Indonesia Rising

After the trauma of the 1997-98 Asian financial crisis, Indonesia has come roaring back, growth averaging over 6% in recent years even as the world struggles with the first financial crisis of the 21st century, and the deepest since the 1930s.

If the developed world remains wracked by ‘slowing pains’, many of Indonesia’s economic challenges can be classed as ‘growing pains’.

Creaking infrastructure, for instance, results from under-investment, but the problem is rendered far more acute by the capacity strains that come with break-kneck economic growth. Roads may be of insufficient number and quality, but the trebling of road traffic over the past decade is the real source of bottlenecks.

Policymakers aim to help the economy kick on to reach its full potential, with growth in the 7-8% range which would see Indonesia become one of the world’s top ten economies by 2025.

While Indonesia’s large domestic market and burgeoning middle class shield the economy to a certain extent from ongoing economic weakness and uncertainty in the developed world, so-called ‘decoupling’ has been proven a mirage for emerging markets. Indonesia is no different. The combination of slowing growth in China and stagnation in developed export markets are two challenges on the immediate horizon.

Economic transition in China, however, brings its own opportunities. Increasingly, rising wages in China mean Indonesia is being sought out as a low cost production hub. Increased domestic demand in China means a massive, growing export market on Indonesia’s doorstep.

During my time working with the World Bank in Indonesia, I made a modest contribution to the latest Indonesian Economic Quarterly.

These are its top five take-aways:

  1. Growth is expected to remain steady, at or above 6% this year and next, but risks are skewed to the downside due to ongoing weakness and uncertainty in the global macro environment. If the global economy were to see a re-run of 2009, growth could fall below 4% in 2013.
  2. Falling commodity prices over the past year have hit Indonesian exports, contributing to what will in 2012 be the country’s first current account deficit in a decade. Modest current account deficits are set to persist given strong internal demand and weak external demand.
  3. Running a current account deficit is perfectly normal for a booming economy with many viable investment opportunities and insufficient domestic savings. Avoiding vulnerability to a ‘sudden stop’ in capital flows means encouraging a continued shift in the balance of inflows from portfolio and short-term debt financing towards more sticky and sustainable Foreign Direct Investment. In turn, this requires a hospitable business environment, notably reduced political instability and policy volatility.
  4. Having fallen rapidly over the past decade, to 12% by March 2012, the pace of reduction in the poverty rate has begun to slow. Moreover, given the number of people just above the poverty line, a severe economic slowdown could see the rate spike higher.
  5. Efforts have been made by government to increase crisis-preparedness, including improved capacity to rapidly adjust public spending, but more work is required to put measures such as bank resolution on a firm legal footing.
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