Indonesia: Riding the wave

Indonesia’s economy is continuing to power ahead, with strong domestic growth and rising demand for export products. However, concerns remain over a potential inflation breakout due to overheated consumer spending fuelled by low interest rates.

The Indonesian economy was given a vote of confidence at the end of November when the Moody’s Investors Service issued a statement saying it was considering raising the country’s credit rating, bringing Indonesia even closer to investment grade. Moody’s said it was looking reviewing the Indonesian government’s Ba2 foreign and local-currency bond ratings, having given them a positive outlook in June.

“Indonesia’s economic resilience is accompanied by sustained macroeconomic balance,” the Moody’s statement said. “The economic policy framework remains increasingly well positioned to deal with evolving macroeconomic challenges and potential shocks.”

Moody’s lead sovereign analyst for Indonesia, Aninda Mitra, said the country’s economic recovery was being sustained alongside well managed external accounts and reasonably good inflation prospects.

“The recent improvement in Bank Indonesia’s foreign currency reserve position coupled with continuing reduction in the government’s debt burden are reducing risk perceptions and encouraging greater inflows of foreign direct investment and long-term capital,” Mitra said.

Though those greater foreign direct investment inflows may be welcome, they do cause raise concerns for some analysts, who fear hot money inflows could result in bubbles developing. These concerns were not allayed when the Bank Indonesia announced on December 3 that it was leaving its key benchmark interest rates unchanged at the record low of 6.5%, introduced in August last year.

These low rates have prompted an increase in bank lending, with loan volume up by more than 16% this year. Though below the 22% or more Bank Indonesia is hoping for by the end of the year, the lower cost of borrowing has bolstered business and consumer activity at the cost of increasing inflation as well.

While Bank Indonesia is still targeting inflation of 6% at most this year, there are increasing suggestions price rises will break through this barrier, with inflation gaining pace as of November to reach a 12-month high of 6.33%.

According to Singapore-based economist Gundy Cahyadi, it is possible inflation could hit 8% in the next three to six months unless steps were taken to take some of the heat out of the economy, such as raising interest rates.

“Questions will persist as to how much longer the rate would stay at 6.5% if inflation were to continue inching higher,” Cahyadi told the Bloomberg news agency on December 3. “At some point, the central bank needs to get its focus back to ensuring inflation meets its target.”

Though inflation may be a concern, the government believes it will not get out of hand, while strong growth will defuse the impact of rising prices. Indonesia’s government is confident that GDP growth will reach the projected 6% this year, a confidence shared by the Asian Development Bank, which has forecast expansion of 6.1% this year and 6.3% in 2011. That said, there was a slight easing of GDP growth in the third quarter, with expansion running at 5.82%, down on the 6.2% as of the end of the second quarter.

In part, Indonesia’s growth spurt is being driven by soaring export returns, with foreign demand for the country’s goods, especially commodities, fuelling economic expansion. According to data released by the Central Statistics Agency (BPS) on December 1, exports topped $14bn in October – a new monthly record – with the year-end total expected to break through the $150bn barrier for the first time in Indonesia’s history, a target that looks likely to be reached given the $135bn total for the first 10 months.

This growth in export sales came despite the appreciation of the rupiah, which has gained some 5% so far this year, which has been easily offset by increased demand and higher prices for commodities such as crude palm oil, with charges up by 40% since January.

While exports are up, it has not all been one-way traffic, with imports also steadily rising thanks to stronger domestic demand, though October’s trade surplus came in at well over $2bn, taking the 10-month total to $15.6bn. Overall, Indonesia imported $12.5bn worth of goods and service in October, up 28% on the same month last year, while the January to October import total came to $109.5bn, around 41% higher than for the same period in 2009.

As long as the global economy continues to want what Indonesia exports, Jakarta should have little difficulty in meeting its own growth objectives. However, this could come at the cost of higher prices at home, and a balance will need to be struck.