Global Business Guide Indonesia

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Why Indonesia | Indonesia Economic Outlook 2016 – Economy not at the Mercy of Global Markets

Blaming global markets for economic woes at home has long been the hallmark of Indonesian policymakers when it comes to explaining less-than-favourable developments to the electorate. The administration of President Joko Widodo was no exception during its first year in office, with officials regularly pointing to low commodity prices, weak demand from China and monetary tightening in the US as reasons for Indonesia’s slowing GDP growth (See What China’s Slowdown Means for Indonesia: A Trade Perspective). However, this defensive stance appears to be changing, which bodes well for the country’s economy in 2016.

Indonesia Economic Outlook 2016
Lower interest rates would help reignite economic activity by encouraging more borrowing, flanking government measures to improving funding for SMEs by reducing the interest rates on subsidised loans.

The announcement of a host of reform measures wrapped in so-called economic policy packages (See Indonesia Introduces Sixth Policy Package to Spur Special Economic Zones) can be interpreted as an acknowledgement by the government that a lacklustre investment climate is, at least to a substantial degree, of the country’s own making. The impact of external events should not be negated; neither, though, should it serve as an excuse for failing to anticipate that very impact. Accepting its own role in Indonesia’s economic travails is the first step to betterment on the part of the government, and while the effect of the measures decided – but yet to be implemented – is hard to ascertain, the fact that the government is now displaying a long-missed sense of urgency should be welcomed by domestic and foreign investors.

A state-sponsored infrastructure boom

Amid an unfavourable investment climate, weakened consumer sentiment and low prices for key export commodities, such as coal, metal minerals, rubber and crude palm oil, Indonesia has become more dependent on government spending to drive economic growth. And the government appears to be heeding the call. The latest GDP report at the time of writing (third quarter of 2015) showed year-on-year (yoy) growth of 4.7%. This is also the predicted full-year growth figure, marking a continuation of the downtrend seen in recent years.

However, the GDP component of government consumption was up 6.6% yoy in the third quarter of 2015, after rising 9.3% from the second quarter. The World Bank estimated that public capital spending rose by an astounding 49.8% yoy in the third quarter. This reflects a significant boost in public spending on infrastructure (See High Stakes for Indonesia's New Infrastructure Push), made possible by much lower spending on fuel subsidies, which were slashed soon after the Widodo administration got to work.

It is clear that the president, popularly known as Jokowi, has embarked on more than just another incremental increase in infrastructure spending. Not only has his administration vastly increased budget funds earmarked for the purpose, but it has also ensured that a greater portion of those earmarked funds is actually spent. This had been the sticking point in the past. Furthermore, the central government took it upon itself to ensure that some large projects get off the ground that for years had been stuck in bureaucratic limbo, often held up by slow-moving local authorities.

The combination of increased budget allocation, higher realised spending and the kick-starting of stalled projects will continue into 2016 and beyond and should in turn lure more private investors to commit to infrastructure development across the archipelago. It might just ignite something of an infrastructure boom.

Rising public and private spending on health

Aside from rising infrastructure spending, the 2016 budget stipulates a vast increase in public expenditure on health, making this a particular focus of state spending – and another intriguing sector for investment. For the first time in 2016, the government plans to break through the mandated health-spending threshold of 5% of GDP, which compares to just 3.7% in the revised 2015 budget.

Key Economic Indicators

Indonesia Economic Outlook 2016

Room for a rate cut

The rupiah proved less vulnerable to US monetary policy than many had feared. Just days after the US Federal Reserve raised the benchmark interest rate on 16th December 2015, Indonesia's currency bounced back to its previous level against the US dollar as if nothing had happened. Coupled with the fact that continued normalisation of US monetary policy over the course of 2016 will likely be quite restrained, this feeds expectations that Bank Indonesia may lower its interest rate early in the year. Inflation in 2016 is seen to remain manageable, with both BI and private-sector economists predicting it to stay within the 3-5% target range.

Lower interest rates would help reignite economic activity by encouraging more borrowing, flanking government measures to improving funding for SMEs by reducing the interest rates on subsidised loans (See Third Time’s A Charm – Indonesia Introduces Third Economic Policy Package). Economists from the World Bank have also urged the government itself to borrow more by allowing for a higher fiscal deficit (the 2016 budget plan assumes a prudent deficit at 2.15% of GDP). Together, these moves would improve private and public sector funding at just the right time for investors to take advantage of more liberal business regulations.

Labour market remains a problem

Indonesia’s labour market has caused investors headaches for a number of reasons, and despite some improvements this will not change any time soon. The issues employers have been lamenting pertain to three aspects: 1) Rigid regulations that make it costly to lay off employees and hard to employ foreigners, 2) a lack of qualified human resources in the country and 3) unreasonable and unpredictable increases in minimum wages.

There has been some improvement on the third of these, as the government introduced a new formula to calculate minimum wages in one of the recent policy packages (See Indonesia Moves to Address Minimum Wage Woes). This should increase the predictability of payroll demands and make the wage-setting process less vulnerable to being hijacked by an uncompromising labour movement that has soured industrial relations in some industrial estates.

The first and second issues, meanwhile, will continue to hamper employment in Indonesia for the foreseeable future. The president and cabinet ministers vowed to make it easier for foreign companies to hire foreign staff, but it remains to be seen how this will be implemented in practice. A much further-reaching liberalisation of employment rules would be needed to impress investors. Improving human resources, meanwhile, requires a major step up in both formal education and vocational training, which in turn requires government resolve and private investment; and even then it will not yield tangible results over night (See Indonesia; Investing in Education).

Regional competition calls for more structural reforms

Indonesian businesses and analysts have enthusiastically greeted the economic policy packages announced so far before they could even be implemented. In the short term, upbeat sentiment alone may buttress the rupiah and lift the overall economic mood in the country, but unless it is swiftly justified by real and ongoing structural reforms, this sentiment may turn sour by the middle of 2016.

Reforms are all the more important as Indonesia is now part of the ASEAN Economic Community (AEC) and also competes for investment with countries that recently signed the Trans-Pacific Partnership pact (See Indonesia and the Trans-Pacific Partnership – Worth the Membership?). As long as business activity is hampered by red tape and regulations that often discourage rather than invite foreign investment, companies may opt for other countries in the region to produce goods and offer services, while the common market allows them to nevertheless sell those goods and services in Indonesia's large market.

It is therefore crucial that the administration quickly follow up the promised measures with concrete regulations. The government has already put its money where its mouth is in boosting infrastructure spending. The first half of 2016 will be important for it to prove that it can do as much in other segments too.

Global Business Guide Indonesia - 2016

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)