Today (22/10), the World Bank released the October 2015 edition of its flagship Indonesia Economic Quarterly, titled "In Times of Global Volatility". In the report the World Bank states that despite current ongoing global uncertainties (caused by looming monetary tightening in the USA and China's economic slowdown), which make macroeconomic management difficult in the year ahead, pro-active government action could offset the negative impact and may help to boost growth.
Indonesia’s growth moderation continued into the second half of 2015 and an uncertain external environment (which also triggers a weakening rupiah rate) has further limited room for both monetary and fiscal stimulus. As such, the government turned its focus to structural and fiscal reforms to raise investor confidence in Indonesia hence attracting investment. The Indonesian government has taken several steps regarding structural and fiscal reforms. Public capital spending is estimated to have climbed 21.4 percent in real terms in the first nine months of 2015 compared to the same period in 2014, providing support to growth. Furthermore, in September and October the government announced a series of reform packages focused on deregulation and decreasing the costs of doing business. In addition, the draft 2016 State Budget signals the objective of further improving the composition of public expenditures by strengthening social programs and by redirecting spending from energy subsidies to infrastructure development. The World Bank notes that timely and effective implementation of these reforms can contribute to accelerated economic growth.
Global headwinds (China's economic slowdown and looming higher US interest rates) pose significant risks to Indonesia’s economic growth outlook as these external factors cause severe volatility in financial markets: driving emerging market currencies down and raising financing costs. At the same time, the slowdown in growth in developing countries and in global trade, and low commodity prices have weighed on Indonesian fiscal and export revenues.
Given the weak external environment, Indonesia's real gross domestic product (GDP) grew at the moderate pace of 4.7 percent (y/y) in the second quarter of 2015, similar to the rate in Q1-2015. Fixed investment remained the main driver of the economic slowdown, but private consumption expenditure grew at a moderate 4.7 percent (y/y) for a second quarter. Meanwhile, net exports contributed positively to growth but only on account of a significant contraction in imports outweighing a slight decline in exports in year-on-year terms. Since GDP growth fell to 5.0 percent and below in 2014 and the first half of 2015, the poverty rate in Indonesia has remained effectively flat.
Subdued domestic demand in Indonesia and low global oil prices continued to alleviate the country's current account deficit. In quarter-on-quarter terms, Indonesia's current account deficit widened slightly to 2.1 percent of GDP in Q2-2015, from 1.9 percent in the previous quarter, owing to weaker services and income accounts, as is typical in the second quarter of every year.
Meanwhile, the country's overall balance of payments turned to a deficit of USD $2.9 billion (1.3 percent of GDP) in Q2-2015. The financial account balance, at USD $2.5 billion, declined to its lowest level since Q1-2013 as the increase in direct investment did not fully offset the decline in more volatile capital flows. Strong government bond issuance supported portfolio flows in the first half of the year, but these flows reversed in August amid the tightening in financing conditions for all emerging markets. Foreign investors were net sellers of rupiah-denominated government debt in July through September, resulting in USD $1 billion outflows. As of September 30, the stock market has experienced net foreign capital outflows of USD 983 million so far this year, with the trend worsening in August and September.
Bank Indonesia maintained a relatively restrictive monetary stance and has intervened in currency markets to smooth nominal exchange rate volatility, helping to prevent disorderly depreciation. On the other hand, tighter monetary policy, coupled with lower external financing and weak domestic credit demand, has contributed to the continued weakness in credit growth. Given the current constraints on monetary policy to respond to slowing domestic demand, Bank Indonesia has eased macro-prudential regulation to support property and motor vehicle credit, with limited visible impact so far.
Despite weak domestic demand-side pressures and tighter credit conditions, consumer price inflation remained above 7 percent y/y between May and August, falling to 6.8 percent (y/y) in September. The main reasons for the high inflation have been the November 2014 retail fuel price rise (a one-time shock to inflation) and persistently high food, especially rice, price increases. Domestic producer rice prices rose by an average of 16.6 percent (y/y) in June through September, at a time when international prices were decreasing. In addition to long-standing structural challenges in the agricultural sector (e.g. falling productivity and high labor intensity, poor infrastructure and connectivity, fragmented markets and transaction costs related to obtaining import licenses), food (in particular rice) price pressures have risen in recent months in part because of El Niño related drought in some regions of Indonesia. The World Bank estimates suggest that moderate to strong El Niño conditions could raise rice prices by up to 10 percent per year, CPI inflation by at least 0.3 to 0.6 percentage points, and the inflation rate experienced by poor households (which spend a larger share of their income on food) by around 1-2 percentage points. Agricultural households are also likely to have to cope with significantly lower incomes.
The World Bank's base line projection for Indonesia's 2015 GDP growth remains at 4.7 percent (y/y). In 2016, growth is expected to pick up somewhat to 5.3 percent, which is in line with the government’s growth assumption in the 2016 draft Budget. Considerable increases in monthly public infrastructure spending since July and measures to improve public project planning and implementation are likely to provide a small boost to fixed investment towards the end of 2015, with most of the impact on GDP growth expected next year. The slight improvement in growth in 2016 is also based on economic activity strengthening in the Euro Area and Japan and global trade rising, albeit at a pace still significantly below the pre-2008 average. As a result, the demand for commodities is expected to increase somewhat and push export and investment growth higher, though still well below the average before the commodities downturn.
World Bank Assumptions Indonesian Economy:
A faster-than-expected slowdown in China and lower-than-projected global commodity prices are a key downside risk to the outlook. Risks stemming from financial market volatility related to uncertainty about both the pace and magnitude of the normalization of US monetary policy and the prospects for China have increased since August. The significant rupiah depreciation, rising refinancing costs, insufficient hedging of foreign currency debt, and reduced profit margins have weakened corporate balance sheets, especially in the natural resources sector. Given significant external headwinds and constrained policy space, improvements to the baseline growth outlook will critically depend on effective implementation of the recently announced reform packages.