Speeches & Transcripts

Speech by World Bank Managing Director and COO Sri Mulyani Indrawati: The Transformation of the Indonesian Economy in Challenging Times

November 30, 2015

World Bank Managing Director and COO Sri Mulyani Indrawati SIPA, Columbia University, New York City, United States

As Prepared for Delivery

You have asked me to speak about Indonesia and the global environment. So let me start with a few words on the world we are living in since the financial crisis of 2008.

When I look back to where the world was five years ago, I see a very different picture.

Emerging markets were confident in 2009. They came out of the global financial crisis strong, producing two thirds of global growth, while high-income countries struggled to recover.

Today, the picture has changed. China’s growth is slowing, Brazil and Russia are in recession. And Indonesia, my country, and the country we want to discuss today, is not living up to its potential.

The tone has changed. The confidence is gone. And you hear a lot more humility coming from the capitals of emerging markets.

The challenges in the global economy are multi-dimensional and well-known. We face:

Lower demand from China; hurting emerging and developing countries;

We expect tightening financial conditions following a likely rise of US interest rates in December;

Low commodity prices wreak havoc on the budgets of exporters;

And weak global trade is failing to kick start the engines.

Putting all of this together, we think that 2016 will continue to be challenging with significant headwinds and broad-based weaknesses.

Global growth continues to disappoint - likely to be about 2.5 percent in 2015, and about 3 percent in 2016.

The recovery in high-income economies is uncertain. The US remains strong, supported by domestic demand. But recent Euro area growth has been disappointing, especially in Germany and France. And Japan’s recovery remains fragile.

The outlook for emerging market is not much brighter. Average growth of the 24 emerging markets is now at 4 %, its lowest level since 2011 when it was at 6%.

The change in their fortunes is striking:

In 2011, all emerging economies had grown for three consecutive years; today, six of them are likely to look back on three consecutive years of slowing growth – among them Brazil, China, and Russia.

In a more challenging global environment, the space for policy stimulus has shrunken.

Since most emerging economies have seen their productivity slow in recent years, the emphasis going forward must be on deepening domestic reforms. The goal is to raise medium-term growth by seeking to reverse these productivity trends.

This is also true for Indonesia.

Indonesia has recovered strongly from the 1998 Asian financial crisis. It has become a thriving democracy, and successfully navigated the 2008 global financial crisis.

High commodity prices and prudent macro-fiscal management helped Indonesia to grow solidly and reduce poverty by half. But poverty reduction has been slowing and many Indonesians who moved out of poverty are vulnerable to fall back.

The changed and challenging global context I mentioned earlier come at a particularly critical time for Indonesia with low commodity prices posing an immediate challenge.

Prices for key export commodities tripled between 2000 and 2010. As a result, rising household incomes significantly boosted private consumption.

But since 2011, prices have dropped by about 57 percent, coinciding with a rapid increase in oil imports, and leading to a significant current account deficit for the first time in 15 years.

Furthermore, Indonesia is aging and the working age population will start to decrease in just a decade. Generating the growth that Indonesia needs to become prosperous will become much more difficult.

The next ten to fifteen years are therefore crucial. Indonesia has to make the most of its existing demographic dividend to avoid getting stuck in the middle income trap.

The reform to-do list is long: Indonesia needs to further reduce poverty and reverse the rapid rise in inequality. With commodity prices no longer supporting growth, Indonesia needs to enhance the quality and diversity of investments away from the resource sector.

What can and needs to be done to transform Indonesia’s economy to realize these aspirations? Recent World Bank studies point to three main sets of priorities.

Indonesia needs to create growth and jobs.

It needs to increase opportunities for all Indonesians.

And, Indonesia needs to do much more to improve governance.

The first set of priorities - creating higher-value jobs - has to do with unleashing the potential of the private sector as an engine of inclusive economic growth.

For this to happen, Indonesia needs to address three main constraints:

First, the large infrastructure gap has cost Indonesia more than 1 percentage of GDP growth over the past decade. Indonesia’s roads and ports are heavily congested. Private firms have to rely on costly sources of electricity.

Example: logistics costs in Indonesia are around 24 percent of GDP, against 16 percent in Thailand.

Second, uncertainty and too many regulations discourage private investment. The new administration has adopted a more open stance towards the role of foreign investment in economy. But major challenges persist, preventing the overall business climate to improve and exploit the benefits of private investment.

Third, skills gaps remain large. 60 percent of Indonesian firms report that finding suitable employees for professional and managerial positions is “difficult.” In the manufacturing sector the number is event higher.

Let me add here that how Indonesia chooses to integrate economically with the rest of the world will be particularly important in addressing these constraints. The recent announcement by President Jokowi of Indonesia joining the TPP is an important first step. I am sure Mari will be discussing this in depth.

The second set of priorities centers around creating opportunities for all Indonesians. Indonesia today is the most unequal country in all of East Asia. And about one third of inequality can be traced to inequality of opportunity.

Compare a child born in Jakarta to non-poor parents who have at least high school education with a child born in a rural area of Papua or Maluku to a poor family with little education. The child born in Jakarta has only a 6 percent chance of lacking proper sanitation, compared with 98 percent for the rural child. These differences extend across all other indicators of opportunity, such as housing, quality health services and education.

One of the reasons for poor service delivery is weak tax collection and sub-optimal public expenditure.

In fact, Indonesia’s revenue-to-GDP and tax-to-GDP ratios are very low by international standards. The country is collecting less than 50 percent of its total potential tax revenue and its public spending is much lower compared to its middle income peers in Asia.

So Indonesia needs to collect more and spend better, particularly at the local level. But the quality of services is persistently low and unevenly distributed across regions. This reflects in part poor spending choices. For instance, in 2012, district governments spent 52 percent of their budgets on personnel and only 3 percent on capital.

The third set of priorities has to do with strengthening governance.

This is particularly - but not only - relevant in the management of Indonesia’s abundant natural resources which are being depleted at unsustainable rates.

Millions of Indonesians in coastal and forest communities whose livelihoods depends on these resources and who are much poorer than the average Indonesian are not fully benefiting from these resources. Poor governance in land-use licensing and lack of law enforcement are main causes for this inequitable overexploitation of natural resources.

Coastal deforestation, water pollution and overfishing will worsen the impact of climate change which will threaten food and water security as well as fisheries and agriculture.

Adapting to these threats, together with measures to mitigate the country’s contribution to greenhouse gases - especially through the burning of peat forests - will be major challenges in the country’s development choices.

Realizing the priorities I have described will be challenging in the current environment. But the good news is that Indonesia has also many “momentum” factors that work in its favor.

First are demographic factors.

Until the demographic window of opportunity begins to close a decade from now, Indonesia will continue to enjoy the dividend of a growing working-age population.

Today, 50 percent of Indonesians are und 30. This increasingly educated and IT-savvy youth - like many in this room today - is an asset that can be used to boost overall productivity and economic growth. With the right policies in place to utilize this labor, Indonesia can benefit from this demographic “dividend”.

Second are developments in China.

China’s rapidly rising wages present Indonesia with an opening to regain a comparative advantage in labor-intensive export sectors. China has seen unit labor costs grow by almost 70 percent since 2005. Combined with slower overall economic growth as China rebalances, this could prompt investors to look to countries like Indonesia.

Rapid urbanization is a third potential advantage for Indonesia.

By 2025, 68 percent of the population is projected to live in urban areas, compared with 52 percent in 2012. As incomes rise and existing large metropolitan areas such as Jakarta and Surabaya become saturated, the demand for consumer durables, shopping space and housing will increase significantly in smaller cities.

Connecting these cities to rural areas and the global economy will be essential in attracting firms and achieving shared prosperity.

With political will and concerted effort, Indonesia can leverage these opportunities and rise to meet the challenges ahead.

At the World Bank Group, we are ready to support this effort. Much of the World Bank research and analysis I presented today will find its way into Indonesia’s development agenda.

Our work with the Indonesian government and the private sector focuses on six areas:

  • Infrastructure;
  • Sustainable energy and connecting millions to reliable electricity;
  • Building the maritime economy and improve connectivity;
  • Collecting more revenue and spending it more effectively;
  • Better services for health-care, education, sanitation and water; and,
  • Holistic landscape management efforts to protect Indonesia’s vast natural resources.

Success in all of these areas will be critical to address Indonesia’s challenges, but most importantly to make use of the countries impressive resources: mainly its people and its natural wealth.

Thank you.