The World Bank appreciates the Indonesian government's push for reform, focusing on enhancing investment growth, revitalization of the domestic industries, and boosting trade. A positive sign is that public capital spending rose by an estimated 49.8 percent (y/y) in Q3-2015. Moreover, the government will further reduce spending on energy subsidies in the 2016 State Budget, instead raising spending on infrastructure and health development as well as social programs. Lastly, the government has unveiled seven economic stimulus packages, dealing with matters such as boosting investment, trade, fiscal stimulus and purchasing power.

The fiscal deficit of Indonesia expanded to 2.5 percent of GDP in October as government spending accelerated, while revenue collection was lower-than-expected (especially on weak tax income). The World Bank warns that if revenue collection remains weak in the last quarter of 2015 and in 2016, then the government's ongoing public infrastructure spending momentum may be at risk.

In October 2015 emerging market assets rebounded after concerns eased about China's economic slowdown and the US interest rate hike (in the preceding two months there were massive capital outflows from emerging markets). However, inflows in emerging markets were not strong, while borrowing costs remained relatively high. The central bank of Indonesia (Bank Indonesia) has kept its benchmark interest rate (BI rate) at 7.50 percent since February 2015. In addition to tight financing conditions, global demand for Indonesian export products remained weak due to  sluggish global growth and persistently low commodity prices.

Indonesia's economy expanded 4.7 percent (y/y) in Q3-2015, roughly the same pace as in the two preceding quarters, supported by growth in government spending on consumption and capital. Private investment, on the other hand, remained subdued, while business sentiment indicators signal persistent weakness and Indonesia's unemployment rate rose from 5.9 percent in August 2014 to 6.2 percent in Q3-2015 (a marked contrast with the declining trend over the past decade).

The forest fires (on parts of Sumatra and Kalimantan) and toxic haze that spread to other parts of Southeast Asia constrained Indonesia's GDP growth. Between June and October, more than 100,000 man-made forest fires destroyed 2.6 million hectares of land. Costs are estimated at IDR 221 trillion (more than twice the reconstruction costs after the tsunami in Aceh in late-2004). Indonesia's real agriculture output declined 4.9 percent (at a quarter-on-quarter seasonally adjusted annualized rate) in Q3-2015.

World Bank's Economic Assumptions Indonesian Economy:

       2014     2015F     2016F
Real GDP
(annual % change)
       5.0        4.7        5.3
Consumer Price Index
(annual % change)
       6.4        6.3        4.6
Current Account Balance
(% of GDP)
      -3.1       -2.0       -2.4
Budget Balance
(% of GDP)
      -2.2       -2.5       -2.2

Source: World Bank

Meanwhile, Indonesia's imports and exports fell to their lowest levels since 2010 due to weak domestic and global economic activity. As imports declined faster than exports, Indonesia's current account deficit narrowed. This managed to ease some external pressures. However, declining capital flows caused a balance of payments deficit. Total net capital flows in the first three quarters were recorded at USD $9.6 billion, down nearly 70 percent from the same period last year. Net foreign purchases of IDR-denominated sovereign bonds (SUNs) were down 54 percent (y/y) in the first ten months of 2015 (losing appeal due to the volatile rupiah), while government foreign currency-denominated debt rose by 80 percent.

Headline inflation eased below 5 percent (y/y) in November as the impact of last year's subsidized fuel price hike waned. However, this will not lead to a loser monetary policy due to weaker capital flows and pressure on the rupiah (ahead of a looming US interest rate hike). Bank Indonesia implemented several measure to safeguard rupiah stability, ranging from foreign exchange interventions in the forward market to the issuance of Bank Indonesia Certificates (SBIs) in foreign currency. The central bank also renewed its bilateral currency swap agreement with China.

The World Bank states that the main external risks remain unchanged i.e. a stronger than projected slowdown in emerging markets (including China), sluggish global economic growth, persistently low commodity prices and financial market volatility due to looming tighter monetary policy in the USA. Internally, there is the risk of weak public revenue collection (as the driver of economic growth in Indonesia has shifted to the public sector).

Further Reading:

World Bank Indonesia Economic Quarterly