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Why Indonesia | Indonesia's 2019 Economic Outlook: Challenging Times amid Political Turbulence

Following a year of economic volatility over the course of 2018, Indonesia's economy is predicted to remain weak in 2019. This is in line with the rising political tensions ahead of the general elections, the ongoing trade war between the country's two biggest trading partners, China and the US, and the prolonged depreciation of the Rupiah (See Indonesia's Economic Outlook in 2018: Modest Optimism, Challenges Remain). 

The Indonesian government needs to find the right solution to address external and internal issues which have dragged down the Rupiah exchange rate to the lowest level since the 1998 financial crisis. That being said, the government is still optimistic that Indonesia’s economy will still grow by 5.3% following the various economic measures that are being implemented towards the end of 2018.

Modest growth

The Jokowi government forecasts that Indonesia's economy will only grow by 5.3% in 2019. This prediction, which was set in the 2019 State Budget, is lower than that of the 2018 State Budget of 5.4% but still higher than the World Bänk’s forecast of 5.2%. Meanwhile, inflation is expected to reach 3.5% +/- 1% and the Rupiah exchange rate is assumed to reach an average of 14,500 IDR per US dollar, or far higher than that in the 2018 State Budget of 13,500 IDR per US dollar.

The country is expected to experience a deficit of 1.84% against its gross domestic product (GDP) in 2019 with estimated revenues of 2.142 trillion IDR and expenditure of 2.439 trillion IDR, up from 2.204 trillion IDR in 2018. Tax revenue is expected to reach 1.781 trillion IDR compared to 1.609 trillion IDR in the previous year (See Indonesian Government Banking on Tax Amnesty to Plug Tax Shortfall).

Energy subsidies are expected to continue to exert pressure on the state budget. This is due to the increase in the energy consumption rate and prices as well as the government’s decision not to change the pricing policy given its impact on consumer purchasing power and the government's popularity ahead of the elections. The Indonesian government allocated an energy subsidy of 157.79 trillion IDR in the 2019 state budget or up 65% from 94.6 trillion IDR in the 2018 state budget. The subsidy consists of 100.69 trillion IDR for fuel subsidies and 57.10 trillion IDR for electricity subsidies (See Investment in Indonesia’s Electricity Sector; Sparks of Life).

The 2019 State Budget set the Indonesian Crude Price (ICP) at $70 USD per barrel, up from $48 USD per barrel in the 2018 State Budget. Oil production is expected to continue its downward trend and reach 775,000 barrels per day while gas production will reach 1,250 thousand barrels of oil equivalent per day, up from 1,200 thousand boepd in the previous year (See Overview: Indonesia’s Downstream Oil and Gas Sector).

In the banking sector (See Indonesia’s Banking Sector; Under Pressure But Staying Strong), the increase in Bank Indonesia’s 7 days reserve repo rate (BI-7DRR) will lead to an increase in the bank lending rate in 2019. Until the third quarter of 2018, Bank Indonesia (BI) has increased its reference rate by 125 bps to 5.5%. As a result, banks are expected to increase their lending rate by 25 - 50 bps. If BI further increases its rate to 5.75% in the last quarter of 2018, the lending rate will go up by 30 bps - 60 bps. The increase in the overall lending rate will discourage potential lenders while at the same time increase the risk of non-performing loans. Consumer loans, in particular, are at risk given their significant role in Indonesia’s banking sector as well as consumerism patterns.

Watch out for external and internal challenges

It is predicted that the external and internal challenges facing the Indonesian economy in 2018 will still linger on over the course of 2019. On the external side, strong US economic growth and the steady increase in the Federal Reserve funding rate in recent years has prompted investors to pull out their capital from emerging markets; including Indonesia.

US-China Trade War

Furthermore, the ongoing trade war between Indonesia's two biggest trading partners, China and the US, which has stemmed from Trump's protectionist policies has begun to take its toll on emerging economies and Indonesia has not been exempt. For every 1% decline in China’s economy, Indonesia’s economic growth is hampered by 0.11% (See What China’s Slowdown Means for Indonesia: A Trade Perspective), while the same decline in the US economy will negatively impact Indonesia’s economic growth by 0.05% (See Indonesia’s Fragility & The Fed).

Since July 2018, the two countries have imposed import duty increases on goods worth $16 billion and $34 billion USD respectively. Furthermore, in September 2018, Trump slapped another 10% increase in import duties on Chinese products worth $200 billion USD which will be increased to 25% in January 2019. The move was retaliated by China by increasing its import duty on US products worth $60 billion USD.

To make matters worse, China is not the only target of Trump's hawkish trade policy. Similar steps were also taken by the US administration against its other major trading partners, including Indonesia, to curb its growing trade deficit. Turkey, Argentine, and South Africa are among those countries which have fallen victim to Trump's protectionism. The three countries have suffered currency depreciation and capital outflows which have compelled their central banks to drastically raise their benchmark rates.

Indonesia still remains a target of the US’s ire as a trade deficit of $4.119 billion USD remains as of June 2018. Trump administration has taken a number of steps to tackle this issue including reviewing the eligibility of 124 Indonesian products included in the generalized system of preference (GSP) as well as asking WTO to impose a fine of $350 million USD as part of an import restriction policy against its products. Some analysts predict that Indonesia's export revenue may decline up to $11 billion due to this ongoing trade war (See The US Presidential Elections and What it Means for Indonesia).

For this reason, Indonesia’s Finance Ministry warned that the country's GDP growth may fall even further to 5.15% if global economic uncertainty continues well into 2019 and thus could hinder Indonesia’s economic growth trajectory. This risk has been somewhat stemmed by Bank Indonesia's (BI) hawkish stance in order to prevent further Rupiah depreciation and capital outflows. The Indonesian government expects BI to increase its benchmark rate again in 2019 to keep pace with the increase in the Fed funds rate.

As an increase in the Fed’s funding rate will cause capital outflows from the country, this move will cause bank interest rates to rise which could inhibit loan growth and lead to a spike in non-performing loans that will eventually hamper economic growth.

Twin Deficits

On the internal side, Indonesia's economy is plagued by twin deficits, i.e. trade and current account deficits. In 2017, the country’s current account deficit reached $17.3 billion USD (-1.7% of GDP). This deficit, fortunately, can be compensated for by foreign capital inflows reaching $29.2 billion USD. Thus, the country still recorded a balance of payment surplus of $11.84 billion USD.

The situation was rather different in 2018 following the increase in the Fed funding rate, investors now prefer to place their money in the US financial market as it is considered to be more attractive and stable than those of emerging economies. This can be seen from the foreign capital inflows in Semester I of 2018 which only reached $6.5 billion USD.

Additionally, the current account deficit in the first semester of 2018 soared to $13.7 billion USD, thus Indonesia’s balance of payments suffered a deficit of $8.2 billion USD. Another internal challenge facing Indonesia’s economy is the trade deficit. As of August 2018, Indonesia recorded a trade deficit of $4.09 billion USD.

Soaring Imports

Indonesia’s growing deficit is due to the country's mounting import levels over the last decade. Indonesia’s imports during January to August 2018 grew 24.52% to $124.18 billion USD from $99.73 billion USD in the previous year. Oil and gas account for the majority of Indonesia's imports with other significant imports being machinery and mechanical planes, automotives, organic chemical material, iron, steel and plastic. 

The Indonesian government recently imposed an increase in income tax of up to 10% on 1,147 imported consumer goods, including cosmetics, furniture, clothing, electronics, automotives, and food products, in a bid to curb imports. This was stipulated in Finance Minister Regulation No. 110/2018.

Other measures have included implementing mandatory B20 requirements to reduce oil imports and requiring the industry to increase local content usage. These are expected to improve the country's trade balance which will lead to a lower demand for the US dollar and a stronger rupiah. These moves, however, were criticised since they will serve to increase prices at a consumer level and slow down the economy. Moreover, analysts have said that the real culprit behind the surge in imports is the Trade Ministry's policy that waived import recommendation requirements from technical ministries/agencies for food commodities such as for rice, raw sugar and salt. 

In addition, the Indonesian government has also halted a number of infrastructure projects, including those deemed of national strategic importance, such as 35 GW power projects, which relied heavily on imported machinery.

Rupiah Depreciation

An additional challenge is the Rupiah depreciation which is expected to weaken until the next elections. From January until September 2018, the Indonesian currency has declined by more than 10% from 13,345 IDR to nearly 15,000 IDR to the US dollar; the lowest level since the 1998 financial crisis.

The same holds true for Indonesia's capital market sector as the Jakarta Composite Index (JCI) has plunged more than 10% in 2018 from its all-time high of 6,689 in February 2018 to 5,811 in September 2018.

Bank Indonesia has been reactive in trying to prevent further depreciation of the Rupiah through actively intervening in the market. As a result, Indonesia’s forex reserves plunged from $131.98 billion USD in January 2018 to $117.8 billion USD in September 2018.

Mixed prospects

Overall, Indonesia’s economic prospects in 2019 are rather a mixed bag. In the short term, economic growth is expected to be modest given the Rupiah depreciation, capital outflows, the widening of the trade and current account deficits as well as the impact of the looming presidential elections. 

Investors usually adopt a wait-and-see approach ahead of Indonesia’s presidential elections. For this reason, the Indonesian government will continue to rely on domestic investment and household spending to drive the country's economy in 2019. The Ministry of Social Affairs has allocated a social assistance budget of 381 trillion IDR in 2019, up 33% from that of the previous year of 287 trillion IDR to boost consumer spending in order to keep this crucial aspect of the economy on a safe track. 

In the longer term, however, Indonesia’s current economic situation may well be the right time for investors to invest in the country, especially in its financial instruments. Indonesian stocks and securities are highly undervalued amid the Rupiah depreciation and thus present a very interesting opportunity for investment. Going forward, the country continues to offer strong economic fundamentals which will continue to underpin the growth of the middle-class and fuel the consumer spending growth in the country. The presidential elections will create short-term headwinds amid the uncertainty created by the likelihood of another two-candidate race as we saw in the previous elections as well. As is usually the case with Indonesia, the medium and long-term present the best options for investors who are willing to hold their nerve and ride out short-term uncertainties.

Global Business Guide Indonesia - 2018

Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)