The fourth quarter of 2013 brought welcome signs that Indonesia’s economy is rebalancing in response to previous monetary policy and exchange rate adjustments, which is positive for macroeconomic stability. The overall economic growth rate was broadly unchanged, at 5.7 percent year-on-year, but the composition of growth tilted more towards net exports while fixed investment remained subdued.
Indonesia’s current account deficit shrank notably in Q4 2013, reflecting these changes, and also helped by a stabilization in the terms of trade and a temporary increase in mineral exports ahead of the January ban. This has supported Indonesian financial markets and the Rupiah, which has rallied about 7 percent so far in 2014.
Fixed investment has moderated significantly and is now subdued by the standards of recent years, and this has driven much of the external balance adjustment. How it now evolves is critical for the growth outlook.
GDP growth is expected to moderate somewhat further over 2014, to a still-solid 5.3 percent year-on-year, in the base case, with consumption and investment demand facing headwinds from the ongoing effects on incomes and profits of weaker commodity prices, tighter credit, higher Rupiah-denominated import costs (all compared with recent years), and regulatory uncertainties.
Indonesia’s gross external financing needs remain significant, and there is a need to support foreign direct investment, animportant contributor to total investment and a source of foreign currency, which has remained generally solid but shown some signs of plateauing.
Portfolio investment has had a strong start to 2014, but can be volatile.
The fiscal sector faces pressures from slower revenue growth and high energy subsidy spending, which in combination could push up the 2014 fiscal deficit to 2.6 percent of GDP in the absence of further, needed reforms to broaden the revenue base and limit fuel subsidy costs.
The World Bank estimates that the current de jure mineral export ban policy will reduce the net trade balance by USD 12.5 billion and generate a total loss in fiscal revenues (royalties, export taxes and corporate income tax) of USD 6.5 billion in 2014-17, including a USD 5.5 to 6.5 billion drag on the trade balance in 2014. While the quantum remains uncertain, negative impacts of this order from the ban, along with the broader economic issues the policy raises, suggest it is worthwhile to evaluate a wider set of policy options to ensure that Indonesia benefits to the maximum extent possible from its considerable mineral wealth in a socially and environmentally sustainable manner.
The World Bank’s forthcoming report, “Indonesia: Avoiding the Trap” argues that Indonesia can achieve shared prosperity, through fast productivity-driven economic growth with inclusiveness, but only by making progress on key structural reforms and implementation.
As it continues to urbanize rapidly, Indonesia also faces the challenge of minimizing urban disaster and climate change risks, a task which can be helped through the use of rapid risk diagnostics.
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