OECD Economic Outlook, Volume 2023 Issue 2

Indonesia

Economic activity continues at a brisk pace, with real GDP growth of 4.9% in 2023 and 5.2% in 2024 and 2025. Household consumption, despite modest real wage gains, will remain the major engine of the economy. Monetary tightening and slowing global trade will weigh on fixed capital formation, but housing construction activity is expected to increase, notably in the new capital city Nusantara. Two years of monetary tightening have pushed down inflation, which is projected to be around 2.5% in 2024 and 2025.

With inflation expectations re-anchored, Bank Indonesia is expected to start easing in mid-2024. The prudent stance of fiscal policy should strengthen Indonesia’s credit image and encourage long‑term capital inflows, contributing to the stabilisation of the exchange rate. After the February 2024 elections, the incoming administration should focus on promoting pro-growth fiscal policy and institutions, in particular through reducing state-owned enterprises’ wide-ranging market privileges, enhancing domestic revenue mobilisation, and making social spending more targeted and effective.

Economic growth is back to its robust pre-pandemic pace

Real GDP growth in 2023 is close to the approximately 5% average annual rate achieved since 2000. Various indicators suggest improving demand conditions. The manufacturing sector continued to expand at the end of the third quarter at a solid, albeit softer, rate and the hotel occupancy rate in January‑July surpassed pre-pandemic levels. However, cement purchases and imports of machinery and equipment, two key indicators of fixed investment, are now lower than a year earlier and demand for new banking finance remains muted. Headline inflation is affected by the strong increase in rice prices, but fell in October to 2.6%. The number of unemployed persons has fallen below 8 million and the jobless rate stands below 6%. There are also positive signs for financial investment over the longer term: the Jakarta Stock Exchange recorded the world’s fourth-highest number of new listings in the January-October period, cross-border private equity deals increased as global institutions look for alternatives to China, and Indonesia was the first sovereign borrower to issue samurai blue bonds in Japan (with proceeds earmarked for sustainable activities in the marine sector).

Indonesia: Economic growth and inflation indicators

1. Real GDP per capita is based on GDP in constant prices (2015 PPP), USD. Quarterly population data are calculated by interpolating annual data. OECD estimates on population data for 2023.

Source: OECD Economic Outlook 114 database; OECD Population database; and CEIC.

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Indonesia: Demand, output and prices

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Indonesia: Inflation and governance 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.

2. Percentile rank indicates the country's rank among all countries covered by each indicator, ranging from 0 (worst) to 100 (best).

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

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The volatile global landscape, and in particular Russia’s war of aggression against Ukraine, has mixed implications for Indonesia. While direct trade with both Russia and Ukraine was limited prior to the war, as were the numbers of visitors from these countries, imports of discounted Urals oil have helped to contain price inflation. Indonesia was negatively affected by high grain and fertiliser prices, but exports have benefited from global price increases for various non-grain crops such as rice, as well as minerals and metals. The terms of trade have improved significantly this year, and net trade has supported growth in 2023, despite export restriction measures on palm oil. Total trade with China in the first semester grew slightly (0.6%) compared with the same period in 2022, whereas it shrunk by 4.7% for ASEAN as a whole.

The policy mix will aim at stability

Close co-ordination between fiscal and monetary policies has supported economic growth and resilience. The effect of Bank Indonesia’s previous six-step increase of the policy rate is increasingly visible, with inflation now within the target range (currently 3.0% consumer price inflation with a ±1% corridor). However, the weakening of the Rupiah amid increasing global uncertainty prompted the central bank to raise the policy rate again in October. Under current commodities markets assumptions, and provided that global tensions do not escalate, Bank Indonesia is likely to make the first rate cut around mid-2024. Given that the revised inflation target for 2024 is slightly more ambitious (2.5% with a ±1% corridor), the switch to a more accommodative monetary policy is likely to be cautious and gradual.

Following a widening of the budget deficit during the pandemic, the authorities have intensified fiscal consolidation since 2022. The 2024 budget targets a deficit of 2.3% of GDP and a neutral fiscal stance will be maintained going forward. Tax policy and administration reforms, as well as the completion of some projects, should help to achieve this goal. While extreme poverty has been largely eradicated, the pandemic showed that the emerging middle class remains vulnerable to shocks and in need of safety nets. The prolonged closure of schools aggravated disparities in access to education and training. The expansion of social protection programmes, in terms of both benefits and coverage, should be accompanied by improvements in their automaticity and targeting. If external risks materialise, any sizeable or long economic slowdown should be addressed through additional discretionary spending, given weak automatic stabilisers. A further gradual increase in capital spending is expected over the medium term, including to speed up investments in Nusantara. These are estimated to be around USD 30 billion over the next decade.

Growth prospects remain favourable

Indonesia is projected to maintain rapid and stable growth over the projection period. Better labour market conditions, lower inflation and improvements in investors’ sentiment will support consumption and investment, offsetting the gloomier global trade picture. Tourism arrivals and average expenditures will also continue recovering.

Despite progress in diversifying export products and markets, in particular through preferential trade agreements with other fast-growing partners, and in developing domestic capital markets, Indonesia remains vulnerable to external risks. These include geopolitical tensions in other regions, unexpected global financial market gyrations, and non-tariff barriers on exports arising from partners’ regulations on deforestation and carbon border adjustment levies. On the other hand, political risk is limited as the February 2024 elections are unlikely to result in a modification of the overall economic policy stance.

Despite major advances in the past 25 years, challenges remain

In the past 25 years under democratic rule, public sector governance and infrastructure have experienced significant improvements, while the macroeconomic policy framework has gained credibility. Considerable resources are being provided to improve infrastructure, with some success. Despite cost overrun and delays, the Jakarta-Bandung railway was inaugurated in September. Indonesia has thus become the fourth non-OECD country with a high-speed train service. In the medium run, however, an average annual growth rate of 5% may be insufficient to turn Indonesia into a high-income economy by 2045, which is the overarching goal of the Indonesian authorities. To achieve this vision, a comprehensive new plan of structural reforms should remove distortions in policy areas such as business regulation, finance, state ownership, and competition and reduce the enduring gap in transparency and regulatory clarity relative to OECD economies. The authorities have shown a strong commitment to fiscal discipline and should now adopt a concrete medium-term fiscal strategy, to reap the demographic dividend before ageing starts to become an issue in less than a decade. Revenue mobilisation would benefit from deepening the 2021 tax reform, notably by improving compliance by high-income taxpayers. The energy subsidy reform should include the return of the semi-automatic pricing formula which was applied in 2015‑18, based on an international oil price index, exchange rate and other tax and distribution costs. Further work is needed on regulatory implementation, including through greater independence of oversight institutions, such as the Corruption Eradication Commission.