Building Block

GDP growth is expected to remain above 5% for the next few years thanks to high levels of public infrastructure spending and export growth.

Indonesia has spent the last few decades shifting into a new role as a regional and global power. Southeast Asia’s largest economy and the fourth-largest country in the world by population has seen its global clout rise in tandem with its growth. Over the past five years, Indonesia has focused on strengthening its economic fundamentals in order to build an economy that can compete effectively in the global marketplace. The government has worked with industry leaders to increase high-tech manufacturing, improve revenue collection, and focus on expenditures that allow for further growth and insulate the country from economic shocks.

After posting strong growth through the first decade of the 2000s, falling commodity prices and shifting regional trends have led to slightly slower yet still stable growth in recent years. A growing population and increased economic complexity means that the Indonesian economy is in no danger of contracting, but after registering GDP growth of over 6% from 2007 through 2012 (save a drop to 4.6% in 2009) the economy has posted growth rates of between 5 and 6% in each of the past five years. 2017’s GDP growth was at 5.1% for the full year, slightly below initial World Bank projections of 5.2%. Though still strong, this figure was below the Southeast Asia regional average, as Vietnam, the Philippines, and Laos all recorded growth of 6.7% and Malaysia saw growth of 5.8%. Indonesian President Joko Widodo’s (known as Jokowi) 2014 campaign included a pledge to bring Indonesia back to the days of 7% GDP growth, a figure not seen since the 1990s. Such a goal looks overly optimistic; the World Bank’s economic growth projections estimate the rate of growth to rise to 5.3% in 2018 and remain at that level through 2020.

The story of the Indonesian economy over the past few years has been the divide between investment and consumption. The Jokowi administration has made infrastructure investment the centerpiece of its economic plan, with the idea that doing so will allow for accelerated growth via major projects that increase efficiency and create jobs. The government’s public outlays on infrastructure have increased significantly over the past few years—budget allocation for infrastructure in 2017 represented a 177% increase over 2014. The administration’s development plan calls for more than 3,000km of new roads, 3,000km of new railroads along with local rail projects in several cities, and the expansion and further development of 24 seaports and 15 airports to improve transport demands. With this is also scheduled a dramatic increase in power generation to meet the anticipated increase in demand. The government has announced plans to install more than 35GW of electrical capacity by 2019, including 109 power plants. While some of these infrastructure projects will be funded through public-private partnerships, the majority is being supported by an increase in government spending. FDI has been growing moderately in infrastructure-related structures, reflecting the cautiously optimistic attitude of foreign investors.

The government’s efforts to spur the economy through infrastructure spending have been admirable, but it has been unable to enact change on as dramatic a level as hoped, largely due to stagnant consumption growth. Consumer spending has lagged behind other sectors of the Indonesian economy over the past two years due to a lack of confidence in the economy and slow wage growth in both the private and public sectors. To compensate for increased infrastructure spending, the Indonesian government has limited expenditures in other areas, and has used the slower growth of the past few years as a reason to freeze public-sector wage increases. In the private sector, the government introduced new minimum wages policies in 2015 that were designed to prevent sharp increases that had in the past scared companies away. While the new regulations remove the instability that comes with such increases, it has resulted in slower increases for private-sector workers and a corresponding reduction in their spending power.
Indonesia’s monetary policy has focused on increasing international confidence and avoiding disruptions. The country’s consumer price index recorded inflation of 3.61% in 2017, according to the national statistical bureau. This value was within Bank Indonesia’s target, and despite significant increases in electricity prices early in the 2017, officials were confident that it was prepared to remain between 3 and 4% in the immediate future. With such an emphasis on government spending, foreign investors had kept a eye on the nation’s budget deficit to see if it would come close to its legal cap of 3% of GDP. 2017 saw the deficit reach 2.57% of GDP, up from 2.49% in 2016. The slight increase in economic growth in 2017 is expected to bring the deficit down to 2.2% of GDP in 2018. International confidence in Indonesia’s fiscal stability was reflected in rating agency Standard & Poor’s decision to upgrade the country’s rating from BB+ junk status to the lowest investment grade of BBB- in May 2017. S&P’s announcement cited the government’s focus on “realistic budgeting” and the strong fundamentals of the nation’s economy.
Moving forward, Indonesia will look to continue the export-heavy trend that has helped its economy overcome sluggish consumer spending. The nation’s export sector has become a major driver of growth, with Indonesia’s trade surplus reaching its highest level in almost six years in September 2017. Improving commodity prices meant that Indonesia’s raw materials had a greater economic impact than in years before, and increased demand from China and Western markets helped bring the current account deficit down to 1% of GDP. The current account deficit is expected to rise to 2% of GDP in 2018, but this is still a marked improvement from when it hit 4.2% of GDP in 2014. With Indonesia committed to significant investment spending, officials are unconcerned with a moderate deficit.

Indonesia also has plans to funnel foreign investment into its tourism and technology industries in order to build new capacity and improve services. The government has increased the number of countries with visa-free travel to Indonesia and launched new marketing campaigns to raise awareness of its lesser-known destinations. It sees the tech sector as particularly important to its goals of building a knowledge-based economy that can provide its population with high-quality jobs. Smartphone and internet penetration rates have been soaring in recent years, and Indonesia has been aggressive in forming partnerships and exchanges with key international market in order to build knowledge transfers and lay the groundwork for a strong national industry. These partnerships have been mutually beneficial: foreign firms are eager to gain access to one of the world’s largest markets, and Indonesian students and entrepreneurs gain valuable experience working with some of the world’s foremost technology firms. With such projects underway, it is easy to understand the optimism around the future of the Indonesian economy.

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