Indonesia Economic Quarterly UpdateContinuity amidst volatility

Shubham ChaudhuriLead EconomistWorld Bank

23 June 2010Jakarta Indonesia

What I’ll be talking about

CONTINUITY: Indonesia’s economy continues to perform well… Quarterly GDP growth has continued in line with decade-averages Inflation continues to be subdued …and the fiscal position continues to be strong

…AMIDST VOLATILITY: Financial markets have been more volatile because of developments in

Europe …and commodity prices have continued to be volatile

…AND THE CONTINUING CHALLENGES this implies Indonesia is more exposed than many other economies to global

financial market and commodity price volatility Commodity price movements matter for Indonesia Understanding Indonesia’s high lending rates, interest spreads and NIMs

Continuity…GDP growth remains robust… Indonesia’s economy continued to grow at a trend rate in Q1, driven by

strong investment growth Economy expanded by 1.3% QoQ in Q1, or by 5.7% YoY A record drop in government consumption was offset by strong investment

and private demand growth Indonesia’s major trading partners also continued to recover in Q1

Sources: BPS via CEIC, World Bank

0

2

4

6

8

0

1

2

3

4

Mar-03 Dec-04 Sep-06 Jun-08 Mar-10

Per cent Per cent

QoQ seas. adjust (LHS)

Year on year (RHS)

Average (LHS)*

-6

-4

-2

0

2

4

6

8

-3

-2

-1

0

1

2

3

4

Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

Quarterly Growth (sa, LHS)

YoY Growth (RHS)

Per cent Per cent

Indonesian GDP growth Major Trading Partner GDP growth

Continuity……and domestic indicators remain strong

Sources: CEIC, World Bank

Other economic indicators have remained stable at high levels Consumer indicators are near

record highs Industrial indicators are

strong

0

20

40

60

80

0

200

400

600

800

Apr-06 Apr-07 Apr-08 Apr-09 Apr-10

'000

Motor vehicles (RHS)

Motor cycles (LHS)

'000

110

150

190

230

60

80

100

120

Mar-06 Mar-07 Mar-08 Mar-09 Mar-10

Index Index

BI Retail sales (RHS)

BI Consumer Survey Index

(LHS)

-30

-20

-10

0

10

20

30

-30

-20

-10

0

10

20

30

Mar-07 Dec-07 Sep-08 Jun-09 Mar-10

Per cent, yoyPer cent, yoy

Cement Electricity

Industrial Production

Continuity……and mainly based on consumption and services Private consumption and services continued to contribute the most to

GDP growth…

Sources: BPS via CEIC, World Bank

-4

-2

0

2

4

-4

-2

0

2

4Q4 Q1

Percentage pont Percentage point

Priv.cons.

Investment

Gov't. cons.

Discrepency(incl. stocks)

Exports

Imports

GDP

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Q4 Q1

Percentage point Percentage point

Agric.

Comms. &transport

Mining & construct

Manufacturing

Retail trade

Other

Continuity…...as has been the case over the last decade …Private consumption and services continued to contribute the most to

GDP growth

Sources: BPS via CEIC, World Bank

-4

0

4

8

12

-4

0

4

8

12

1993-95 2000-05 2006 2007 2008 2009

Net exportsStocks & Discrep.InvestmentGovernmentPriv ConsGDP

Percentage point Percentage point

0

2

4

6

8

0

2

4

6

8

1993-95 2000-05 2006 2007 2008 2009

Services IndustryMining AgricultureGDP

Percentage point Percentage point

Continuity…Inflation continues to track historic lows…

Though headline inflation picked up slightly in May to 4.2% YoY…

…core inflation remained near decade lows, at 3.8% in the year to May The rise in headline inflation was mainly driven by food prices, which

were the only component of CPI to grow above historical averages in the first 5 months of 2010…

…while core inflation remained low due to low capacity utilization levels and appreciation of the rupiah, which limited imported inflation

Inflation is expected to pick up in the 2nd half of 2010, as demand and credit growthcontinue to recover, and administered prices are moved closer to economic costs

Source: BPS

-4

0

4

8

12

16

-1

0

1

2

3

4

May-07 May-08 May-09 May-10

Core Inflation(RHS)

Inflation YoY(RHS)

Inflation MoM(LHS)

Per cent Per cent

Continuity……and the fiscal position remains strong

0

10

20

30

40

50

60

70

80

0

10

20

30

40

50

60

70

80

2005 2006 2007 2008 2009

Philippines

IndiaVietnam

ThailandIndonesia

Malaysia

China

Korea

Percent to GDP Percent to GDP

0 10 20 30 40 50 60

2005

2006

2007

2008

2009External Debt/GDP

Domestic Debt/GDP

Percent

Indonesia

…with Indonesia continuing to set a global record pace in reducing its public debt-to-GDP ratio

Continuity……with continuing modest budget deficits…

Sources: BPS via CEIC, World Bank

The revised 2010 budget approved by the DPR targets a deficit of 2.1% of GDP

0 50 100 150 200 250 300 350

Personal

Materials

Capital

Int. payments

Subsidies

Social

Others

Transfers

Revised

Proposed Revised

Budget

2010 budget revision (IDR Tln)

Continuity……which may come in even lower than targeted…

Sources: BPS via CEIC, World Bank

Alternative projections of revenue and projected weaker disbursement suggest the budget deficit will be significantly smaller than current government projections, about 1.0% of GDP in 2010 and as low as 0.4% in 2011 The pickup in commodity prices is likely

to support slightly stronger government revenue growth in 2010

The choice of price measure for nominal growth (deflator versus CPI) has a significant impact on revenue projections

By the end of Q1 2010, only 5 percent of allocated capital expenditure has been spent compared with 10 percent in 2009

-5

0

5

10

15

20

25

30

35

-5

0

5

10

15

20

25

30

35

2001 2003 2005 2007 2009 2011

Per cent Per cent

Tax revenue growth

Nom. economic growth (GDP deflator)

Nominal economic growth (CPI)

Forecasts

0

5

10

15

20

25

Personal Materials Capital Int. payments

Subsidies Social Others Total CG Transf. Total

2008 2009 2010

Q1 actual spending vs revised budget (APBN-P) (%)

Continuity……if we use the GDP deflator as a price gauge

Nominal GDP calculated using the GDP deflator instead of CPI leads to significant reductions in the budget deficit The national accounts implicit price deflators offer a broader measure of prices than

the CPI The relationship between the CPI and economy-wide prices in Indonesia weakened

after 2004, largely due to an acceleration in investment prices that was not captured by the CPI…

…but was captured by the GDP deflator, which as a result has a closer correlation with overall prices in Indonesia

As a result, using the GDP deflator rather than CPI improves the forecast of government tax revenues

- 2.5

- 2.0

- 1.5

- 1.0

- 0.5

0.0

- 2.5

- 2.0

- 1.5

- 1.0

- 0.5

0.0

WB projections with slower (CPI) inflation WB projections APBN projections

Per cent of GDP Per cent of GDP

2010 2011

Continuity….The outlook remains broadly positive

Sources: BPS, CEIC, World Bank. World Bank projections

Outlook remains for gradual pick-up in growth Continued strong private domestic demand and investment are

expected to drive growth, offsetting any drag from imports outpacing exports

A slowdown in major trading partner growth should not impact Indonesia too much

Inflation is expected to accelerate in second half of 2010 on solid domestic demand, credit growth, a more stable exchange rate and rising commodity prices

2009 2010 2011Gross domestic product (Annual per cent change) 4.5 5.9 6.2

Consumer price index (Annual per cent change) 4.8 5.1 6.3

Balance of payments (USD bn) 12.5 6.1 5.1

Budget balance (Per cent of GDP) 1.6 1.0 0.4

Major trading partner growth (Annual per cent change) -0.9 5.0 4.3

…amidst volatilityDownside Risks have Increased

External factors have increased risks to the outlook… Weak demand from OECD economies due to debt crisis could slow

down recovery in Indonesia’s MTPs Increased risk aversion due to debt crisis could increase financial

market volatility and capital outflows Ongoing commodity price volatility could affect real economy

forecasts and the budget

…some of which call for the immediate attention of policy makers: Addressing large capital inflows and outflows Implementing policies to reduce vulnerability to commodity price

shocks

…amidst volatilityCapital outflows pushed markets down in May

Indonesian equities and bonds weakened in May due to large capital outflows that also put the rupiah under pressure Increased risk aversion due to European events triggered $5.7bn of net

foreign capital outflows in May, 90% of this in SBI sales The JCI fell by 5.5% on the month, yields on five year IDR sovereigns rose

by 50 basis points, and Indonesian EMBI USD bond spreads widened by 100 basis points.

The rupiah weakened by 1.8% against the USD

8,000

9,000

10,000

11,000

12,000

13,000-55,000

-35,000

-15,000

5,000

25,000

45,000

Jan-07 Mar-08 Apr-09 May-10

Net Foreign Capital Inflows (LHS)

IDR/USD (RHS)

IDR Appreciation

IDR billion IDR per USD

-45000

-30000

-15000

0

15000

30000

45000

0

15000

30000

45000

60000

75000

90000

Jan-07 Mar-08 Apr-09 May-10

IDR billion IDR billion

Foreign holdings of SBI outstanding (LHS)

Net Foreign Purchases of SBI (RHS)

…amidst volatilityFinancial markets vulnerable to capital outflows

After a record month of $4bn of net capital inflows in April, May’s $5.7bn in net capital outflows demonstrated Indonesia’s vulnerability to volatile capital flows Compared to late 2008, Indonesia’s financial markets are more exposed now to

a sudden reversal of capital flows due to the high percentage of foreign holdings of equities, bonds and SBIs

Reserves fell by $4bn in May as BI bought rupiah to smooth out exchange rate volatility caused by capital outflows

90% of the outflows were SBI sales; new BI policies may help stem some of this going forward

0 100 200

Total FX Reserves

Short-Term Debt*

Corporate External ST Debt*

Foreign Holdings of Stocks

Foreign Holdings of Bonds

Capital Inflows in prior 12 months Sept

2008

May 2010

USDbn

* For 2010, short-term debt and corporate external short term debt reflect March numbers

...and the reserves cushion is deeper

Financial sector is more vulnerable to a sudden reversal of capital flows

...but short term external leverage is little changed

8500

9500

10500

11500

1250020000

40000

60000

80000

Jan-07 Nov-07 Sep-08 Jul-09 May-10

IDR/USD (RHS)Total Reserves

(LHS)

IDR Appreciation

USD million IDR per USD

…and some challenges this implies Indonesia particularly exposed to global volatility

Open capital account, relatively large presence of non-resident investors in local financial markets

Importance of commodity prices for Indonesia’s economy

Reasons Annual

1. Share of aggregate value added 26%

2. Share of total exports 63%

3. Share of GDP 14%

4. Share of total imports 34%

5. Share of GDP 6%

6. CPI weight (raw foods, h/hold energy) 48%

7. Poverty Basket CPI 74%

8. Share of total Government revenues 23%

9. Share of tax revenues 8%

10. Market capitlisation of Commodity shares on IDX* 18%

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70Per cent Per cent

Share (%) of commodities in exports

…and some policy challenges Real economy, budget vulnerable to commodity price shocks

Volatility of commodity prices affects real economy and price forecasts in Indonesia as well as budget projections consider 3 scenarios of commodity price shocks on the economy (+30%,

+15% and -15%) We found commodity price movements have a large impact on prices, and a

more subdued impact on the real economy The poverty rate declined slightly with an increase in commodity prices

Sources: World Bank

-15% Baseline 15% 30% -15% Basline 15% 30%

Exports 14.3 15.0 15.6 16.2 10.5 11.1 11.7 12.3

Imports 18.7 18.3 17.9 17.5 11.9 11.6 11.4 11.2

Trade Balance 14.3 14.2 13.6 13.2 16.7 13.2 9.1 5.3

GDP 5.8 5.9 6.0 6.1 6.1 6.2 6.4 6.5

GDP Deflator 9.3 9.3 9.9 10.2 11.5 12.2 13.2 13.9

Nominal GDP 15.7 15.9 16.5 16.9 18.3 19.2 20.4 21.3

CPI 5.0 5.1 5.3 5.5 6.0 6.3 6.5 6.7

Core inflation 4.2 4.3 4.5 4.7 5.8 6.0 6.1 6.3

Poverty CPI 6.5 6.8 7.1 7.4 6.8 7.2 7.5 7.8

Poverty rate 13.2 13.0 12.9 12.8 12.4 12.2 12.0 11.9

2010 2011

…and some policy challengesHigh lending rates, NIMs may stifle investment

Indonesia has the highest NIMs in the region, driven by high lending rates High deposit-side competition but low

lending competition for banks in Indonesia leads to high deposit and lending rates, as well as NIMs

High and volatile historical inflation and bond yields increase the risk premium lenders charge on loans

Micro-level inefficiencies such as high operating costs combined with the non-competitive market structure may also contribute to higher NIMs

A deeper financial sector with a more competitive market structure, lower inflation volatility, improved corporate reporting, and higher bank-level efficiency could help reduce rates and NIMs going forward

2

6

10

14

18

2

4

6

8

10

Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10

Lending Rates (RHS)

Net Interest Margin (LHS)

Deposit Rates (RHS)

Percent Percent

BI Policy Rate (RHS)

0 5 10 15 20

CPI

5yr yield

Deposit Rate

Lending Rate

Indonesia

Philippines

Thailand

Malaysia

2006-2010 Average

Percent

Indonesia Economic Quarterly UpdateContinuity amidst volatility

Shubham ChaudhuriLead EconomistWorld Bank

23 June 2010Jakarta Indonesia