Indonesia economic quarterly : looking forward

56790 INDONESIA ECONOMIC QUARTERLY Looking forward September 2010 Preface The Indonesian Economic Quarterly reports on and synthesizes the past three months' key developments in Indonesia's economy. It places them in a longer-term and global context, and assesses the implications of these developments and other changes in policy for the outlook for Indonesia's economic and social welfare. Its coverage ranges from the macroeconomy to financial markets to indicators of human welfare and development. It is intended for a wide audience, including policy makers, business leaders, financial market participants, and the community of analysts and professionals engaged in Indonesia's evolving economy. This Indonesian Economic Quarterly was prepared and compiled by the macroeconomic analysis team at the World Bank's Jakarta office, under the guidance of Lead Economist Shubham Chaudhuri and Senior Country Economist Enrique Blanco Armas: Magda Adriani (rice prices), Andrew Blackman (trade flows, balance of payments), Andrew Carter (government revenues), Andrew Ceber (national accounts, domestic demand, medium term macroeconomic projections, executive summary), Fitria Fitrani (trade flows and ASEAN-China FTA), Faya Hayati (prices and real incomes), Ahya Ihsan (government expenditure), Diva Singh (financial markets, monetary conditions, banking sector). Banking sector input was also provided by Neni Lestari and P.S. Srinivas. Andrew Ceber, Tia Chandra, Ashley Taylor and Tim Bulman shared the editing and production. Enrique Blanco Armas provided detailed comments on earlier drafts. For more World Bank analys is of Indonesia's economy: For information about the World Bank and its activities in Indonesia, please visit www.worldbank.org/id In order to be included on an email distribution list for this Quarterly series and related publications, please contact madriani@worldbank.org. For questions and comments relating to this publication, please contact tbulman@worldbank.org. iii Table of contents Preface iii Executive Summary: Looking forward viii A . ECONOMIC AND FISCAL UPDATE 1 1. Indonesia's robust recent growth performance is expected to continue 1 a. Private demand accelerated in the first half of 2010, offsetting a slowdown in government spending .......................................................................................................................................... 1 b. Import growth continues to outpace that of exports .................................................................... 2 c. Indonesia's economic growth is likely to rise further .................................................................. 3 2. The balance of payments surplus was near historic highs in Q2, but future narrowing is expected 5 3. Indonesian financial markets strengthened with the return of strong capital inflows 5 a. Indonesian asset prices strengthened in line with renewed capital inflows .............................. 5 b. With money supply growth and inflation picking up, BI has raised the statutory reserve requirement for commercial banks ................................................................................................ 7 c. Credit growth increased significantly in Q2, boosted by working capital and investment loans ................................................................................................................................................. 8 4. Core inflation continues to recover while headline inflation accelerated sharply due to temporary food supply shocks 10 a. CPI inflation rose in mid-2010 because of weather-related supply disruptions ...................... 10 b. The inflation outlook for 2010 remains unchanged, but stronger price growth is expected in 2011 ................................................................................................................................................ 11 5. Poverty continues to trend downwards 13 6. Reallocating and improving the quality of fiscal spending is on the Government's agenda 14 a. The government proposes a reallocation of expenditures in the 2011 budget........................ 14 b. Slow disbursement rates have continued through 2010 ........................................................... 15 c. World Bank projections are for the budget deficit for 2010 to be slightly lower than previously anticipated ................................................................................................................... 15 7. The focus of risks is shifting towards the medium-term 19 a. If demand exceeds supply capacity there may be a reemergence of inflation ........................ 19 b. There is a risk that Indonesia's economy will not grow as quickly as expected if the reform agenda is slowed ........................................................................................................................... 20 B. SOME RECENT DEVELOPMENTS IN INDONESIA'S ECONOMY 21 1. Update on the ASEAN-China Free Trade Agreement 21 a. The implementation of ACFTA tariff reductions ......................................................................... 21 b. The rising importance of China in Indonesia's imports reflects a range of factors ................ 22 c. ...but initial statistical analysis does not support the arguments that import growth from China has been impacted by the ACFTA tariff reductions......................................................... 23 d. Look at the ACFTA as the media to exchange market access .................................................. 25 2. Piecing together insights into the movements in household purchasing power 26 a. During the previous decade households experienced large increases in real consumption. 26 b. Consumer confidence indices and inflation measures provide real-time insights into developments in real consumption ............................................................................................. 27 c. Recent increases in some volatile food items particularly affected the purchasing power of poor and rural households ........................................................................................................... 29 3. Medium-term macroeconomic projections 30 a. Drivers of potential growth in the economy ................................................................................ 30 b. Growth accounting revisited ........................................................................................................ 31 c. Baseline projections ..................................................................................................................... 32 d. Advantages, disadvantages and further work ............................................................................ 33 e. Implications and conclusions ...................................................................................................... 34 C. INDONESIA 2014 AND BEYOND: A SELECTIVE LOOK 35 1. Improving Access to Financial Services: Analysis and ideas for policy-makers 35  a. What is access to finance/financial inclusion and where does Indonesia stand? .................. 35 b. Demand-side aspects: what products and services do people need? What is currently available to them? ......................................................................................................................... 36 c. Supply-side Aspects: Who are the market players and what is their role in providing access to financial services? .................................................................................................................... 37 d. The role of ICT in improving access to finance .......................................................................... 38 e. Policies to promote access to finance ........................................................................................ 39 2. Labor Reform in Indonesia