by the central bank should be accompanied by reinstating improved surveys of inflation expectations to help guide policy decisions. The recent vote of the Financial Omnibus Law, which empowers the central bank to purchase bonds directly from the government if the president declares a crisis, may create policy dilemmas and weaken the credibility of the monetary authorities.

The OECD projection assumes that no further fiscal support is provided via tax cuts and deferrals. The new Tax Harmonisation Law is likely to improve tax collection and the government is committed to respect the 2003 Fiscal Law that caps fiscal deficits at 3% of GDP, after a suspension in 2020-22 due to the pandemic. Due to sound macroeconomic policy, public debt (narrowly defined) stands at less than 40% of GDP, a manageable level given the composition in terms of maturity and creditors. Accordingly, there are adequate buffers to respond to future adverse shocks, for instance through increased capital spending. Spending on subsidies to households and businesses, principally for energy, amounts to some 3% of GDP, more than a quarter of tax revenues. This support is insufficiently targeted and inconsistent with emission reduction goals, but paring it back in the near term would prove very difficult.

Activity will keep growing, but slightly more slowly

In the course of 2023, GDP growth will gradually return towards the 5% trend growth seen over the past 15 years. Public investment will be boosted by the resumption of construction activity in the new capital city Nusantara. China’s reopening should boost tourism exports, provided measures are implemented to improve planning and co-ordination at all levels of government and across relevant policy areas, such as health and safety, skills development and destination management. A more predictable supply of energy and grains, helped by improved storage facilities, will help to stabilise headline inflation within Bank Indonesia’s target range (3±1%) from the second half of 2023.

Indonesia’s dependence on commodities and reliance on international capital markets and personal remittances make it highly vulnerable to external developments. Despite improved fundamentals, a run on emerging markets could substantially shock the economy as in previous similar crises. On the domestic front, political risk may increase in the run-up to the elections if there are indications of a reversal in the delivery of critical reforms, which could interrupt progress in accountability and transparency.

Pro-active public policies can help in raising competitiveness, but caution is in order

Elevating Indonesia’s participation in global value chains (GVC), while also promoting domestic value added and accelerating sustainable development, ranks high among the government priorities. Pro-active industrial and trade policies are being used, in particular an export ban on unprocessed nickel and incentives to attract global producers of batteries for electric vehicles. Constant monitoring of this strategy is necessary to avoid expensive mistakes and the pursuit of potentially contradictory goals. Improving the investment climate, focusing on the areas where the OECD Product Market Regulation indicators show that Indonesia lags behind its peers, could be a more effective policy, especially at a time when global companies are seeking to diminish their exposure to China. Such a horizontal approach to improve the investment climate is also more likely to generate jobs, including for women, than one that targets capital-intensive sectors. The business sector would also benefit from increasing labour supply through further reforms to promote formal employment among women, as well as more extensive childcare services and flexible working-time arrangements. Reforms should also create an environment conducive to large-scale investment in renewables. This would diversify the energy mix, currently skewed towards coal, helping achieve emissions reduction targets.