Indonesia Economic UpdateClearing skies and the road ahead

Shubham ChaudhuriSenior EconomistWorld Bank

14 September 2009Jakarta Indonesia

The Indonesian economy through the global financial crisis, and the road ahead

Indonesia has weathered the storm wellWhy?

Clearing skies are ahead

The coming policy agenda

Indonesian economy through the crisis5 facts

1. Growth rising

2. …and more robust than elsewhere

3. Financial markets are recovering

4. Inflation is at its low point…but remains higher than Indonesian’s neighbors

5. Social impact has been limited

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

0

2

4

6

8

0

1

2

3

4

Jun-02 Mar-04 Dec-05 Sep-07 Jun-09

Per cent Per cent

Year on year (RHS)

QoQ seasonally adjusted (LHS)

-60%

-30%

0%

30%

60%

90%

2005 2006 2007 2008 2009

MotorcyclesVehicles

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

-30

-20

-10

0

10

20

30

40

50

2005 2006 2007 2008 2009

I ndustrial production

Cement sales Electricity use

by industry

%

60

70

80

90

100

110

120

2005 2006 2007 2008 2009

120

140

160

180

200

220

240

BI retailsales index

(SA; RHS)

BI consumer confidence index

(LHS)

Danarakesa consumer survey (LHS)

Index Index

Indonesia through the global crisisGrowth has been stronger than elsewhere

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

Sources: CEIC, Haver Analytics, BPS, JP Morgan, World Bank

(GDP growth, quarterly, seasonally adjusted)

-6

-4

-2

0

2

4

6

India

Chin

a

Indonesi

a

Philip

.

U.S

.

Euro

Are

a

Mala

ysi

a

Japan

Thailand

Q3 2008 Q4 2008 Q1 2009 Q2 2009%

Indonesia through the global crisisFinancial markets are stabilizing

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

Sources: JP Morgan, BI, CEIC, World Bank

(EMBI spreads on sovereign USD bonds)

0

2

4

6

8

10

12

J an 07 J ul 07 J an 08 J ul 08 J an 09 J ul 09

-80

0

80

160

240

320

400% bps

Indonesian USD bond spreads

(LHS)

Indonesian spreadsless global emerging market average (RHS) 0

3

6

9

12

15

18

21

J an08

Apr08

J ul08

Oct08

J an09

Apr09

J ul09

Indonesia

Philippines

Thailand

%(local currency 5 year bond yields)

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

8,400

9,000

9,600

10,200

10,800

11,400

12,000

12,600

J an 07 J ul 07 J an 08 J ul 08 J an 09 J ul 09

30

35

40

45

50

55

60

65USDbn

IDR/USD Foreign exchange reserves

(USD bn; RHS)

Exchange rate (IDR/USD; LHS)

Indonesia through the global crisisInflation, at its low point, is still relatively high

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’

Sources: BPS, CEIC< World Bank estimates of poverty basket inflation

-4

0

4

8

12

16

20

24

-1

0

1

2

3

4

5

6

Aug-07 Feb-08 Aug-08 Feb-09 Aug-09

Per cent Per cent Food(RHS)

Inflation - monthly(LHS)

Poverty basket (RHS)

Inflation (RHS)

-5

0

5

10

15

20

-5

0

5

10

15

20

Aug-05 Aug-06 Aug-07 Aug-08 Aug-09

Per cent Per cent

Indonesia

China

Japan Thailand

India

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

19.1 18.4 18.2 17.4 16.7 16.017.8

16.615.4

14.2

6.4 6.18.1

9.1

11.59.9

11.210.3

9.3 8.5 8.1

23.4

0

5

10

15

20

25

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

National poverty rate (%) Open unemployment rate%

Why has Indonesia weathered the storm so well?

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

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

0 4 8 12 16 20 24Medium- and high-tech manufacturing output (% GDP)

GD

P g

row

th (

Sep-0

8 t

o M

ar-

09

)

Japan

Australia

Taiwan

Malaysia

Germany

Korea

Mexico Thailand

Spain

Italy

Netherlands

Canada

France

UKUS

Indonesia

%

%

(producers of capital and high-tech goods suffered larger falls in GDP)

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

Sources: MoF and World Bank

77.1

102.580.0

58.338.6 32.9

76.455.2

45.6

34.9 32.9

65.4

0

20

40

60

80

100

120

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009*

0.0

0.5

1.0

1.5

2.0

2.5

3.0% %

Deficit (RHS)

Public debt (LHS)

(central government budget deficit and debt levels)

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

-20

0

20

40

60

80

S1 2005 S1 2006 S1 2007 S1 2008 S1 2009

-40

0

40

80

120

160

Fiscal Balance Govt. deposits at BI (RHS)

IDR trillion IDR trillion

The outlook: skies continuing to clearWith the outlook now for gradual recovery

Source: World Bank

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

-3

0

3

6

2001 2003 2005 2007 2009 2011

-3

0

3

6

Jun-09 Sep-09

Forecasts

Per cent Per cent

(Annual growth ofIndonesia’s major export destinations)

0

20

40

60

80

100

2005 2006 2007 2008 2009 2010 2011

I nternational energy

International non-energy

Indonesian export prices

Index

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

The outlook: skies continuing to clearWhat it has meant and is likely to mean for Indonesia

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

2008 2009 2010 2011

Gross domestic product 6.1 4.3 5.4 6.0

Consumer price index 9.8 4.7 5.6 6.5

Major trading partner growth 2.1 -1.8 3.3 3.4

Poverty rate 15.4 14.2 13.6 11.5

2008 2009 2010 2011

Gross domestic product 6.1 4.3 5.4 6.0

Consumer price index 9.8 4.7 5.6 6.5

Major trading partner growth 2.1 -1.8 3.3 3.4

Poverty rate 15.4 14.2 13.6 11.5

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

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?

The outlook: skies continuing to clear…and these risks impact the outlook for Indonesia

3

4

5

6

7

3

4

5

6

7

2001 2003 2005 2007 2009 2011

High Low Reference

Per cent Per cent

(Annual GDP growth)

There is both upside potential (from policy breakthroughs) and downside risks (from more adverse global environment) to the base outlook

2008 2009 2010 2011

Reference projection 15..4 14.2 13.6 11.5

High scenario 15..4 14.2 13.9 11.8

Low scenario 15..4 14.2 13.4 11.3

(Poverty rate)

Sourcse: BPS, World Bank projections

Looking ahead to accelerating growthRising or floating

Per-capita real GDP grow th trajectories(constant 2000 USD)

Indonesia (1978 to 2007)

Indonesia"floating"

Philippines (1993 to 2006)

Indonesia"ris ing"

Thailand (1979 to 1993)

0

400

800

1200

1600

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

Source: World Bank

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 if energy subsidies are redirected towards targeted social spending

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

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

…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

0

2

4

6

8

10

2000-02 2002-04 2004-08

Agriculture, mining &manufacturingServices

%

Sources: BPS and World Bank

(average annual growth)

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

10/16/08

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)

10/16/08

Indonesia Economic and Policy Update:Clearing Skies

Shubham ChaudhuriSenior EconomistWorld Bank

14 September 2009Jakarta Indonesia