Indonesia Economic Update Clearing skies and the road ahead

1. Indonesia Economic Update Clearing skies and the road ahead Shubham Chaudhuri Senior Economist World Bank 14 September 2009 Jakarta Indonesia

2. The Indonesian economy through the global financial crisis, and the road ahead • Indonesia has weathered the storm well • Why? • Clearing skies are ahead • The coming policy agenda

3. Indonesian economy through the crisis5 facts • Growth rising • …and more robust than elsewhere • Financial markets are recovering • Inflation is at its low point…but remains higher than Indonesian’s neighbors • Social impact has been limited

4. Indonesia through the global crisisGrowth has picked up from the start of 2009 • After stalling at the end of 2008, quarterly growth rates show the economy has been recovering through the first half of 2009 • Exports have recovered faster than imports, supporting GDP • Domestic demand remained robust, supported by election spending, and now the government’s stimulus spending (aggregate GDP growth) Sources: BPS via CEIC, World Bank

5. Indonesia through the global crisis…and other indicators also show recovery After the downturn of late 2008, other indicators show conditions picking up since the start of 2009 Consumer confidence at record highs Car & motorcycle demand recovering Industrial activity has picked up Sources: BPS, GAI, PLN, ICA and Astra via CEIC, Danarakesa, World Bank

6. Extreme volatility in financial markets in late 2008 led to a sharp falls in real output in most economies The global economy started to stabilized and recover in Q2 Indonesia through the global crisisGrowth has been stronger than elsewhere (GDP growth, quarterly, seasonally adjusted) Sources: CEIC, Haver Analytics, BPS,JP Morgan, World Bank

7. Yields on Indonesian debt have returned to early 2008 levels Spreads on Indonesian debt spiked during the financial market turbulence with Indonesia singled out as a vulnerable country More volatile than elsewhere, too But they have subsequently recovered, and are now below global emerging market levels Indonesia through the global crisisFinancial markets are stabilizing (EMBI spreads on sovereign USD bonds) (local currency 5 year bond yields) Sources: JP Morgan, BI, CEIC, World Bank

8. Indonesia through the global crisisFinancial markets are stabilizing The rupiah, and foreign exchange reserves, have stabilized During the peak period of market volatility, the rupiah depreciated by over one-third, and foreign reserves fell sharply – before recovering Source: BI

9. Inflation is near its low-point Lower food prices benefiting poorer households especially Core inflation has fallen less But Indonesia’s inflation remains much higher than its trading partners’ Indonesia through the global crisisInflation, at its low point, is still relatively high Sources: BPS, CEIC< World Bank estimates of poverty basket inflation

10. Indonesia through the global crisis And the social impact limited • National poverty fell to 14.2% • Open unemployment also fell in the year to February • Employment growth outpaced the increase in the workforce • But most new jobs were informal Source: BPS

11. % 2 1 Indonesia 0 Australia -1 Canada -2 France Spain -3 US GDP growth (Sep-08 to Mar-09) Netherlands UK -4 Italy Korea -5 Germany -6 Malaysia -7 Japan Taiwan -8 Mexico Thailand -9 0 4 8 12 16 20 24 % Medium- and high-tech manufacturing output (% GDP) Why has Indonesia weathered the storm so well? (producers of capital and high-tech goods suffered larger falls in GDP) • Structure of the economy • Relatively low trade shares overall – a large domestic market (with the added benefit of momentum coming in) • Exports weighted towards commodities and sent to a diverse range of markets • Low manufacturing/tech shares and correspondingly higher commodity shares in trade • But these factors are likely to limit Indonesia's growth prospects going forward Sources: IMF, CEIC, Thomson-Reuters, RBA, BPS,World Bank

12. Why has Indonesia weathered the storm so well? Strong position coming into the crisis Relatively strong financial sector – with little exposure to critical financial products Low corporate leverage Low public debt, strong fiscal position (central government budget deficit and debt levels) Sources: MoF and World Bank

13. Why has Indonesia weathered the storm so well? Proactive Government responses Financial market safety net response Expenditure stimulus plus tax cuts response Public finance response (Central government budget balance and bank deposits at the end of the first half of each year, IDR trillions) Sources: Ministry of Finance and BI

14. The outlook: skies continuing to clearWith the outlook now for gradual recovery • The outlook for the global economy has stabilized, and foresees a gradual recovery in growth • China and other developing economies are projected to lead the recovery • But global growth is projected to remain below the ~5% average of recent years into the next decade (Annual growth ofIndonesia’s major export destinations) Source: World Bank

15. The outlook: skies continuing to clearCommodity prices, still volatile, recovering some of their losses • International commodity prices are back to 2006 levels • Outlook for some further, small recovery (Index, July 2008 peak = 100) Source: World Bank

16. The outlook: skies continuing to clearWhat it has meant and is likely to mean for Indonesia • Indonesia is positioned to do well, but a weaker global environment means that growth prospects may be somewhat lower than they have been and sustaining growth is going to take a push • Gains in poverty reduction likely to slow • Budget deficit may well be smaller than government’s proposed budgets, suggesting greater scope for stimulatory spending • Scope to lock-in current low inflation rates Sources: BPS, CEIC, World Bank. World Bank projections

17. The outlook: skies continuing to clearBut considerable global risks remain • The medium term global challenge is to unwind the various stimuli used to fight the downturn: • Reducing the fiscal stimulus and developed country debt burdens is made more difficult by aging populations and political will • And unwinding monetary stimulus is difficult due to uncertainty around lags (too soon and recovery suffers, too late and inflation takes off) and the shift from goods inflation to asset price volatility • This implies that financial markets may remain volatile for some time (exchange rates, commodity prices, interest rates and so forth) • Indonesia is particularly vulnerable to this volatility • Still the volatility, and impact on the economy, is likely to be smaller than late 2008 • And the longer term challenges • Addressing global imbalances – improving but are still large implying weaker world growth as OECD consumers save more and consume less • And a difficult structural adjustment to higher world capital and energy prices – compounded by higher carbon prices?

18. The outlook: skies continuing to clear…and these risks impact the outlook for Indonesia • There is both upside potential (from policy breakthroughs) and downside risks (from more adverse global environment) to the base outlook (Annual GDP growth) (Poverty rate) Sourcse: BPS, World Bank projections

19. Looking ahead to accelerating growthRising or floating Source: World Bank

20. Realizing the development agenda • Indonesia is poised for government-catalyzed and private sector- driven investment and growth with the right policy improvements for the investment climate and complementary public investments • …and Indonesia has to put in place a social protection system appropriate for an emerging middle-income economy • Indonesia can afford to spend more on these development priorities • Indonesia’s fiscal and debt position is strong… • …and there are resources to be had ifenergy subsidies are redirected towards targeted social spending

21. A big push on infrastructure – a two part strategy • Indonesia is ready for and needs some breakthroughs: • Easing transport and logistics bottlenecks and connecting and integrating Indonesia’s domestic markets and regions: • Backbone infrastructure: Trans-Java highway (trans Sumatra too?) • This could change global perceptions (Indonesia as a BRIC?) while being desirable in its own right • While delivering a big push at the local level by: • Building world-class cities by investing in urban infrastructure (mass transport, housing, water and sanitation) in the key cities that drive Indonesian competitiveness • Revitalizing PDAMs to provide water and sanitation to Indonesia’s citizens (and especially a growing middle class) • But this will require providing resources and changing incentives – including through performance linked matching grants to Local Governments for roads/water/sanitation

22. Accelerating investment climate reforms and attacking coordination problems • Take a more aggressive stance toward facilitating domestic and foreign investment including • Lower entry barriers, including the time and cost to start a business, the Negative List (maintaining the positive improvements in the 2007 revision while relaxing restrictions in key sectors) • Lower operating costs with a focus on actionable steps to improve logistics, • Improve trade facilitation (replacing paper copies with a single electronic document and approval) through the National Single Window • and control the proliferation of non-tariff barriers that raise costs and reduce competitiveness • To solve difficult coordination problems success here might require a Regulatory Reform Commission with a broad mandate and authority to balance interests, address policy, coordination and implementation issues

23. …and the sectors with major reforms have experienced accelerating growth • Service sectors, many deregulated at the start of the decade, have been growing much faster than the rest of the economy • Partly this reflects the fact that telecoms, retailing and domestic airlines all experienced rapid growth • But partly that other sectors, especially mining and manufacturing have not been doing as well (average annual growth) Sources: BPS and World Bank

24. Putting in place a Social Protection System Consistent with Middle Income Status • Opportunities and Challenges • Indonesia has the resources and institutional capacity to develop effective social protection systems • as demographic and epidemiological challenges mount • Key elements • Build proven and successful social assistance and poverty alleviation programs(PNPM, BOS, BLT,…) into a comprehensive social assistance program • Lay the groundwork for a future National Health Insurance System that is clear, feasible and affordable • And put in place a grand bargain between employers and workers on severance pay that provides worker’s security without discouraging job creation

25. But all of this will require a bigger push on institutional and civil service reforms • Replicate models of institutional reform underway (at the Ministry of Finance – especially Tax and Treasury) in other institutions with significant contact with the public—Customs, BPOM, Manpower, Trade and Industry… • Complement ongoing bureaucracy reforms at the institution level with a modernized regulatory framework and central institutional set-up for civil service policy making, regulation and management • Improve compensation, recruiting and promotion but link it to accountability • Allowing fit for function institutions (not one size fits all)

26. Indonesia Economic and Policy Update: Clearing Skies Shubham Chaudhuri Senior Economist World Bank 14 September 2009 Jakarta Indonesia