INDONESIA ECONOMIC QUARTERLY 03|18 TOWARDS

INCLUSIVE GROWTH

Frederico Gil Sander,

Lead Economist

March 27, 2018

Recent economic developments and outlook

Collecting more and spending better for inclusive growth

How is the health of the Indonesian economy?

The Indonesian economy grew slightly faster…

4Source: BPS; World Bank staff calculations

5.15.2

-4

-2

0

2

4

6

8

Dec-15 Jun-16 Dec-16 Jun-17 Dec-17

Private consumption Government consumption

Investment Net exports

Stat. discrepancy* Change in inventories

GDP

GDP growth yoy and contributions,

percentage points

…as investment remains on multi-year highs thanks to higher machinery purchases

5Source: BPS; World Bank staff calculations

-2

-1

0

1

2

3

4

5

6

7

8

Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17

Buildings & Structures Machine & Equipment Vehicles

Other Equipments Cultivated Bio. Res. Intellectual Property

Investment

Growth in gross fixed capital formations yoy and contributions to growth, percent

-2

0

2

4

6

8

10

12

Feb-16 Aug-16 Feb-17 Aug-17 Feb-18

Headline

Administered Food

Core

Administered price increases

Headline inflation declined in the second half of 2017…

6

Change from the previous year, percent

Source: BPS; World Bank staff calculations

1,469

1,463

1,138

-4

3,824

191

3,593

2,610

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

2011 2012 2013 2014 2015 2016 2017

Manufacturing Agriculture, forestry and fishery Other Industry Services Total

…while labor markets remained robust

7

Net jobs created, by sector, thousands

Source: BPS; World Bank staff calculations

8

Ada apa dengan

Konsumsi3?

What is the matter with consumption? – Part 3

Rp

Private consumption growth was slightly below its 10-year average but well above pre-2008 levels

9Source: BPS; World bank staff calculations

20174.95

2001-2007 average

4.05

2008-2017 average

5.10

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2001 2003 2005 2007 2009 2011 2013 2015 2017

Private consumption growth, year-on-year, percent

The effects of inflation and the Rupiah, key drivers of consumption, often come with a lag

10Source: World Bank staff analysis

A depreciation in the exchange rate has a negative impact on private consumption after four quarters

Quarters since the shock

Consumption growth declines 4

quarters after the depreciation

Quarters since the shock

An increase in inflation has a negative effect on private consumption growth in the following quarter

Change in log difference in private consumption growth

Consumption growth declines the

quarter after the rise in inflation

Are debt levels too high?

In short – no

12

Source: IMF Fiscal Monitor (October 2017), World Bank staff calculations

… which are expected to remain stable even under certain shocks

…thanks to prudent fiscal policies that led to a decline in debt levels…

Indonesia’s debt levels are among the lowest in the world...

20

25

30

35

40

2008 2010 2012 2014 2016 2018 2020

Government debt, % of GDP, under baseline and -1 std. deviation

Baseline

GDP

Exchange rate

0

10

20

30

40

50

60

70

80

90

100

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Fiscal balance (LHS)

Debt (RHS)

Source: World Bank staff calculations

Indonesia

0

50

100

150

200

250 Debt-to-GDP (percent) Percent

At the same time, maintaining a prudent fiscal stance is warranted

13

Source: ADB – Asian bonds online

39.8

0

5

10

15

20

25

30

35

40

45Indonesia

Korea

Malaysia

Thailand

Foreign holdings of local currency bonds, percentYields on 10-year bonds, US vs. Indonesia, percent

2.26 US 2.82

7.11 Indonesia7.02

4.89 Yield differential

4.20

0

1

2

3

4

5

6

7

8

Source: CEIC and World bank staff calculations

Foreigners hold nearly 40 percent of Indonesian Government bonds

With Fed normalization, yield differentials are narrowing

Structural reforms will further enhance Indonesia’s borrowing capacity

14

Source: IMF Fiscal monitor and World Bank staff calculations

Note: Indonesia* simulates Indonesia’s debt/revenues ratio with a 1 percent increase in the revenue/GDP ratio

Debt-to-revenues ratio, percentCredit-to-GDP ratios as of Q3 2017, percent

Source: BIS and World Bank staff calculations

Higher revenue collections can further enhance Indonesia’s credit strength

A deeper financial sector would support growth and provider greater domestic liquidity

39.156.8 63.0

84.7

115.6

134.1

210.5

0

50

100

150

200

250

182 189 194

259 261276

326

0

50

100

150

200

250

300

350

How much should we worry about Rupiah depreciation?

The Rupiah depreciated in 2018, but has significantly appreciated since the taper tantrum

16Source: BIS; World Bank staff calculations

-9.0

-6.0

-3.0

0.0

3.0

6.0

9.0

12.0

15.0

18.0

21.0

Malaysia Singapore Japan Philippines China Thailand Korea Indonesia India

Real effective exchange rate (increases denote appreciation)

Columns: percent change, December 2013 – December 2017

Dots: percent change, December 2017 – February 2018

IDR moves partly reflect wider CA deficit linked to investment, and increasingly financed by FDI

17

Source: BPS; World Bank staff calculations17

-25

-20

-15

-10

-5

0

5

10

15

20

25

Dec-15 Dec-16 Dec-17

Other

Fuel

Capital

Raw materials net of fuel

Consumer goods net of fuel

Imports

Trade

19 19

22

17

4

23

-20

-15

-10

-5

0

5

10

15

20

25

30

2012 2013 2014 2015 2016 2017

Other

Financial Intermediation

Manufacturing

Mining and Quarrying

Agriculture, Hunting, and Forestry

Foreign Direct Investment, USD billionImports, yoy growth, percent

How much can growth accelerate in 2018 and 2019?

Growth is likely to remain steady over in the near-term, despite rising global risks

19

Source: Bank Indonesia, BPS, Ministry of Finance, World Bank staff calculations

2016 2017 2018f

Real GDP Annual percent change 5.0 5.1 5.3

Consumer price index Annual percent change 4.3 3.8 3.5

Current account balance Percent of GDP -1.8 -1.7 -1.9

Budget balance Percent of GDP -2.5 -2.4 -2.3

Global outlook favorable

Domestic conditions conducive

Risks of protectionism are rising; normalization of unconventional post-GFC monetary policy remains potential source of volatility

100

56 5648

100

59

94100

0

20

40

60

80

100

120

140

160

China Vietnam India Indonesia

Wages Unit Labor Costs

Accelerating growth beyond 5.5 percent in the near term will be challenging

Indonesia’s economy has capacity to grow between 5.0 – 5.5 percent based on current levels of infrastructure, skills, and productivity

20

28,181

9,629

3,811

0

5,000

10,000

15,000

20,000

25,000

30,000

Advanced Emerging Indonesia

Source: World Bank staff calculations using IMF (2017) data

Note: 2015 estimates. Unweighted averages computed for 14

advanced economies and 21 EMs

$1.5

trillion

to

close

this

gap

Source: OECD PISA

14

55

0

10

20

30

40

50

60

2012 2015

Share of students who do not meet level 2 proficiency levels

Source: UNIDO, WB staff calculations

Note: wages for finishing, weaving, and spinning of textiles

Average wages and unit labor costs, indices (China = 100)

Low wages but high costs because of low productivity

Average public capital stock per capita, 2015 USD

55 percent of 15-year-olds ‘functionally illiterate’

$1.5 trillion needed to close infrastructure gap with other EMs

So what can be done to advance Indonesia’s development in 2018, 2019 and beyond?

Put forward a bold “policy sambal” to radically open the economy and bring in investments and jobs

Invest in quality of life: improve people’s lives and build long-term foundations for inclusive growth

21

Recent economic developments and outlook

Collecting more and spending better for inclusive growth

Collecting more and spending better are key drivers of inclusive economic growth

23

Spending Effectively Spending More on

Priority Sectors

Spending

Differently

Collecting

more…

…and better

INCLUSIVE GROWTH

Spending

Better

Health, education, urban

infrastructure, connectivity,

social assistance

The quality of spending has improved as expenditures shifted towards priority areas for inclusive growth…

24

28%

6%

0%

5%

10%

15%

20%

25%

30%

2014 2015 2016* 2017*

Infrastructure Health

Education Social protection

Energy subsidies

Percent of Central Government spending excluding transfers to subnational governments

Source: Ministry of Finance, World Bank staff calculations

Note: 2014-2015 refer to actual spending, 2016 and 2017 are budgeted. Infrastructure only includes line ministry spending and does not include below

the line capital injections to SOEs.

…but Indonesia still needs to spend more in some areas...

25

1.4

0.6

2.42.3

1.1

4.9

0

1

2

3

4

5

6

Health Social assistance Infrastructure, incl. housing

Current level of spending Estimates of needed level of spending

Source: World Bank staff calculations

Percent of GDP

…by further reallocating expenditures away from poorly targeted subsidies…

26

4.0

1.2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0

50

100

150

200

250

300

350

400

450

Fuel Electricity

Food Fertilizer

Other non-energy subsidies Total subsidies (% GDP)

Source: Ministry of Finance, World Bank staff calculations

IDR trillion Percent of GDP

…and increasing revenue collections

27

Malaysia

Peru

Philippines

South Africa

Indonesia Thailand

Singapore

0

10

20

30

40

50

60

8 9 10 11 12

General government revenue, percent of GDP, 2016

Source: IMF Fiscal Monitor, World Bank staff calculations

Log GDP per capita in 2011 PPP

Excises – consider higher tobacco, vehicle, and environmental excises (such as taxes on plastic bags) to incentivize good behavior and raise revenues

VAT – lower threshold and reduce exemptions for greatest bang-for-the-buck

Income tax – lower threshold and simplify the tax code to get more individuals in the tax net

Tax administration – improve IT systems and HR to boost compliance

Revenues are well below what would be expected given Indonesia’s income level, constraining expenditures

In education, Indonesia can spend better to improve quality for all children

Dramatically reduce stunting through coordinated interventions

Invest in quality early childhood education for all Indonesian children

Launch a presidential initiative on education quality focusing on improving learning outcomes

Investments in education build a legacy for future growth – and parents care about their children today and will recognize the Government’s efforts

28

Spending better, but also spending more, is needed in the health sector

29

JKN is very popular with Indonesians, but faces a chronic deficit

Increase investments in primary health care, promotive and preventive interventions, particularly for vulnerable populations living in rural and remote locations

Indonesia, 1.08

0

2

4

6

8

10

12 General Government spending on health, percent of GDP

Source: WDI

Spending on health is among the lowest in the world

Emphasize quality over numbers in social assistance

30

The move of social assistance spending from subsidies to direct transfers has been positive...

...but after a large expansion in the PKH, focus should be on ensuring all eligible families are reached by the program and on increasing benefits➢ IDR 1 of spending in higher benefits

leads to more poverty reduction than the same IDR 1 spent on new beneficiaries

Share of beneficiaries by consumption decile, percent

Despite improvements, many poor households do not receive PKH, while some richer households do

Source: SUSENAS and World Bank staff calculations

0%

5%

10%

15%

20%

25%

30%

35%

1 2 3 4 5 6 7 8 9 10

2010 2014 2017

Spending and revenue policies influence inclusive growth in the long-term, but also today’s distribution

31

-0.12

-0.10

-0.08

-0.06

-0.04

-0.02

0.00

Change in Gini coefficient from market to disposable income, points

Source: Commitment to Equity, latest comparable data available

TERIMA KASIHTHANK YOU

Questions?fgilsander@Worldbank.org