East Asia Forum

Economics, Politics and Public Policy in East Asia

and the Pacific
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Indonesia’s economy continues to surprise

25th September, 2010

Author: Thee Kian Wie, Indonesian Institute of Sciences

The Indonesian economy continues to surprise with its very healthy growth rate through the
period of global financial crisis. The growth rate, driven by consumer spending, investment, and
exports, has surpassed most predictions at 6.2 per cent during the second quarter of 2010.
Domestic consumption is robust, investment figures are encouraging and exports are expanding
at least as fast as global growth. While monetary policy and financial regulatory concerns
remain, Indonesia is well-positioned for broad-based economic growth.

Perception indicators increasingly support the view that Indonesia’s economy is on an upswing.
The Japan Credit Rating Agency has upgraded Indonesia’s investment grade from BB+ to
BBB; the first in 13 years. Other credit rating agencies, including Fitch, Standard and Poor’s
and Moody’s, have also upgraded Indonesia’s sovereign rating. Last year Indonesia was the
only member of the G20 to lower its public debt-to-GDP ratio: a very positive economic
management indicator.

What is responsible for Indonesia’s surprising growth performance?

Prices have been reasonably stable although inflation is still a worry. Even so, the inflation rate
in August 2010 was lower than previously estimated, at 0.76 per cent month-on-month, or 6.44
per cent year-on-year. A major factor accounting for Indonesia’s generally higher inflation was
the increase in electricity tariffs in July. And here, even though the direct impact of this increase
was higher than expected, the indirect impact appears to have been relatively mild so far. For
this reason, the Bank of Indonesia’s decision to keep the policy interest rate at 6.5 per cent for
the time being seems sensible.

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Meanwhile, Indonesia’s banking sector is in good shape and has successfully weathered the
global financial crisis (GFC). It was protected by prudential guidelines and sound banking
practices, and is strongly solvent, with contained risk exposure, and solid profitability. The most
recent World Bank and International Monetary Fund assessment of Indonesia’s financial
system concluded that it is generally healthy, as demonstrated by its success in recovering
quickly from the GFC.

On the trade side, there is good news too. Indonesia’s balance of payments during the second
quarter recorded a big surplus of US$ 5.4 billion, $6.6 billion during the first quarter. This was
due to the good performance of non-oil and gas sectors, a positive natural gas balance, and a
surplus in the capital and financial account due to inflows of FDI and portfolio investment.

More specifically, Indonesia’s exports to the developed nations have not substantially
weakened, despite apparent signs of a slowdown in these markets. Indonesia also increased its
level of imports, with higher capital goods (machinery, mechanical and electrical appliances,
and aircraft) inflows.

Unfortunately, green field investment in manufacturing has not mirrored the performance of
other sectors. Foreign direct investment (FDI) amounted to US$ 3.7 billion the second quarter of
2010. Near-zero FDI was directed towards manufacturing.

FDI predominantly flowed into the transport, storage and communication sectors (US$ 1.5
billion); mining (US$ 0.6 billion), trade (US$ 0.4 billion) and electricity, gas, and water supply
(US$ 0.3 billion). While this is good, more direct investment into the manufacturing sector would
lead to higher employment and a faster reduction in absolute poverty. Government estimates
identify $210 billion of infrastructure development over the next 5 years, of with almost $100
billion to be funded by the private sector. Strong foreign investment flows are vital Indonesia’s
economic expansion plans.

The IMF and World Bank report identified two major issues that urgently need government
attention: protection and support of financial regulators, and weak creditor rights.

The creditor rights issue is seen in the ability of large corporate borrowers to challenge contracts
through long and arduous court battles. This in turn leads banks to focus on small and
medium-scale (SME) lending. Indonesia is ranked 146 out of 183 countires surveyed in the
2010 Ease of Doing Business Index, with outstanding claims taking 570 days to enforce, for 120
per cent of the claim’s cost.

The financial regulator issue specifically refers to the political decision earlier this year to bail out
the corruption-tainted Bank Century (now Bank Mutiara). It culminated in the ‘resignation’ of
then Finance Minister Sri Mulyani Indrawati, now a World Bank Managing Director). As a result,
the pending adoption of the Financial System Safety Net law, which would clarify the
responsibilities of various regulatory agencies, is crucial to achieving greater financial stability.

All in all, Indonesia’s economy is in a solid position. While inflationary and regulatory issues
remain, with robust growth of the economy Indonesia is poised for increased economic and

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 East Asia Forum
Economics, Politics and Public Policy in East Asia
and the Pacific
http://www.eastasiaforum.org

political influence within Southeast Asia.

Thee Kian Wie is a senior economist at the Indonesian Institute of Sciences (LIPI) in Jakarta
and will be presenting the Economics Update at the Indonesian Update [1], to be held at the
ANU, September 24-25.

Article from the East Asia Forum: http://www.eastasiaforum.org

URL to article:
http://www.eastasiaforum.org/2010/09/25/indonesias-economy-continues-to-surprise/

[1] Economics Update at the Indonesian Update: http://rspas.anu.edu.au/economics/ip/IU10/

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