Indonesia. Real Sector. The economy grew 3.7% in the first three quarters.
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1 Indonesia Real Sector The economy grew 3.7% in the first three quarters. The economy grew in a 3.5-4% range in each of the first three quarters, in spite of adverse effects from the 22 Bali bombing, the outbreak of SARS in the region, and the Iraq war. GDP increased 3.9% in the third quarter, bringing growth for the first three quarters to 3.7%. The August terrorist bombing at Jakarta s Marriott Hotel had only a limited impact on growth, but it did slow the recovery of tourism. The Government has retained its forecast of about 4% growth this year, slightly higher than 22 s actual growth (Table 1). Table 1: GDP Growth and Projections (%) 1 Badan Pusat Statistik, ; Ministry of Finance projections, 23, ADB, Asian Development Outlook 23 Update, October IMF, World Economic Outlook, October World Bank, East Asia Update Regional Overview, October Consensus Economics Inc., Asia Pacific Consensus Forecasts, November Official ADB IMF World Bank Consensus Economics Figure 1: Growth of GDP Expenditure Components (y-o-y, %) -6 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Private Public Consumption Consumption Gross Domestic Gross Fixed Investment Capital Formation Consumer spending stays strong, but investment is weak. Consumer spending continued to provide the main impetus to growth, with household expenditures contributing 3.3 percentage points in the third quarter (Figure 1). A sharp decline in deposit rates and continued easy access to credit enabled consumers to increase spending. Real exports were weak, with an increase of less than 1% in each of the three quarters. The continued slump in tourism and a 38% appreciation of the real effective exchange rate since end-2 hurt export earnings. Nonetheless, import compression allowed net exports to contribute to growth. Real imports fell 5.7% in the third quarter, compared with a 3.6% rise in the first half, reflecting weak investment. Fixed investment was flat in the third quarter, compared with 3.5% growth in the first half. As a share of GDP, capital formation remains subdued at 19.9%, only slightly above the postcrisis trough of 19.5% in mid-1999 and well below the 29-3% rate before the 1997 crisis.
2 Figure 2: Sectoral GDP Growth (y-o-y, %) -6 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Agriculture Construction Manufacturing Services Agriculture and manufacturing were weak in the third quarter. Agricultural expansion slowed to.8% in the third quarter from 3.5% in the first half as drought and floods damaged production (Figure 2). Manufacturing output rose a moderate 2.4% in the third quarter, similar to the rate in the first half, reflecting weak exports and subdued investment. In contrast, the services sector expanded a healthy 5.1% in the third quarter from 4.4% in the first half, even though the Marriott bombing set back tourism. Fiscal and Monetary Developments The budget deficit was revised up marginally. The Government marginally revised up the targeted budget deficit for this year to 1.9% of GDP from 1.8%. The deficit for the first three quarters was Rp22.6 trillion, below the official target of Rp25.6 trillion and the projected full year deficit of Rp34.5 trillion. Non-oil and gas tax revenues are rising at slower-than-expected rates, but this is being offset by an increase in oil and gas receipts, net of subsidies. Expenditures, including development projects, also are behind target. Total interest payments have been contained by the substantial decline in the three-month SBI interest rate. The authorities have again given priority to fiscal consolidation next year. The draft budget for 24 targets a surplus in the primary account, which excludes interest payments, of 2.2% of GDP, similar to this year s, and the overall deficit is expected to shrink to 1.2% of GDP. Realization of primary surpluses, combined with lower interest rates, currency stability, and asset sales have contributed to a fall in the public sector debt/gdp ratio from a peak of over 1% to around 7% this year. Financing next year will rely heavily on the domestic bond market. With the exit from the IMF loan program and consequent ineligibility for Paris Club debt relief, financing next year will lean more heavily on domestic sources. The Government plans to raise Rp28 trillion (1.3% of GDP) in the local bond market, up from a targeted Rp11.7 trillion this year. It also intends to draw down Rp26 trillion (1.2% of GDP) from its reserves at the central bank. Net issuance in the bond market will still 47
3 8 4-4 Figure 3: Short-Term Interest Rate, Real Bank Credit Growth, and Inflation Rate (%) -8 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Three-Month Interbank Lending Rate, End of Period Growth in Real Bank Credit to Private Sector, End of Period (y-o-y) Inflation Rate (y-o-y) remain modest at Rp3.5 trillion, so by itself should not exert much pressure on interest rates. However, the integrity of the budget and its financing will depend on maintaining overall stability during the 24 elections. Inflation has eased to around 6%, the lowest level in three years. Inflation slowed to 6.1% in the third quarter, the lowest since the last quarter of 2 (Figure 3). The Government revised down its year-end forecast to 6% from 9%. A stronger currency, a more prudent monetary policy and lower food prices all had moderating effects. The rupiah appreciated 5% against the US dollar and is 6% stronger in real effective terms through November 23 (Figure 4). Also, base money has remained well below IMF program targets. The central bank has lowered its year-end projection of base money growth by three percentage points to 1.8% Figure 4: Exchange Rate Index, Weekly Average (last week of Jun 1997=1, $/Rupiah) Short-term interest rates have dropped to record lows. The moderation in inflation and increased currency stability have allowed Bank Indonesia to guide short-term interest rates to record lows. The one-month and three-month SBI rates have fallen to about 8.5% from 12.9% at end-22, following a 4.5 percentage point decline last year. Bank deposit rates declined with the SBI rates. However, lending rates have proved to be stickier, with working capital rates declining to 16.4% from 18.3% at end Jun Jan Jan 2 12 Apr Nov 23 Commercial bank credit has been growing at a double-digit pace since February in both nominal and real terms. Consumer lending has increased at an annual rate of about 3%, and its share of total credit edged up to 23.5% as of August from 21.8% at end-22. In recent quarters, loans to private firms also have expanded. Banks may be resuming intermediary functions after a long hiatus, partly as interest income from government bond holdings decline. Balance of Payments Exports weakened, but the current account surplus remains large. The dollar value of exports weakened through the first three quarters (Figure 5). Merchandise exports fell 1.9% in September, after starting 48
4 Figure 5: Growth of Merchandise Exports and Imports, Dollar Value (y-o-y, %) -5 98Q1 99Q1 Q1 1Q1 2Q1 3Q1 Exports Imports the year with a gain of 22%. Much of the 7.5% increase in exports in the first nine months came from oil and gas shipments. Non-oil and gas exports grew a modest 3.6%. Imports tracked the deceleration in exports, reflecting subdued investment and the likely high import component of manufactured exports. The merchandise trade surplus in the first nine months was $21.6 billion, about 7% higher than a year earlier. This surplus helped offset some of the decline in tourism revenue. The market consensus is for a $6.7 billion (about 3% of GDP) current account surplus for the full year, compared with $7.5 billion (4.3% of GDP) realized last year. Tourist arrivals hit a six-year low in April as the Bali bombing and SARS took their toll, but arrivals posted a strong 25% average month-on-month growth in May-June. Following the Marriott bombing, arrivals declined in August and September to 9% below the year-earlier period. Capital account improves with slower private sector outflows. Net private capital outflows slowed to a total of $1.8 billion in the four quarters to March from $6.1 billion a year earlier, reflecting debt restructuring, including write-offs, and portfolio inflows. In spite of large asset sales, net foreign direct investment has continued in deficit. Most recent data shows an outflow of $2.65 billion in the first quarter, underscoring a poor investment climate. A 3.7% rise in foreign investment approvals in the first nine months, to $6.2 billion, was likely a result of asset sales by IBRA. Approvals of new projects were still below year-ago levels, suggesting that investor confidence remains weak. Figure 6: International Reserves and External Debt ($ billion) 98Q1 98Q3 99Q1 99Q3 Q1 Q3 1Q1 1Q3 2Q1 2Q3 3Q1 3Q Gross International Reserves Total External Debt Higher reserves should help fund next year s increased obligations. Foreign exchange reserves rose to $34.7 billion in November from $31.6 billion at end-22 (Figure 6), equivalent to about six months of imports and over twice the level of short-term external debt. The exit from the IMF loan program at the end of 23 and the consequent ineligibility for Paris Club debt relief mean that external financing requirements will rise by about $3 billion next year. The current account surplus and increase in reserves provide room to pay the Government s higher debt obligations without putting undue pressure on the rupiah. Current account surpluses and debt restructuring enabled total outstanding external debt to decline to $132.8 billion as of end-september from a peak of $15.9 billion in As a share of GDP, total public and private external debt was about 7%, compared with 157% in
5 Financial and Corporate Restructuring IBRA is making significant progress on asset sales. IBRA realized Rp12.7 trillion from asset sales by the end of August, exceeding its target for the period and almost half the Rp26 trillion goal set for 23. Proceeds from bank sales have exceeded the fullyear target and loan disposals appear on track, with 45% of the target met. But the sale of companies acquired from former shareholders of insolvent banks is lagging. IBRA intends to sell most remaining assets by February 24, when its mandate expires. Corporate debt restructuring has progressed. Apart from loans resolved by IBRA, corporate sector debt restructuring advanced significantly under the Jakarta Initiative. Between its inception in 1998 and 1 October 23, the Jakarta Initiative Task Force (JITF) successfully mediated memoranda of understanding in 96 cases with debt of $2.5 billion, about 7% of total debt registered. Of this amount, $1.9 billion was mediated this year, less than the amounts in previous years, probably because later cases tend to be more complex. Resolution of NPLs increasingly will depend on the courts. Headline nonperforming loans declined to 8.3% of total loans in September from a peak of 49.2% in January System-wide NPLs, including those in IBRA, are higher. With the JITF s mandate to end this year and IBRA to close in February, the pace of debt restructuring will depend more heavily on the market mechanism and, therefore, on the courts. The Government s program for legal reforms, including an amendment of the bankruptcy law and general improvement of commercial courts performance, will assume added significance. Prospects and Policy Issues Growth in 24 is forecast at 4.4%. The Consensus Economics survey forecasts GDP growth at 3.8% this year, rising to 4.4% in 24. Slightly stronger growth next year appears achievable if the global environment improves further, the Government makes progress on its post-imf reform agenda, and risks related to 5
6 the long electoral season remain modest. Low interest rates and ample access to credit should support private consumption. And while investment may remain subdued, its effect on GDP could be offset by a concomitant weakness in imports. Macroeconomic stability needs to be preserved. With electoral uncertainty likely to persist for the first 1 months of 24, market confidence must be retained to preserve the gains made over the past 18 months. The Government s White Paper on policies to be implemented after its exit from the IMF loan program provides a useful road map for investors. These reforms are broadly classified into three areas macroeconomic stability, financial sector reforms, and policies to increase investment, exports, and employment. Continued vigilance over monetary policy by the central bank and coordination with Government will become more important in 24. The drawdown of government reserves at the central bank for budget financing could have an undesirable expansionary impact on base money growth. The central bank and the Government also plan to cooperate on the relatively large value of bonds to be issued, so that systemic liquidity and interest rates can be managed. Meeting fiscal targets will depend on further tax reforms, including the expansion of the tax base and more efficient collection. The budget s reliance on asset sales as a source of funds will drop next year. However, further progress on disposal of IBRA s unsold assets, including majority stakes in Bank Lippo and Bank Permata, would help investor sentiment and enhance efficiency. Stronger investment flows would enable faster long-term growth. Policies to improve the investment climate have lagged. Indonesia s export performance, for example, should arguably have been stronger this year given the rise in non-oil commodity prices. Structural and institutional problems continue to hinder investment and productivity growth. It is also possible that Indonesia is losing price competitiveness as its real effective exchange rate appreciated 38% over the past three years. While much of this strength likely reflects a correction of the sharp plunge during the crisis and a marked improvement in macroeconomic fundamentals since, there are concerns that exports are now less competitive. Over the longer-term, without a sustained increase in investment, growth is unlikely to accelerate at rates sufficient to reduce unemployment and poverty. The World Bank estimates that 52.3% of Indonesians live in poverty in 23, using the $2-a-day benchmark. Cognizant of this imperative, the White Paper addresses the main impediments to investment, including legal and governance 51
7 reforms, rationalizing labor laws, harmonizing and simplifying central and regional regulations, and buttressing security against terrorism and crime. Progress in these areas could lead to higher investment over the longer term, given the size of the market, abundance of natural resources, and a literate workforce. 52
8 Indonesia: Selected ARIC Indicators Q1 Q2 Q3 Q4 1Q1 1Q2 1Q3 1Q4 2Q1 2Q2 2Q3 2Q4 3Q1 3Q2 3Q3 Output and Prices GDP Growth (%) Private Consumption Expenditure Growth (%) Public Consumption Expenditure Growth (%) Gross Domestic Investment Growth (%) Gross Fixed Investment Growth (%) Agricultural Sector Growth (%) Manufacturing Sector Growth (%) Construction Sector Growth (%) Services Sector Growth (%) Exports of Goods and Services Growth (%) Imports of Goods and Services Growth (%) Inflation Rate (%) Unemployment Rate (%) Monetary and Fiscal Accounts Growth of Broad Money, M2 (%) Three-Month Interbank Lending Rate (%) Growth in Real Bank Credit to Private Sector (%) NPL Ratio of the Banking System Average Stock Price Index National Government Fiscal Balance as % of GDP Central Government Debt as % of GDP Government Expenditure on Education (% of Total) Government Expenditure on Health (% of Total) External Account, Debt, and Exchange Rates Growth of Merchandise Exports ($ fob, %) Growth of Merchandise Imports ($ cif, %) Current Account Balance as % of GDP Net Foreign Direct Investment ($ Billion) Net Portfolio Investment ($ Billion) Gross International Reserves ($ Billion) Total External Debt as % of GDP Real Effective Exchange Rate (1995=1) Average Exchange Rate (Local Currency to $) 2,327 2,89 1,224 7,848 8,45 1, ,391 8,243 8,74 9,241 9,778 11,226 9,717 1,33 1,176 9,15 8,95 9,43 8,91 8,485 8,433 Note: All growth rates are on a year-on-year basis.... = not available. 1 End of period. 2 Central government debt refers only to government s and state enterprises outstanding external debt. 3 Trade weighted using wholesale price index for trading partners and consumer price index for the home country. Sources: Data on output and prices, M2, real bank credit to private sector, nonperforming loan ratios of the banking system, national government fiscal balance, central government debt, government expenditure on education and health, merchandise exports and imports, current account balance, net foreign direct and portfolio investment, gross international reserves, and total external debt are from national sources. Data on interbank lending rate, average stock price index, and average exchange rate are from Bloomberg LP. Real effective exchange rates are based on REMU staff calculations.
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