Asia Macro: Is 3 years of 6%+ growth a dream? No, it’s Indonesia!

Indonesia has reported annual growth of more than 6 percent in four of the last five years. In 2009, in the aftermath of the Lehman’s blowup, Indonesia  “only” managed 4.6 percent growth when the US reported -3.1 percent , Singapore -0.9 percent and South Korea +0.3 percent ). How does it achieve such strong, steady growth?

Unlike a number of Asian economies, the Indonesia archipelago of almost 250 million people (the fourth most populated country in the world) has the advantage of domestic consumption currently accounting for close to 54 percent of GDP (35 percent in China). This means that the economy has not been subjected to the wild swings in performance seen by other Asian peers of late as the global economy slows. Impressive, but one must take note that about 12 percent of the population still live below the national poverty line with a smaller percentage able/willing to contribute to the strong growth.

Investment has also started to play an important role in contributing to growth – almost 33 percent of growth at the Q2 estimate (and the largest contribution since 1997) while construction also contributes the rest of the lion’s share at 10.3 percent. What about exports, the bastion of most Asian economies?

Commodities exports
Indonesia’s exports are firmly in the commodities camp – gas, plywood, rubber and textiles being the major exports and hit record highs (value-wise) in 2011 as commodity prices firmed. Since 2007 Indonesia is a net oil importer and the government runs subsidy schemes for fuel, cooking oil, rice and electricity. Fuel subsidies account for about 30 percent of budget expenditure (in contrast infrastructure investment is only about 7.5 percent) and a failure to reduce subsidies earlier this year is putting pressure on national accounts. By law, the maximum allowed budget deficit is 3 percent of GDP but the economy is currently facing a budget deficit of 3.6 percent.

The government generally promotes fiscally conservative policies, resulting in a debt-to-GDP ratio of less than 25 percent, a small current account surplus, a fiscal deficit below 2 percent, and historically low rates of inflation. As a result, Fitch and Moody's upgraded Indonesia's credit rating to investment grade in December 2011, though S&P still keeps its BB+ rating. Earlier this year the OECD upgraded Indonesia’s country risk classification and it now stands on a par with Brazil, India, Russia and Mexico.

Foreign direct investment
This upgrade has helped Foreign Direct Investments to reach an all-time high in the second quarter of 2012 with more than half of total investments targeted at Java, the country’s most infrastructure-ready island which is the hub for manufacturing and industrial business. The top 5 target sectors for FDI were mining; chemical and pharmaceutical industries; transport, storage and telecommunications; metal, machinery and electronic industry; and food/crops and plantations.

Government forecasts are for growth of between 6.3 and 6.7 percent this year though median forecasts are closer to 6.0 percent. The trade balance slipped into deficit between April and July this year, the longest stint in deficit since records started in the early 1980s, reflecting a slight dip in domestic demand. Trade policy has a suspicion of trying to protect its domestic industries from influxes of cheap foreign goods. Inflation is relatively well-behaved by historical standards (4.3 percent y/y in September) and has enabled bank Indonesia to hold key rates steady at 5.75 percent, with surveys suggesting it will remain unchanged through to mid-2013.

Corruption remains a challenge
What are the challenges going forward?  President Yudhoyono’s government has made inroads into stamping out graft and corruption and this progress needs to be continued. This is being slightly hampered by a number of corruption charges being made against members of the President’s Democratic Party. Poverty reduction and battling unemployment still remain key focuses for the current administration along with reducing the economy’s reliance on fuel subsidies, a costly item in the government’s budget. A lack of comprehensive infrastructure outside of the key industrial areas could also prove a deterrent to the continued inflow of investment capital.