Global Business Guide Indonesia

Indonesia
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Why Indonesia | Indonesia’s Economic Outlook in 2017: Remain Cautiously Optimistic

It is widely anticipated that Indonesia’s economic growth in 2017 is set to improve as the government’s economic policy packages launched throughout 2015 — 2016 begin to take effect on the Indonesian economy. The success of the Tax Amnesty Programme (See Indonesian Government Banking on Tax Amnesty to Plug Tax Shortfall) in the second half of 2016 is already serving to boost the confidence of investors and Indonesian business players. Furthermore, the policy is beginning to yield more fiscal room to the government so as to resume its aggressive infrastructure development and economic reform programmes which have slowed down in the second semester of 2016 due to a decline in revenue collection which led to budget and spending cuts. This renewed thrust should eventually attract more investment and drive the country’s economy forward to improve GDP growth.

Optimistic economic forecasts

The World Bank forecasts that Indonesia’s economy will grow by 5.3% in 2017. This is higher than the average economic growth of emerging economies of 4.4% and the global economy of 2.8%. Meanwhile, Bank Indonesia projects that the Indonesian economic growth in 2017 will reach 5-5.4%. This is more or less the same as the government’s growth target set in the 2017 State Budget of 5.1%.

According to the Indonesian central bank, the increased confidence of investors and business players following the success of the Tax Amnesty Programme is key to ensuring improvements in the performance of the Indonesian economy. Exports are expected to grow along with the increase in commodity prices such as palm oil (See Indonesian Palm Oil Industry Overview – Biodiesel as a New Source of Revenue Growth), rubber (See Indonesia’s Rubber Industry: Increased Competition and Falling Prices), and coal (See Indonesia’s Coal Mining Sector: A Silver Lining Behind Dark Clouds) which will also drive the economies of commodity-based provinces in Sumatra and Kalimantan. This will be further bolstered by increased household and government spending which still remains a major growth driver in Indonesia’s domestic consumption based economy.

The exchange value of the rupiah in 2017 is expected to remain stable and under control at 13,100 — 13,300 IDR to the US dollar (See Indonesia’s Fragility & The Fed). Meanwhile, the Jakarta Composite Index will rise as issuers on the Indonesia Stock Exchange recorded increased profit amid a flood of capital inflows.

On the negative side, Bank Indonesia forecasts that inflation in 2017 will reach 4% plus/minus 1% or comparable with the target set in the 2017 State Budget of 4%. BI, however, warned that the inflation may reach 5% or higher if the government removes the energy subsidy. The Indonesian government plans to cut LPG and electricity subsidies in 2017 by removing the electricity subsidy of 900 VA customers and implementing a closed distribution system for the 3kg LPG tank. According to BI, the move by PLN will contribute 0.95% to headline inflation (See Investment in Indonesia’s Electricity Sector; Sparks of Life). Other factors which will also contribute to Indonesia’s inflation rate are the increase in food prices, cigarette excise tax, and the administered prices.

Indonesia as a country is expected to experience a deficit of 330.2 trillion IDR or 2.41% against gross domestic product (GDP) in 2017 with estimated revenue of 1,750.2 trillion IDR and expenditure of 2,080.4 trillion IDR. The current account deficit will, therefore, increase slightly but still remain below 3%.

BI projects that bank credit growth in 2017 will be in better shape than in 2016 and estimates that it will increase by 10% - 12%. This will be supported by lower interest and lending rates which President Joko Widodo is pushing to be in the single digits with the people’s business credit interest rate expected to go as low as 7%.

The repatriated funds from the Tax Amnesty Programme which has reached 143 trillion IDR as of early November 2016 and is expected to increase to 180 — 200 trillion IDR by the end of the year, should help cover the deficit as well as increase Indonesian banks’ liquidity and third party funds against gross domestic products (GDP) by a ratio of 1.7% - 2% in 2017. Additionally, the success of the tax amnesty in expanding the tax base should provide greater room for fiscal manoeuvring as well as increase Indonesia’s state tax revenue which will enable the government to boost infrastructure development (See Concrete Developments in Indonesia’s Infrastructure).

The country is the largest economy in Southeast Asia with an enormous market and an abundance of resources.That said, there is still a lot that needs to be done with the infrastructure which the government should prioritise in improving.

Finance Minister Ms Sri Mulyani Indrawati has stated that fiscal policy is expected to play a key role in strengthening Indonesia’s economy in 2017. It will become an effective instrument in dealing with global and regional challenges as well as ideally support inclusive and resilient economic growth in 2017 and beyond.

Improving tax compliance in Indonesia is expected to help the government achieve the tax revenue target of 1,498.8 trillion IDR and increase the tax ratio to 11.52%. Budget saving and a well-targeted budgeting process that prioritises urgent and priority sectors are also anticipated to help avoid budget cuts in 2017 and avoid breaking investor momentum.

Digital technology development in the financial sector such as financial technology (FinTech) is expected to improve the efficiency and effectiveness of Indonesia’s financial industry which will help broaden the market. In addition, micro, small and medium enterprises (MSMEs) which make up 99.99% of the country’s business players are expected to continue to drive the country’s economy throughout 2017.

Watch out for external factors

Aside from Indonesia’s internal economic factors, the government should also watch out for external factors such as a hike in interest rates by the US Federal Reserve, the economic slowdown in China (See What China’s Slowdown Means for Indonesia: A Trade Perspective), and the fear of greater protectionism by the US government under its newly-elected President Donald Trump (See The US Presidential Elections and What it Means for Indonesia).

Despite Indonesia’s economic strengths being rooted in its strong domestic market, the country still remains vulnerable to external shocks. A rate rise by the US Federal Reserve would cause capital outflows from Indonesia as the rupiah remains a fragile currency. Furthermore, for every 1% decline in China’s economy, Indonesia’s economic growth is cut by 0.11%, while the same decline in the US economy will slash Indonesia’s economic growth by 0.05%.

BI’s Governor Mr Agus Martowardojo has said that the central bank will closely watch President-elect Trump’s actual policy rather than responding to the conjecture brought about by the current negative sentiment and uncertainty. The Coordinating Minister for Economic Affairs Mr Darmin Nasution added that a more protectionism-focused America will definitely impact Indonesia’s economy. At this stage, however, it is impossible to predict until firm US trade policies are made public and thus far President-elect Trump has proved himself to be completely malleable on his campaign promises.

Global oil prices are expected to remain low in 2017, however, recent announcements by OPEC members that the cartel has finally managed to agree on limiting oil output have seen a recent jump in prices. The 2017 State Budget set the Indonesian Crude Price (ICP) at $45 US dollars per barrel (See Overview: Indonesia’s Downstream Oil and Gas Sector). Oil lifting is expected to continue its downward trend and will reach 815,000 barrels per day while gas lifting will reach 1,150 thousand barrels of oil equivalent per day (See Will Indonesia Become a Net Importer of Natural Gas by 2020?).

Other external developments that need to be monitored are the election results in France and Germany in 2017. These two countries are the backbone of the European economy and their policies will impact many countries, including Indonesia. In addition, investors are also anticipating the British government’s policies after voting to leave the European Union, which many fear could further slow global and European economic growth (See Indonesia and the EU CEPA – Deal or No Deal?)

More economic reforms needed

The Indonesian government has launched 14 economic policy packages since September 2015 which are expected to improve the country’s investment climate. These policies include deregulation of a number of sectors, simplification of foreign investment permits and procedures, elimination of double taxation in the real estate sector, and facilitation for the e-commerce sector (See Indonesia’s 14th Economic Policy Package to Kick-Start E-Commerce Industry).

Many economists predict that these policies will begin to take effect from 2017 onwards. Should these policies be well implemented, meaning that they are backed up by sufficient supporting administrative infrastructure throughout the entire country, they can serve to take Indonesia’s economy to the next level. This, however, will be the greatest challenge given Indonesia’s heaving bureaucracy and uneven implementation of policies due to decentralisation. To counter this mismatch, the Indonesian government should then place its focus on encouraging deregulation at the local level. This is crucial to achieving the central government’s programmes as they will not bring about the desired results without the support of local governments.

Moreover, a structural transformation is needed to ensure sustainable economic growth across Indonesia. The government needs to provide more incentives, accelerate infrastructure development (See High Stakes for Indonesia's New Infrastructure Push), push industrialisation efforts, improve coordination with the finance industry and develop a local raw material industry to reduce reliance on imports. The latter is vital as many sectors of Indonesia’s economy still rely on imported raw materials such as the pharmaceutical, petrochemical, cocoa (See Indonesia’s Cocoa Industry: Lack of Supply Still Hampers Growth and Investment), and steel industries. Meanwhile, high reliance on raw material imports will impact the current account performance in the long run and can lead to overheated economic growth.

Foreign direct investment is expected to increase in 2017 along with the improvement in foreign investment permitting processes and procedures (See FDI Growth in Indonesia: A Timely Reminder of Long-term Upside). The government’s generous incentives and the development of new industrial areas should serve to lure more investors to Indonesia. This is bolstered by the improvement in Indonesia’s rank in The World Bank’s ease of doing business report from 106th position in 2015 to 91st position in 2016 and the UNCTAD’s survey on the most attractive investment destination countries in which Indonesia rose from 14th position in 2014 to 9th position in 2016.

A number of policies that will boost industrial growth in 2017 include discounted industrial gas prices for three industries, namely fertiliser (See Harvest Time for Indonesia’s Fertiliser Industry), petrochemicals and steel, the KLIK incentive for industrial areas which allows investors to immediately commence construction after obtaining a principle permit, and the Single Fuel Price policy.

Presidential Regulation No. 40 /2016 on the Determination of Natural Gas Prices and the Regulation of Energy Minister No. 16/2016 on the Procedures for Certain Gas Consumers to Apply for Special Gas Prices will cap the industrial gas price at a maximum of $6 US dollar per mmbtu. Lower gas prices will benefit local industries as they will bring down energy costs and improve their competitiveness in domestic and export markets. Meanwhile, the Single Fuel Price policy will drastically reduce logistics and transportation costs, reduce the price of goods and services, and improve consumer purchasing power in Indonesia’s emerging provinces.

Global Business Guide Indonesia - 6th December 2016

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