A Collective Sigh of Relief - Deloitte

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Global Economic Outlook 2nd Quarter 2012 38 foreign capital can play a critical role in bridging the investment gap. Furthermore, the government’s push to develop value-added industries, if successful, could benefit the economy over the medium and long term. Indonesia’s economic fundamentals are robust. Policies that leverage Indonesia’s strengths can potentially catapult the economy to achieve GDP growth rates beyond 7 percent. Smaller is better As the developed world struggles with huge deficits and debt, Indonesia’s strength lies in its low debt profile and small budget deficit, which was a mere 1.1 percent of GDP in 2011. The government’s expenditure on subsidies was higher than anticipated, but strong revenues combined with lower spending on capital projects and social initiatives offset these additional costs. Given robust GDP growth, tax revenues will likely remain strong in 2012. Current projections peg the deficit at 1.5 percent of GDP in 2012. However, if the government is unable to implement its rollback on subsidies and oil prices shoot up due to geopolitical uncertainty, Indonesia’s budget deficit will, in all likelihood, be higher. Despite this downside risk, Indonesia’s budget does not pose a significant challenge to its economy. On the contrary, Indonesia’s problems stem from unspent allocations for public projects. Meanwhile, fiscal prudence put a lid on inflation, allowing the central bank sufficient leeway in pursuing an easy monetary policy. The Bank of Indonesia has been fairly proactive in its policy actions. In the Board of Governors’ meeting in February, the Bank of Indonesia cut its interest rate by 25 basis points to 5.8 percent. The move came as a surprise, but it underscores Indonesia’s concern about growth prospects in the weak global macroeconomic environment. The rate cut also highlights the confidence of the Bank of Indonesia in implementing a countercyclical monetary policy while maintaining its inflation targets and exchange rate. The country has benefitted from ebbing inflation, but this trend will likely reverse during the latter half of the year if subsidies are rolled back. The Bank of Indonesia is expected to uphold its policy stance in the near term and remain vigilant to emerging risks. A further interest rate cut is unlikely. However, the looming risk of a worsening global economy will ensure that monetary policy is not tightened prematurely. In addition, robust GDP growth and limited borrowing requirements will reduce the debt-to-GDP ratio to below 24 percent in 2012. Indonesia’s outstanding public debt — 24.3 percent of GDP in 2011 — is much lower than the emerging market average of 37.8 percent. Moreover, contingency proposals that allow the government to draw on deposits accumulated through excess borrowing in the past provide a buffer. If conditions deteriorate, resulting in smaller revenues or larger expenses, the government has the means to stimulate the economy.
Persistent challenges Pervasive corruption is a major impediment to Indonesia’s growth prospects. Bureaucratic bottlenecks, political interference, and judicial inefficiencies weigh on foreign investment and private sector participation in Indonesia. Of late, the government has initiated several anticorruption measures to improve governance. Several offenders have been prosecuted and even jailed. The recent crackdown on corruption has also resulted in bureaucratic reluctance in spending money — even on worthwhile projects. Yet, new cases of tax evasion and bribery continue to be the order of the day. Corruption and bureaucratic delays also weigh on Indonesia’s competitiveness. Indonesia’s poor performance on global comparison metrics such as days required to start a business, cost to start a business, number of procedures, etc. are a significant deterrent to investors. Together, these factors result in less-than-favorable conditions for global manufacturers to invest in Indonesia. The country also fares poorly in terms of diversification of industries and a dearth of value-added industries. Furthermore, poor labor laws result in frequent labor union strikes, road blockages, and production disruptions. As a result, Indonesia’s labor advantage remains underutilized. The government faces the uphill task of strengthening institutions, ushering labor reforms, and altering Indonesia’s image in the eyes of potential investors. Indonesia Moreover, the country lacks adequate infrastructure to support its growth aspirations. Infrastructure inadequacies result in connectivity breakdowns, adding to transportation and distribution costs and eventually higher inflation. Indonesia’s ports and airports are in need of improvement and cannot cater to high-capacity vessels. While the government has indicated its desire to remove infrastructural bottlenecks, whether the plan will be backed by credible action remains to be seen. A slowing world economy will definitely impact Indonesia’s growth prospects in one way or another. Slowing commodity prices could drive down export revenues and result in economic deceleration. However, domestic demand could partially offset the decline in external demand. Growth in Indonesian tourism has been curtailed by instances of terrorism. Notwithstanding the downside, Indonesia’s economy has significant potential. Foreign investment could increase if investors make long-term investments by pursuing high returns in Indonesia. Furthermore, private investment will likely increase if authorities can establish legislative certainty. Overall, the economy is expected to grow by 6.5 percent in 2012. However, if the government succeeds in eliminating bottlenecks that hold back Indonesia’s growth, the economy could outperform consensus expectations. Geographies 39
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