Global Business Guide Indonesia

Indonesia
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Outlook: Indonesia’s Economy in 2014
The year 2013 exposed a number of weak spots in Indonesia’s economic setup and demonstrated that the country remains vulnerable to capital outflows. At the same time, GDP growth slowed and consumer sentiment was dragged down by higher fuel as well as electricity prices and rising interest rates. In many ways, 2013 was a sobering experience for an economy that overflowed with self-confidence just two years earlier, and it begs the question as to what 2014 holds in store. National elections add a political dimension to uncertainty over Indonesia's immediate future, but they could usher in brighter business prospects and help the economy get back on form.

Outlook: Indonesia’s Economy in 2014
A lower Rupiah, tighter credit conditions and slower GDP growth will make Indonesia's economy less dependent on domestic consumption, foreign investment and commodity exports
 

Macroeconomic Adjustment

After key economic indicators worsened in the course of 2013, there are reasonable expectations that the year ahead should see some trends turn for the better.

GDP: While still strong by global comparison, Indonesia's economy has gradually slowed over the past two years. By the third quarter of 2013, annual GDP growth had declined to 5.6%, down from 6.5% in 2011. The slowdown was at first largely owed to lower global prices for key Indonesian export commodities such as thermal coal, natural rubber, gold and crude palm oil, and more recently also to slowing investment and consumption. Net exports are set to remain subdued going into 2014 amid large stockpiles of rubber and coal in China. Investors will likely remain cautious ahead of presidential elections in July, while household spending – the core pillar of Indonesia's economy – is under the cosh as consumers fret about inflation. If downward pressure on the Rupiah persists, Bank Indonesia (BI) may be compelled to raise interest rates further in early 2014, which could hurt investment and consumption in the short run. On the bright side, public spending is set to buoy GDP in 2014, as the state budget plan foresees an increase of 6.7% over 2013, largely to boost infrastructure development. The second half of the year could see brighter prospects for both investment and household spending, as inflation is expected to come back down which would allow BI to relax its monetary policy. Assuming the world economy continues to strengthen, so should global commodity prices and hence Indonesian exports.

Rupiah: On a downward trend for more than two years, the rupiah's exchange value dropped below 12,000 to the US dollar in November 2013, making it the year's worst performer among Asian currencies. The driving forces behind the Rupiah's depreciation to a four-year low were the worsening trade balance and asset sales by global portfolio investors fearing that the US Federal Reserve would soon begin to reduce quantitative easing. The weaker rupiah in turn stoked imported inflation by driving up the domestic cost of imported goods and materials. The current account deficit reinforced negative sentiment about Indonesia's currency to the extent that traders appeared to disregard repeated rate hikes and other countermeasures taken by the central bank. Approaching the end of 2013 however, a growing number of experts opined that the devaluation no longer fairly reflected the economic fundamentals, which gives rise to hope that the currency might regain some strength in 2013. That said, the government appears quite willing to accept a lower Rupiah as it seeks to bolster exports; it is therefore unlikely that the currency will return to its 2011 strength any time soon.

Trade: Indonesia's current account balance turned negative in late 2011 and has remained in red territory almost ever since, dragged down by poor exports and, more recently, faltering foreign investment. However, the current account gap narrowed slightly in the third quarter of 2013 to $8.5 billion (3.8% of GDP) after hitting $10.0 billion (4.4% of GDP) in the second quarter, mainly because non-oil and gas imports fell more than exports. The combination of a weak currency and elevated interest rates should prove a potent mixture to further reduce the current account deficit in 2014, because a weak Rupiah makes imported goods and services less affordable for Indonesian firms and consumers, while higher borrowing costs constrain domestic demand by tightening credit conditions. It seems reasonable, therefore, to expect the current account deficit to shrink further next year, which should improve investor confidence in Indonesia's economy as a whole.

Monetary policy: Bank Indonesia raised its benchmark interest rate by a total of 1.75 percentage points between June and November 2013 in an effort to stabilise consumer prices. Further tightening in early 2014 appears quite possible after the rate action so far failed to arrest Rupiah devaluation. In an interview with Bloomberg in early December, BI Senior Deputy Governor Mirza Adityaswara has said the bank might use interest rates and reserve requirement ratios to curb inflation and shrink the current-account deficit to below 3% of GDP in 2014. The central bank seems happy to trade in a few basis points of GDP growth in exchange for a more balanced current account. Adityaswara called the Rupiah “undervalued” at 12,000 to the dollar but seemed to be comfortable with a level between 11,000 and 11,500, saying this would help reduce import demand.

New Political Verve?

A lower Rupiah, tighter credit conditions and slower GDP growth will make Indonesia's economy less dependent on domestic consumption, foreign investment and commodity exports. Together, these three factors amount to a fundamental economic adjustment that will impact the country well beyond 2014. How this adjustment plays out will also depend on the political context, which should become clearer following national legislative elections in April 2014 and the presidential poll in July.

While political change naturally entails a degree of risk for investors, Indonesia's elections may well come to be seen as revitalizing the economy. President Susilo Bambang Yudhoyono's final term in office has been criticised by some as unambitious, not least because corruption scandals engulfing high-ranking figures within his Democratic Party appear to have drawn much of the attention away from economic reform. At the same time, the president's struggle to push through unpopular reforms such as the fuel price hike against resistance from within the ruling coalition have raised questions as to how much progress can be expected before a new government takes office.

One problem with Indonesian elections is that they frequently end in protracted legal quarrelling to determine the winner, typically with mutual accusations of foul play. While more of an issue at the local level, the economic risks this poses for 2014 should not be dismissed out of hand. Neither should the possibility of violence ahead, during or following the polls in April and July. However, Jakarta's 2012 gubernatorial elections and a number of other mostly-peaceful regional elections since suggest that the likelihood of widespread violence is low.

A new government may find itself in a freer position to open Indonesia to more foreign investment – a policy for which the current government would risk a populist backlash in the impending elections, given the current sentiment of economic nationalism. While incumbent Finance Minister Chatib Basri, Bank of Indonesia Governor Agus Martowardojo and the head of the Investment Coordinating Board, Mahendra Siregar, have all been dubbed “reformers”, it is unclear how much they can promise, let alone implement, before the elections. One of the foremost concerns on investors' minds are the excessive wage increases and at times hostile industrial relations that Indonesia witnessed in recent years. Government officials appeared to be unable or unwilling to act as mediators between labour representatives and employers, instead changing legislation in line with union demands. This is another area that a new government should be able to address in a more pragmatic, less populist manner.

One Sector's Pain is Another's Gain

The macroeconomic shifts in Indonesia will affect some industries more than others and will generally help export and harm imports. Exporters will enjoy the weaker Rupiah, while importers, as well as domestic-focused companies within the country, will grapple with lower purchasing power in the hands of local consumers.

This suggests slower growth should be expected in consumer-focused industries that in the past years have enjoyed exceptional increases, such as fast-moving consumer goods (See Indonesia’s Fast Moving Consumer Goods (FMCG) Sector) and the automotive sector (See Indonesia’s Automotive Industry). The effects of a slowdown in consumer spending, coupled with higher BI interest rates, may also be felt at banks and consumer finance companies, sectors that similarly have seen exceptional growth.

Purchasing power and interest rates will be of less concern in the healthcare and pharmaceutical sectors (See Indonesia’s Healthcare Sector), where spending is generally motivated less by choice and more by need. In addition, the launching of universal healthcare in 2014 should boost demand for medical services, making this one of the most appealing sector in the near and medium term. Infrastructure developers stand to benefit from pressing demand for better transportation along with improved regulations on public-private partnerships (PPPs) and increased government spending. Foreign investors in the extractive industries will hope for a more accommodative and less nationalistic political environment after the elections, though in the case of metal mining the most important question will be how the government intends to circumvent its own ban on the export of mineral ores (See Metal Mining: Foreign Investment More Necessary than Ever ).

A number of sectors could be newly opened for foreign investors and existing ownership limits lifted as government officials have proposed revisions to the negative investment list. The proposals, which require presidential approval, could see foreign companies operate Indonesian airports and seaports and hold greater stakes in pharmaceutical and telecommunication companies (See An Overview of Indonesia’s Telecommunication Sector) and tourism businesses, among others.

Global Business Guide Indonesia - 2014

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