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As a member of the “fragile five”, Indonesia should have been hit hard by the turmoil that has embraced global financial markets this year. However, it has performed relatively well in comparison to other EMs. The reasons for this outperformance are not immediately apparent—activity indicators are mixed and the trade balance has fallen into deficit. Nonetheless, markets seem to have turned more positive on Indonesia as a result of higher government spending and investment, easier monetary policy and central bank measures to support the currency. Indonesia may have reached a turning point that could reverse the growth slowdown.

Indonesia has been a prime example of recent emerging market (EM) strife (see our previous commentary, Indonesia between the Chinese rock and the Fed’s hard place): high levels of US dollar debt leave it exposed to tighter US monetary policy; dependency on China leaves it exposed to the slowdown there; and, as a commodity exporter, it is exposed to the ongoing rout in commodity prices. In addition, underinvestment has led to the build-up of supply bottlenecks in the economy and a loss of competitiveness. As a result, the Indonesian Rupiah (IDR) weakened 51% from mid-2013, when the Fed announced the tapering of its quantitative easing programme, until October 2015. This pushed up inflation and forced Bank Indonesia to increase interest rates. The bottom line has been a growth slowdown to levels well below potential of over 6%.

Most recent indicators show little sign of a turnaround. Real GDP growth was flat at 4.7% in Q3 2015 and other activity indicators still point to a slowdown. Manufacturing PMIs for Q4 were all below 50, suggesting the sector is contracting. Motor vehicle sales, an important indicator of domestic demand, are still falling (down 7.0% year on year in December). Furthermore, the current account continues to display weakness, with a deficit in Q3 2015 (1.9% of GDP) and trade deficits reported in November and December, a reversal from consistent surpluses earlier in the year.

Indonesia real GDP growth



Indonesia real GDP growth


Sources: Statistics Indonesia and QNB Economics

First, government spending has picked up, particularly investment spending, which was 45% higher than in 2014. Investment spending should be a key driver of growth in Indonesia as it should boost demand in the short term and tackle the longer term problem of reducing supply bottlenecks.

Second, lower oil prices, a sharp slowdown in inflation (down to 3.3% year on year in December from 7.3% in July) and relative stability of the currency, gave Bank Indonesia room to cut interest rates by 25 basis points to 7.25% on 14th January, with lower inflation and more cuts expected. This should also support growth going forward.

Third, in response to another round of currency weakness in August and September, Bank Indonesia introduced measures to stabilise the currency, including foreign exchange interventions in the forward market as well as tighter regulation of this market. Since the end of September, the currency has recovered, strengthening 5%. Despite interventions, Bank Indonesia has still managed to build foreign exchange reserves, which rose from USD100bn in November to USD106bn in December. This suggests that the trade deficit is being offset by capital inflows, with investors encouraged by the improving outlook for fiscal and monetary policy. The government successfully issued USD3.5bn of bonds in early December at a 10-year yield of 4.8% to help finance the 2016 budget, which would have contributed to capital inflows.

The improvement in the economic outlook has been reflected in financial markets. Having been a focus of investor concerns about EMs, Indonesia has outperformed during the recent global market turmoil. While EM stockmarkets fell 6.5% in January, the Jakarta stock exchange is up 0.5%. While EM currencies have fallen 1.7%, the IDR has strengthened 0.1%.

In conclusion, a number of recent developments do look positive for the economy. The outperformance of Indonesia’s financial markets may be signalling that the economy has reached a turning point and we could begin to see a pickup in GDP growth during 2016. We, therefore, stand by the forecast in our September Economic Insight report for real GDP growth of 5.0% in 2016.

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