Reviving Indonesia's GDP Growth: Focusing on the Quick Wins

Early last month, Indonesia posted slower economic growth than analysts had expected. First quarter real GDP growth was booked at 4.71 percent year-on-year (yoy), weaker than the previous quarter’s figure of 5.01 percent, a record low since 2009.

Sluggish economic growth is widely seen as due to weak global conditions, falling natural resources and commodity prices and delays in budget disbursement following budget revisions. Government spending growth eased to 2.21 percent yoy in the first quarter of 2015, compared with 2.83 percent yoy in the fourth quarter of 2014.

However, as mentioned by Mandiri’s analysis on May 20, (Indonesian economic outlook: Bringing back confidence), despite many countries experiencing declining growth since last year, the Indonesian economy is expected to do much better on the back of better investment and government spending in Q1 2015. Capital expenditure realization was low in Q1 2015, as the revised budget was only approved in mid-February.

We have also highlighted the importance of supporting long-term infrastructure projects, structural reform within industry and sustaining export performance through commodity-based manufacturing. Several stages of smaller project tender processes and infrastructure maintenance have been completed, but larger infrastructure projects such as power plants, ports and toll roads will only be executed in the second half of 2015. Even then, we still do not expect government capital spending to be fully absorbed because of financing risk that reflects higher downside risk.

However, infrastructure development and structural reform takes time to execute and the effects will only being reflected in the longer term. Infrastructure projects also need extensive funding, which translates into allocation of government spending. More than 60 percent of the government infrastructure projects scheduled to start in Q2 2015 are in the post-tender and construction phases. Realization is likely to accelerate further in the coming periods, along with adjustments in some ministries’ nomenclature resolves. Currently, four of 11 ministries have cleared the issues, including the ministries with the biggest budget allocations, such as the Public Works and Public Housing Ministry.

While not neglecting these long-term developments, Indonesia can look into executing smaller or shorter-term infrastructure projects, as a proxy to revive regional economies. Improvement in management or add-on facilities in existing infrastructure can also help to increase revenues and efficiency. For example, better management of resources or operational chains in transportation infrastructure (ports/airports/railways) can help the logistics or distribution channel side and cut industry costs.

There is notable risk in economic growth from slower spending in commodity-centric regions. The fall in commodity prices has hit provinces such as East Kalimantan, Aceh, Riau and West Papua. These regions were among those that created a new wave of domestic demand after the 2008 commodity boom, which now has subsided. Of 34 provinces, 16 provincial governments have recorded lower spending realizations than last year.

What can help revive domestic spending appetites in these regions? Looking at the income distribution in Indonesia, the government can focus on how to empower and stimulate buying power among the middle and working classes. Giving non-cash subsidies to the poor and vulnerable can help ensure their basic consumption level does not fall further. Providing tax incentives or relief to companies that don’t cut their employment level, especially those in manufacturing and labor intensive industry, will help to keep unemployment rates low and provide income, which generates consumption.

To increase buying power, Bank Indonesia (BI) plans to relax its macro prudential measures to accommodate slowing growth. Coordinating with the Financial Services Authority (OJK), the central bank will loosen the loan-to-value (LTV) ratio for home and motor vehicle ownership. According to BI, the current housing LTV will be raised by a maximum of 10 percent from the current 70 percent. Another step is to relax the loan-to-deposit (LDR) ratio reserve requirement policy, which will be executed this month. By taking such steps, BI expects bank loans to reach Rp 80 trillion and inject an additional 0.2 percentage points into GDP growth.

If these steps to optimize non-interest rate fields are successful, BI projects that Indonesia’s economic growth will pick up in the second half of 2015 as a result of accelerated banking credit and government spending. However, maintaining financial stability remains a concern. External factors linked to US normalization policies and Indonesia’s current account deficit limits monetary policy flexibility, which increases perceptions of macro risk in Indonesia. The rupiah is still considered to be under heavy pressure, meaning that BI may conduct twin interventions in the bond and FX markets in the future.

As mentioned, above are several measures that Indonesia could take to revive growth. However, these are only quick-win solutions and the country still needs to work on structural reformation in a number of economic sectors, including financial inclusion, financial deepening and better legal frameworks.

Source: The Jakarta Post

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I'm Burhan Turnip, an investment junkie based in Jakarta, Indonesia. This is my take on writing Indonesia investor blog. Let's break down investing topics in Indonesia. Get in touch with me via burhanturnip [at] gmail [dot] com

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