East Asia-Pacific Economic Update Clearing skies William E. Wallace Lead Economist World Bank 4 November 29 Jakarta Indonesia
Indonesia through the global crisis Growth has been picking up After stalling at the end of 28, then dropping less less than anticipated the economy has been recovering quickly in the first half of 29 In particular exports fell less and have been recovering faster than imports Meanwhile domestic demand held up well, supported by momentum, election spending, and most recently, the government s stimulus (aggregate GDP growth) Sources: BPS via CEIC, World Bank
Indonesia through the global crisis And Indonesia has done relatively well The extreme volatility in financial markets led to a sharp falls in global output but there are clear signs that the global economy has been stabilizing and even beginning to recover since Q2 % 6 4 (GDP growth, quarterly, seasonally adjusted) Q3 28 Q4 28 Q1 29 Q2 29 2-2 -4-6 India China Indonesia Philip. U.S. Euro Area Malaysia Japan Thailand Sources: CEIC, Haver Analytics, BPS, JP Morgan, World Bank
Indonesia through the global crisis With the social impact surprisingly limited National poverty fell to 14.2% Open unemployment also declined to from 8.5. to 8.1% in February Employment growth outpaced the increase in the workforce But most new jobs were informal 25 % 2 23.4 19.1 National poverty rate (%) Open unemployment rate 15 1 6.4 6.1 8.1 9.1 11.5 9.9 18.4 18.2 17.4 16.7 16. 17.8 16.6 15.4 11.2 1.3 9.3 14.2 8.5 8.1 5 1999 2 21 22 23 24 25 26 27 28 29 Source: BPS
Indonesia through the global crisis And rapidly moderating inflation BUT Inflation is likely at or near its lowpoint With lower food prices benefiting poorer households 21 % 18 15 12 9 6 3 However, core inflation has fallen less Cost of the poverty basket (LHS) 27 28 29 Food (LHS) Monthly headline inflation (RHS) Headline inflation (LHS) 6% 5 4 3 2 1-1 Therefore, despite the decline, Indonesia s inflation remains higher than trading partners and remains a concern as growth picks up? 2 15 1 5 Per cent, YoY Indonesia US Per cent, YoY Korea India Japan China -5-5 Jan-6 Oct-6 Jul-7 Apr-8 Jan-9 Oct-9 2 15 1 5 Sources: BPS, CEIC< World Bank estimates of poverty basket inflation
Indonesia through the global crisis While financial markets have recovered For example, rupiah, and foreign exchange reserves are now back to the levels of mid 29 12,6 IDR/ USD 12, Foreign exchange reserves (USD bn; RHS) USD 65 bn 6 11,4 55 This is good news but risks putting more pressure on exporters and raises flags around rapid inflows of portfolio capital 1,8 1,2 9,6 9, Exchange rate (IDR/USD; LHS) 5 45 4 35 8,4 Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9 3 Source: BI
Indonesia through the global crisis Relieving some pressures on government finances Yields on Indonesian debt have returned to early 28 levels Spreads on Indonesian debt spiked during the financial market turbulence with Indonesia singled out as an especially vulnerable country But yields have now recovered, and are a bit remarkably now below global emerging market levels % 12 4 bps 1 (EMBI spreads on sovereign USD bonds) 8 6 4 Indonesian USD bond spreads (LHS) 32 24 16 8 21 % 18 15 12 9 6 (local currency 5 year bond yields) Indonesia Philippines 2 Indonesian spreads less global emerging market average (RHS) Jan 7 Jul 7 Jan 8 Jul 8 Jan 9 Jul 9-8 3 Thailand Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 Sources: JP Morgan, BI, CEIC, World Bank
Indonesia through the global crisis but creating new risks Non-residents have been net buyers of equities, Bonds and SBIs For example, non residents added 11.5 tr of Bonds in September in September alone These inflows reduce the cost of equity and borrowing in Indonesia but raise macro risks, as funds can be withdrawn during bouts of financial turmoil 12 IDR tr 1 8 6 4 Non-residents holdings of Bonds and Equities Non-residents' holdings of SUNs (LHS) 2 Net non-resident IDX purchases in the past 3 days (RHS) Jan 8 May 8 Sep 8 Jan 9 May 9 Sep 9 IDR 12 tr 9 6 3-3 -6 Sources: DG Debt, IDX, CEIC, World Bank
Why has Indonesia weathered the storm so well? Structure of the economy Relatively low trade shares overall a large domestic market (with the added benefit of momentum coming in) Exports weighted towards commodities and sent to a diverse range of markets Low manufacturing/tech shares and correspondingly higher commodity shares in trade But these factors are likely to limit Indonesia's growth prospects going forward GDP growth (Sep-8 to Mar-9) % 2 1-1 -2-3 -4-5 -6-7 -8-9 (producers of capital and high-tech goods suffered larger falls in GDP) Spain Australia Netherlands Italy Mexico Indonesia Canada US UK Japan France Germany Korea Malaysia Thailand Taiwan 4 8 12 16 2 24 % Medium- and high-tech manufacturing output (% GDP) Sources: IMF, CEIC, Thomson- Reuters, RBA, BPS, World Bank
Why has Indonesia weathered the storm so well? Strong financial and fiscal positions Relatively strong financial sector with little exposure to critical financial products Low corporate leverage Low public debt, strong fiscal position (central government budget deficit and debt levels) 12 % 3. % 1 8 6 4 2 12.5 77.1 8. 76.4 Deficit (RHS) 65.4 58.3 55.2 Public debt (LHS) 45.6 38.6 34.9 32.9 32.9 2.5 2. 1.5 1..5. 1998 1999 2 21 Sources: MoF and World Bank 22 23 24 25 26 27 28 29*
Why has Indonesia weathered the storm so well? Government response Financial market safety net raised deposit guarantee Tax cuts plus an increase in spending Increased social spending (BLT/PNPM, Bos) (Central government budget balance and bank deposits at the end of the first half of each year, IDR trillions) IDR trillion IDR trillion 8 16 6 12 4 8 2 4-2 Fiscal Balance Govt. deposits at BI (RHS) S1 25 S1 26 S1 27 S1 28 S1 29-4 Sources: Ministry of Finance and BI
Our outlook is for the skies to continue to clear Indonesia is positioned to do well, but a weaker global environment means that growth prospects are somewhat lower than they have been and sustaining growth is going to take more a push from policy than has been the case in recent years. Over the medium term we expect that, other things equal, Exports, non commodity at least, are likely to recover slowly constraining job growth and poverty reduction However, there is scope to lock-in current low inflation rates at closer to regional levels (not as projected) And room for fiscal expansion 28 29 21 211 Gross domestic product Consumer price index Major trading partner growth 6.1 4.3 5.4 6. 9.8 4.7 5.6 6.5 2.1-1.8 3.3 3.4 Poverty rate Sources: BPS, CEIC, World Bank. World Bank projections 15.4 14.2 13.6 11.5
The outlook: skies continuing to clear But considerable global risks remain Despite these positive outcomes it is too early to assume that the world economy free from danger, and countries will have to continue to provide stimulus a bit longer -- However the approaching global challenge will be to unwind these stimuli : Reducing the fiscal stimulus and developed country debt burdens made more difficult by aging populations and difficult political choices With unwinding the monetary stimulus also difficult due to uncertainty around lags (too soon and recovery suffers, too late and inflation takes off) and an apparent shift from goods inflation to asset price inflation is this underway This implies that financial markets may well remain volatile (exchange rates, commodity prices, interest rates) And, as noted, Indonesia as a commodity producer is particularly vulnerable Still we believe that medium term volatility, and impacts on the economy, will be smaller than they were last year And then there are the longer term challenges adjustments that will take decades Addressing global imbalances US consumption, Asian investment And a difficult structural adjustment to higher world capital and energy prices compounded by higher carbon prices
Looking ahead Rising or floating 16 Per-capita real GDP grow th trajectories (constant 2 USD) Indonesia "rising" 12 8 Philippines (1993 to 26) Thailand (1979 to 1993) Indonesia "floating" 4 Indonesia (1978 to 27) 1978 198 1982 1984 1986 1988 199 1992 1994 1996 1998 2 22 24 26 28 21 212 214 Source: World Bank
Realizing the development agenda Indonesia is poised for government-catalyzed and private sectordriven investment and growth with the right policy improvements for the investment climate and complementary public investments and Indonesia has to put in place a social protection system appropriate for an emerging middle-income economy Indonesia can afford to spend more on these development priorities Indonesia s fiscal and debt position is strong and there are resources to be had if energy subsidies are redirected towards targeted social spending
A big push on infrastructure a two part strategy Indonesia is ready for and needs some breakthroughs: Easing transport and logistics bottlenecks and connecting and integrating Indonesia s domestic markets and regions: Backbone infrastructure: Trans-Java highway and connecting the major islands Infra breakthroughs would change global perceptions (Indonesia as a BRIC?) while being desirable in their own rights While delivering a big push at the local/regional level by: Building world-class cities by investing in urban infrastructure (mass transport, housing, water and sanitation) in the key cities that drive Indonesian competitiveness Revitalizing PDAMs to provide water and sanitation to Indonesia s citizens (and especially a growing middle class) But this will require providing resources and changing incentives including through performance linked matching grants to Local Governments for roads/water/sanitation
Accelerating investment climate reforms and attacking coordination problems Take a more aggressive stance toward facilitating domestic and foreign investment including Lowering operating costs with a focus on actionable steps to improve logistics, Improving trade facilitation (replacing paper copies with electronic documents/approvals) the National Single Window, Controling the proliferation of non-tariff barriers that raise costs and reduce competitiveness and Lowering entry barriers, including the time and cost to start a business, and reducing restrictions that deter the foreign investment needed to improve competitiveness and create jobs Difficult coordination problems will require something like a Regulatory Reform Commission with the mandate to balance interests, address policy and implementation issues
and the sectors with major reforms have experienced accelerating growth Service sectors, many deregulated at the start of the decade, have been growing much faster than the rest of the economy Partly this reflects the fact that telecoms, retailing and domestic airlines all experienced rapid growth But partly that other sectors, especially mining and manufacturing have not been doing as well as reforms in these have lagged 1 % 8 (average annual growth) Agriculture, mining & manufacturing Services 6 4 2 Sources: BPS and World Bank 2-2 22-4 24-8
Putting in place a Social Protection System Consistent with Middle Income Status 1/16/8 Opportunities and Challenges Indonesia has the resources and institutional capacity to develop effective social protection systems as demographic and epidemiological challenges mount Key elements Build proven and successful social assistance and poverty alleviation programs (PNPM, BOS, BLT, ) into a comprehensive social assistance program Lay the groundwork for a future National Health Insurance System that is clear, feasible and affordable And put in place a grand bargain between employers and workers on severance pay that provides worker s security without discouraging job creation
But all of this will require a bigger push on institutional and civil service reforms Replicate models of institutional reform underway (at the Ministry of Finance especially Tax and Treasury) in other institutions with significant contact with the public Customs, BPOM, Manpower, Trade and Industry Complement ongoing bureaucracy reforms at the institution level with a modernized regulatory framework and central institutional set-up for civil service policy making, regulation and management Improve compensation, recruiting and promotion but link it to accountability Allowing fit for function institutions (not one size fits all) 1/16/8
Indonesia Economic Update William E. Wallace Lead Economist World Bank 4 November 29 Jakarta Indonesia