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Indonesia Economic QuarterlyBuilding Momentum
Shubham ChaudhuriLead EconomistWorld Bank
8 April 2010Jakarta Indonesia
Outline
Indonesia’s economic momentum built through 2009
Policy has generally supported this momentum, and near-term risks may be smaller than they first appeared
Strong capital inflow
China-ASEAN FTA
Fiscal stimulus
Impact of windfall revenue on the Budget
The improving near-term economic outlook allows focus to shift to building the current momentum into the medium term
The Government’s medium development plan (RPJMN)
Infrastructure
Social protection
Building momentumIndonesia’s growth built through 2009 Indonesia’s economy accelerated each quarter of 2009, ending the year
outpacing the past decade’s average Economy expanded by 4.5% in 2009
Growth has been broad based across all components of GDP
Indonesia’s trading partners have also recovered, supporting trade volumes
Sources: BPS via CEIC, World Bank
-8
-4
0
4
8
-8
-4
0
4
8
Dec-02 Sep-04 Jun-06 Mar-08 Dec-09
QoQ Seas. Adjust.
Year on year
Per cent Pe cent
0
2
4
6
8
0
1
2
3
4
Dec-02 Sep-04 Jun-06 Mar-08 Dec-09
Per cent Per cent
QoQ seas. adjust (LHS)
Year on year (RHS)
Average (LHS)*
Building momentum …and other domestic indicators are strong
Sources: CEIC, World Bank
-30
-20
-10
0
10
20
30
-30
-20
-10
0
10
20
30
Jan-07 Oct-07 Jul-08 Apr-09 Jan-10
Industrial production
Electricity (industrial)
Cement sales
Per cent Per cent
Other economic indicators have stabilized at high levels
Consumer indicators are around record highs
Industrial indicators are strong
0
20
40
60
80
0
200
400
600
800
Feb-06 Feb-07 Feb-08 Feb-09 Feb-10
'000
Motor vehicles (RHS)
Motor cycles (LHS)
'000
110
150
190
230
60
80
100
120
Feb-06 Feb-07 Feb-08 Feb-09 Feb-10
Index Index
BI Retail sales
BI Consumer Survey Index
Building momentumInflation has fallen to decade lows
Headline inflation has picked up from its low point
Core inflation has continued to fall, to decade lows of 3.6% year to March
Inflation picked up at the start of the year, largely because the seasonal increases in food prices were larger than normal, and this affected poorer households especially
As the harvest comes in andglobal growing conditionsimprove, these increases shouldunwind
But inflation remains higher thanin most of Indonesia’s neighbors
And Indonesia has delayedpassing on to consumers lastyear’s recovery in globalenergy prices
Source: BPS
Building momentumFinancial markets have bounced back Yields on Indonesian debt have returned to pre-crisis
Spreads have narrowed further than other emerging markets
In January, yields on five year IDR sovereigns hit their lowest level since these bonds were first issued in 2003
Agencies have raised their sovereign debt rating for Indonesia
Sources: BPS via CEIC, World Bank
-200
-100
0
100
200
300
400
0
200
400
600
800
1000
1200
Jan-05 Nov-05 Sep-06 Jul-07 May-08 Mar-09 Jan-10
Indonesian EMBI USD Bond Spreads(LHS)
Indonesian Spreads Less Global EMBI Average(RHS)
Basis points Basis points
0
3
6
9
12
15
18
21
24
0
3
6
9
12
15
18
21
24
Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
Indonesia
Philippines
Thailand
Malaysia
United States
Percent Percent
Building momentum2009 budget deficit was smaller than expected
Sources: BPS via CEIC, World Bank
Revenue surged at the end of 2009, while expenditure was only a little weaker than expected cutting the budget deficit to 1.6 per cent of GDP The government spent about 95 per cent of the revised Budget
Programmatic spending was up on previous years; subsidies and interest costs down
The fiscal stimulus is estimated to have added as 1 percentage point to GDP growth
-20
-18
-16
-14
-12
-10
-8
-20
-18
-16
-14
-12
-10
-8
Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09
Per cent Per cent
Realized growth
Growth excluding the VAT payment
Previous forecast
IEQ Q3IEQ Q2
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
J an Feb Mar Apr May J un J ul Aug Sep Oct Nov DecMonthly 2007 Monthly 2008 Monthly 2009 Monthly 2009
Monthly 2009 Cum. 2007 Cum. 2008 Cum. 2009
Government tax revenues Share of line ministries’ budget spent
The OutlookFaster growth, moderate inflation
Sources: BPS, CEIC, World Bank. World Bank projections
Outlook remains for gradual pick-up in growth
Major trading partner growth is expected to pick up and drive exports
Domestic demand, particularly investment, and more export processing activity, are expected to drive further import growth
Inflation should slowly pick up into 2011 on solid domestic demand and a more stable exchange rate
2009 2010 2011
Gross domestic product (Annual per cent change) 4.5 5.6 6.2
Consumer price index (Annual per cent change) 4.8 5.3 6.1
Poverty rate (Per cent of population) 14.2 13.5 11.4
Balance of payments (USD bn) 12.5 6.2 4.7
Budget balance (Per cent of GDP) -1.6 -1.3 na
Budget balance, government projection (Per cent of GDP) -1.6 -2.1 na
Major trading partner growth (Annual per cent change) -1.0 4.3 4.0
There are both risks to the outlook and near-terms issues to consider
10/16/08
Some risks for the outlook:
Withdrawal of global fiscal and monetary stimulus
Weak demand from OECD economies, as consumer and public debt levels are addressed
Ongoing economic reforms in the region so growth is more reliant on domestic demand
On top of these external risks to Indonesia’s economic outlook arenear-term issues challenging policy makers:
Strong capital inflows into Indonesia
Ongoing exposure of Indonesia’s budget to commodity price shocks
Fears that the ASEAN-China FTA will have a significant impact on domestic producers
The Outlook…and these risks impact the outlook for Indonesia
Annual GDP growth
There are both upside potential (from policy breakthroughs and stronger improvements in the global economy) and downside risks to the outlook
Scenarios
Sourcse: BPS, World Bank projections
3
4
5
6
7
3
4
5
6
7
2002 2004 2006 2008 2010
Low High Reference
Per cent Per cent
2010
Reference 4.3 17 1.0 9400 5.6
Low 3.1 14 0.8 11000 5.0
High 4.7 18 7.2 8500 6.2
2011
Reference 4.0 25 5.7 9400 6.2
Low 1.7 15 4.1 10000 5.6
High 4.9 31 14.8 9000 6.4
MTP* CreditExport prices
Rupiah (USD/IDR) GDP
The OutlookRisks remain to the global outlook
The medium term global challenge is to unwind the various stimuli used to fight the downturn:
Reducing the fiscal stimulus and developed country debt burdens is made more difficult by aging populations and political will
And unwinding monetary stimulus is difficult due to uncertainty around lags (too soon and recovery suffers, too late and inflation takes off) and the shift from goods inflation to asset price volatility
This implies that financial markets may remain volatile for some time (exchange rates, commodity prices, interest rates and so forth)
Indonesia is particularly vulnerable to this volatility
Still the volatility, and impact on the economy, is likely to be smaller than late 2008
And the longer term challenges
Addressing global imbalances – improving but are still large implying weaker world growth as OECD consumers save more and consume less
And a difficult structural adjustment to higher world capital and energy prices – compounded by higher carbon prices?
The proposed revised BudgetVolatile oil prices again expanding the deficit
Sources: MoF and BPS. World Bank 2010 projections
The proposed revised 2010 Budget projects a wider deficit of 2.1% of GDP
Mostly due to higher oil price projections, repeating past years’ experience
Total expenditure is expected to increase by around 3 per cent in 2010
Mostly due to higher energy subsidies and transfers to subnational governments
Delayed reform of regulated energy prices and higher outlook for global oil prices are expected to increase subsidy costs by 30%
0
1
2
3
4
5
2004 2005 2006 2007 2008 2009 2010
APBN Realized%
* projected
*
Energy subsidies, as % of GDP
The proposed revised BudgetVolatile oil prices again expanding the deficit
Sources: BPS via CEIC, World Bank
Tax revenues are expected to increase significantly as incomes recover
With a stronger exchange rate and given past patterns, revenues may be event stronger than projected
There are upside risks to the government’s projections; stronger assumptions about the economy and for revenues reduce the deficit towards 1% of GDP
The wider deficit can be easily financed from the 2009 financing surplus
And the government is well-advanced on its commercial debt sales, selling debt at sharply lower interest rates and for longer terms
The proposed revised Budget Volatile revenues hinder effective budgeting
A large spike in revenues with, eg, higher oil prices means more funds need to be allocated to the education budget under the ’20% rule’
Some of the problems with these ‘windfalls’ to the education budget have been addressed:
The Government’s early revision to the state budget reduce the risk of a large windfall arising late this fiscal year
The revised budget establishes an education endowment fund to help ensure that ‘windfalls’ are managed and spent well
Strengthening budget contingency planning in MoNE and MoRA could also help to better manage the problem
Windfalls for the education budget are part of a broader problem, namely, volatility in the budget caused by energy subsidies and fluctuations in resource revenues
Some policy challengesFinancial markets continue to rebound, bringing large capital inflows USD 6.6 billion of foreign capital has flowed into Indonesian financial
assets since June 2009
In this time the Rupiah appreciated 9%
And the central bank has allowed its foreign exchange reserves to grow, while ‘sterilizing’ these increases
The cost of this sterilization is estimated to be low…so far
Sources: BPS via CEIC, World Bank
15
30
45
60
75
-40
-20
0
20
40
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
IDR trillion USD billion
Total Reserves (RHS)
Net Foreign Capital Inflows (LHS)
June 2009
8500
9500
10500
11500
1250025000
35000
45000
55000
65000
75000
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10
IDR/USD (RHS)
Total Reserves (LHS)
IDR Appreciation
USD million IDR per USD
June 2009
Some policy challengesLimited impact from the ACFTA
Sources: MoF
Cuts in tariffs on goods imported from China start in 2005 and another round occurred on 1 January 2010.
The cuts in January were relatively small and follow gradual reduction; higher tariffs remain on some ‘sensitive’ goods
Few traders are using the lower rates available under the agreement
…suggesting this round of tariff reductions is likely to have a small impact
The agreement offers large potential benefits to Indonesia
Since tariff reductions began in 2005, Indonesia’s exports to China have increased by almost 70%
The agreement also promiseslower prices forIndonesianconsumers andproducers, andbetter access toChina's markets
2004 2005 2006 2007 2008 2009 2010 2011 2012Agriculture 11.9 10.5 9.6 9.4 9.4 6.9 6.8 6.8 6.7Chemicals 6.5 6.5 6.5 5.4 5.4 2.4 1.5 1.5 1.2E. Machinery 6.8 6.8 6.8 4.6 4.6 2.1 0.5 0.5 0.4Fish 4.7 0.1 0.1 0.2 0.2 0.1 0.1 0.1 0.0Leather, Rubber, Footwear 8.7 8.7 8.7 7.3 7.3 4.3 3.5 3.5 3.0Other Manufacturing 7.3 7.3 7.3 5.5 5.5 2.2 0.6 0.6 0.2Metals 9.8 8.9 8.9 6.5 6.5 3.2 1.7 1.7 1.3Minerals 5.1 6.0 6.0 5.0 5.0 1.9 1.2 1.2 1.1NE Machinery 2.6 2.6 2.6 2.0 2.0 0.8 0.3 0.3 0.2Petroleum 5.0 3.2 3.2 1.2 1.2 1.2 1.2 1.2 1.2Textiles & Clothing 10.8 10.8 10.8 7.6 7.6 4.3 1.6 1.6 1.1Transport Equipment 28.7 28.7 28.7 18.8 18.9 18.5 18.4 18.4 18.1Wood, Pulp, Paper, Furniture 4.7 4.7 4.7 4.3 4.3 1.1 0.4 0.4 0.0Average 9.9 9.6 9.5 6.4 6.4 3.8 2.9 2.9 2.6
Realizing the development agenda
The improving economic environment allows Indonesia to shift focus to the medium term development issues
Indonesia is poised for government-catalyzed and private sector- driven investment and growth with the right policy improvements for the investment climate and complementary public investments
The Government focuses on these issues in its new medium term development agenda (RPJMN)
The improved economic environment allows Indonesia to spend more on its development priorities
Indonesia’s fiscal and debt position is strong…
…and there are resources to be had if energy subsidies are redirected towards targeted social spending and infrastructure investments
Realizing the development agendaAccelerating investment climate reforms and attacking coordination problems
More aggressive stance toward facilitating domestic and foreign investment: Foreign direct investment levels are relatively low; these investments are
far less footloose than short-term inflows into capital markets
Lower entry barriers, including the time and cost to start a business, the Negative List
Lower operating costs with a focus on actionable steps to improve logistics,
Improve trade facilitation through the National SingleWindow
and control the proliferationof non-tariff barriers that raisecosts and reducecompetitiveness
Solution for Coordination:Regulatory Reform Commission
10/16/08
Foreign direct investment as % of GDP, 2004-2008
0
1
2
3
4
5
6
7
Vie
tnam
Thailand
Mala
ysi
a
Chin
a
India
Indonesi
a
Philip
p's
%
Sources: UNCTAD, World Bank
Realizing the development agenda…supporting investment growth As China rebalances from investment to consumption-led growth,
Indonesia will want to spur investment and net exports
Contributions to annual average growth, 2003-2008
Source: World Bank
-2
0
2
4
6
8
10
12In
donesi
a
India
Chin
a
Net exports
Investment
Private consumpt'n
Total growth
%
Realizing the development agendaPolicies need to support economy-wide growth
Sectors with the greatest reforms grew faster last decade
Service sectors, many deregulated at the start of the decade, have been growing much faster than the rest of the economy
Telecoms, retailing and domestic airlines all experienced rapid growth
But partly the reflects that other sectors, especially mining and manufacturing have not been doing as well
10/16/08
(average annual growth)
0
2
4
6
8
10
2000-02 2002-05 2005-09
Agriculture, mining & manufacturing Services%
Source: BPS via CEIC
Putting in place a Social Protection System consistent with Middle Income Status
Opportunities and Challenges
Indonesia has the resources and institutional capacity to develop effective social protection systems
as demographic and epidemiological challenges mount
Key elements
Build proven and successful social assistance and poverty alleviation programs (PNPM, BOS, BLT,…) into a comprehensive social assistance program
Lay the groundwork for a future National Health Insurance System that is clear, feasible and affordable
And put in place a grand bargain between employers and workers on severance pay that provides worker’s security without discouraging job creation
10/16/08
But all of this will require a bigger push on Institutional and Civil Service Reforms
Replicate models of institutional reform underway (at the Ministry of Finance – especially Tax and Treasury) in other institutions with significant contact with the public—Customs, BPOM, Manpower, Trade and Industry…
Complement ongoing bureaucracy reforms at the institution level with a modernized regulatory framework and central institutional set-up for civil service policy making, regulation and management
Improve compensation, recruiting and promotion but link it to accountability
Allowing fit for function institutions (not one size fits all)
10/16/08
Indonesia Economic QuarterlyBuilding Momentum
Shubham ChaudhuriLead EconomistWorld Bank
8 April 2010Jakarta Indonesia
Slides not used
10/16/08
These development items are consistent with the Government’s development plan
The Government’s 11 priorities;
i) Bureaucracy and governance reform,
ii) Education,
iii) Health,
iv) Poverty reduction,
v) Food security, vi) Infrastructure,
vii) Investment and business climate,
viii) Energy,
ix) Environment and disaster management,
x) Least developed, frontier, outer, and post conflict areas, xi) culture, creativity, and technological innovation.
10/16/08
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