In this column we are going to take a quick look at all the challenges (both domestic and global ones) Indonesia is facing (or has faced recently) as well as the developments that support an optimistic view. This should shed  some light on the stability (or instability) of the Indonesian economy and its prospects for the near future.

A. Global Economy

In recent years global markets have been plagued by severe volatility brought about by the economic slowdown of China, monetary policy adjustments conducted by the central bank of the USA (Federal Reserve), and sluggish growth in the Eurozone and Japan (causing the central banks of these regions to implement an accommodative monetary policy).

Challenge: Markets continue to be confronted with weaker-than-expected macroeconomic data from China. As China is the world's second-largest economy and the world's largest energy consumer further slowing growth (or a hard landing) of the country will have a negative impact on global economic growth and puts continued downward pressure on global commodity prices. These issues are here to remain as China is being transformed from an economy driven by export and public investment to an economy driven by domestic consumption. This process will require time.

Challenge: Indonesia's exports, highly dependent on (raw) commodities such as crude palm oil and coal, plunged 14.6 percent (y/y) to USD $150.25 billion in 2015. Further dropping commodity prices can only exacerbate the country's export performance, thus limiting foreign exchange earnings. In December 2015, Indonesian exports fell for a 15th straight month. The low crude oil price also pushes down prices of other commodities and therefore - while being a net oil importer - Indonesia cannot benefit too much (or perhaps not at all) from the current low crude oil prices.

Optimism: The December Fed Fund Rate hike did not cause severe capital outflows from emerging markets (including Indonesia) as the move had already been expected and anticipated by investors and, in fact, it removed a chunk of uncertainty from markets. Moreover, the move was evidence that the economic recovery of the world's largest economy persists. The Federal Reserve is expected to remain acting carefully by raising its key interest rate gradually and modestly in the period ahead, thus averting sudden shocks that can can lead to capital outflows from riskier assets.

Macroeconomic Indicators Indonesia:

    2010   2011   2012    2013    2014    2015    2016
Gross Domestic Product²
  (annual percent change)
   6.4    6.2    6.0     5.6     5.0     4.7¹     5.3¹
• Consumer Price Index
  (annual percent change)
   5.1    5.4    4.3     8.4     8.4     3.4     4.0
Exchange Rate
 9,074  8,773  9,419  11,563  11,800  13,400¹  13,900¹
Current Account Balance 
(percent of GDP)
   0.7    0.2   -2.8    -3.3    -2.9    -2.0¹    -2.3¹
• Foreign Exchange Reserves
  (in billion USD)
  96.2  110.1  112.8    99.4   111.9   105.9  

¹ indicates a forecast
² Statistics Indonesia (BPS) shifted the basis of the computation from the year 2000 to 2010 and adopted a significantly updated methodology, hence GDP growth results between 2010 and 2014 have been revised in early 2015
Sources: World Bank, Statistics Indonesia, Bank Indonesia and International Monetary Fund (IMF)

B. Domestic Economy

Indonesia's economic growth in the fourth quarter of 2015 is not expected to have improved significantly despite fiscal stimulus and deregulation measures introduced by the Indonesian government through a series of economic stimulus packages.

Challenge: Although Indonesia's key interest rate (BI rate) was cut by 0.25 percent to 7.25 percent in January 2016 (still a relatively high rate) there seems limited room for more rate cuts amid ongoing concern about China's hard landing and expectation of more US interest rate hikes this year. Businesses would like to see a lower interest rate in order to expand their business. Total credit growth in Indonesia during 2015 expanded by a mere 9.8 percent (y/y) to IDR 4,083 trillion (approx. USD $296 billion), failing to fall within the central bank's target range of 11-13 percent (y/y). With the BI rate still relatively high, credit expansion has difficulty to rise.

Challenge: Slower growth of third-party funds at Indonesian banks and the decision of the Indonesian government to increase government bond issues may lead to a near-term liquidity squeeze for local lenders.

Challenge: Despite having appreciated significantly since October 2015, the rupiah is still facing obstacles in the form of more US interest rate hikes in 2016 and China's hard landing (accompanied by a weaker yuan).

Optimism: Household consumption in Indonesia remained stable in 2015 and constitutes a main pillar of support for the nation's economic growth. Moreover, the Indonesian government is committed to enhance infrastructure development. Starting from the second half of 2015 there has been detected growth in public spending on much-needed infrastructure development projects.

Optimism: After inflation at 8.4 percent (y/y) in both 2013 and 2014 (due to the subsidized fuel price reforms), the consumer price index of Indonesia has finally eased to a comfortable level, well within the central bank's target range. At the end of 2015 Indonesian inflation eased to 3.4 percent (y/y). Although there remain some inflationary pressures from the food product component, we expect that inflation will be under control in 2016 at around 4 percent (y/y), especially as oil prices have difficulty to rise in the near future.

Optimism: Indonesia's current account deficit has been a major concern to many investors since late 2011. In 2015 this deficit is estimated to have declined to around 2 percent of GDP from 3.1 percent of GDP in the preceding year. However, as this decline is primarily caused by plunging imports into Indonesia (a sign of weaker economic activity) it is not all optimism.

Optimism: Indonesia's financial system stability (and liquidity) seems in check with a capital adequacy ratio (CAR) at 21.1 percent and a non-performing loan ratio at 2.7 percent.