ECONOMIC HEALTH CHECK
Strong Domestic Demand Cushions Indonesia from Global Uncertainty
IMF Survey online
October 21, 2011
- Robust economic outlook, with worries about inflation
- Infrastructure investment would promote medium-term growth
- IMF advises vigilance over capital flows
Despite increasing global turbulence, Indonesia’s economy has performed robustly, boosted by strong consumer spending and investment at home, says the IMF in its latest assessment of the Indonesian economy.
In an interview with IMF Survey online, to coincide with the publication of the country’s Article IV report, the IMF’s mission chief, Thomas Rumbaugh looks at the prospects for this large Asian economy.
IMF Survey online: what are the economic prospects for Indonesia?
Rumbaugh: The outlook is very robust. In the near term we expect Indonesia to continue to grow above 6 percent both in 2011 and in 2012. We say this despite the global volatility we see because the domestic foundation of economic growth in Indonesia is so strong. We see strong credit growth, and despite lower growth in the rest of the world, we think that Indonesia is still going to grow at a strong rate.
In fact, the outlook is so robust in 2012 that we're a little bit worried about inflation picking up and we think that's something the authorities are going to need to watch closely.
Over the medium term we see Indonesia continuing to grow and develop. In fact, they have the potential to raise their growth rate even more over the medium term, but to do that they have to invest more in infrastructure. Improvements need to be made to highways, ports, and other areas across the country, and in some of the more remote regions. If they do that, we think the growth rate can be even higher than 6 percent. Perhaps even above 7 percent.
IMF Survey online: You have mentioned the threat of inflation; can you elaborate on that risk?
Rumbaugh: Recent developments in inflation have been relatively benign, especially after adjusting for swings in food and gold prices. However, we believe that there are still inflation risks for 2012 and the period ahead.
Domestic demand conditions are still quite robust—GDP growth is strong, as are production indicators. Credit growth is high and, in addition, the Indonesian government has committed to reduce expensive energy subsidies. Electricity tariffs are likely to be increased next year, and fuel prices are expected to rise at some point. When this happens, policies will need to be adjusted to ensure those price adjustments do not spill over into overall inflation.
IMF Survey online: Many countries in Asia have been in receipt of large capital inflows. What’s been the impact of such inflows on Indonesia?
Rumbaugh: Capital flows have been volatile to Indonesia as they have been to all emerging markets and this is a challenge for the authorities. We've seen periods where the capital flows have been very high, and recently we've seen reversals. We think Indonesia has managed this volatility very well and they should continue to do the same things: keep the exchange rate flexible, and monitor credit growth closely to make sure that it doesn't become excessive and feed into inflation.
IMF Survey online: Indonesia introduced moderate fiscal stimulus in the wake of the global downturn and this was reduced in 2010. What is its fiscal position now?
Rumbaugh: In the area of fiscal policy, the overall stance of the budget is very strong from a macroeconomic point of view. The deficit is low as are debt levels. This has been a strength for the economy. But there are weaknesses in the structure of the budget that they need to address. First, Indonesia spends too much money on subsidies, and tax revenues are still very low. If it addresses these two points by lowering subsidies and raising tax revenue, that will give it more money to improve the social safety net and social services, and to spend more on investment including for infrastructure.
IMF Survey online: Picking up on your point about the need to improve the social safety net and social services, the IMF has been emphasizing the need for more "inclusive growth." That is, growth that encompasses all sections of society in a country. How successful has Indonesia been in achieving this type of growth?
Rumbaugh: Indonesia continues to make good progress in lowering poverty. The national poverty rate declined from 13.3 percent in March 2010 to 12.5 percent as of March 2011. This is a continuation of the same pace experienced from 2007 to 2010. Strong economic growth and rising household incomes have more than offset the impact on consumers of higher food prices.
As for other social indicators, primary and secondary education has improved, but progress in overall health care is less evident. Infrastructure constraints—which I mentioned before—are one major factor limiting access to health care in rural areas. Another area of concern is the high degree of informality and bad working conditions resulting from labor market rigidities that cause employers to avoid official full-time workers and hire more part-time and temporary workers.
To achieve more inclusive growth, Indonesia needs to improve infrastructure and deepen labor market reform, as well as enhance the effectiveness of policies on education, health care, and social protection.