Policy changes and reforms to grow Indonesia's economy

 

Indonesia is the only G20 economy in South-east Asia and is home to the world’s fourth-largest population. While it possesses a variety of natural resources, taking full advantage of this endowment is challenging due to constraints such as an archipelagic geography, an infrastructure deficit and workforce inefficiencies. Reforms aimed at addressing some of these shortcomings are on the table, though they face growing resistance, especially amid the Covid-19 crisis.

Development Strategy

Since the 1997-98 Asian financial crisis the authorities have increasingly sought to boost stability and contain risks where possible. According to the IMF’s latest Article IV Consultation, conducted in July 2019, the main risks are external and include rising trade tensions between the US and China, and fluctuating commodity prices.

Since the start of 2020, however, the likelihood of Covid-19 weighing on economic activity has grown significantly, leading to downgrades in domestic and global growth forecasts, and the adjustment of spending plans to support public health. Nonetheless, medium-term opportunities still exist, and the re-election of President Joko Widodo, better known as President Jokowi, in May 2019 has been followed by greater reform efforts that seek to boost confidence and investment.

A key part of the reform drive was the submission of the Omnibus Bill on Job Creation to the House of Representatives on February 12, 2020. The bill constitutes an overhaul of the legislative and regulatory frameworks, presenting 73 laws for review and amendment in areas such as construction, labour, investment and land acquisition (see analysis). President Jokowi has pledged to see through plans to ease labour market rules that have discouraged investors in the past, yet significant opposition from labour unions in late April led him to delay deliberations over the bill. Meanwhile, the administration continues to streamline the licensing and regulatory process for businesses, and has proven willing to adjust investment restrictions in response to market conditions by relaxing investment rules in the banking sector to facilitate consolidation, for example.

Significant developments over the past two decades include a drop in the poverty rate of more than 50% and the emergence of a middle class that contains upwards of 50m people. The country’s four unicorn and one decacorn tech start-ups are indicative of Indonesia’s rising consumer power and regional influence, with local companies such as the ride-hailing and payments platform Gojek expanding into neighbouring countries.

For some, digital technology holds further potential for the country’s micro-, small and medium-size enterprises (MSMEs). “Economic inclusion can be achieved via business partnerships that help improve MSME performance. Considering the importance of MSMEs to Indonesia’s economy, it is important to help them maximise business growth through technology,” Reiner B Rahardja, CEO of blockchain company Tokoin, told OBG.

Structure & Oversight

Sri Mulyani is the minister of finance and has held the position since 2016, as well as from 2005 to 2010, during which she was credited with helping mitigate the effects of the 2007-08 global financial crisis. Bank Indonesia (BI), the central bank, also gained recognition for its response to the crisis, and its monetary policy is perceived as a bulwark against economic instability. Economic planning and strategies are carried out by the National Development Planning Agency (BAPPENAS), while the Indonesia Investment Coordinating Board (BKPM) is responsible for facilitating investments.

The central government shares revenue with the regional governments and has devolved some of its powers to them as a result of a reformation process in the aftermath of the 1997-98 Asian financial crisis. Cities and regional governments have authority and licensing power over areas such as land access.

Performance

Real GDP growth was 5.03% in 2019.

While this was the lowest rate since 2015, economic expansion has remained relatively consistent, at just over 5% between 2016 and 2019. Annual growth in the final quarter of 2019 was the lowest in three years at 4.97%, compared to 5.18% in the same quarter of 2018, which the Ministry of Finance attributed to weakening investment, spending and exports, as well as a slowdown in demand globally.

Prior to the outbreak of Covid-19, an uptick in GDP was expected in 2020, particularly since the election in 2019 had instigated a wait-and-see approach in some sectors of the economy. At a policy meeting in February Perry Warjiyo, governor of BI, predicted Covid-19 would have a V-shaped effect on economic growth in 2020, with a baseline growth rate of 5.1% that could rise to 5.2% with fiscal policy support. However, as the pandemic quickly worsened and numerous countries enacted strict lockdown measures, this was revised down to 2.3% in April. In the same month the IMF downgraded Indonesia’s growth estimate for the year from 5.1% to 0.5%, while the Asian Development Bank put it at 2.5%. Standard Chartered, for its part, sees annual growth of 0.4% and a contraction of 4.3% year-on-year in the second quarter of 2020.

The services sector is the largest contributor to GDP, at about 43%. Industry is the second largest, at roughly 40%, and agriculture accounts for the remainder. Longterm trends show growth in services, a contraction in industry and a stable share for agriculture. The contribution of services to the economy increased from 39.5% in 2007 to 43.6% in 2017, whereas industry’s contribution over the same 10-year period declined from 46.8% to 39.4%. Within industry, resource extraction has grown in its contribution while manufacturing has decreased. Indonesia is the world’s largest exporter of palm oil, and a crucial source of petroleum, coal and industrial metals like copper.

Inflation stood at 2.7% in 2019, lower than the 3.1% predicted by BI but within its target range of 2.5-4.5%. In April 2020 the bank remained confident that by the end of the year inflation would remain controlled, at 3±1%.

The current account deficit narrowed from 2.9% of GDP in 2018 to 2.7%, or $30.4bn, in 2019 thanks to a goods trade surplus, which BI attributed to an increase in non-oil and gas exports and a decline in oil and gas imports, as a result of policies such as the B20 programme. The programme was fully implemented in September 2018 and requires that all diesel fuel has a bio-content of 20%. The decrease in the deficit marked a turnaround from a 1.4-percentage-point increase in 2018 and should place the economy in good stead in light of the global uncertainty caused by the pandemic and the likelihood that emerging markets will see capital outflows as investors sell off riskier assets for safer havens in cash and Treasury bonds.

Running current account and budget deficits – which are expected to widen as a result of Covid-19 – mean currency fluctuation is a key concern. Since 2013 BI has allowed the rupiah to float against foreign currencies, but it has also intervened in the market: for example, by expending a large portion of its foreign currency reserves in 2018 to slow depreciation. In 2019 the rupiah recovered, gaining 3.6% against the US dollar, and, even in the face of the pandemic, the currency is considered undervalued. As of early May 2020 the currency was valued at around Rp15,350:$1.

Fiscal Policy & Plans

Indonesia’s budget for 2020 was initially set at $180bn, up 3% on 2019. A budget deficit of $22bn was targeted, equal to about 1.8% of GDP, which represented a decrease from 1.9% in 2019. According to some analyses published following the budget statement, Indonesia’s cautious stance was tantamount to foregoing some of its growth potential. In its “Indonesia Economic Outlook 2020” report, the Institute for Economic and Social Research, a think tank at the University of Indonesia, suggested fiscal stimulus could create higher multiplier effects from consumption if spending benefits were to trickle down to middle- and lower-income groups.

However, things quickly changed with the global spread of Covid-19 in the early months of 2020, and the budget deficit is now expected to hit 5.1% of GDP following a spending pledge of Rp405.1trn ($28.6bn) in March to safeguard the economy and public health. Outlined in the plan published by the Ministry of Finance and BI are fiscal stimulus initiatives that fall under a couple broad categories. These include front-loading government spending by expanding housing subsidies and the non-cash food assistance programme, among other measures; and tax reform through reducing and exempting income tax, and accelerating value-added tax refunds. Non-fiscal stimuli focus on easing restrictions on import/export processes.

Regarding long-term policy, the foundations for this were set with the 2011 launch of the Master Plan for Acceleration and Expansion of Indonesia’s Economic Development, which targets GDP per capita of between $14,250 and $15,500 by 2025. Achieving this would entail GDP growth of 6.4-7.5% annually. In 2019 per capita GDP at current prices was $4245.

Monetary Policy

BI reversed direction in 2019, with four cuts to its policy rate – the seven-day reverse repossession rate – to end the year at 5%. BI raised rates in 2018 as a response to external pressures such as the hiking of US interest rates. The benchmark rate was trimmed twice more in early 2020 and held at 4.5% following a BI meeting in mid-April. “This decision has taken into account the need to maintain external stability, including the rupiah exchange rate, amid greater global uncertainty,” Warjiyo told local press.

The current staff at BI have navigated recent financial crises and are therefore well placed to maintain a reliable and familiar monetary policy based on past experiences. Indeed, leaders are aware of the influence that global financial flows can have, particularly given that economic shocks in developed markets often lead to a pullback from emerging ones.

To further improve its oversight of monetary movement, BI instituted a monitoring system for foreign currency in the beginning of 2020. This means that importers of goods worth at least $10,000 will have to report how much foreign currency they use for overseas purchases to the central bank, a condition that only exporters had been subject to previously.

Trade

The year 2019 began with the value of imports greater than exports on a monthly basis, but by summer this trend fluctuated. Over the year the non-oil and gas trade balance registered a surplus of $4bn, while oil and gas trade recorded a deficit of $9.3bn; however, the latter was down from $12bn a year earlier. The latest data from BI showed an overall trade surplus of $2.62bn in the first quarter of 2020, compared to a deficit of $1.28bn in the final quarter of 2019. According to a press release in March 2020, BI aims to “continue to strengthen policy synergy with the government and other relevant authorities to strengthen external resilience, including the trade balance outlook”.

Overall, raw natural resources comprise roughly 40% of total export value. In this category, the highest-value exports are coal briquettes, palm oil, gas, rubber and crude oil, and the main export markets are China, the US, Japan, India and Singapore. Export volume is generally tied to global economic conditions, although the trade surplus recorded in the first quarter of 2020 suggests some resilience to the uncertainty caused by the Covid-19 outbreak. Exports of palm oil and its associated products performed particularly strongly in 2019, when it rose by 4.2% to 36.18m tonnes; however, drought and a decrease in fertiliser usage are expected to see lower yields in 2020.

Meanwhile, Indonesia’s main imports are refined petroleum, crude petroleum, telephones, vehicle parts and gas. China is the largest source of imports, followed by Singapore, Japan, Malaysia and Thailand. The overall volume of imports is affected more by domestic conditions and generally tracks the rate of GDP growth.

Foreign Investment

According to the UN Conference on Trade and Development (UNCTAD), the country received a record $24bn in foreign direct investment (FDI) in 2019. UNCTAD credits this 12% increase from 2018 to foreign inflows into retail and wholesale trade, including the digital economy and manufacturing. For the whole of 2020 BKPM set a target of Rp487.3trn ($34.4bn) for FDI and Rp886trn ($62.5bn) for overall investment realisation; however, the latter figure was outlined in January, before the pandemic took hold.

The negative investment list details sectors closed to foreign ownership. In late 2018, 54 industries were removed from the list and full ownership of an entity was allowed in certain situations in eight sectors: communication and information, energy and mineral resources, health, transportation, job training, tourism, trade and forestry. As part of the reforms put forward for President Jokowi’s second term, the list’s repositioning as a positive investment list was mooted. The financial services industry stands out as an area where foreign investment is encouraged, and the state has shown flexibility with its policies in order to facilitate deals. “Indonesia sometimes sends a muddled message to foreign investors but knows it needs to offer incentives to attract foreign investment,” Greg Arnold, an associate with Vriens & Partners, a Jakarta-based government affairs consultancy firm, told OBG.

The administration’s progress on improving the business environment in an effort to attract further investment is marked by the country’s ranking in the World Bank’s ease of doing business index. Indonesia ranked 120th in 2014, when President Jokowi was first elected, but has since improved to 73rd out of 190 countries in the “Doing Business 2020” report.

Indonesia’s increasing openness to foreign investment is receiving considerable attention, especially given its large population and abundance of natural resources – although this openness varies by sector. Investors in upstream energy and mining cannot own more than 50% of specific extraction projects for the entire life of a project. In mining, regulations mandate divestments in a phased process resulting in a foreign owner possessing a minority stake by the 10th year of activity. In the energy sector, licences for existing oil blocks held by foreign companies are not always renewed after expiration. Foreign investors that develop these projects are generally expected to sell them, often to state-owned enterprises such as Pertamina, the public energy producer and distributor.

Resource-sector investment models based on exporting will likely face fewer restrictions if they include local downstream processing. The past five years have seen periodic export bans on unprocessed minerals, such as nickel – including a two-year ban imposed from January 2020 that is intended to help Indonesia move up the nickel processing chain (see Industry chapter). In other sectors, conditions on the ground have led to a relaxing of rules for foreign investment. This includes banking, where the 40% foreign ownership cap has been relaxed in certain circumstances.

The government has also moved to improve the experience for foreign investors by reducing bureaucratic obstacles. One recent move to this end was the November issuance of Presidential Instruction No. 7 of 2019. The bill clarifies that BKPM is the issuer of business licences and the main point of contact for foreign investors looking to enter the country or start a new venture. The instruction mandates that the procedure for licence issuance be accelerated through updating the online single submission (OSS) system. The OSS platform was introduced in July 2018 to smooth foreign investors’ entry into the market by providing licences through a web-based engine, and 1m licences had been issued through December 2019. However, the system has suffered from technical issues and a lack of cooperation between the central and regional governments.

Outlook

While early signs suggest that Indonesia is tapping all available resources to weather the economic storm caused by the global pandemic, the virus’ full impact on public health, economic growth and investment will not become apparent for some time. Meanwhile, earlier reform efforts, such as the Omnibus Bill on Job Creation that was put forward in February 2020, are meeting pushback, although such moves are seen by the administration as key to boosting FDI, human capital development and, ultimately, broader economic growth. Many regard such moves as key to helping the economy make a quick rebound in 2021.

You have reached the limit of premium articles you can view for free. 

Choose from the options below to purchase print or digital editions of our Reports. You can also purchase a website subscription giving you unlimited access to all of our Reports online for 12 months.

If you have already purchased this Report or have a website subscription, please login to continue.

The Report: Indonesia 2020

Economy chapter from The Report: Indonesia 2020

Cover of The Report: Indonesia 2020

The Report

This article is from the Economy chapter of The Report: Indonesia 2020. Explore other chapters from this report.

Covid-19 Economic Impact Assessments

Stay updated on how some of the world’s most promising markets are being affected by the Covid-19 pandemic, and what actions governments and private businesses are taking to mitigate challenges and ensure their long-term growth story continues.

Register now and also receive a complimentary 2-month licence to the OBG Research Terminal.

Register Here×

Product successfully added to shopping cart