Indonesia economic quarterly : back on track?

52200 INDONESIA ECONOMIC QUARTERLY Back on track? December 2009 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 their implications 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 Poverty Reduction and Economic Management group's macroeconomic analysis team at the World Bank's Jakarta office. Shubham Chaudhuri, Senior Economist, led the team and edited this Quarterly with Tim Bulman, Economist. Contributions came from Andrew Blackman and Fitria Fitrani (external sector, trade flows and balance of payments), Andrew Carter (government revenues and balance), Andrew Ceber (national accounts and domestic demand), Diva Singh, Neni Lestari and Telisa Falianty (financial markets, monetary sector and banking indicators), Ahya Ihsan (government expenditures and balance) Tim Bulman (prices and government financing) and Matt Wei-Poi (poverty and labor market analysis). Magda Adriani and Fitria Fitrani provided data support to the team. Edgar Janz and Vivi Alatas prepared the feature on developments in Indonesia's labor market, Shubham Chaudhuri described Indonesia as a middle income country, and Claudia Rokx prepared the material for the feature on health financing. Dhauhari Sitorus, Nathan Dal Bon and P. S. Srinivas provided editorial suggestions. The full team is under the leadership of World Bank Jakarta Office Lead Economist William E. Wallace. 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. For information about the World Bank and its activities in Indonesia, please visit www.worldbank.org/id i Table of contents Preface i Executive Summary: Back on track? iv A. ECONOMIC UPDATE 1 1. Indonesia's economy, less affected than most by the global downturn, has returned to near-pre- crisis growth rates 1 a. Growth was broadly based ............................................................................................................. 1 b. The economic recovery, with higher global commodity prices, has stabilized inflation at decade lows ..................................................................................................................................... 3 2. Indonesia's financial indicators remain volatile, rising by more than most 5 a. The balance of payments remained in surplus in Q3, with capital flowing into Indonesian financial assets ................................................................................................................................ 5 b. Equity and fixed income markets and the rupiah have continued the strengthening trend, at a slowing pace ................................................................................................................................. 6 c. The gains in financial markets and the exchange rate have been partly due to significant capital inflows .................................................................................................................................. 8 d. Despite the overall robustness of the banking sector, credit growth is showing only moderate recovery .......................................................................................................................... 9 3. The economic outlook is expected to be a little stronger than last quarter, with an ongoing, gradual recovery 10 4. The government's budget deficit is likely to be near target 15 a. Weaker-than-projected government revenue is offset by below-budget spending ................. 15 B. SOME RECENT DEVELOPMENTS IN INDONESIA'S ECONOMY 21 1. Indonesia's trade flows through the global crisis: from peak to trough and back again 21 2. The rupiah since late 2008: the scale of its movement and the driving factors 23 a. The rupiah has appreciated significantly since March, especially against the weakening US dollar ............................................................................................................................................... 23 b. Inflows of capital into liquid financial assets explain much of the appreciation... ................. 24 c. ...with the recovery in commodity prices fuelling strength as well .......................................... 26 C. INDONESIA 2014 AND BEYOND: A SELECTIVE LOOK 29 1. Seeing Indonesia as a middle-income country 29 2. Indonesia is entering a demographically critical decade 30 3. Creating better jobs for Indonesia's growing labor force 31 4. Financing healthcare for Indonesia's growing labor force and aging population 34 LIST OF FIGURES Figure 1: GDP growth returned to pre-crisis averages in Q3 ............................................................ 1 Figure 2: Growth across Indonesia's trading partners has rebounded ........................................... 1 Figure 3: Contributions to GDP expenditure growth ......................................................................... 2 Figure 4: Production sectors' contribution to growth ....................................................................... 2 Figure 5: Motor vehicle and motorcycle sales .................................................................................... 2 Figure 6: BI retail sales and consumer confidence ............................................................................ 2 Figure 7: Trade flows are recovering... ............................................................................................... 3 Figure 8: ...supported by global commodity prices, which are lifting Indonesia's export prices.. 3 Figure 9: The pick-up in inflation earlier in the second half of 2009 has not continued, allowing inflation to fall to decade lows ...................................................................................... 4 Figure 10: ...and consumers expect prices to be stable into the first half of 2010 ......................... 4 Figure 11: The IDX has risen more than most regional indices, before tracking sideways from late September ................................................................................................................ 6 Figure 12: ...and the rupiah's appreciation against the USD is the second strongest in the region .............................................................................................................................. 6 Figure 13: Local currency government bond yields, steadily falling across all tenors since March, have returned to early 2007 levels.................................................................... 7 Figure 14: Indonesian sovereign USD bonds have settled at levels slightly above their historical average, but have strengthened by more than most emerging market debt ............ 7 Figure 15: Indonesia has absorbed USD 6.5 billion in foreign capital since March, USD 2.6 billion of this in September and early October ............................................................ 8 Figure 16: Reserves have increased strongly since March while M2 growth has been slow, suggesting BI has been sterilizing its foreign exchange interventions .................... 8 Figure 17: Credit growth dropped sharply after September 2008 but has picked up since mid- 2009 ................................................................................................................................. 9 Figure 18: While other countries (apart from India) have seen credit slowdowns as well, Indonesia's stands out due to its rapid credit growth in the two years prior to October 2008 ................................................................................................................... 9 Figure 19: Despite various policy actions by the central bank, lending rates have only dropped 7 percent since January while deposit rates have fallen by 31 percent .................. 10 Figure 20: Indonesia is the only country where lending and deposit rates rose in the year to June 2009 ...................................................................................................................... 10 Figure 21: Indonesia's growth outlook improves ............................................................................. 11 Figure 22: ...along with the outlook for trading partners ................................................................ 11 Figure 23: Roll-over rates on Indonesia's external debt have also been high through 2009 ....... 14 Figure 24: ...have their greatest impact on 2010 growth ................................................................. 15 Figure 25, Figure 26: Spending on core programs has improved compared with recent years, but lower spending on `other' items and subsidies lowers overall spending ........ 16 Figure 27: VAT revenues have become more volatile than consumption spending recently ...... 20 Figure 28: VAT revenues from more industries producing more discretionary goods ................ 20 Figure 29: ...were particularly weak during the slowdowns around the turn of 2009 and 2006 ... 20 Figure 30: Trade values peaked in mid-2008, and troughed in February 2009 .............................. 21 Figure 31: From March, the rupiah has nominally appreciated much more against the USD than the USD has weakened against a broad basket of currencies ................................. 23 Figure 32: Indonesia's exchange rate has also appreciated significantly in real terms against a basket of currencies .................................................................................................... 23 Figure 33: The USD Index has moved in the opposite direction to global stock indices since the onset of financial market turmoil in September 2008................................................ 24 Figure 34: Indonesian local currency bond yields have fallen by one-third since March, but remain well above yields elsewhere ........................................................................... 24 Figure 35: There have been significant net capital inflows into Indonesia since March... ........... 25 Figure 36: ...increasing the stock of foreign capital held in Indonesia by USD 6.5 billion