Indonesia: Constraints Prompt Slower than Expected Growth

July 8, 2015

Higher infrastructure spending needed to support the economy

Jakarta, July 8, 2015 – Although still growing faster than other commodity exporting countries, subdued fixed investment and weaker consumer spending growth are lowering GDP growth in Indonesia, says a new World Bank report.

Growth is forecasted at 4.7 percent for 2015, revised down from the previous forecast of 5.2 percent, and the 4.7 percent growth of GDP in the first quarter of 2015 is the slowest pace since 2009, says the July 2015 edition of the Indonesia Economic Quarterly, or IEQ, which outlines the country’s options to achieve a strong and sustainable rebound. 

“Unfavorable conditions such as continued low commodity prices and moderating investment growth have led to slower gains for the economy.  But Indonesia can respond by raising quality spending in infrastructure while containing the fiscal deficit to within the legal limit of 3 percent of GDP.  Improved infrastructure will reduce logistics costs and lower prices, boosting economic growth and equity” said Rodrigo Chaves, World Bank Country Director for Indonesia. 

Progress in addressing fiscal sector challenges will also be vital. On the expenditure side, it is crucial to remove the implementation constraints to capital spending, which is targeted by the Budget to double. On the revenue side, tax revenue was targeted by the Budget to increase by 30 percent but fell 1.3 percent in 2015 through May compared with the same period last year. 

The introduction of electronic tax return submissions and other reforms are positive, but more measures to improve revenue collection would also help shore up Indonesia’s fiscal position in the medium-term.  

Like many middle-income countries, Indonesia’s economy is still adjusting to the sharp decline in recent years of commodity prices and the near prospect of normalization of US monetary policy. This has turned the current account balance into a deficit, hurt corporate revenues in commodity sectors and slowed private investments. Fixed investment contributed 1.4 percent of GDP year-on-year in the first quarter of 2015 – or half its average contribution in 2010. Investment is expected to pick up in the second half of 2015, but by less than previously forecasted, partly due to lower than previously projected public capital spending over 2015 as a whole. 

“Good macroeconomic fundamentals allowed Indonesia to prevent growth from sliding following declining demand and prices, as was the case with many large commodity-exporting countries such as Brazil, South Africa, Chile and Peru. Indonesia is still growing at a faster pace. But reverting to higher growth will require fiscal reforms to collect more and spend better on infrastructure as well as improving market regulations that affect competition, trade, and private investment. Public policies to reduce food inflation would also help consumer confidence” said Ndiame Diop, World Bank Lead Economist for Indonesia.

Continued growth slowdown has affected consumer spending, which grew by only 4.7 percent year on year in the first quarter, compared to an average growth rate of 5.3 percent last year. Weakening sales data of motorcycles and other vehicles show that spending is also slowing in the second quarter.  Private consumption accounts for 55 percent of total GDP expenditure.

Moderating consumer demand has contributed to the contraction in imports, down by 14.4 percent year on year in the first quarter.  Exports – of both commodities and manufacturing – also fell, by 13 percent year on year, due to continued subdued global demand, including from China and Southeast Asian neighbors.

The July 2015 edition of the Indonesia Economic Quarterly also discusses the country’s tremendous geothermal energy potential and the need for a more conducive regulatory environment to harness it. The report also takes stock of Indonesia’ school grants program, or BOS, which has helped provide operational funds to 220,000 primary and junior secondary schools since its inception ten years ago.

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