Indonesia: Maintaining expansion

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Indonesia: Maintaining expansion

Indonesia: Maintaining expansion

Asia Pacific Economic Outlook, October 2012

The Indonesian economy is slowing down, but it has fared better than its regional peers. However protectionist regulations and political scandals are casting a shadow on its growth prospects.

Due to limited reliance on exports, Indonesia has been able to cope better than many of its export-dependent neighbors whose external sectors are weighing down on growth prospects. By contrast, Indonesia expanded even faster than expected during the first half of the year. Real GDP expanded by 6.4 percent during the second quarter, up marginally from 6.3 percent during the first three months of the year.

An abundance of natural resources, rising private consumption, and a favorable investment climate have made Indonesia an attractive destination for foreign investors. However, while strong macroeconomic fundamentals remain in the economy’s favor, a recent wave of protectionist measures and uncertainty related to regulations are sending mixed signals to the foreign investment community. Moreover, corruption and political scandals are beginning to cast a shadow on the administration’s ability to initiate long-term economic reform.

In 2009, President Susilo Bambang Yudhoyono’s pledge to eradicate corruption was the main reason for his election. Since then, a number of corruption scandals have tarnished the government’s reputation. The former treasurer of the ruling Democratic Party was recently convicted for corruption. While President Susilo Bambang Yudhoyono’s record remains unscathed, the former treasurer made a series of allegations around several other party members. This will likely hurt the president’s image as a strong campaigner against corruption and may hinder policymaking.

Nevertheless, the upcoming presidential election in 2014 will likely influence the government’s policy agenda in the months to come. The government will likely maintain a populist stance, increase public spending, and refrain from implementing unpopular polices such as the abolition of energy subsidies. Energy subsidies are expected to account for 24 percent of GDP in the draft budget of 2013. Earlier this year, the government was expected to remove subsidies for the sake of fiscal savings, but it has been unsuccessful because of strong opposition in the parliament.

In recent months, the government has also announced a number of new regulations in order to stimulate domestic businesses while limiting foreign ownership in Indonesia. These new laws are seen as increasingly nationalistic and may deter foreign investment. For example, in March, the government capped the foreign ownership limit in Indonesian mining companies to 49 percent and is now planning to limit ownership of crude plantations as well. More recently, the government raised mineral royalties from 1 to 10 percent, which will likely hamper external investment in the sector. In April, the central bank also announced plans to limit foreign control in domestic commercial banks. Analysts believe  that the limit on foreign ownership of banks will likely be reduced from 99 percent to 50 percent. Further, the Trade Ministry announced that it would modify the operations of foreign franchises; under the new regulation, inventories of foreign franchises much contain at least 80 percent locally manufactured products, and the number of retail outlets must be limited to 150 stores.

 

Moreover, corruption and political scandals are beginning to cast a shadow on the administration’s ability to initiate long-term economic reform.

While a series of protectionist laws may please the electorate, foreign investors will be forced to think twice. So far, foreign investment has been undeterred on the back strong growth prospects, but the exact impact remains to be seen as most of these regulations have not been implemented on the ground yet. Instead, they have added more ambiguity to the business environment in Indonesia. Foreign investment, especially in infrastructure, is critical for economic growth in the Indonesian archipelago. Currently, infrastructure spending is equivalent to only about 4 percent of GDP, which is quite low for a growing economy like Indonesia.

Notwithstanding the impact on foreign investment, the government has announced a stimulus plan for the second half of 2012 to stimulate its economy at a time when dampening external conditions are weighing on growth. In June, the Finance Ministry announced that it will increase capital spending by $2.5 billion for the rest of the year, while it will also raise the minimum tax slab for household income. However, the estimated increase in expenditure is equivalent to only about 0.03 percent of GDP and will likely have a limited impact on growth.

Indonesia: Maintaining expansion
Cover Image by Stephanie Dalton
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