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publication October 3, 2017

October 2017 Indonesia Economic Quarterly: Closing the Gap

  • Indonesia’s real GDP expanded by 5.0 percent year on year in Q2 2017, unchanged from Q1. Growth rates have been steady at around 5 percent since Q1 2014, lower than those recorded at the beginning of the decade.
  • Indonesia’s macroeconomic fundamentals are sound and have been strengthening, as the Government continues to implement critical structural reforms.
  • Investment growth rose to the highest levels since Q4 2015, driven largely by investments in buildings and structures.
  • Private consumption growth unexpectedly remained unchanged in Q2. The steady momentum in private consumption, which accounts for over half of Indonesia’s GDP, stands in contrast to several favorable drivers, such as strong job growth, double-digit wage increases and the shifting of the Idul Fitri festive season to Q2 this year
  • The absence of pickup in growth in Q2, particularly in private consumption, is a puzzle that requires further data and analysis. One possibility is that the economy is adjusting to recent reforms, while growth dividends come with a lag.
  • Government consumption contracted from the previous year, partly reflecting base effects of a large increase in material spending in Q2 last year, combined with fewer working days in Q2 this year.
  • After surging in Q1, export and import growth both slowed significantly, in part reflecting easing commodity prices in Q2 and fewer working days due to the Idul Fitri holidays.
  • Fiscal and monetary policies responded to growth concerns with prudent stimuli:
    • The 2017 Revised Budget sets out a higher fiscal deficit of 2.9 percent of GDP, up from 2.4 percent in the original 2017 Budget, mainly due to an increase in expenditure. Revenues were also revised downward.
    • Recently, the Central Bank embarked on a new easing cycle, cutting interest rates by 25 basis points in both August and September to support GDP growth, noting lower than expected inflation and sluggish credit growth.
  • Real GDP growth is expected to reach 5.1 percent in 2017, climbing to 5.3 percent in 2018, on a supportive global economy and stronger domestic demand as reforms continue and gradually start paying dividends.
  • It is critical to maintain reform momentum as gaps in physical and human capital, and institutional quality, are still significant. Alleviating these shortfalls are vital and require steadfast commitment to reforms and ensuring their implementation on the ground. Should these structural reforms be overlooked, potential growth could slow and weigh on the outlook.
  • The infrastructure needs in Indonesia’s fast-growing, rapidly urbanizing economy are vast. However, years of underinvestment have led to a large infrastructure deficit, constraining Indonesia’s growth and limiting the pace of poverty reduction.
  • Boosting the participation of the private sector in infrastructure development will require improvements in:
    • the complex legal and regulatory environment for public-private partnerships
    • project planning, appraisal and selection processes
    • transparency and efficiency of state owned enterprises that dominate the infrastructure sector
    • the depth of local banking and capital markets.