Indonesia country focus: Macro outlook

Christine Lagarde, managing director of the International Monetary Fund (IMF), has urged students to usher in the next phase of Indonesia’s transformation. During a recent speech she gave at the Universitas Indonesia in Jakarta, she advised the students to help create an economy that is not only “vibrant” and “inclusive” but, critically, also outward-looking and ready to take its rightful place on the global stage. Ms Lagarde told the students that to achieve this, Indonesia needs to continue to broaden its growth model so that it can compete in manufacturing, agriculture and other services, as well as core extractive industries. This, the IMF managing director said, means the nation needs to capitalise on its “vast reservoir” of talent and entrepreneurship to become a global player across a much wider range of activities.hideMs Lagarde conceded that she was not just thinking about the interests of these Indonesian youngsters but also the wider world, as it struggles to maintain its economic recovery in the face of strong headwinds such as a weaker than expected recovery in advanced economies and a slowdown in emerging regions such as Latin America. Time to step up The world needs economies such as Indonesia to step up the pace and bolster global trade in the process. “Quite frankly, the global community needs its fourth largest and most youthful population to play a lead role in the global economy. Imagine the Garuda – the mythical bird that is your country’s emblem. Like this bird, I would encourage you to spread your wings and embrace the possibilities the world has to offer you,” said Ms Lagarde. Ms Lagarde added that Asia as a region is still expected to lead global growth. But even here, the pace is proving to be slower than expected and there is a real risk that it may slow even further, given the recent spike in global risk aversion and financial market volatility. The wider macroeconomic conditions spell potential trouble for Indonesia, pointed out the IMF managing director. The first issue is China, one of Indonesia’s main trading partners. “The transition to a more market-based economy and the unwinding of risks built up in recent years is complex and could well be somewhat bumpy. That said, the authorities have the policy tools and financial buffers to manage this transition. Other emerging economies, including Indonesia, need to be vigilant to handle potential spillovers from China’s slowdown and tightening of global financial conditions,” explained Ms Lagarde. “At the same time, commodity prices have come off their peak, and this decline is projected to persist. Both of these factors imply that external demand for Indonesia’s goods is likely to be weaker for some time to come,” she added. The third big risk is the rise in interest rates as the US economy solidifies. Ms Lagarde said this could pose a risk for emerging economies, including Indonesia, in the form of weaker capital flows, higher interest rates and financial volatility. Ms Lagarde said the recent turbulence highlights the need for even greater resilience. “That requires rejuvenating the country’s growth momentum – for the Garuda to have strength, one of its key virtues,” she said. Action is needed now. Growth in Indonesia has slowed for the past four years and has recently fallen below 5% for the first time since the global financial crisis. Ms Lagarde said that clearly this slowdown need not be permanent and Indonesia can shift to a higher growth trajectory. But it needs to get on the right side of ongoing shifts in the global economic and financial landscape. The big question is: how? The answer is by taking advantage of its huge resources and potential and opening up further to the wider region and world. Massive resource The simple fact is that Indonesia is the eighth largest economy in the world by some measure, and home to more than half of the labour force in the Association of Southeast Asian Nations (ASEAN) community. Moreover, unlike other countries in the region that have ageing or even shrinking workforces, Indonesia has a reservoir of young people that it can draw upon for many years to come. It is even true that more than 70% of the population in 2030 will be of working age, which is a huge asset of 180 million young people. To release this massive resource Indonesia needs to tackle its unnaturally high youth unemployment rate of more than 20%, more than four times the overall unemployment rate. It also needs to face up to the fact that while poverty rates in the country have been halved, income inequality has seen a rapid rise during the past decade. “No growth can be sustainable if its benefits are enjoyed only by a few,” pointed out Ms Lagarde. To overcome these obstacles, Indonesia needs to embark on “bold” reforms that will further modernise its economy, create jobs for its youth and make it fit for a 21st century global leader, she said. To do this it must engage with the world, achieve a more balanced economy and make the whole world its “playground”, she added. “’Your Indonesia’ should not be just a story about commodity exports and a large domestic market. There is a whole new class of markets to be conquered – not just in your neighborhood, but globally as well,” said Ms Lagarde. “There are more than 1.5 billion consumers that will be entering the global middle-class during the next few years. And it will be up to you to make that conquest. This is achievable. By developing the economy’s potential in manufacturing, agriculture and services. By generating opportunities for all. And by building a world-class infrastructure of physical and human capital,” she added. Key areas This will need a focus on three areas: infrastructure, investment and trade. Indonesia’s infrastructure gap remains large compared to its peers, especially in power and transport. Logistics costs account for 24% of gross domestic product in Indonesia, compared to only 13% in Malaysia. Because of disparities in transport costs, the price of some basic commodities can be 20 times higher in eastern provinces than in Java, explained the IMF executive. The electrification rate is about 80%, compared to universal coverage in Indonesia’s peers. The reduction of transport costs and ramping up of power production can help create jobs in manufacturing and services and enable Indonesian businesses to better connect and serve a global clientele, said Ms Lagarde. The good news is that Indonesia’s President Jokowi has made infrastructure improvement a top policy priority. During the coming four years, infrastructure spending will be boosted by an average of 8% per year. The next big area to tackle is the investment climate and the regulatory shackles that continue to limit its potential, said Ms Lagarde. “The experience of dynamic economies such as China during the past decade, and Japan and Korea before it, demonstrates one thing: these countries developed their potential by engaging more fully with the world. Learning from the world, internalising new technologies and then going out into the global market place to compete in an ever-broadening range of activities and services,” she explained. “Indonesia can do the same. But first it needs to remove constraints that shackle its private sector. On the investment side, this means streamlining complex regulatory requirements. It also means harmonising overlapping and contradictory national and local regulations,” added Ms Lagarde. There is good news from the top on this front too. President Jokowi has committed to jumpstart investment. The Land Acquisition Law is being revamped and a one-stop services shop has been established for business licensing. “These are steps in the right direction,” said Ms Lagarde. The third big element is trade integration, according to the IMF boss. “A successful trade development strategy hinges on resisting the pressure to look inward and removing barriers to competition – especially when the going gets tough and there is turbulence in the seas. Trade has always been a key driver of Indonesia’s economic activity. Now it is all the more important to reap the potential dividends from further trade liberalisation and integration, especially within the ASEAN Economic Community,” she explained. Prosperity for all For prosperity to last, however, it needs to be inclusive. Everyone must share in its fruits. But Indonesia has a problem here because women and young people are currently not fully included, added Ms Lagarde. One in every five young persons is not in education, employment or training. At about 50%, women’s participation in the labour force is less than two thirds that of their male counterparts. Close to 40% of young women (aged 15-24) are not in education or employment, according to IMF figures. And yet it is estimated that a rise in the rate of labour force participation by women from 50% today to 64% by 2030 could potentially add 20 million more skilled workers. Ms Lagarde described this as an economic “game-changer”. Another important factor is financial inclusion because access to credit is a key link between economic opportunity and economic outcome, as well as being essential for individual empowerment. Unfortunately, however, currently almost two thirds of the Indonesian population have no access to any banking services, and close to half have no savings accounts. Micro-credit programmes, such as those recently implemented by Bank Rakyat Indonesia, have been successful and extended coverage to remote areas but more effort is still needed to increase financial integration in the region. Ms Lagarde concluded that the world needs economies like Indonesia to be engaged and active in forging a new form of global cooperation. “One that reflects ongoing shifts in the global landscape, where dynamic economies such as Indonesia have their rightful place. Your country has immense potential and its destiny lies in your hands. You will be the leaders of the change that will enable Indonesia to soar to new heights. Let the Garuda spread its wings,” she said. OECD urges Indonesia to focus on education, corruption and renewables The Organisation for Economic Co-operation and Development (OECD) forecasts that economic growth in Indonesia will pick up gradually next year and reach 5.5% in 2017. It predicts that public spending should gather pace and the impact of the significant fall of the rupiah since early 2014, notwithstanding its a recent strengthening, should provide a boost. As noted by the International Monetary Fund, low prices for many primary commodities and regulatory uncertainty will continue to hold back private investment. The OECD notes that the government has focused primarily on the removal of obstacles to its infrastructure investment plans. But inconsistent signals about the protection of domestic industry, openness to foreign investment and free trade are hurting business confidence. The strategy of insisting that all insurance coverage is placed with domestic insurers when possible and the creation of a new national reinsurance company as discussed below confirms this. The OECD described the almost complete removal of fuel subsidies at the beginning of 2015 as a “very positive” step. But it also said that the new administrative fuel price-setting regime is still “cumbersome”. Corruption and environmental destruction remain big problems that need to be tackled sooner rather than later, says the OECD in its latest report on Indonesia. “Corruption and lack of enforcement are permitting the illegal clearing and burning of forests, resulting in lower carbon absorption and severe air pollution throughout the region. The government could do more to promote the use of renewables, including tapping Indonesia’s vast geothermal potential,” states the organisation in its report. The OECD agrees with the IMF that the Indonesia government must focus on education, inclusion and access to credit for poorer sections of the population. Angel Gurría, OECD secretary general, focused on these topics as she introduced the OECD Education Policy Review of Indonesia with the country’s minister of culture and elementary and secondary education, Anies Baswedan. The Policy Review points out that Indonesia faces a “unique window of opportunity”, with 43% of its 250 million-strong population under the age of 25. “To reap the demographic dividend, the Indonesian government must raise the quality of education, through improvements in teacher training, professional development and increased accountability. It must extend participation in the education system, to ensure that all students have an equal chance to progress to higher levels of learning. And it must strive for greater efficiency within the education sector,” concludes the report. The economic survey points out that the central government’s strong fiscal position, marked by low deficits and low public debt, offers an opportunity to raise greater revenues to fund higher spending targeted at the improvement of education, boosting infrastructure and expanding the social security system. “Better targeting of existing social security programmes would ensure that measures to alleviate poverty—including cash transfers, healthcare spending and food subsidies—benefit those most in need. Reducing high levels of labour market informality, through the easing of labour market rigidities, would improve incentives for workers to join the social security system,” the survey concludes.

Indonesia country focus: Macro outlook

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