The economy of Indonesia, which has been slowing since 2011, will have difficulty to rebound in 2015 as the central bank’s key interest rate (BI rate) is expected to be raised again to avert capital outflows brought on by higher interest rates in the US and to combat accelerated inflation after domestic subsidized fuel prices have been raised by the new government led by president-elect Joko Widodo (Jokowi). After a GDP growth pace of 6.5 percent (y/y) in 2011, economic growth in Southeast Asia’s largest economy fell to 5.8 percent (y/y) in 2013.
In the second quarter of 2014, Indonesia’s GDP growth continued its downward trend to 5.17 percent (y/y), the slowest quarterly growth result since the third quarter of 2009. This slowing trend is partly caused by Bank Indonesia’s higher BI rate. Between June and November 2013, the central bank increased the BI rate gradually yet aggressively from 5.75 percent to 7.50 percent. The central bank felt a higher interest rate environment was needed in an effort to combat high inflation (which accelerated to around 9 percent y/y after subsidized fuel prices were raised in June 2013), and to curb the wide current account deficit (which should then support the Indonesian rupiah exchange rate that had depreciated over 25 percent against the US dollar during 2013).
The higher interest environment in Indonesia led to slowing credit growth (to the private sector) from 21.4 percent y/y in the fourth quarter of 2013 to 19.1 percent y/y in the first quarter of 2014, and to 16.6 percent y/y in the second quarter of 2014.
Indonesia's Quarterly GDP Growth 2009–2014 (annual % change):
|Year|| Quarter I
||Quarter II||Quarter III||Quarter IV|
Source: Statistics Indonesia (BPS)
Gross Domestic Product of Indonesia 2006-2013:
(in billion USD)
(annual percent change)
|GDP per Capita
Sources: World Bank, International Monetary Fund (IMF) and Statistics Indonesia (BPS)
As prices of subsidized fuels are expected to be raised again significantly before the year-end, inflation will accelerate again. Moreover, US economic data signal that economic growth in the world’s largest economy is structural and therefore the Federal Reserve may raise its key interest rate sooner than expected. For emerging markets this means that capital outflows are most likely, particularly those emerging markets that show financial or fiscal weaknesses. Indonesia is one of these vulnerable countries as it has to cope with a wide current account deficit (mainly caused by costly oil imports to meet domestic fuel demand). Therefore, Jokowi wants to curb state spending on fuel subsidies (set at IDR 276.1 trillion in the 2015 State Budget) and spend the available funds on economic and social development. Specifically the lack of quality and quantity of infrastructure is one of the bottlenecks of the country and results in high logistics costs that weakens the competitiveness of the country's businesses.
Although the Indonesian government and international institutions (such as the Asian Development Bank) expect that GDP growth of Indonesia will accelerate in 2015, Jokowi will need to push for true reforms, which is not easy remembering that he has to cope with a hostile Merah-Putih coalition in parliament), in order to offset the negative impact of a higher BI rate on economic expansion. Such reforms include higher subsidized fuel prices, productive government spending, optimize tax income, and improve the investment climate by fostering a sound legal system, bureaucratic reform and infrastructure development.