Czynniki ryzyka i perspektywy

  • Yudhoyono’s second presidential mandate has not delivered much but political stability is likely to be preserved after the 2014 elections.
  • Security climate still affected by communal violence, mainly fuelled by Islamist radicals.
  • Indonesia has shown great resilience to exogenous shocks thanks to robust fundamentals and strong domestic demand, which contributes to the widening current account deficit, though. China’s slower commodity demand and the Eurozone crisis represent two top economic risks.
  • Rising FDI are expected to cover external financing needs, provided emerging resource nationalism does not hinder the investment drive.
  • Public finances continue to improve and would require a fiscal reform to finance future necessary spending notably in infrastructure.
  • The banking sector is sound, whereas the country’s external debt levels are expected to remain rather sustainable.

Fakty i liczby

Zalety

  • Political stability consolidated
  • Strong domestic demand
  • Supportive large commodity sector
  • Weak external (government) debt

Wady

  • Infrastructure bottlenecks
  • Energy subsidies
  • Communal violence, terrorism threat from Islamist radicals
  • Difficult business environment

Main export products

  • Oil & gas (16.6% of current account receipts), coal (11.8%), palm oil (7.6%), processed rubber (6.2%), textile (5.8%), base metal products (5.2%), electrical apparatus (5.1%), tourism (3.5%)

Income group

  • Lower middle income

Per capita Income (USD)

  • 2,500

Population

  • 248.6 m

Description of electoral system

  • legislative: 5-year-term; next election: 2014

Description of electoral system

  • presidential: 5-year term; next election: 2014

Head of State and of government

  • President Susilo Yudhoyono

Ocena ryzyka dla kraju

Political stability likely to continue beyond 2014 polls

The positive momentum enjoyed under President Yudhoyono’s first-term rule seems remote as his second term has been marked by waning popularity notably due to corruption scandals affecting his own Democratic Party (PD), and by overall political apathy. Yudhoyono has ensured political stability and democratic continuity largely free of political violence, but has disappointed in the past few years as far as poverty reduction and infrastructure development are concerned. He has given preference to making modest compromises to keep his coalition united and to remain in control of the situation rather than launching ambitious reforms. Therefore, not much is to be expected before 2014 with the prospect of the next general elections. The Golkar party – which belongs to the ruling coalition and is headed by Aburizal Bakrie, one of Indonesia’s wealthiest businessmen - appears to be the favourite so far, well ahead of the Democratic Party of Struggle and the ruling PD. If Bakrie were to win, his policy would possibly be quite detrimental to liberal reforms and FDI, in line with a few recent protectionist measures from the Yudhoyono government, especially in the mining sector, where Bakrie and his family dynasty have many business interests.

Nonetheless, a pragmatic middle way between opening to FDI and protection of domestic interests is the most likely forecast of government policy beyond 2014. In any case, his victory is not yet taken for granted as his reputation remains seriously tarnished by a huge environment disaster his business group caused in 2006.

Security risks remain despite some improvement

A noticeable achievement under Yudhoyono’s presidency is the more effective fight against terrorism. Jemaah Islamiyah (JI), the largest regional terrorist and Islamist network, has been weakened by an intensified crackdown by national intelligence services that has led to many arrests and deaths among JI’s top figures. The movement is far from dismantled, however, and the security climate is still affected by religious and communal violence. Islamic militancy remains a top risk for internal stability in the world’s largest Muslim country – although popular support for religious-based parties and Muslim extremism has never been so low - and seems to have shifted to smaller extremist groups that resort to small-scale terrorist attacks. The widening income divide will continue to be a key factor fuelling terrorism as well as growing religious intolerance against non-Muslim groups.

Indonesia has frequently been faced with separatist movements within several provinces since its independence in 1945. Although the East Timor (independence) and Aceh (wide autonomy) issues were resolved several years ago, Indonesia still faces long-standing autonomist pressure in West Papua. This year, clashes with strong Indonesian military forces have multiplied and the security situation has deteriorated, especially after the killing of a Papuan independence leader. Indonesian rule and violent repression are increasingly contested locally, and tensions will persist until more powers are devolved to Papuans.

Abating yet robust economic activity

Indonesia’s economy has been remarkably resilient to the 2008-2009 global economic and financial crisis, and remains one of Asia’s and the world’s best performing economies. Indonesia’s average real GDP growth in 2009-2011 (5.8%) was even as high as before the crisis over the same period of time. Solid performances in challenging times are explained by continued stable macroeconomic management and stronger fundamentals, thereby creating latitude to weather down shocks. After a 15-year high of GDP growth (6.5%) last year, the economy has slowed down due to the eurozone crisis and a gloomy global context including lower Chinese-Indian demand for Indonesian commodities. However, the external negative impact is not so pronounced as to alter significantly a comparatively bright economic outlook. Indonesia’s resilience and relative stability have to do with a more balanced economic structure which - unlike many Asian countries - relied less on exports to in-crisis advanced countries in 2009 and much more on robust domestic demand, which is the first growth driver as it accounts for 60% of GDP.

Indonesia_Graph1EN

Meanwhile, a combination of slowing exports and soaring imports of capital goods and a growing
middle-class has shifted the current account into deficit for the first time since 1997. Even though exports are expected to be supported in the long-term by China and India’s rising demand for Indonesian natural resources (e.g. rubber, coal, palm oil), the current account is likely to remain in the negative around a low 2-3% of GDP due to the investment drive. The evolution is not too concerning per se given that it mainly reflects a natural path of rising investment-related imports aimed at supporting Indonesia’s future economic development. An extra contribution to the deficit comes, however, from the fact that Indonesia has become a net oil and gas importer as a consequence of declining oil production due to maturing fields and lacking FDI in the oil sector in the 2000s. Although the latter have bounced back since 2011, the LNG sector - with reserves estimated at 50 years at current production - will gradually gain a higher relative economic importance for domestic use and export aims (about 10% of world LNG exports).

Indonesia_Graph2EN

External financing needs are to be met amid global uncertainty

As far as closing the balance of payments gap is concerned, external financing needs are expected to be met in coming years by FDI flows that are attracted by high growth prospects and investment  opportunities. Therefore, Indonesia’s authorities will have to keep attracting large volumes of FDI, which are taking up a prominent position in Indonesia’s financial account, bringing more resilience given their more long-term nature. Since 2010, FDI figures have been very good as inflows reached a record USD 20 billion (i.e. slightly more than India) in 2011 –mainly in the commodity industry- and are still on an upward trend this year. However, future developments might partly be dependent on the government’s stance on FDI as its latest moves on the matter have been more nationalistic (e.g. reduced foreign ownership in the mining sector, an export ban from 2014 onwards of unprocessed metals, copper, gold, and also low-quality coal) allegedly to preserve natural resources and fulfill domestic needs. It is certainly to hope that the authorities will get the balance right to avoid deterring necessary foreign investments.

Indonesia’s economy faces two downside risks: a sharper decline in China’s commodity demand (with consequences indirectly on world prices and directly on Indonesian export as China is the country’s second export market) and short-term capital flight to safer havens. To offset destabilizing capital outflows, besides an FDI boost, Indonesia might still make use of its foreign exchange reserves or, if necessary, tap into the Chiang Mai Initiative Multilateralization fund: a USD 240 billion pooled by ASEAN+3 Asian countries. Looking forward, the moderate widening of the current account deficit and heightened investor risk aversion, which have led so far in 2012 to more than 5% depreciation of the rupiah against the USD, are likely to keep some downward pressure on the local currency.

Inflation has remained under control over the past few years despite sporadic surges in times of overheating. Under less buoyant and more uncertain economic conditions, monetary policy is to keep inflation within the 3.5-5.5% target range in the medium-term. Main inflation pressures will come from higher food prices and hikes in domestic fuel prices reflecting higher world oil prices or attempts to cut energy subsidies.

Fiscal discipline pays off but further reform needed

The health of public finances has steadily improved thanks to continued budget discipline that has allowed a constant sharp decline of government debt since 1999, from 92% to 24.5% of GDP in 2011, a downward trend that is expected to continue. Prospects are also favourable for the budget balance, which is stable around a modest deficit (allowing some fiscal stimulus in 2012), and interest charges that have decreased from 11.3% in 2009 to 8% of total revenues. These achievements and the improved public finances outlook have allowed Indonesia’s sovereign debt to regain its investment grade among credit rating agencies, a status it had lost during the Asian crisis.

The only aspect on which the authorities need to put more emphasis is a fiscal reform aimed at strengthening a structurally low public revenue base (only 16% of GDP) that is by far insufficient for a large economy given its huge infrastructure and social welfare needs. On the expenditure side, a lingering issue lies in heavy energy subsidies (3.4% of GDP and 20% of total spending), with attempts to cut them failing frequently due to unpopularity so that vulnerability to commodity price fluctuations will remain.

Indonesia_Graph3EN

Indonesia’s promising long-term outlook with an expected average 6.5% GDP growth, rests on a high growth potential supported by a demographic dividend (with half relatively young among the world’s fourth largest population), strong saving and investment rates and a broad-based economy relying on consumer demand expected to further rise and large resource endowments. However, given global uncertainties, the time is right to give impetus to Indonesia’s development particularly in tackling weak infrastructure (transport and power supply) and congestion in large cities and transport. With barely an annual average of 2-3% of GDP invested in infrastructure, Indonesia lags well behind levels reached by regional peers (including India). Yudhoyono’s “master investment plan (2011-2025)” is therefore essential to improving productivity, competitiveness and avoiding economic activity paralysis due to congestion. Sizable government plans, focusing on other priorities such as education, health or poverty reduction, mean a large share will have to come from private sources to meet official growth targets. This might be challenging given multiple obstacles within Indonesia’s difficult business environment (bureaucracy, corruption, hard land acquisition, uncertain law enforcement…).

A sound financial sector clouded by Eurozone crisis contagion

The Indonesian banking sector remains solid and, besides the impact from the global credit squeeze, has hardly been affected by the 2008-2009 world financial crisis. Banks are healthy, not relying on foreign capital, being sufficiently capitalized, well-supervised, profitable and burdened with low non-performing loans -i.e. less than 2.5% of total loans- despite a gloomier economic context. Indonesia can therefore look at the future with optimism even though optimism is mitigated by the contagion risk of the eurozone crisis  to the Indonesian financial sector (notably the bond market) due to threats of foreign capital withdrawal. Moreover, bank credit growth might have to be alleviated from a high 25% p.a. if the economic slowdown is to persist with the risk that loan quality deteriorates and inevitably leads to rising bad loans. In the medium-to-long-term, economic expansion is likely to go together with a wider and more deepened financial sector, and higher credit penetration as financial intermediation remains relatively weak.

External debt appears sustainable

Apart from the year 2009, when it increased for the first time since 2001 as a consequence of the global economic slowdown and strong depreciation of the rupiah, Indonesia’s external debt-to-GDP ratio remains on a downward trend. External debt evolution has been favourable over the past decade thanks to robust economic activity, high commodity prices and demand, and, on average, a rather stable rupiah. Hence, external debt ratios have decreased to 26.6% relative to GDP (i.e. halved since 2004) and to 98.7% relative to export receipts (-20% since 2009) in 2011. Although the latter might increase somewhat due to weaker export growth projections, external debt stock will remain sustainable in the medium-to-long-term. Robust economic growth forecasts and expected strong non-debt creating capital inflows will help to keep Indonesia’s external debt in manageable territory even with the country facing external shocks.

Indonesia’s external liquidity has further improved as foreign exchange reserves have hit record levels, breaching the USD 100 billion threshold in 2010 and staying above afterwards. Their tremendous surge (+65% from end 2009 to summer 2012), partly fuelled by sharp FDI inflows, allows five months’ import cover that is likely to decline gradually in the future as a result of expected stronger imports. The external liquidity situation is quite comfortable as foreign exchange reserves can cover twice the short-term debt - risen to nearly 25% of exports though- and more than four times a rather modest debt service. The ratio to export earnings has been stable around an average 13% in the past few years and is expected to remain so in the medium-to-long-term.

Indonesia_Graph4EN

Risk outlook

In spite of huge external shocks since 2008, Indonesia’s economy has proved resilient and has highlighted its reduced vulnerabilities made possible by the constant strengthening of fundamentals and the pursuit of macroeconomic stability. Therefore, in spite of a more uncertain global climate, slower Chinese demand and the eurozone crisis seen as main future risks, Indonesia’s risk classifications are expected to stay stable.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com