SINGAPORE, December 31, 2019 – Indonesia’s economic prospects have been solid despite external headwinds, supported by a large-scale infrastructure investment program and the continuation of structural reforms, according to the 2019 Annual Consultation Report on Indonesia published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was prepared based on AMRO’s Annual Consultation Visit to Indonesia from July 1-10, 2019, and data available up to September 15, 2019.
Real GDP, which grew at 5.2 percent in 2018, is projected to grow at 5.1 percent in 2019, supported by resilient consumption and continued investment. The inflation outlook is benign with headline consumer price index firmly anchored within the target band of 3.5±1 percent. Export performance, meanwhile, continues to be constrained by a weaker global outlook and subdued commodity prices. The re-election of President Joko Widodo for a second five-year term starting in October 2019, is expected to strengthen structural reform momentum and enhance Indonesia’s growth prospects.
The authorities have pro-actively recalibrated the policy mix to strengthen resilience and support growth. Bank Indonesia (BI)’s policy rate hikes and judicious forex interventions had supported the external sector in weathering spillovers from emerging market (EM) turbulence, rising U.S. interest rates, and a strengthening U.S. dollar in 2018. At the same time, BI had relaxed macroprudential measures to ensure adequate liquidity in the banking system and to bolster bank financing to the real sector. While the pressure on the external position had abated, BI was prudent in putting its policy rates on hold in early 2019, as financial markets were still volatile, reflecting continuing uncertainties over the U.S.-China trade tension and the underlying strength of the global economy. With capital outflow pressures easing further, BI lowered its policy rates three times between July and September by a total of 75 basis points, to support growth in a benign inflationary environment. This followed an earlier move to lower the rupiah reserve requirement ratio for conventional and sharia banks by 50 basis points to 6 percent and 4.5 percent, respectively, while keeping the average reserve requirement unchanged at 3 percent in June.
On the fiscal front, the authorities have adopted a prudent fiscal stance and taken steps to broaden the tax base and enhance tax compliance, and to improve spending quality. Initiatives to encourage compliance include lowering the tax rate applicable to micro, small and medium-sized enterprises in 2018, and a Tax Amnesty (TA) program enrolled in 2016-2017. Enhanced tax administration, on the back of a broader tax base, coupled with higher oil revenue, led to an increased revenue of about 13.1 percent of GDP and a lower fiscal deficit of 1.8 percent of GDP in 2018. On the expenditure front, to promote productive spending, the authorities reduced energy subsidies and stepped up performance-based transfers to regional governments and village funds.
Downside risks in the short-term are mainly external and will continue to affect Indonesia adversely via trade and financial channels. A sharper-than-expected slowdown in global demand, especially from China, aggravated by ongoing trade tensions, could weigh further on Indonesia’s commodity exports and growth. There is also a risk that the recent escalation in geopolitical tensions in the Middle East could lead to a sharp rise in global oil prices and worsen Indonesia’s trade balance. As foreign investors hold a significant share of rupiah-denominated assets, Indonesia remains susceptible to risks of capital flow volatility.
In light of ongoing headwinds, AMRO recommends the authorities continue to strike an appropriate balance in the policy mix to strengthen resilience and support growth. A still-benign inflationary environment may provide BI with room to pursue an accommodative policy stance if the domestic economy were to weaken unexpectedly. It is also crucial to maintain a market-based exchange rate mechanism with judicious interventions to mitigate excessive rupiah volatility. On the fiscal front, continued efforts are needed to strengthen tax administration and broaden the tax base, considering Indonesia’s low tax revenue relative to its regional peers. Ongoing efforts to strengthen tax officers’ capacity are commendable, and the newly-established Data Management Unit under the Directorate General of Taxes that focuses on analyzing data and information, including those retrieved from the Automatic Exchange of Information initiative and TA program, is expected to enhance tax compliance. Energy subsidy reforms, which have been stalled since the second half of 2017, should be renewed to enhance budget spending quality and reduce the subsidy burden on the government budget.
Continued structural reforms, coupled with ongoing economic diversification efforts, are essential to boost Indonesia’s growth potential. The authorities have rolled out 16 economic packages since 2014, with the latest package extending tax incentives to a wider range of investment activities and opening more sectors to foreign investors. Further streamlining investment procedures, in particular enhancing the Online Single Submission platform, is crucial. To address the infrastructure gap, the authorities have been implementing major infrastructure projects under the Medium-term National Development Plan (RPJMN) for 2015-2019, with joint funding from the private sector. To support infrastructure financing, efforts towards financial deepening have been stepped up, including the introduction of new financial instruments. To broaden the domestic investor base, the authorities should review the current pension fund system and (tax) incentives for long-term savings/investment.
The recent shift in policy priorities to focus more on human capital development for the next RPJMN 2020-2024, especially in the areas of education, vocational training, healthcare, and social safety net, is a welcome move. To maintain labor cost competitiveness, a review of the current labor policy that indexes annual minimum wage increase to nominal GDP growth is recommended. In diversifying its economy, Indonesia is poised to realize its tourism potential, benefiting from initiatives such as the “10 New Balis”, alongside enhanced connectivity and tourism-related infrastructure development. Indonesia should also make a concerted effort to attract more FDIs into manufacturing for exports, and adopt policies to embrace digital technology and promote e-services to leverage on Indonesia’s rapidly growing middle class.
About AMRO and AMRO Annual Consultation Report:
The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute to securing the economic and financial stability of the ASEAN+3 region, which include 10 ASEAN countries and China (including Hong Kong), Japan, and Korea. AMRO fulfils its mandate by conducting macroeconomic surveillance, supporting the implementation of the regional financial arrangements, the Chiang Mai Initiative Multilateralisation (CMIM), and providing technical assistance to the members.
The Annual Consultation Report was prepared in accordance with AMRO’s macroeconomic surveillance function. AMRO is committed to monitoring, analyzing and reporting to its members on their macroeconomic status and financial soundness. It also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.