Challenges for Indonesia's Economy to Persist in 2016
With the year 2015 coming to an end, it is worthwhile to take a look at the challenges that Indonesia faced this year and whether these challenges will remain in 2016. In short, we believe that the current external challenges persist into the new year. Although the country's economic growth is projected to accelerate to 5.3 percent year-on-year (y/y) in 2016 from an estimated 4.7 percent (y/y) in 2015 (the fifth consecutive year of slowing gross domestic growth expansion), this growth is primarily caused by improved government spending.
The main external challenges that are expected to persist in 2016 are (1) further monetary tightening in the USA, (2) China's economic slowdown, and (3) low commodity prices.
Tighter Monetary Policy of the US Federal Reserve
In the latest policy meeting of 2015, the central bank of the USA (Federal Reserve) decided to raise its key Fed Fund Rate by 0.25 percent, a move that was expected by most market participants and therefore led to limited capital outflows only from emerging markets. In August and September Asia's emerging markets had already been plagued by severe capital outflows as concern about China's economy heightened (particularly after the country let its yuan devalue sharply), while expectation of a US interest rate hike increased.
However, the US Federal Reserve is expected to implement more interest rate hikes in 2016, albeit gradually and gently. Although on the one hand this is a positive sign as it would signal that the economic recovery of the USA remains on track, on the other hand it may trigger capital outflows from Indonesia, hence putting pressure on Indonesian assets. The rupiah, which is particularly vulnerable, may need to be defended by Indonesia's central bank (Bank Indonesia) through an interest rate hike. Currently, Indonesia's benchmark interest rate is already relatively high at 7.50 percent thus curtailing credit expansion and economic growth.
Economic Slowdown of China
The economy of China has a major impact on the Indonesian economy as China, the world's second-largest economy, is the key trading partner of Indonesia. China's economic growth has slowed due to a dramatic decline in trade amid worldwide sluggish growth. Furthermore, the country's overheated property market caused a contraction in its construction output, while the manufacturing sector slumped as demand for Chinese exports fell. The drop in China's heavy industry and construction has been a drag on prices of oil, iron ore and other commodities. Meanwhile, the country is transforming its economy from investment and export-driven to consumption-driven, a process that is accompanied by growing pains.
The International Monetary Fund (IMF) expects China's economy to expand by 6.3 percent (y/y) in 2016, down from an estimated 6.8 percent (y/y) in 2015, and down from the 7.3 percentage point growth in 2014. It is estimated that for each one percentage point decline in China's GDP growth, Indonesia's economic expansion is curbed by 0.5 percent.
Although China's yuan was included in the IMF's Special Drawing Rights (SDR) - with a weightage average of 10.91 percent - in early December 2015, China may decide to devalue its yuan again in 2016 in an effort to boost the country's export performance and economic growth. Other Asian emerging markets may follow suit by weakening their currencies in order to keep their export products competitive.
Weak Commodity Prices
Sluggish global growth and in particular China's economic slowdown cause downward pressure on commodity prices. Furthermore, a supply glut (in the USA and OPEC member countries) triggers low oil prices (such low prices are also a negative signal for prices of other commodities). For Indonesia this situation is problematic as the country relies heavily on exports of (raw) commodities (and this is why the government is keen on developing downstream industries).
GDP Growth Outlook Indonesia:
| Institution | 2015 | 2016 |
| Indonesian Government | 5.1% | 5.3% |
| Bank Indonesia | 4.9% | 5.4% |
| Asian Development Bank (ADB) | 4.9% | 5.4% |
| World Bank | 4.7% | 5.3% |
| International Monetary Fund (IMF) | 4.7% | 5.5% |
Various sources