Indonesia’s robust economy continues to grow

Indonesia has proved to be less exposed to the global recession than many of its neighbours, and its economy expanded by 4.2% year on year in the first half of 2009. As a result, the Economist Intelligence Unit has revised up its forecast for real GDP growth to 4.1% (from 2.6% in our previous forecast) in 2009 and 4.4% (from 3.4% previously) in 2010.

The government’s US$7.1bn stimulus package for 2009, which includes cash transfers and higher salaries for civil servants, is supporting household expenditure. So are lower prices for food and fuel, which have provided a boost to personal disposable income.

However, we forecast that fixed investment will expand by only 0.5% this year, as domestic firms will experience difficulty in obtaining capital. Before the onset of the global financial crisis, domestic non-financial corporations obtained almost 50% of their financing from abroad. The Western investors that provided much of this cash have since scrambled to sell assets to meet their own short-term liabilities, which have become difficult to roll over. As a result, many investment plans in Indonesia are being postponed or dropped. Moreover, weak overseas demand will continue to prompt companies in the export sector to reduce investment. Although firms have so far not moved to lay off employees in large numbers, possibly because of the high severance costs that they must pay to sacked workers, we expect the unemployment rate to rise in response to the contraction in investment.

Although exporters will struggle amid economic weakness in 2009, imports are also likely to decline significantly. We therefore expect the foreign balance to continue to make a positive contribution to growth. Indeed, this contribution, at 1.2 percentage points, will be double that in 2007 and 2008.

There are still downside risks to our forecast. The international financial crisis could deepen, with a more damaging impact on global economic growth and capital inflows to Indonesia than we currently expect. The rupiah’s exchange rate is also important to the health of the Indonesian economy. Although the currency has appreciated since mid-March, renewed weakness is possible, and the effect of a collapse in the value of the rupiah (not our central forecast) would be to lower the spending power of most Indonesians. A weaker rupiah would also make it more difficult for local corporations to meet their external debt obligations, raising the number of bankruptcies.

In addition, political risks exist: if deteriorating economic conditions spark social unrest, investment growth could be even more sluggish than currently forecast as investors lose confidence in the country. That said, the outlook remains broadly encouraging. The convincing re-election of the president, Susilo Bambang Yudhoyono, is likely to boost political stability and will give the new administration a strong mandate to pursue economic reforms—even though many of these will have to wait until the worst of the global economic downturn has passed. There are also signs that the rate of contraction in the global economy has slowed in recent months, while conditions in global financial markets have also improved. A stronger recovery in the global economy than we currently forecast would enable Indonesia’s economy to grow at a faster rate.

Source: The Economist

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