Indonesia’s Slowing Economic Growth: the Case of Private Consumption

GDP growth is calculated using four elements: private consumption, gross investment, government spending and exports (minus imports). It is interesting to take a closer look at one of these elements, i.e. private consumption (which accounted for about 55 percent of GDP growth in Indonesia in 2012), and analyze its contribution to GDP as well as current and near future trends of Indonesia's private consumption.

	2006	2007	2008	2009	2010	2011	2012
GDP (in billion USD)	285.9	364.6	432.1	510.2	539.4	706.6	850.0
GDP (annual percent change)	5.5	6.3	6.1	4.6	6.1	6.5	6.2
GDP per Capita (in USD)	1,643	1,923	2,244	2,345	3,010	3,540	3,592

^{Sources: World Bank and International Monetary Fund (IMF)}

After the commodities boom of the 2000s waned, the main pillar for economic growth of Indonesia has been private consumption. Indonesia is characterized by a quickly expanding middle class and corresponding rising per capita GDP. Research firms, such as the Boston Consulting Group (BCG) and McKinsey, expect that Indonesia’s middle class will grow to between 130 and 140 million people by the period 2020-2030. In 2012, the country's middle class is estimated at around 75 million people, out a total population of over 240 million people.

In terms of GDP growth, an expanding middle class constitutes an important asset. More and more people - with rising purchasing power - will increase consumption (or start consumption) of all sorts of products: food, clothes, cars, houses and more. This development gives a boost to various domestic industries, for example fast-moving consumer goods, property and manufacturing, and leads to more employment opportunities due to expanding industries, provided that the country contains these industries (and not need to import the products to meet domestic demand). Most products with higher technological content, however, are still imported.

Taking a look at corporate earnings reports of Indonesian companies engaged in consumer goods and property we see spectacular growth rates in recent years. As such, the story of Indonesia's private consumption is rosy and also contains a rosy outlook for the future. However, there are currently some bumps in the road due to recent macroeconomic developments in Indonesia as well as the impact of global uncertainties.

The major enemy of people's purchasing power is high inflation. Indonesia, which always contains a relatively high inflation rate due to the country's higher economic growth compared to developed countries, is currently coping with significant inflation. This development is mainly due to the Indonesian government’s decision to increase prices of subsidized fuels in late-June (by an average of 33 percent), which made transportation costs much more expensive. As a result, prices of many products and services were raised. In September 2013, the country's inflation rate stood at 8.40 percent, while it is estimated to accelerate to 9.8 percent by the end of the year. This is much higher than the central bank's initial target of 4.5 percent (a calculation which did not include higher fuel prices) in 2013. In mid-2014, Indonesia's inflation rate is expected to be back at a normal level (4.5 to 5.0 percent).

Besides impacting directly (and negatively) on people’s purchasing power, high inflation has also triggered a monetary policy response from Indonesia's central bank (Bank Indonesia), which curbs private consumption and thus cools economic expansion. In recent months, Bank Indonesia raised the country's benchmark interest rate (BI rate) gradually from 5.75 percent to 7.25 percent in September, causing loans and mortgages to become more expensive. The resulting slower expansion of private consumption is therefore partly to blame for the country's slowing economic growth.

There is, however, one advantage to a slowdown in private consumption. As prices of commodities have been reduced significantly in recent years, while imports have grown at the same time, Indonesia turned into a net importer since last year. The country’s widening current account deficit stood at USD $9.8 billion in the second quarter of 2013, equal to 4.4 percent of GDP, a worrying number. This wide deficit has scared investors away from Indonesia. When in May 2013 the Federal Reserve started to speculate about an end to its monthly massive USD $85 billion bond-buying program (quantitative easing), investors quickly pulled their money out of emerging countries that show some weaknesses in their financial make-up. The widening current account deficit of Indonesia was a major contributing factor that led to falling investor confidence, resulting in capital outflow from the Indonesia stock index and bond market as well as a seriously depreciating rupiah exchange rate against the US dollar. The rupiah has been one of the worst performing Asian currencies, depreciating 16.2 percent since the start of this year, thus making imports more expensive. With less purchasing power to buy imported products, the value and quantity of imports can be curtailed, thus reducing the trade deficit.

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