Economic growth of Indonesia has been slowing since 2011 due to weak global demand for commodities (hence impacting negatively on Indonesia’s export earnings) and Indonesia’s higher interest rate environment. The central bank of Indonesia (Bank Indonesia) raised its key interest rate (BI rate) gradually between mid-2013 and late-2014 from 5.75 percent to 7.75 percent in an effort to combat high inflation (triggered by two subsidized fuel price hikes), curb the country’s wide current account deficit, and limit (looming) capital outflows triggered by monetary tightening in the USA. As a consequence, Indonesia’s economic growth pace slowed to a five-year low of 5.02 percent (y/y) in 2014.

During his successful presidential campaign Joko Widodo, inaugurated as Indonesia’s seventh president in October 2014, pledged that structural reforms would get Indonesia’s economic growth back on track. Through these structural reforms, accelerated infrastructure development and investment realization should lead to a +7 percentage point GDP growth by the end of Widodo’s term in 2019. Initially, market participants were thrilled to see Widodo taking the driver’s seat in Indonesia. However, approximately half a year after his inauguration markets are now aware that they have been too optimistic (about economic acceleration) and realize that Widodo cannot perform miracles.

Despite having a vibrant domestic market (domestic consumption accounts for about 55 percent of the country’s economic growth), Indonesia is not immune to international economic turmoil, and instead sees spill-over effects: lower global commodity prices and the sharply depreciated rupiah (imported inflation) reduce people’s purchasing power. As such, Widodo targets to reduce the country’s dependence on commodity exports and household consumption, instead focusing on infrastructure development and investment realization. The president made a promising start by seriously reducing government spending on subsidized fuels and relocate a large chunk of these funds to much-needed infrastructure development. However, due to red tape, weak coordination between government agencies, persistent land acquisition troubles, and lack of financial resources (as the private sector is hesitant to participate in the government’s ambitious infrastructure projects) most projects have not seen groundbreaking yet. When witnessing the groundbreaking ceremony of the Trans Sumatra toll road on Thursday (30/04), Widodo acknowledged that there have been a number of obstacles that blocked infrastructure development at the start of his term, including the lack of financial resources to finance these projects. However, after the Revised 2015 State Budget was approved by Indonesia’s House of Representatives (DPR) in February 2015, Widodo is convinced that the promised infrastructure development will commence soon.

But, to make matters more complicated, market players doubt whether Indonesia’s fiscal budget (which was passed in February 2015), is realistic. The central government targets a 30 percent rise in this year’s tax revenue to meet spending. However, in recent years the country’s tax revenue only grew at a single-digit pace. Expectation of lower-than-projected revenue would mean that the government will have to cut on infrastructure spending.

Regarding Indonesia’s relatively high interest rate environment, Bank Indonesia made a surprise 0.25 percent rate cut (to 7.50 percent) in February 2015 as the central bank is convinced that the country’s economic fundamentals are improving and therefore it could provide some fuel for economic acceleration. However, it will require several months before this move will have an effect on the economy. Moreover, the 0.25 percent rate cut is considered too little to make a real impact and therefore Indonesian businesses have requested Bank Indonesia to cut its interest rate again. However, it is highly unlikely that the central bank will aggressively cut its BI rate soon as inflation may accelerate to 6.80 percent (y/y) in April, while the current account deficit still hovers around 3 percent of GDP (an alarmingly wide deficit). Lastly, a relatively high BI rate can limit the capital outflows (from emerging economies) that are expected to occur when the US Federal Reserve decides to raise its benchmark Fed Fund Rate (this may happen in the third or fourth quarter).

Weak Corporate Earnings Reports Listed Indonesian Companies

Over the past week, key Indonesian companies (listed on the Indonesia Stock Exchange) posted weaker-than-expected Q1-2015 corporate earnings reports. These companies included Astra International, Bank Mandiri, Indofood Sukses Makmur, and Bank Central Asia (BCA).

Astra International, regarded the barometer of the Indonesian economy due to its presence in most sectors of the economy, posted a 15.6 percent decline in Q1-2015 net profit and a 9 percent decline in revenue compared to the same quarter in 2014 due to lower earnings from automotive and commodity-related businesses.

Bank Central Asia, Indonesia’s third-largest lender by assets, saw net income growth slow to 11 percent in Q1-2015, significantly lower than the 27 percentage point growth pace it recorded in the first quarters of 2014 and 2013. Slowing profit growth of BCA is caused by the slowdown in business activities in Southeast Asia’s largest economy (resulting in weaker domestic appetite for loans). Similarly, Bank Mandiri, Indonesia’s largest lender by assets, posted a mere 4 percent (y/y) rise in Q1-2015 profit, down from a growth figure of 14 percent (y/y) in the same quarter last year. Bank Mandiri, which is for 60 percent state-owned, is now counting on government-led infrastructure projects to revive loan growth in the remainder of 2015.

Indofood Sukses Makmur, Indonesia's largest food processing company and a global leading producer of instant noodles, posted a 37 percent (y/y) plunge in Q1-2015 profit due to people’s weakening purchasing power and the depreciating rupiah.

Moreover, other data also suggest that Indonesia’s economic growth has continued to slow at the start of 2015. For example, cement sales (-3 percent), car sales (-14 percent) and motorcycle sales (-19 percent) all fell in the first quarter compared to the same quarter last year. Sales of cement, cars and motorcycles are important figures as they provide information about consumer confidence, purchasing power and infrastructure (and property) development.

Due to investors’ concerns about the further slowing Indonesian economy in the first quarter of 2015, Indonesia’s benchmark Jakarta Composite Index (IHSG) fell 6.4 percent over the past week becoming the worst-performing emerging market in Asia so far this year. It is suspected that many investors have sold Indonesian stocks and invested profits in Chinese, Korean and Taiwanese stocks (stock markets in India and the Philippines are also plagued by this development).

Jakarta Composite Index (IHSG):

The latest two-day policy meeting of the Federal Reserve that ended on Wednesday (29/04) did not make a significant impact on the performance of Indonesian stocks last week as there were no surprising results. Although the Fed did not rule out hiking rates at the next meeting it also downgraded the US growth outlook, implying that a quick US interest rate hike is highly unlikely.

Meanwhile, the Indonesian rupiah only depreciated 0.02 percent to IDR 12,948 per US dollar on Friday (01/05) according to the Bloomberg Dollar Index. However, Bank Indonesia's benchmark rupiah rate (Jakarta Interbank Spot Dollar Rate, abbreviated JISDOR) appreciated 0.03 percent to IDR 12,937 over the past week.

Indonesian Rupiah versus US Dollar (JISDOR):

| Source: Bank Indonesia

Lastly, Indonesia has been plagued by ‘bad press’ as the country executed eight convicted drug traffickers (seven of which are foreign citizens) on Wednesday morning, despite fierce international criticism.