Jakarta Globe | Insight

Growth Challenges for 2018

Jakarta. Although the Indonesian economy is expected to grow at a faster pace this year and in 2019 thanks to favorable domestic tailwinds and potentially positive external factors, the government still needs to convince consumers and investors that the upcoming elections will not derail that growth.

Finance Minister Sri Mulyani Indrawati told reporters on Tuesday (02/01) that she estimates the domestic economy to have grown 5.05 percent last year, lower than the stated growth target of 5.2 percent in the revised 2017 state budget. The economy grew 5.02 percent in 2016.

However, the 2018 state budget has set a growth target of 5.4 percent.

“The nation’s economic performance [in 2017] was supported by external as well as domestic factors. External factors include improvements in global economic conditions that have supported Indonesia’s export performance positively,” Sri Mulyani said. She added that trade picked up in the third quarter last year as exports improved 17.3 percent year-on-year.

Finance Minister Sri Mulyani Indrawati speaks about the performance of 2017 state budget during a press conference in Jakarta on Jan. 2. (Antara Photo/Galih Pradipta)
Finance Minister Sri Mulyani Indrawati speaks about the performance of 2017 state budget during a press conference in Jakarta on Jan. 2. (Antara Photo/Galih Pradipta)

The country’s economy grew 5.1 percent in the third quarter of 2017, compared with 5.0 percent in the second quarter, due to the gradual recovery of global commodity prices and stronger global economic growth that helped offset sluggish domestic spending.

The Central Statistics Agency (BPS) will officially release the country’s 2017 economic data in February.

Government Spending

Sri Mulyani highlighted on Tuesday the role of government spending in spurring economic growth that will be visible in the official economic data for 2017. She said President Joko “Jokowi” Widodo’s administration is committed to boosting infrastructure spending to stimulate growth.

During a press conference on the state budget’s performance for last year, the minister revealed that the government’s capital spending increased 22.9 percent to Rp 208.4 trillion ($14.6 billion). Most of this was directed towards the construction of new highways, bridges, airports and 618 kilometers of railway networks.

2018 Growth Driver

Two months before Sri Mulyani’s announcement, a Singapore-based economist praised the country’s strong fundamentals but highlighted the still-challenging investment environment that continues to hamper faster growth.

“Indonesia has one of strongest fundamentals in the region. Public debt is below 30 percent of GDP, one of the lowest among emerging market economies. Inflation has been moderate at around 4 percent in recent years. Governance is stable and political risk is low,” DBS Bank economist Gundy Cahyadi wrote in a note on Nov. 20.

“Yet, afflicted by the hangover from the 2014/15 commodity crash and a still-challenging investment environment, economic growth has been stuck at 5 percent, well below Indonesia’s potential, in our view,” he added.

The economist highlighted that policy-making may become more challenging with the looming 2019 presidential election.

“Indonesia would need a major pull from the external environment to move to a higher gear,” he said.

“GDP growth may still pick up slightly to 5.3 percent and 5.4 percent in 2018 and 2019, respectively, up from our forecast of 5.1 percent for 2017. Stronger commodity prices will translate into a higher contribution of net exports to overall GDP growth. Investment growth will continue its gradual recovery. Meanwhile, consumption growth remains relatively stable at 5 percent,” Gundy said.

He added that even if the government maintains an accommodating fiscal policy stance, or continues spending on infrastructure, “there is not much room for stimulus, given the 3 percent fiscal-deficit rule.”

The law does not allow the government to post budget deficits of more than 3 percent.

Data released by Sri Mulyani on Tuesday showed that the unaudited 2017 budget deficit stood at 2.57 percent of gross domestic product, compared with 2.49 percent in 2016.

Gundy said DBS forecasts Indonesia’s budget deficit to hit 2.6 percent of GDP in 2018.

“Our forecast is higher than the government’s official deficit target of 2.2 percent of GDP for 2018; it is driven mostly by a potential shortfall in revenues rather than an increase in spending,” he said.

Indonesia has continually failed to meet its budget revenue targets in recent years, with tax revenue collection remaining the biggest problem. Last year’s tax revenue collection had a shortfall of Rp 132.1 trillion, with Sri Mulyani arguing that the target was set too high in the first place.

Tony Prasetiantono, director of the Center for Economic and Public Policy Studies at Gadjah Mada University in Yogyakarta, said at a seminar on Dec. 18 that he was upbeat that the economy will grow stronger this year, but added that he was not as optimistic as the government’s predictions laid out in the 2018 state budget.

“I am predicting 5.3 percent growth,” he said.

Tony said an expected rise in the United States Federal Reserve’s key interest rate this year may affect capital inflows into Indonesia. On the other hand, the country’s export performance is still vulnerable to commodity price fluctuations, which also affect overall growth.

Regarding accelerated infrastructure spending, Tony said he has not seen much of an impact on ongoing projects.

“Next year, in 2019, I think we may be able to see the impact,” he said.

Investment to Pick Up

Another source of growth for Indonesia is investment. A report commissioned by the Institute of Chartered Accountants in England and Wales (ICAEW) and Oxford Economics, which provide economic advice and forecasts to international organizations, highlighted the possible positive impact of the rating upgrade by Standard and Poor’s last year.

“In February 2017, Moody’s upgraded its credit outlook on Indonesia to ‘positive’ from ‘stable,’ suggesting that if the measures designed to contain the current-account deficit and slow the growth in private-sector external debt stay on track, then Indonesia may be upgraded from its current Baa3 rating. And in May, reassured by the steps taken to stabilize the fiscal position, S&P upgraded Indonesia’s rating to BBB- from BB+, meaning that the country now has an investment-grade rating from all three major agencies,” according to the report, published in December.

“These developments should spur investment inflows. Meanwhile, the outlook for direct investment should also be supported by the various policy packages announced by the government last year. These packages should restore investor confidence in Indonesia and help lift FDI [foreign direct investment] – which weakened noticeably in 2015,” said Sian Fenner, an economic advisor at ICAEW and lead Asia economist at Oxford Economics.

Oxford Economics forecasts a modest improvement in Indonesia’s fourth-quarter GDP growth, on the back of robust government spending and investment. It expects the economy to grow at 5.3 percent this year.

“We maintain our view that GDP will grow 5.1  percent in 2017; albeit with the risks to the forecast tilted to the downside due to the relative sluggishness of private consumption growth. We continue to forecast slightly faster growth of 5.3 percent in 2018,” Fenner said in the report.

Economists speak about Indonesia's economic growth prospects during a discussion hosted by the Institute of Chartered Accountants in England and Wales (ICAEW) in Jakarta in December. (Photo courtesy of ICAEW)
Economists speak about Indonesia’s economic growth prospects during a discussion hosted by the Institute of Chartered Accountants in England and Wales (ICAEW) in Jakarta in December. (Photo courtesy of ICAEW)

While Indonesia is expected to enjoy favorable domestic tailwinds, the expected increase in political tension in the upcoming election appears to be a double-edged sword. On the one hand it may help spur growth due to higher spending by political parties, but it may also cause businesses to adopt a wait-and-see approach before making investment decisions.

Candidates planning to run in the 2019 presidential election must register by August this year, while campaigns can only begin on Sept. 23 and must end on April 13, 2019.

Dendi Ramdani, head of industry and regional research at state-controlled lender Bank Mandiri, said last month that “historical data shows that investment trends ahead of elections experience a bit of a slowdown,” which may offset increased consumption growth due to higher spending by political parties or candidates.

Dendi also highlighted the risk involved in Sri Mulyani’s plan to reallocate fiscal spending to more productive areas and reducing subsidies. In 2016, the minister set to work by cutting ministerial and regional spending in a bid to regain credibility on fiscal policy after tax revenue fell far short of the government’s target.

“The transition must be smooth so that it won’t hurt the state’s spending capacity to help stimulate economic growth,” he said.

He echoed other economists by saying that a 5.4 percent growth target would be difficult to achieve.

“I think a 5.3 percent growth rate is the maximum for 2018,” Dendi said.

Additional reporting by Sarah Yuniarni, Nurjoni & Abdul Hakim