Key Findings on Indonesia: East Asia and Pacific Economic Update, May 2012

May 23, 2012

  • In the fourth quarter of 2011, Indonesia’s growth came in at 6.5% and has increased on a seasonally-adjusted, quarterly basis. Annual growth in 2011 was also 6.5% the highest annual growth rate since 1996, up from 6.1% in 2010.

  • In early March 2012, the government submitted its revised 2012 budget to parliament. The deficit in the proposed and approved revised 2012 budget was 2.2% of GDP, up from 1.5 percent in the original 2012 budget primarily due to higher energy subsidies. However, the World Bank forecasts that if oil prices average US$120 a barrel over the year, the deficit for 2012 could raise to 3.1% of GDP if there is no subsidized fuel price adjustment, or 2.5% of GDP is a fuel price rise is implemented in the 3rd quarter of 2012.

  • Additional spending on fuel subsidies represents significant opportunity costs, but not necessarily a short term fiscal sustainability problem given Indonesia’s strong initial debt position. However, the risk of hitting Indonesia’s deficit limit of 3 percent of GDP might prompt a tightening in spending in key development areas.

  • A moderation of export growth is projected for 2012, reflecting a downward revision to Indonesia’s major trading partner growth, but there is expected to be continued support from domestic drivers of growth. However, any fuel price hike later in the year, and the resulting inflation, could take some edge off private consumption growth.

  • Overall, growth is 2012 is forecast to remain robust at 6.1 percent, and to move back up to 6.4 percent in 2013.

  • Developments in the global economy and financial markets also represent an important downside risk to Indonesia’s short-term outlook. International financial markets and portfolio flows to Indonesia remain volatile, and the global economic outlook is uncertain. The direct impact of lower growth in the EU on Indonesia is likely to be limited, as its exports are relatively diversified by destination.

  •  However, while Indonesia’s reliance on commodity exports has supported growth over the past few years of rising commodity prices, it also represents a source of vulnerability. In this respect, developments in China are of particular interest given their influence on commodity demand and prices (as discussed in the main section of the report).

  • Looking to the medium-term, sustained efforts to remove other distortions in economic activity and to improve the allocation and efficiency of government  spending can help Indonesia reach its objectives of inclusive and higher growth. Redirecting spending by reducing fuel subsidies is only the first step.

  • Progress in improving the allocation and efficiency of government spending is crucial to enable Indonesia to achieve its potential of sustained 7 percent-plus growth, while ensuring that the benefits of this growth are enjoyed by all. Improvements in the business climate and regulatory policy can also help Indonesia reach these higher growth rates.