World Bank Positive About Indonesia's Economic Outlook
In its latest East Asia and Pacific Economic Update, the World Bank is optimistic about Indonesia's recent economic performance as well as its future prospects. The country's FY-2017 gross domestic product (GDP) expanded at the fastest pace in four years, led by stronger investment and net exports. Meanwhile, its current account deficit narrowed to a six-year low, while the central government's budget deficit reached the lowest since 2014, on the back of stronger global trade and strengthening commodity prices.
Regarding the foreseeable future, the World Bank is optimistic that - despite weaker commodity prices - the nation's economic outlook is positive due to rising private and government consumption, partly lifted by the upcoming elections. In 2018 Indonesia will organize local elections, while legislative and presidential elections are scheduled for 2019.
Recent Developments
Indonesia's economic growth touched 5.2 percent year-on-year (y/y) in the fourth quarter of 2017, the highest growth in six quarters. Accelerating economic growth was driven by higher domestic demand, stronger investment, and rising private and government consumption. Albeit slowing, Indonesia's export and import growth remained robust due to a sustained recovery in global trade and commodity prices.
Net exports, however, were a drag on growth in Q4-2017 as imports grew at a faster pace than exports, partly reflecting higher investment in machines and equipment. After significant destocking in Q3-2017, inventories accumulated in the next quarter, contributing positively to GDP growth. On the production side, manufacturing continued to contribute the most to growth among the nine production sectors, while construction and other services sectors saw the largest growth.
Headline consumer price inflation eased to an average of 3.5 percent (y/y) in Q4-2017 from 3.8 percent (y/y) in the preceding quarter, largely due to muted food price inflation, which reached the lowest quarterly average in 14 years. Core inflation in Q4-2017 remained unchanged from the 3 percent in the preceding quarter, the lowest quarterly average on record, reflecting stable inflationary pressures as the economy operates at near-full employment. In annual terms, headline inflation was 3.8 percent, higher than the 3.5 percent in 2016, predominantly due to increases in administered prices, notably the three electricity tariff hikes in the first half of 2017.
Indonesia's macro financial conditions remained stable. Bond yields declined by an average of 150 basis points (bps) across all tenors in 2017, following a 90 bps drop in the preceding year. Monetary policy remained stable with the policy interest rate being held steady at 4.25 percent in Q4-2017, following the two consecutive 25 bps cuts in Q3-2017. Gross capital inflows in 2017 surged more than three times that of 2016 on improved investor confidence due to the credit rating upgrades.
Total government spending grew the fastest in three years last year, supported by higher capital, material, and social spending. Notably, the disbursement of capital expenditures improved from 73 percent in 2016 to 97 percent in 2017 - the highest in six years. Overall, capital expenditures grew by 21.1 percent in 2017. While total tax revenues as a share of GDP fell to less than 10 percent in 2017, the exclusion of receipts from the one-time tax amnesty program actually yields an increase in the tax ratio from 2016, reflecting ongoing tax reform efforts. Higher commodity prices helped revenue growth reach a six-year high and kept the fiscal deficit at 2.4 percent of GDP in 2017, the lowest in three years.
Meanwhile, in the external sector, Indonesia's current account deficit widened to 2.2 percent of GDP in Q4-2017, from 1.7 percent of GDP in the preceding quarter, driven primarily by a lower surplus in goods trade and wider deficit in the service account. Reflecting the improved terms of trade and the recovery in global trade, the current account deficit stood at 1.7 percent of GDP for full-year 2017, the lowest in six years.
The official poverty rate - calculated using Indonesia's national poverty line - was 10.1 percent in September 2017, 0.6 percentage points lower than in the same month one year earlier, the largest year-on-year decline since March 2013. While growth in employment and real earnings slowed between August 2016 and August 2017, job creation tilted towards formal, manufacturing work, with the share of workers in the agricultural sector experiencing its largest y/y decline since 2004.
Outlook
The economic outlook for Indonesia is positive with GDP growth projected to reach an average of 5.3 percent (y/y) in the medium-term, on strengthening domestic demand lifted by the upcoming regional and presidential elections, recovery in private consumption, and still easy financing conditions. Net exports, however, will drag economic growth as investment growth is import-intensive.
Headline inflation is expected to pick up in the next few years due to higher import costs associated with higher crude oil prices. The fiscal balance is expected to narrow modestly over the forecasting horizon, in line with the smaller deficit stipulated in the 2018 budget and as critical revenue enhancing reforms are implemented. The current account deficit is expected to widen over the medium term, in line with stronger domestic demand and weaker terms of trade.
The international poverty rate (those living below USD $1.90 per day in 2011 PPP terms) is estimated to have fallen to 5.6 percent in 2017 and reach below 4 percent by 2020. Although the pace of poverty reduction is forecast to be slower than in the preceding decade, the y/y declines expected in 2017 and 2018 are larger than the y/y declines witnessed in 2015 and 2016, with stronger prospects for economic growth outweighing the effects of rising inflation.
Risks and Challenges
Risks to the economic growth outlook of Indonesia are tilted to the downside. On the external front, with protectionism on the rise, there is a risk that the nascent recovery in global trade could stall, weighing on Indonesian exports and hence growth.
Although the normalization of US monetary policy is proceeding in an orderly manner, there is a risk that such movements may lead to financial volatility as markets undergo valuation corrections as seen as with the US stock market earlier this year. For example, faster-than-expected inflation could trigger unexpected monetary tightening, leading to volatile capital outflows from emerging markets.
Progress on poverty reduction could stall or be undone by economic shocks. The recent malnutrition crisis in Papua, measles outbreaks across several provinces, and the hike in rice price inflation since late 2017, are likely to have disproportionate effects on the earnings and purchasing power of the poor and vulnerable.
Selected Indicators Indonesia:
| 2016 | 2017E | 2018F | 2019F | 2020F | |
| Real GDP Growth (constant market prices) |
5.0 | 5.1 | 5.3 | 5.3 | 5.4 |
| - Private Consumption | 5.0 | 5.0 | 5.1 | 5.2 | 5.2 |
| - Government Consumption | -0.1 | 2.1 | 4.0 | 4.5 | 5.0 |
| - Gross Fixed Capital Investment | 4.5 | 6.2 | 6.0 | 5.7 | 6.5 |
| - Exports, Goods & Services | -1.6 | 9.1 | 7.0 | 6.0 | 5.5 |
| - Imports, Goods & Services | -2.4 | 8.1 | 7.0 | 6.0 | 6.5 |
| Real GDP Growth (constant factor prices) |
4.6 | 4.8 | 5.3 | 5.3 | 5.4 |
| - Agriculture | 3.4 | 3.8 | 4.0 | 4.1 | 4.2 |
| - Industry | 3.8 | 4.1 | 4.5 | 4.7 | 5.0 |
| - Services | 5.7 | 5.7 | 6.4 | 6.1 | 6.1 |
| Inflation (Consumer Price Index) | 3.5 | 3.8 | 3.5 | 3.7 | 3.7 |
| Current Account Balance (% of GDP) |
-1.8 | -1.7 | -1.9 | -2.1 | -2.3 |
| Financial & Capital Account (% of GDP) |
1.9 | 2.9 | 3.5 | 3.8 | 4.2 |
| - Net Foreign Direct Investment (% of GDP) |
1.7 | 2.0 | 2.8 | 3.2 | 3.6 |
| Fiscal Balance (% of GDP) |
-2.5 | -2.4 | -2.3 | -2.3 | -2.2 |
| Debt (% of GDP) |
28.3 | 25.5 | 28.9 | 29.2 | 29.2 |
| Primary Balance (% of GDP) |
-1.0 | -0.8 | -0.7 | -0.6 | -0.5 |
| International Poverty Rate (USD $1.9 in 2011 PPP) |
6.5 | 5.6 | 4.8 | 4.1 | 3.4 |
| Lower Middle Income Poverty Rate (USD $3.2 in 2011 PPP) |
31.1 | 28.9 | 26.9 | 25.0 | 23.1 |
| Upper Middle Income Poverty Rate (USD $5.5 in 2011 PPP) |
62.8 | 61.2 | 59.7 | 58.2 | 56.7 |
E = estimate
F = forecast
Source: World Bank, East Asia and Pacific Economic Update - April 2018