Indonesia Investment Summit 2015: Structural Reforms Needed
At the Indonesia Investment Summit 2015, organized in Jakarta on 15-16 January 2015, Bank Indonesia official Arief Mahmud presented several views of the central bank on the current Indonesian economy and the global and domestic challenges that it faces. As is widely known, Indonesia has been experiencing a process of slowing economic growth since 2011 due to sluggish global economic growth in combination with the rebalancing of the domestic economy. However, growth is expected to accelerate in 2015.
Mahmud emphasized the threat of high volatility due to current uncertain global economic conditions as the economy of Japan has fallen into recession, the economy of China has been experiencing slowing economic growth, while the Eurozone’s economy remains sluggish. This means that the world economy is currently running on one engine only: the US economy. Meanwhile, from the domestic side, Indonesia is implementing structural reforms (such as scrapping fuel subsidies) to boost higher (long-term) economic growth. However, on the short-term these structural reforms lead to limited economic growth as the central bank needed to raise its benchmark interest rate (BI rate) aggressively in an effort to curb high inflation. Between June 2013 and November 2014 Bank Indonesia raised its BI rate from 5.75 percent to 7.75 percent. This move was also conducted in order to curb the country’s wide current account deficit, support the rupiah exchange rate and avert severe capital outflows amid monetary tightening in the USA.
Bank Indonesia has also pushed for prudent policy in terms of external debt, particularly private sector foreign debt. The country’s privately-held foreign debt rose three-fold between end-2005 and 2014 (surpassing public sector external debt in 2012). In October 2014 Indonesia’s total outstanding external debt reached USD $294.5 billion, of which USD $161.3 billion (54.8 percent of total foreign debt) was privately-held debt. Earlier, research conducted by Indonesia’s central bank had signalled that this privately-held external debt is vulnerable to three risks i.e. currency risk, liquidity risk and overleverage risk. Mahmud stated that the sharp increase of private sector foreign debt is logical considering that the central bank implemented a higher interest rate environment in Indonesia since 2013, thus making the private sector turn abroad to obtain new funds.
Apart from the fuel subsidy reform, Indonesia needs much heavier structural reforms to achieve a GDP growth rate of +7 percent (year-on-year) as had been promised by President Joko Widodo during the campaign period ahead of the presidential election. One of the major challenges is to turn Indonesia from a (raw) commodity exporter into a manufacturing exporter. According to Mahmud, it is vital to boost the domestic supply side in Indonesia amid rising demand (triggered by an expanding middle class that currently numbers about 75 million). Boosting domestic supplies will curtail inflation and curb the country’s trade and current account deficits (and possibly turning these back into a surplus) as there will be less need for imports. Mahmud also pointed to the (seemingly) paradox situation that, currently, export growth directly leads to import growth due to the relatively high import content of the country’s export products. As such, export growth only has limited positive impact on the country’s trade balance.
Asked about whether the current low global oil prices are assessed positively by Bank Indonesia, Mahmud replied that theoretically the low oil prices should have a positive impact on Indonesia (the country being a net oil importer) as inflation should reduce, GDP growth should accelerate and there should be more fiscal room for public investments in structural sectors (such as infrastructure, healthcare and education). However, the crude oil price is closely related to prices of other commodities and therefore the positive impact of cheaper oil imports are largely offset by the weakening value of commodity exports. He added that the government’s push for much-needed infrastructure projects in 2015 will also imply a weakening of the country’s trade balance as these projects require a high amount of imported materials.
Mahmud further stated that investment (both public/private and foreign/domestic) will be the backbone of Indonesia’s economic growth in 2015. He agrees that the government should provide incentives to attract foreign investment in domestic value-added sectors. In fact, Mahmud expects to see a race among Asian emerging markets to attract foreign investment through competitive incentives in the years ahead. The central bank expects to see a GDP growth rate of between 5.4 and 5.8 percent this year.
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