Driving commercial and political engagement between Asia, the Middle East and Europe
Driving commercial and political engagement between Asia, the Middle East and Europe
Driving commercial and political engagement between Asia, the Middle East and Europe
Indonesia has been applauded for its prudent monetary and fiscal policy, but it isn’t immune to global risks that could adversely impact growth. In a new research briefing, Zhouchen Mao, Head of Research and Advisory at Asia House, takes stock of Indonesia’s economic trajectory, key growth sectors, and the wider investment outlook.
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According to the International Monetary Fund (IMF)’s Regional Economic Outlook for Asia and Pacific, the region remains a relatively bright spot despite the recent downgrade of growth forecast for 2022 and 20232 amid a slew of simultaneous headwinds.3 For Indonesia, the country has proven resilient to challenging global macroeconomic conditions in 2022,4 and the economy is expected to grow by five per cent in 2023 even as the global economy continues to be buffeted by uncertainty and volatility.
Under the G20 Presidency, Indonesia utilised its chairmanship to both advocate for global coordination for the post-pandemic recovery and optimise its domestic economy to become increasingly sustainable, productive, and resilient as Indonesia aspires to become a developed country by 2045.
This Asia House report provides an assessment of the country’s macroeconomic conditions and potential risks, in sections one and two respectively, followed by a close examination of the sector-specific investment opportunities associated with Indonesia’s economic development priorities.
Indonesia has enjoyed a strong economic recovery from the pandemic, with the economy expected to expand by 5.1 per cent in 2022.5 This expansion is driven by an amalgamation of increasing domestic consumption propelled by the lifting of pandemic restrictions, surging commodity prices, and robust exports. In fact, the economy is forecast to return to pre-pandemic growth trajectory of five per cent, a level that is significantly higher than other G20 countries, which as a group is projected to grow by only 2.1 per in 2023.6
The silver linings in Indonesia’s growth are likely to be domestic consumption and exports. The former accounts for more than 50 per cent of GDP, and is gradually recovering, spurred by the easing of pandemic related restrictions. Additionally, exports of manufactured goods and commodities, such as coal, oil, gas and palm oil, should continue to benefit from relatively high prices, given China’s near-term prioritisation of energy security.
“The silver linings in Indonesia’s growth are likely
to be domestic consumption and exports”
Indonesia’s strong export growth – amid higher commodity prices – has resulted in a cumulative US$34.92bln trade surplus in the period between January and August 2022.7 That said, this surplus should narrow in the remainder of 2022 and into 2023 due to deceleration of external demand8 and a continuing rebound of imports pertaining to the improved domestic economy.
Fiscal developments will be of interest: the government is committed to a path of fiscal consolidation as part of the exit strategy from COVID-19 support, with the government set to reinstate the deficit ceiling of three per cent in 2023 as pandemic stimulus measures begin to wane down. The restoration of deficit cap means the conclusion of the fiscal debt financing scheme by end-2022 – a pandemic-related policy that provided critical support to the government.9
However, the fiscal financing has been labelled a source of downside risk that could undermine investor confidence due to concerns over political interference in monetary policy. Furthermore, the increase of tax generated revenue will help to reduce both pandemic-triggered tax revenue drop and the deficit following an increase of Value-Added Tax (VAT), which applies to sales of nearly all goods and services, from 10 per cent to 11 per cent in April 2022. The rate will gradually increase to 12 per cent by January 2025.10
While Indonesia has been applauded for its prudent and responsive monetary and fiscal policy, it is not immune from global risks that could adversely impact the economy’s growth trajectory. The most immediate concern stems from domestic monetary tightening and a strong US dollar.
The impact of monetary tightening and strong US dollar
For an extended period, Bank Indonesia (BI) resisted increasing interest rates as commodity exports and various subsidies helped to insulate the economy from global price shocks and keep the Rupiah stable. The central bank’s decision to delay monetary tightening until August has also enabled the private sector to recover from the pandemic, leading a sustained growth momentum that in turn provided more headroom for the bank to address inflation and the Rupiah’s depreciation as private consumption remains resilient.
When BI did decide to raise interest rates for four consecutive months from 3.5 to the current 5.25 per cent amid tighter global monetary policy, the moves were calibrated since inflationary pressure remains largely exogenous. That said, while the bank had described the tightening cycle as “pre-emptive”11 to stabilise the Rupiah and bring inflation down to the bank’s target range of between two and four per cent, a higher borrowing cost will inevitably affect some parts of the private sector, namely non-commodity industries such as retail, which will weigh on wage and employment vis-à-vis the overall consumer sentiment.
Furthermore, a strong US dollar could benefit the export and the tourism sector, but such gains will be uncut by costlier imports, particularly when domestic demand is rebounding, and add to growing inflation that will drag on domestic demand over the coming quarters. Although growth uncertainties and risk aversion are likely to keep US dollar strong in the near-term, which means further depreciation of the Rupiah, currency risk in Indonesia is low considering the current account surplus and ample (albeit declining) foreign exchange reserves. External debt servicing could also be impacted by a strong US dollar, but the risk is limited since foreign currency-denominated debt has fallen due to higher issuance of Rupiah-denominated debt in recent years.12
Slowing global trade and falling commodity prices constitute double risk
The likelihood of a slowdown in global trade in the months ahead will dampen the consumer sector and growth in exports that was buoyed by a rise in commodity prices, pulling the brakes on one of Indonesia’s biggest export earners. The likelihood of a decline in Indonesia’s trade volumes will result in a narrower trade surplus and less foreign exchange revenues. This will likely prompt BI to continue increasing interest rates to rein in demand13 over the coming quarters as external pressure intensifies, potentially stalling the domestic recovery.
Softening global demand will ease most commodity prices from their peak, but a decline in revenue could pose challenges to Indonesia’s pro-cyclical fiscal policy. Changes in commodity prices could lead to budget constraints. This is because a significant amount of government subsidies are funded by revenue generated from commodity sales. That said, higher oil and gas prices could potentially help offset risks as commodity prices return to normal.
The impact of China’s economic slowdown
China’s slowing economy, triggered by zero-COVID policy and domestic issues, will undoubtedly bring challenges to Indonesia’s economy, as it will on a global level. Uncertainties in the Chinese property sector despite numerous stimulus measures will continue to have a spill over effect on the commodity prices as seen in the slump of iron-ore, a key ingredient of steel, in recent months.14
As the second biggest foreign investors in Indonesia, Chinese inward investment could continue to expand at least in the near-term, particularly in the field of minerals,15 due to China’s focus on energy and food security to sustain its manufacturing and steelmaking output. But this trend could change should the Chinese economy continue to slow amid a transition to a new growth model.
Notwithstanding the external risks, Indonesia remains an attractive destination for foreign investors (Asia House, 2021). As the chair of Group 20 (G20), Indonesia identified three priority areas for this year’s multilateral forum: to establish a resilient global health system, boost digitalisation as part of a wider recovery scheme, and support sustainable energy transition. In so doing, the G20 presidency provided Indonesia momentum to boost investor confidence and showcase opportunities, particularly for sectors linked to the abovementioned priorities. Equipped with investment-grade sovereign rating from major credit agencies, the positive environment has also been supported by government reforms to encourage investments.
Sustainability and downstream development
Indonesia needs an estimated US$150bn to 200bn per year until 2030 to decarbonise and fulfil the aspiring goal of net-zero emission by 2050.15 The financing of this transition towards a sustainable economy and society will not only attract foreign capitals, but it also provides opportunities for pathways that facilitate the economy’s diversification.
That said, minerals will still have a key role in the energy transition and Indonesia’ commodity-led development strategy. The government’s increasing emphasis on the development of greener downstream industries marks a structural shift that moves away from exporting raw commodities, to focus on downstream operations that would stimulate value-added exports, bolster production capacity, and attract foreign investments.
“As the world’s biggest nickel producer and the country
with the largest nickel reserves, Indonesia aims to become
an alternative electric battery production hub to China”
Equally as important, downstream development will enable Indonesia to move up the value chain in manufacturing and diversify its sources of national income. Moving up the global value chain will also raise incomes and reduce poverty where Indonesia utilises its comparative advantage in possessing a cheaper and large labour force to gain capital and expertise to manufacture higher value-added goods (World Bank, 2017).
For example, as the world’s biggest nickel producer and the country with the largest nickel reserves, Indonesia aims to become an alternative electric battery production hub to China via the creation of an electric vehicle (EV) supply chain. This is reflected in the development of High-pressure Acid Leaching (HPAL) processing projects, the construction of Indonesia’s first battery plant,16 and the national priority to advance EV industry.17 Coupled with government incentives,18 this strategy will bring substantial economic and investment opportunities, especially in the production capacity and EV supply chain.
Infrastructure is key development priority
Infrastructure development has been at the forefront of President Jokowi’s government since the start of his presidency in 2014. Important national priorities also depend on expanding infrastructure developments. The economy needs reliable infrastructure to connect supply chains, which forms a core part of Indonesia’s downstream development strategy – in order to move goods and services across the country quickly and efficiently.
Reliable infrastructure will connect households across metropolitan areas to greater employment, healthcare, and education opportunities. The establishment of a Sovereign Wealth Fund, Indonesia Investment Authority, in 2021 will play a central role in managing the government’s infrastructure development strategy (Asia House, 2021), while serving as a co-investor to attract much-needed foreign investment.18
Increasing infrastructure development is said to not only boost growth, but also bodes well for Indonesia’s attempt to capitalise on US-China competition and ensuing efforts by some multinational corporations to de-risk their supply chains amid calls for friend-shoring. As Indonesia’s supply chain participations grows, a larger stock of infrastructure along with digitalisation will reduce the cost of production and transportation of goods and services, which in turn will fuel productivity.
The digital economy has ample room for growth
Indonesia was dubbed Southeast Asia’s fasting growing internet economy, set to reach around US$150bln in 2025.19 The increasing number of internet users and the growing popularity of e-commerce and financial technology (fintech) are the driving force behind the transformation of Indonesia’s digital landscape. While the country’s home-grown technological companies, such as Gojek and Bukalapak, have seen exceptional growth in recent years, Indonesia’s huge market size also means strong competition that compel major tech companies to constantly innovate and grow.
Going forward, e-commerce will represent one of the biggest drivers of Indonesia’s digital economy, building on the momentum generated by the pandemic. As for fintech, it is another key ingredient of growth that has been dominated by peer-to-peer (P2P) lending and e-payment platforms. Despite attracting the second largest funding in ASEAN, the industry has yet to reach its potential given the country’s large unbanked population and increasing internet penetration.
“Going forward, e-commerce will represent one
of the biggest drivers of Indonesia’s digital economy”
An additional factor that will continue to propel Indonesia’s fintech’s development is that a majority of Indonesia’s workforce is in the informal sector and micro, small, and medium sized enterprises (MSMES) which makes borrowing from banks difficult. As a result, P2P lending firms are popular given their accessibility for small loans and their low interest rate.
Furthermore, digitalisation in education and health in the forms of online lectures and medical consultation have also accelerated since the onset of the pandemic. The increasing usage of healthcare applications will likely have transformative impact on not just the ways in which consultations are done, but also in terms of how patients’ data are collected, stored, and shared. The demand for healthcare in general will be huge given the country’s population, which offers new opportunities for investors. Increasing digitalisation will alleviate government burdens on hospitals given the disparities in availability of medical doctors across the country.
Similarly, online education has blossomed since the pandemic. However, rural-urban discrepancies in income, speed of internet, and accessibility to technological devices are the main challenges to digitalisation. Yet, there remains untapped opportunities in urban areas where the more affluent middle-class often seek online extracurricular activities such as online language classes. There is also room for foreign expertise in the development of 5G connectivity under the National Medium-Term Development Plan in urban centres, while domestic operators continue to expand 4G network coverage in rural areas.
Indonesia’s resilience amid global uncertainties along with its ample natural resources and untapped opportunities makes it an appealing destination for foreign investors. Increasing foreign investments in priority areas such as infrastructure, sustainability, and the digital economy would bring advantages to businesses and achieve the government’s developmental objectives through greater integration of value and supply chain, increased productivity, and greening of the economy. Despite Indonesia’s positive outlook, though, domestic growth faces significant risks in 2023 that could undermine the country’s trajectory. Investors will need to weigh these risks against Indonesia’s growth potential.
This research note is for advisory purposes only. Asia House is not responsible for investment decisions.
Asia House provides a range of research and advisory services to help organisations meet their objectives. To find out more about Indonesia-focused advisory services at Asia House, please contact Jonathan Smith, Corporate Affairs Manager, at: jonathan.smith@asiahouse.co.uk
NOTES
1. https://www.fitchratings.com/research/sovereigns/indonesia-budget-reaffirms-credible-fiscal-consolidation-path-23-08-2022
2. IMF reduced the region’s growth forecast for 2022 and 2023 by 0.9 and 0.8 per cent, respectively to 4 per cent in 2022 and 4.3 per cent in 2023.
3. The report identified three major headwinds: 1. Global financial tightening, particularly in the US that contributed to a strong US Dollar and precipitated capital flight from emerging markets. 2. The conflict in Ukraine has led to a spike in commodity prices, putting additional pressure on headline inflation. 3. China’s economic slowdown could reverberate across the region amid intimate trade and financial relations.
4. The GDP expanded by 5.72 per cent in Q3 year-on-year.
5. https://www.bloomberg.com/news/articles/2022-08-05/indonesia-s-gdp-growth-on-track-amid-mounting-global-uncertainty
6. Moody’s cut global economic growth forecasts as financial conditions tighten. https://www.moodys.com/research/Moodys-cuts-global-economic-growth-forecasts-as-financial-conditions-tighten–PBC_1340740#:~:text=Moody%E2%80%99s%20Investors%20Service%20has%20reduced,to%202.1%25%20from%202.9%25
7. https://www.bi.go.id/en/publikasi/ruang-media/news-release/Pages/sp_2424822.aspx#:~:text=For%20the%20period%20from%20January,the%20same%20period%20of%202021.
8. September trade surplus reached US$4.84bln, a decline from US$5.76bln in August that is triggered by weakening global demand.
9. Under the scheme, the central bank agreed to buy US$30bln worth of government bonds in 2021 and 2022 in order to provide cheaper financing for COVID-19 stimulus measures.
10. https://www.bloomberg.com/news/articles/2021-10-01/indonesia-eyes-top-income-tax-bracket-raises-vat-in-new-bill
11. https://asia.nikkei.com/Economy/Indonesia-hikes-key-interest-rate-to-4.75-highest-in-over-2-years
12. https://www.bi.go.id/en/publikasi/ruang-media/news-release/Pages/sp_2411722.aspx
13. Narrowing trade surplus and increasing import costs will not only lead to constrains over subsides and government revenues, but also drive up inflation which in turn forces the central bank to increase interest rate and rein in demand and inflation.
14. https://www.wsj.com/articles/iron-ore-prices-buckle-as-china-property-market-slump-drags-on-11667560177
15. Chinese investment in Indonesia reached US$1.56bln between July and September, a significant increase of US$595m during this period in 2021. https://www.scmp.com/economy/global-economy/article/3197592/mineral-hungry-china-triples-indonesian-investments-jakarta-pushes-downstream-processing
16. https://asia.nikkei.com/Business/Energy/Indonesia-wins-20bn-in-G-7-other-support-to-speed-net-zero-push
17. The project is a joint venture between Indonesia Battery Corp and South Korea’s LG Group, with battery production set to start in 2024 and supply Hyundai’s electric vehicles. https://www.reuters.com/business/autos-transportation/south-koreas-lges-hyundai-motor-start-work-indonesian-ev-battery-plant-2021-09-15/
18. EV industry was classified as a national priority in a 2019 presidential degree. https://suryacipta.com/en/indonesia-as-the-most-lucrative-automotive-market-in-southeast-asia/
19. Government incentives include import tariff reductions for machinery and materials used for EV production and tax incentives for EV manufacturers that make at least US$346m in investments
20. https://www.reuters.com/markets/asia/indonesian-sovereign-wealth-fund-draws-20-bln-co-investments-2022-09-29/
21. https://www.bi.go.id/en/publikasi/ruang-media/news-release/Pages/sp_2417522.aspx#:~:text=By%202025%2C%20the%20digital%20economy,Rp4%2C531%20trillion%20by%202030.
