Contents

Introduction......................................................................................................................................2

Production Output Performance Analysis.......................................................................................3

1. Gross Domestic Product.......................................................................................................3

2. GDP per Capita.....................................................................................................................4

3. Indonesia’s GDP comparison in Global Persepective..........................................................4

4. Goverment’s Measures to Achieve the Production Output Performance.............................6

Labour Market Analysis..................................................................................................................7

1. Type of Unemployment........................................................................................................7

2. Indonesia’s Unemployment Rate..........................................................................................8

3. Government Measures to Achieves Full Employment.......................................................10

Price Level Analysis......................................................................................................................15

1. Inflation Rate Trend in Indonesia (Consumer Price Index)................................................15

2. Inflation and Its Typical Cause...........................................................................................15

3. Indonesia’s Inflation Rate...................................................................................................16

4. Traditional Peaks of Inflation in Indonesia........................................................................18

5. Monetary Policy and the BI Rate........................................................................................18

6. Indonesian Inflation in Globlal Persepective......................................................................19

Conclusion.....................................................................................................................................20

Introduction

Indonesia is the biggest country in South East Asia. The government of Indonesia wants to

explore the relevant fiscal and monetary measures and the impact of their coordination on their

national economy in the background of poor economic and political parameters of the country.

Despite slowing down in recent years, Indonesia’s growth trajectory remains impressive. The

country’s gross national income per capita has steadily risen, from $2,200 in the year 2000 to

$3,524 in 2014. Today, Indonesia is the world’s fourth most populous nation, the world’s 10th

largest economy in terms of purchasing power parity. It has made enormous gains in poverty

reduction, more than halving the poverty rate since 1999, to 11.3 percent in 2014.

Between the years of 1965 and 1997 the Indonesian economy grew at an average annual rate of

almost seven percent. This achievement enabled Indonesia to graduaNte from the ranks of low

income countries into that of the lower-middle income countries. However, the Asian Financial

Crisis that erupted in 1998 caused a severe negative impact on the Indonesian economy, resulting

in decline in gross domestic product (GDP) of 13.6 percent in 1998 and limited growth of 0.3

percent in 1999.

Out of a population of 252 million, more than 28 million Indonesians currently live below the

poverty line and approximately half of all households remain clustered around the national

poverty line set at 292,951 rupiahs per month ($24.4).

Employment growth has been slower than population growth. Public services remain inadequate

by middle income standards. Indonesia is also doing poorly in a number of health and

infrastructure related indicators, and as a result, may fail to reach some Millennium Development

Goals (MDG) targets. For example, data from 2013 shows that Indonesia still suffers 228 infant

deaths for every 100,000 live births, while the MDG aims to reduce this to 105 deaths by 2015.

Also, despite recent progress, access to improved sanitation facilities currently stands at 68

percent of the population, which remains significantly short of the MDG target of 86 percent.

The investment climate, though generally positive, faces continued regulatory uncertainties,

shortcomings in infrastructure provision, and adjustments in minimum wages. However, the

establishment by the Investment Coordination Board of a One-Stop-Service for business

licensing has encouraged investors.

2

Production Output Performance Analysis

1. Gross Domestic Product

Gross Domestic Product (GDP) is an aggregate measure of total economic production for a

country. GDP represents the market value of all goods and services produced by the

economy during the period measured.

Real GDP often reffers as Constant GDP is the the value of final goods and services

produced in a given year when valued at constant prices. This valuation means that the

Constant GDP shows real growth of a country economic by eliminate inflation effect.

However, real GDP is not perfect tools to measures economic welfare due to neglect quality

improvement, household production, underground / illegal activity, health and life

expectancy, leisure time, environmental damage, political freedom and social justice. Thus,

real GDP can be used to compare welfare in one country with that in another.

Between the years 2004 and 2013 the Indonesia economy grew at an average annual rate of

about 6 percent with the exception of 2009 and 2013 when, amid global financial turmoil

and uncertainty, Indonesia’s GDP growth fell to 4.6 percent and 5.58 percent respectively.

Table 1.1. Indonesian Current GDP, Real GDP, GDP growth, Real GDP Per Capita and GDP per Capita Growth.

Year GDP (current US$)

GDP (constant 2005 US$)

GDP growth (annual

%)

GDP per capita (constant 2005 US$)

GDP per capita growth (annual %)

2004 256,836,883,304 270,471,818,103 5 1,222 4

2005 285,868,619,206 285,868,619,206 5.69 1,273 4.17

2006 364,570,515,631 301,594,114,117 5.50 1,324 4.01

2007 432,216,737,775 320,730,327,692 6.35 1,389 4.91

2008 510,228,634,992 340,018,098,955 6.01 1,452 4.54

2009 539,580,085,612 355,757,098,753 4.63 1,498 3.17

2010 755,094,157,595 377,898,901,817 6.22 1,570 4.81

2011 892,969,104,530 401,214,448,583 6.17 1,646 4.84

2012 917,869,913,365 425,407,883,059 6.03 1,723 4.68

2013 910,478,729,099 449,142,287,180 5.58 1,798 4.35

Note: Retrieved from World Bank. Copyright 2015 by World Bank.

As shown in Table 1.1 is that the global economic downturn brought on by the global

financial crisis in the late 2000s had a relatively small impact on the Indonesian economy as

compared to its impact on other countries. In 2009 Indonesia’s GDP growth dropped to 4.6

percent, which meant that the country was one of the top GDP growth performers

3

worldwide. This success was mainly due to relatively limited importance of Indonesian

exports towards the national economy, maintained high market confidence, and sustained

robust domestic consumption. Domestic consumption in Indonesia (in particular private

consumption) contributes around two-thirds to the country’s national economic growth.

With annually around seven million people being added to its middle class, Indonesia

contains a consumer force that drives the economy and has triggered significantly increased

domestic and foreign investments from 2010 onwards However, even the GDP (current

US$) shows significant growth, the real GDP (constant 2005 US$) growth remain in static

level. There is indication this number of growth not accompanied with the management of

other macroeconomic indicators which could potentially reduce the impact of economic

growth (such as inflation, balance of payments deficit) and also, the impact of trickle-down

effect of economic growth does not necessarily provide a stable posistive effect on reducing

unemployment and poverty.

2. GDP per Capita

GDP per capita has currently reached its highest level in Indonesian economic history and is

forecast to grow higher. However, one can question whether per capita GDP is an

appropriate measurement for Indonesia as Indonesian society is characterized by a high

degree of inequality with regard to income distribution. In other words, there exists a gap

between statistics and reality as the wealth of the 43,000 richest Indonesians (who represent

only 0.02 percent of the total Indonesian population) is equivalent to 25 percent of

Indonesia’s GDP. The 40 richest Indonesian account for 10.3 percent of GDP (which is the

same amount as the combined wealth of the 60 million poorest Indonesians). These numbers

indicate a huge concentration of wealth within the small elite.

3. Indonesia’s GDP comparison in Global Persepective

Indonesia’s per capita GDP and real GDP in global prespective by comparing it to two

important economic powers: the United States (USA) and China. (see table 1.2).

4

Table 1. 2. Real GDP per Capita Comparison and Real GDP Growth Comparison

Real GDP per Capita (USD) Real GDP Growth (%)

2010 2011 2012 2013 2010 2011 2012 2013

USA 43,961 44,325 45,009 45,661 2.9 1.5 2.8 1.9

China 2,891 3,150 3,378 3,619 10.3 9.2 7.4 7.7

Indonesia 1,570 1,646 1,723 1,798 6.1 6.5 6.2 5.8

Note: Adapted from World Bank Data. Copyright 2015 by World Bank.

Looking at GDP per capita it is immediately visible that Indonesia still has a long road ahead

compared to the more developed nations. In Fact, Indonesia has one of the lowest per capita

GDP of any nation in the world. Effective government policy is needed to provide more

Indonesian children with education as well as to stimulate job creation in order to absorb a

growing workforce.

Indonesian per capita GDP has been rising steadily in the 2000s and beyond. Initially, the

World Bank had forecast Indonesia to hit the USD $3,000 mark around the year 2020 but

the country managed to reach this level a decade earlier. Reaching this level of USD $3,000

is considered as being an important step because it will result in accelerated development in

a number of sectors (such as retail, automotive, property) because of rising consumer

demand, thus being a catalyst for economic growth. The Indonesian government has set the

target of reaching USD $5,000 by the year 2015.

Real GDP growth shows a promising perspective. While the developed world in Europe and

the United States - plagued by public debts - will grow modestly for some time to come,

emerging economies in South America and Asia show robust economic growth. These

countries share certain characteristics such as the presence of abundant natural resources,

large and fast-growing populations, low labor and production costs and, lastly, relatively

stable political environments. One of these countries is Indonesia. But to reach impressive

growth rates such as China during the last two decades, it needs to invest heavily in its

infrastructure and focus on more political, economic and social reforms.

5

4. Goverment’s Measures to Achieve the Production Output Performance

Indonesian government plan to achive the production output performance throught The

Masterplan for Acceleration and Expansion of Indonesia’s Economic Development.

The Masterplan for Acceleration and Expansion of Indonesia's Economic Development

(abbreviated MP3EI) is an ambitious plan by the Indonesian government to accelerate the

realization of becoming a developed country of which the fruits and prosperity will be

enjoyed equally among the people. By utilizing the MP3EI, Indonesia aims to earn its place

as one of the world’s developed countries by 2025 with expected per capita income of USD

$14,250-$15,500 and total gross domestic product of USD $4.0-$4.5 trillion. To achieve

these objectives, real economic growth of 6.4 to 7.5 percent is expected for the period of

2011-2014. This economic growth is expected to coincide with a decrease in the rate of

inflation from 6.5 percent in 2011-2014 to 3.0 percent in 2025. The combined growth and

inflation rates reflect the characteristics of a developed country.

The vision for 2025 will be achieved by focusing on three main goals:

a. Increase value-adding and expanding the value chain for industrial production processes,

and increase the efficiency of the distribution network. In addition, to increase the

capability of the industry to access and utilize both natural and human resources. These

increases can be attained by the creation of economic activities within regions as well as

among regional centers of economic growth.

b. Encourage efficiency in production and improve marketing efforts to further integrate

domestic markets in order to push for competitiveness and strengthen the national

economy.

c. Push for strengthening of the national innovation system in the areas of production

process and marketing with a focus on the overall strengthening of sustainable global

competitiveness towards an innovation-driven economy.

6

Labour Market Analysis

1. Type of Unemployment

There are several types of unemployment which are:

a. Cyclical unemployment

Cyclical unemployment exists when individuals lose their jobs as a result of a downturn

in aggregate demand (AD). If the decline in aggregate demand is persistent, and the

unemployment long-term, it is called either demand deficient, general, or Keynesian

unemployment. For example, unemployment levels of 3 million were reached in the UK

in the last two recessions, between 1980 and 1982, and between 1990 and 1992. In the

most recent recession of 2008-2010, unemployment levels rose to 2.4m in the last quarter

of 2009, and are likely to peak at over 2.5m during 2010.

b. Demand deficient unemployment

This is caused by a lack of aggregate demand, with insufficient demand to generate full

employment.

c. Structural unemployment

Structural unemployment occurs when certain industries decline because of long term

changes in market conditions. For example, over the last 20 years UK motor vehicle

production has declined while car production in the Far East has increased, creating

structurally unemployed car workers. Globalisation is an increasingly significant cause of

structural unemployment in many countries.

d. Regional unemployment

When structural unemployment affects local areas of an economy, it is called ‘regional’

unemployment. For example, unemployed coal miners in South Wales and ship workers

in the North East add to regional unemployment in these areas.

e. Classical unemployment

Classical unemployment is caused when wages are ‘too’ high. This explanation of

unemployment dominated economic theory before the 1930s, when workers themselves

were blamed for not accepting lower wages, or for asking for too high wages. Classical

unemployment is also called real wage unemployment.

7

f. Seasonal unemployment

Seasonal unemployment exists because certain industries only produce or distribute their

products at certain times of the year. Industries where seasonal unemployment is

common include farming, tourism, and construction.

g. Frictional unemployment

Frictional unemployment, also called search unemployment, occurs when workers lose

their current job and are in the process of finding another one. There may be little that can

be done to reduce this type of unemployment, other than provide better information to

reduce the search time. This suggests that full employment is impossible at any one time

because some workers will always be in the process of changing jobs.

h. Voluntary unemployment

Voluntary unemployment is defined as a situation when workers choose not to work at

the current equilibrium wage rate. For one reason or another, workers may elect not to

participate in the labour market. There are several reasons for the existence of voluntary

unemployment including excessively generous welfare benefits and high rates of income

tax. Voluntary unemployment is likely to occur when the equilibrium wage rate is below

the wage necessary to encourage individuals to supply their labour.

2. Indonesia’s Unemployment Rate

With around 250 million people, Indonesia is the fourth most populous country in the world

(after China, India and the United States). Moreover, the country has a young population as

around half of the total population is below the age of 30 years. Combined, these two

features imply that Indonesia currently contains a large labor force; one that will grow larger

in the foreseeable future.

Table 2.1. Unemployment Rate of Indonesia

2004 2005

2006

2007

2008

2009

2010

2011

2012

2013

Unemployment, total (% of total labor force) (national estimate) 10 11 10 9 8 8 7 7 6 6

Unemployment, male (% of male labor force) (national estimate) 8 10 9 8 8 8 .. .. 6 6

Unemployment, female (% of female labor force) (national

13 14 13 11 10 9 .. .. 7 6

8

estimate)

Note: Adapted from World Bank Data. Copyright 2015 by World Bank

The table above indicates Indonesia's unemployment rate in recent years. It shows a steady

downward trend, in particular regarding female unemployment. Female unemployment has

declined rapidly and is reaching the male unemployment rate. However, gender equality, as

in most countries, is an issue in Indonesia. Although considerable progress has been made in

several key areas (education and health), women are still more likely to work in the informal

sector (twice as much as the amount of men), in poorly remunerated occupations and are

paid less than men for similar work.

A characteristic of Indonesia is that the unemployment rate is categorized in seasonal

unemployment, Fricional unemployment, demand deficient unemployment which highest

for people between the age of 15 and 24, far above the country's national average. Freshly

graduated students from universities, vocational schools and secondary schools have

difficulties finding their place in the national workforce. Almost half of Indonesia's total

number of workers possess a primary school degree only. The higher the education degree,

the lower its share towards Indonesia's workforce. In recent years, however, there is a

changing trend visible: the share of higher education degree holders rises, while the share of

those that went to primary school only decreases.

Table 2.2. Youth Unemployment Rate of Indonesia

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Unemployment, youth total (% of total labor force ages 15-24) (national estimate)

30 32 30 25 23 22 21 22 19 31

Unemployment, youth male (% of male labor force ages 15-24) (national estimate)

27 29 28 24 22 22 24 21 19 20

Unemployment, youth female (% of female labor force ages 15-24) (national estimate)

34 38 34 27 26 23 29 23 19 21

Note: Adapted from World Bank Data. Copyright 2015 by World Bank

Vulnerable employment (unpaid workers and own-account workers) for both men and

women is rather high in Indonesia compared to developed countries and its regional peers.

For Indonesian men this number reaches around 60 percent of the country's total male

employment force during the last decade, while this number is around 70 percent for

9

women. Many that fall in the category of vulnerable employment belong to the informal

sector.

3. Government Measures to Achieves Full Employment

In order to achieve the development of objectives of the current five year period, the

Medium Term National Development Plan 2010-2014 has been used as the main guideline

for the development of economic and social goals including employment.

The policy direction of national development that include employment plan which focus on

manpower development and expansion refers to the outline of Medium Term National

Development Plan 2015-2019. This medium plan consists of various labour and employment

program, such as follows:

a. Improving the manpower competency, quality and productivity to create a competitive

labour force and new entrepreneurs;

b. Managing a conducive work climate to build a harmonious industrial relationship;

c. Increasing intensity and quality of labour norm inspection and law enforcement;

d. Improving the function of labour market institution and the facility of manpower

domestic and overseas placement as well as creating job opportunities through

productive resources empowerment;

This Medium Plan has been broken down into employment activities as follows:

1. Employment creation

a. Creating conducive social economic conditions for employment creation

b. Identifing the potential of centers for economic growth

c. Promoting conducive business climate

d. Supporting entrepreneurship and SMEs

e. Eliminating discrimination in the workplace

f. Enhancing labour intensive program in the public sector and applied appropriate

technology

g. Empowering vulnerable groups

2. Labour productivity

a. Developing human resources

10

b. Revitalizing vocational training and education

c. Improving productivity in the workplace

d. Providing fair compensation and incentive based on performance

3. Industrial relations

a. Conducting capacity building to develop constructive social dialogue

b. Reforming labour laws and regulations

c. Empowering industrial relation institution

d. Settling industrial relation dispute

e. Increasing management system of occupational safety and health

4. Social protection

a. Promoting national social security system

b. Providing social security administrators, which are the Labour Social Security

Administrator (BPJS of Employment) and the Health Social Security

Administrator (BPJS of Health).

In order to achieve full employment, Indonesia’s government also use following

macroeconomic policy:

1. On the comprehensive growth strategies, Indonesia believes that employment policy

area is critical for G20 countries, as Framework Working Group and IOs have

identified such the area into one of four main elements and high-impact policy area.

2. A wide range of employment policy can be considered to one country choose proper

policy commitment as long itvis consistent with the Growth strategies.

Future growth strategy should be reflected in the linkages of poverty alleviation and

unemployment rate reduction. In terms of employment programs, building a strong

economic capacity and competitiveness are some long term challenges that will be the main

factors. To support this program, several plans will be implemented, such as:

1. Infrastructure development of roads, harbours/airports, telecommunication, railways,

etc. in the rural and outskirts areas to help local resources create jobs and improve

local economic activities.

2. Develop open market should be developed by providing facilities, incentive policies

and conducive environment for private sector running its business. Indonesia

11

supports SMEs financing as they are an important factor in fostering high economic

growth and employment, especially labour absorption.

3. Promote entrepreneurship to empower labour force to create job. This endavour is

conducted through entrepreneurships program for university graduates who have

entrepreneurial passion and productivity orientation. Training and support, in both

technical and managerial skills, will be given to help new entrepreneur to run their

small/medium business by utilizing available natural and human resources. In this

program, the government (MoMT) will also provide business assistance in the form

equipment, depending on the type of business they are going to run. This program,

collaborated with universities, banks, and businesses has a purpose to educate and

encourage university graduates to become young entrepreneurs.

Bank Indonesia (BI) also contributed by launching entrepreneurship program in 2012

as a part of the national Entrepreneurship Movement program to promote

entrepreneurship and to increase employment. This program (in 2014) is focused on

agribusiness sector and export-oriented commodities. BI will continue to support the

program and will enhance the focus to cover women entrepreneurship in 2015 and

other sectors for the period after.

4. The empowerment and optimalization of public vocational training centres, aimed to

improve the quality and productivity of labour force, will be continued in the near

future. Additionally, as a part of “smart industrial policies”, the government will also

encourage the private sector to provide training for those seeking jobs so that it can

avoid the so called “labor mismatch”. This strategy will be accomplished through tax

scheme by treating cost of training spent by companies as deductible for income tax.

5. To further strengthen Indonesia’s economic resilience, fiscal measures in human

capital investment development will be continued. The government will still

maintain the constitutional requirement of 20% allocation of our state budget for

education. Moreover, to provide incentives for innovation and to encourage

technological development, the plan of providing tax incentives for companies who

relocate their Research and Development process in Indonesia will be developed.

6. To encourage job creations, the government have provided a variety of tax-related

incentives such as tax incentives for labor-intensive businesses, and an increase in

12

non-taxable income. These policies will be continued in the future to further spur

economic gwoth and create emloyment. In addition, new simplified tax policy for

small and medium businesses is targetted to improve SMEs’ business operations and

management while promoting better access to investment and banking services.

7. Female Participation

a. Indonesia correlates some aspects that still need to be improved in order to

support the improvement of living standard and sustainable development

programs, as well as program implementation of Millennium Development Goals

(MDGs) which will be done in 2015 of 8 indicators, there are four of 2015 MDG

targets have been achieved, namely improvement of primary education, gender

equality and the empowerment of women, reduction in child mortality, and to

build a global partnership for development.

b. Two Goals to be achieved by budget allocation on other priorities in the field of

welfare of the people in 2014, one of which is the completion of the

implementation of gender mainstreaming policy (PUG) field of labor. Therefore,

government increase the 2014 budget for the sub-function for the empowerment

of women riding around Rp192,7 billion or 2.8 percent.

c. Indonesia has advanced its efforts to boost female labour force in high level

political system. The Law No. 2/2011 regarding Political Party states in article 2

(5) that Political Party Management at central level must include at least 30% of

female representation. Also article 29 (1a) states that in the recruitment process,

political party should consider at least 30% of female representation to become

member of parliament candidate.

d. Indonesia has a ministry with a vision of addressing female participation issues,

gender equality and the fulfilment of children's rights, namely: Ministry of

Women’s Empowerment & Children Protection. The main purpose of the

Ministry of Women Empowerment and Child Protection are:

1) To provide programs and gender-responsive government policies;

2) Ensure improvement and fulfilment of women's rights;

3) Ensure improvement and fulfilment of children's rights;

13

4) To ensure the realization of the policy on gender responsive data system and

in accordance with the interests of the child;

5) Making management accountable.

Action plan in 2014-2015:

a. Increase the number of policies / programs / activities in the field of gender

responsive to Political, Social and Legal, implemented by ministries,

Institutions and Local Government (with the main target to 11 line ministries

and 26 provinces).

b. Improving the equality of women participation in SMEs, industry, and trade

activities with the main area target in 3 provinces;

c. Increase fulfilment of women in agriculture, forestry, fisheries, marine, food

security and agribusiness, coordinating with 3 line ministries and 3

provincial governments.

8. Administrative reforms and funding are needed to improve educational outcomes

a. According to Law no. 20/2003 regarding National Education System, the

Government shall allocate 20% of its annual budget to education sector through:

providing scholarships to fresh graduates of senior high schools to pursue their

higher education; allocating vocational training and to develop school and

university curriculums that support entrepreneurship.

b. Developing employment competency standards by increasing Number of

guideline administration and management development Vocational Training

Institution (LPK) and Number of formulated and established Indonesia National

Skill Competency Standards

c. Competency based training and apprenticeship by increasing Number of licensed

Professional Certification Institutions (LSP) (1st/2nd/3rd party) ; people in the

labor workforce that have competency based training; Number of Competency

Test Assessor that have capacity improvement; Number of trainers that have

competence improvement.

14

Price Level Analysis

1. Inflation Rate Trend in Indonesia (Consumer Price Index)

The level and volatility of Indonesia's inflation rate have historically been higher than in some

peer emerging nations. Whereas these other emerging countries shared inflationary rates of

between three and five percent during the period 2005 to 2013, Indonesia contained an

average annual inflation rate of around 8.5 percent in the same period.

2. Inflation and Its Typical Cause.

Inflation means there is a sustained increase in the price level. The main cause of inlation are

either excess aggregate demand (economic growth too fast) or cosh push factors (supply side

factors)

15

a. Demand Pull Inflation.

If the economy is at or close to full employment then an increase in aggregate demand

leads to an increase in the price level. As firms reach full capacity, they respond by

putting up prices, leading to inflation. Also, near full employment, workers can get higher

wages which increases their spending power.

Aggregate demand can increase due to an increase in any of its components which are:

Consumption, Government Expenditure, Investation, International Trading.

b. Cosh Push Inflation

If there is an increase in the costs of firms, then firms will pass this on to consumers.

There will be a shift to the left in the agrregate supply.

Cosh push inflation can be caused by many factors, for example:

- Rising Wage

- Rising Import Prices

- Rising in Material Prices

- Profit Push Inflation

- Declining Productivity

- Higher Taxes

3. Indonesia’s Inflation Rate

Peaks in Indonesia's inflation volatility correlate with administered price adjustments. Energy

prices (fuel and electricity) are set by the government and therefore do not float according to

market conditions, meaning that the resulting deficit has to be absorbed by subsidies. This

puts serious pressure on the government's annual budget deficit and also limits public

spending in more long-term productive matters, such as infrastructure and social expenditures.

Moreover, re-arranging energy subsidies implies political risks as social unrest emerges

inflicted by inflationary pressures. One characteristic of Indonesia is that a large quantity of

its population is clustered just above the poverty line, meaning that a relatively minor

inflationary shock can push them below that line. When the Susilo Bambang Yudhoyono

administration decided to reduce its massive fuel subsidies in late 2005 due to the rising

international oil price, it soon led to double-digit inflation rates of between 14 and 19 percent

(year on year) until October 2006. Furthermore, the country's core inflation - which excludes

16

items that are vulnerable to temporary price volatility - has been volatile as well because of

second round effects of energy price adjustments that pass through to the broader economy

(for example through rising transportation costs).

Reduction of energy subsidies remain a top priority on the government's agenda. In early

2012, the government proposed a fuel price increase but social unrest and political opposition

in parliament made a sudden increase impossible. Eventually in June 2013, gasoline was

raised by 44 percent to IDR 6,500 (USD $0.66) and diesel by 22 percent to IDR 5,500 (USD

$0.56) per liter. But despite the 2013 price hike, a significant portion of Indonesia's fuel prices

remain subsidized and therefore various international organizations (including the World

Bank and International Monetary Fund/IMF) as well as domestic institutions (such as

Indonesia's Chamber of Commerce and Industry/Kadin) support further subsidy reductions. In

2013 and 2014, the government has also reduced subsidies for electricity - both for

households (although exempting the poorer segments of society) and industries.

Indonesia's inflation outlook is highly influenced by the decision to further reduce these

subsidies. The World Bank estimates that a IDR 2,000 increase in fuel prices can add about

three percentage points to the level of headline inflation and can add over one percentage

point to core inflation. Electricity price hikes, however, are estimated to have a smaller impact

(< 1 percent) on the pace of inflation. As an illustration, the central bank of Indonesia (Bank

Indonesia) initially targeted an inflation rate of 4.5 percent in 2013. However, after the fuel

and electricity price hikes, inflation accelerated to 8.37 percent (yoy) by the year-end.

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Inflation, consumer prices (annual %)

6 10 13 6 10 5 5 5 4 6

Bank Indonesia Target

5 5 5 5 5 4.5 5 5 4.5 4.5

Note: Adapted from World Bank and Bank Indonesia

Indonesia's characteristic volatile inflation rate causes a traditionally larger deviation from the

annual inflation projections of Bank Indonesia. The consequence of such inflationary

uncertainty is that it creates economic costs, such as the country's higher (domestic and

international) borrowing costs compared to its emerging market peers. When a good track

record of meeting annual inflation targets is established, greater monetary policy credibility

will follow.

17

The lack of quantity and quality of Indonesia's infrastructure also entails robust economic

costs. This hampers connectivity in the archipelago, thereby increasing transportation costs

for services and products. Distribution disturbances due to infrastructure-related issues are

frequently reported and made the government realize the importance of more investments in

the country's infrastructure. Infrastructure has been labelled a top priority in the Masterplan

for Acceleration and Expansion of Indonesia's Economic Development (abbreviated MP3EI);

an ambitious long-term government development plan which is yet to bear fruit.

Food prices are traditionally highly volatile in Indonesia and subsequently impose a big

burden on the poorer households who live under or just above the poverty line. These

households spend more than half of their total expenditure on food items. Higher food prices

therefore cause serious poverty basket inflation which may lead to increases in the level of

poverty. Failing harvests in combination with a slow reaction of the government to substitute

food products with food imports are causes for inflation peaks.

4. Traditional Peaks of Inflation in Indonesia

Discarding administered price adjustments, there are two traditional annual peaks of inflation

in Indonesia. The December-January period always brings higher prices due to Christmas and

New Year celebrations, while the traditional floods in January (amid a peak of the rainy

season) results in disrupted distribution channels in several regions and cities, thus causing

higher logistics costs. The second peak comes in the July-August period. Inflationary

pressures in these two months emerge as a result of the holiday period, the holy Muslim

fasting month (Ramadan), Idul Fitri celebrations and the arrival of the new school year. A

marked increase is detectable in spending on food and other consumables, accompanied by

retailers adjusting prices upwards.

5. Monetary Policy and the BI Rate

With annual GDP growth close to six percent, the economy of Indonesia has been rapidly

expanding in recent years, characterized by surging domestic demand (domestic

consumption accounts for around two-thirds of the country's economic growth), robust

private sector credit growth and increased business access to credit. Moreover, public sector

wages have increased due to administrative reforms and private sector wage growth has

18

accelerated (Indonesia's regional minimum wages were raised significantly in 2012 and

2013). As robust economic growth brings along inflationary pressures, recent monetary

policies (in 2013 and 2014) were aimed at safeguarding financial stability, particularly after

inflation surged due to the 2013 fuel prices hike and amid the looming end of the Federal

Reserve's quantitative easing program (which led to large capital outflows from emerging

markets, including Indonesia), at the expense of further economic growth.

Bank Indonesia (BI), Indonesia's central bank, has as main objective to ensure rupiah

stability. It uses a wide range of instruments to stem mounting inflationary pressures in the

country. Its bank rate policy is adjusted when inflation targets are not met. Between

February 2012 and June 2013, the country's benchmark interest rate (BI rate) had been set at

a historic low of 5.75 percent. After this period, inflationary pressures increased due to

higher fuel prices and global uncertainty about the US quantitative easing program.

Subsequent capital outflows resulted in sharp rupiah depreciation. Therefore, Bank

Indonesia adjusted its BI rate upwards. Another measure to tighten monetary policy was the

raising of the reserve requirements on both local and foreign currency deposits at Indonesian

banks. Lastly, BI curtailed foreign investors' demand for Central Bank bills (SBIs) by

extending the required holding period from one to six months, stretching the maturity of SBI

issues to nine months and by introducing longer maturity non-tradable term deposits (which

are available to banks only). These measures aimed at mitigating the flow of 'hot money'

into Indonesia.

6. Indonesian Inflation in Globlal Persepective

The table below puts Indonesia's recent inflation performance (annual percent change) in

global perspective by comparing it to inflation figures from the United States (USA) and

China.

2009 2010 2011 2012 2013

USA -0.4 1.6 3.0 1.7 1.5China -0.7 3.3 5.4 2.6 2.6

Indonesia 4.8 5.1 5.4 4.3 6.4Notes: Adapted from World Bank. Copyright 2015 by World Bank.

19

Conclusion

Future forecasts for Indonesia's economic development are still positive but have been revised

down by all international organizations and the Indonesian government due to prolonged global

uncertainty. The recently unveiled Masterplan for the Acceleration and Expansion of Indonesia’s

Economic Development (or, MP3EI), spanning the years 2011 to 2025 and which designates six

regions as main economic corridors, aims to place Indonesia inside the top ten of biggest global

economies by 2025. This Masterplan implies major investments in infrastructure - something

that has been hampering Indonesia's economic growth - and is supposed to result in GDP growth

reaching eight or nine percent annually. However, these growth rates seem too ambitious for the

near future (2014 to 2017). Authoritative international institutions (World Bank, IMF and Asian

Development Bank) project Indonesia's annual GDP growth in the range of 5.3 to 6.0 percent for

the period 2014 to 2017. These organizations stress that sufficient political and economic reform,

in combination with large investments in infrastructure, will add one or two percentage points to

current GDP growth forecasts.

20