Indonesia Economy: Strong performance but risks lie ahead

March 16, 2011

  • Indonesia’s economic development during the first quarter of 2011 has similarities to 2008 with strong economic momentum coupled with a rise in commodity prices
  • Economic growth exceeded expectations in the last quarter of 2010, with quarterly growth well above the average for the last ten years
  • Rising prices of commodities bring challenges, and opportunities, for Indonesia

Jakarta March 16, 2011 - Indonesia’s economic situation during the first quarter of 2011 seems to be a déjà vu of 2008. The strong momentum in the domestic economy coupled with rising international and domestic commodity prices resembling conditions three years ago motivate the title of the World Bank’s March 2011 Indonesia Economic Quarterly - “2008 Again?”.

The report, which was launched at the Paramadina Graduate School on March 16, has two main messages. First, Indonesia is showing strong economic performance. Growth in the fourth quarter of 2010 exceeded expectations and was well above the average quarterly growth rate for the last ten years. The World Bank’s growth forecast for 2011 has been upgraded to 6.4 percent, moving up to 6.7 percent in 2012. Balance of payments inflows are strong and foreign direct investment has increased, reaching record levels.

The second main message from the report is that, despite this bright economic outlook, increases in commodity prices also bring risks for Indonesia. Many global commodity prices are back at or above their 2008 peaks. Shubham Chaudhuri, Indonesia Lead Economist, World Bank, explained that rising commodity prices may bring positive benefits for the country’s GDP as a whole because of Indonesia’s resource wealth. “However, risks lie for poor households who may be greatly affected by sharp increases in living costs,” he warned. For example, rising food price inflation can pose a risk to progress on poverty reduction. Shubham added that at the global level the World Bank estimates that the increases in food prices seen since June 2010 have led to an estimated 44 million more people entering poverty.

Another risk associated with rising commodity prices is that higher oil prices may cause Indonesia to spend more on fuel subsidies. Indeed, fuel subsidy expenditures have exceeded the original budget allocation in six out of the last seven years. This spending on fuel subsidies could instead be used to finance spending on social protection programs or on infrastructure development, which is one of the main factors holding back Indonesia’s growth potential. During the report launch, Chatib Basri, from the National Economic Committee of the President of the Republic of Indonesia, also expressed his concerns that fiscal or inflationary concerns associated with rising oil prices may also trigger capital to flow out of Indonesia, particularly from government bonds.

The report also highlighted the emergence of the middle income class in Indonesia. From 2003 to 2010 around 7 million people per year have moved into the middle income class, defined as that segment of the society with spending of US$ 2 to US$ 20 per day. Shubham explained that Indonesia can benefit from the rising consumer demand of a growing middle income population. At the same time the demand for public goods is likely to shift to better quality and more sophisticated services in health and tertiary education. He added that, “Policies will also need to be put in place to meet rising middle class expectations of productive employment opportunities.” Mohammad Ikhsan, special advisor to the Vice President of the Republic of Indonesia, commented that the middle income class will change the landscape of future policy formulation