Year of uncertainty for Indonesia's economy

This year is likely to be a challenging one for the Indonesian economy.

As the government of President Joko Widodo enters its third year in office, Indonesia will conduct direct elections next month in 101 regions, from provincial to district and municipality levels.

Already, political tension has been on the rise since September last year in relation to the election of the Jakarta governor - and that dynamic is expected to intensify. Economic stability will depend on how well the government manages the political situation, as well as threats to internal security from terrorism and to national unity from grassroots conflict.

Externally, Indonesia faces global uncertainties, especially in relation to the direction of United States economic policy under President-elect Donald Trump.

There is rising anxiety over Mr Trump's planned protectionist policy, which could hurt Indonesia's global trade either directly or indirectly. The US is Indonesia's biggest export destination, accounting for more than 12 per cent of total exports.

Indonesia's other major economic partners - China, Japan, the European Union and Singapore, all big sources of foreign investment - are also experiencing weak growth amid declining global trade. That could affect investment levels.

Indonesia's government has downgraded its gross domestic product (GDP) growth forecast for this year to 5.1 per cent.

To boost growth and maintain stability, Indonesia must balance its fiscal expansionary policy and monetary policy. PHOTO: REUTERS

Traditionally, the economy relies on domestic consumption and government spending. which together contribute almost 70 per cent to overall GDP. Both are currently stagnating.

The government has tried to boost consumer spending by easing the loan-to-value requirements for housing and automotive loans. However, data from Bank Indonesia showed that credit growth remained weak and stood at only 8.5 per cent year-on-year last November, lower than the 9.8 per cent growth the year before.

Initially, Bank Indonesia targeted 12 to 14 per cent credit growth, but economic conditions did not pick up as expected. Lower corporate and consumer credit growth signals slower investment and private consumption. According to Bank Indonesia's consumer survey, conducted last September, households remain uncertain about the economy and are holding back spending.

As for government spending, there may be further cuts in this year's budgets in anticipation of tax revenue shortfalls, given sluggish business expansion and consumer spending.

The tax amnesty programme will have a positive but limited impact on state revenue. The nine-month programme launched last July will end in March this year.

It had a good start but now is stagnating as the government turns its focus to target small and medium-sized enterprises (SMEs).

According to data from the tax office, SMEs contributed less than 5 per cent of the total amount of penalty or redemption payments during the first and second phases of the tax amnesty programme. It remains to be seen how the tax officers can reach out to 60.7 million SMEs across the archipelago, of which around 90 per cent are micro-businesses.

To boost growth and maintain economic stability, the Indonesian government must find the right balance between its fiscal expansionary policy and monetary policy. Cuts to Bank Indonesia's key interest rate to boost credit growth will not work due to the banks' reluctance to cut their lending rate. With the US Federal Reserve's raising of its policy rate last December and plans for another three rate increases this year, there is a risk of sudden capital outflows from emerging markets - including Indonesia - to the US.

Given this, Bank Indonesia is likely to maintain the benchmark interest rate at 4.75 per cent and continue its macro-prudential and stabilisation policy to manage volatility in the financial market.

There is economic merit in forging closer ties with China but here, too, the government in Jakarta has to manage public sentiment, which in some quarters remains critical of such ties. One area that needs improvement is the transparency of economic deals with China.

Yet there remain ample opportunities for strong growth in Indonesia given continued interest from foreign investors. Data from the Investment Coordinating Board shows a positive trend since 2015.

The government's moves to improve legal certainty and promote law enforcement are another reason for optimism. If it is able to deliver clear, comprehensive and consistent policies to stimulate economic activity, GDP growth may be stronger than the current target of 5.1 per cent.

If Indonesia can deliver strong growth, that will be an important boost to regional growth.

•The writer is a fellow at the ISEAS - Yusof Ishak Institute. S.E.A. View is a weekly column on South-east Asian affairs.

A version of this article appeared in the print edition of The Straits Times on January 05, 2017, with the headline 'Year of uncertainty for Indonesia's economy'. Subscribe