OECD Economic Outlook, Volume 2018 Issue 1

Indonesia

Economic growth remains robust and is projected to edge higher in 2018 and 2019. Stronger consumer confidence and real income growth will lift private consumption. Infrastructure investment will remain high. Improvements in licensing and transport connectivity will support private investment and export performance. Inflation has been subdued, but the effects of higher commodity prices and currency depreciation will generate some upward pressure.

Bank Indonesia raised interest rates in May to contain exchange rate pressure. Some further tightening is assumed over the projection horizon as US interest rates rise. A steeper path may be needed if capital outflows persist. The budget deficit is projected to narrow slightly, which is prudent given rising uncertainty. Continued reforms to the tax administration and strengthened compliance will provide the means for higher infrastructure and social spending that promote inclusive growth. Reducing structural and administrative bottlenecks and fighting corruption remain crucial to strengthen growth.

The expansion is continuing

GDP growth remains robust, supported by easier borrowing conditions, greater confidence, stronger external demand and higher commodity prices. Investment has been particularly buoyant, driven by infrastructure and rebounding machinery and equipment spending. Capital goods imports have been strong, and manufacturing firms are more optimistic than in recent years. However, the cost of servicing unhedged foreign‑currency debt has risen. Reforms to ease administrative burdens have improved the business environment, and credit rating agencies have upgraded sovereign debt ratings. But other new regulations will impose costs on firms. Growth in household spending has been stable at fairly high levels. Consumer confidence is high, and retail sales and household credit growth may have troughed. Stronger external demand and past commodity price rises have boosted exports.

Indonesia

1. Manufacturing sector.

2. In 2000 and 2002 S&P set Indonesia's credit rating as 'selective default'.

Source: CEIC; OECD Main Economic Indicators database; Trading Economics; and OECD calculations.

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Inflation is around the mid‑point of the new target range of 3.5% +/‑ 1%, which is ½ percentage point lower than in 2017. Core inflation is subdued, reflecting a relatively soft retail trading environment. Food price inflation is picking up, partly driven by some temporary shortages. However, prices of some products, such as rice, are capped. The government has announced plans to contain inflation by freezing administered energy prices for 2018‑19. The current account deficit has widened, partly due to higher oil imports, but is relatively moderate. In the early months of 2018, prospects of higher US interest rates led to capital outflows and rupiah depreciation.

Indonesia. Demand, output and prices

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Macroeconomic policies are balancing growth and resilience

The fiscal deficit is projected to narrow in 2018 and 2019, as the central government prudently focuses on creating more distance from the legislated 3%‑of‑GDP ceiling. Social spending is becoming more effective overall. However, energy subsidies are increasing anew. Steps to contain non‑subsidised energy prices are increasing financial pressure on state‑owned enterprises (SOEs). Public infrastructure investment, including by SOEs, will raise current and potential growth. The sustainability of this strategy depends on good governance at, and monitoring of, SOEs. Strengthening compliance, building on the 2016‑17 tax amnesty, and investing in the tax administration are crucial for raising revenues meaningfully and sustainably.

Indonesia

1. Excludes administered and volatile food prices.

Source: OECD Main Economic Indicators database; CEIC; Thomson Reuters; and Bank Indonesia.

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Monetary policy is also contributing to macroeconomic stability. After easing during 2016 and 2017 Bank Indonesia raised its key policy rates by 25 basis points in May to support the rupiah and has used foreign exchange swaps to add liquidity to the local money market. Official reserves are high relative to history but are below their February 2018 peak due to interventions to limit currency depreciation. Credit growth has been relatively low despite declining lending rates, though non‑bank financing has flourished. Banks’ reserve requirements will be adjusted again in July and October 2018 to give banks greater flexibility to manage their liquidity, which is expected to lower funding costs.

The central bank is therefore projected to raise interest rates, although by less than US rates, to help maintain the current exchange rate, which the projections assume unchanged. This would let the bank conserve its reserves for intervening to limit volatility during bouts of heightened uncertainty. Further measures to deepen financial markets and increase liquidity would improve resilience.

Prudent macroeconomic policies and structural reforms have been recognised in credit rating upgrades and higher rankings in measures of competitiveness and the business environment. Further regulatory simplification and enhanced regulatory certainty would help Indonesia attract foreign investment and capitalise on those upgrades. Recent regulatory changes to facilitate the hiring of foreign workers should ease skills shortages and foster knowledge transfer. Tackling informality and improving education outcomes would raise incomes and medium‑term growth and broaden the tax base. In education, there is a need to raise enrolment and quality, including through regular teacher assessment and professional development.

Growth is projected to rise modestly

Tailwinds from relatively low lending rates, recent commodity price increases and greater optimism are expected to support the economic expansion. Inflation is projected to stay within Bank Indonesia’s target range, with inflationary pressures rising but remaining contained. Consumption is projected to accelerate thanks to income gains and low inflation. Investment growth will remain high, supported by the need to finish infrastructure projects ahead of major events, such as the Asian Games and elections (at the subnational level in 2018 and presidential and national levels in 2019). A key downside risk to the projections is that continued capital outflows or significant current account deterioration could require tighter monetary policy than assumed, which would slow growth. The elections create upside and downside risks: additional spending may boost consumption, but higher uncertainty would weigh on private demand. Improved logistics and improvements in competitiveness of non‑commodity exports will maintain robust export growth even as trading partner growth slows somewhat. Further increases in commodity prices would raise nominal export growth and government revenues more than projected.