Indonesia: Economy

Indonesia has a market-based economy in which the government plays a significant role. There are 141 state-owned enterprises, and the government administers prices on several basic goods, including fuel, rice, and electricity.

In the mid-1980s, the government began eliminating regulatory obstacles to economic activity. The steps were aimed primarily at the external and financial sectors and were designed to stimulate employment and growth in the non-oil export sector. Annual real gross domestic product (GDP) growth averaged nearly 7% from 1987-97 and most analysts recognized Indonesia as a newly industrializing economy and emerging major market. The Asian financial crisis of 1997 altered the region's economic landscape. With the depreciation of the Thai currency, the foreign investment community quickly reevaluated its investments in Asia. Foreign investors dumped assets and investments in Asia, leaving Indonesia the most affected in the region. In 1998, Indonesia experienced a negative GDP growth of 13.1% and unemployment rose to 15%-20%. In the aftermath of the 1997-98 financial crisis, the government took custody of a significant portion of private sector assets via debt restructuring, but subsequently sold most of these assets, averaging a 29% return. Indonesia has since recovered, albeit more slowly than some of its neighbors, by recapitalizing its banking sector, improving oversight of capital markets, and taking steps to stimulate growth and investment, particularly in infrastructure. GDP growth steadily rose in the following decade, achieving real growth of 6.3% in 2007 and 6.1% growth in 2008. Although growth slowed to 4.5% in 2009 given reduced global demand, Indonesia was the third-fastest growing G-20 member, trailing only China and India. Growth rebounded in 2010 to 6.1% and is forecast to have reached 6.2%-6.5% in 2011. Poverty and unemployment have also declined despite the global financial crisis, with the poverty rate falling to 12,5% (March 2011) from 13.3% a year earlier and the unemployment rate falling to 6.6% (February 2011) from 6.8% a year earlier.

Indonesia’s improving growth prospects and sound macroeconomic policy have many analysts suggesting that it will become the newest member of the “BRIC” grouping of leading emerging markets. In December 2011, Fitch Ratings upgraded Indonesia’s sovereign debt rating to investment grade. A similar upgrade to investment grade is expected from Standard and Poor’s and Moody’s.

In reaction to global financial turmoil and economic slowdown in late 2008, the government moved quickly to improve liquidity, secure alternative financing to fund an expansionary budget and secure passage of a fiscal stimulus program worth more than $6 billion. Key actions to stabilize financial markets included increasing the deposit insurance guarantee twentyfold, to IDR 2 billion (about U.S. $235,000); reducing bank reserve requirements; and introducing new foreign exchange regulations requiring documentation for foreign exchange purchases exceeding U.S. $100,000/month. As a G-20 member, Indonesia has taken an active role in the G-20 coordinated response to the global economic crisis.

Economic Policy:                                                                                                                                                                                          After he took office on October 20, 2004, President Yudhoyono moved quickly to implement a "pro-growth, pro-poor, pro-employment" economic program, which he has continued in his second term. The State Ministry of National Development Planning (BAPPENAS) released a Medium-Term Development Plan for 2010-2014 focused on development of a “prosperous, democratic and just” Indonesia. The Medium-Term Development Plan targets average economic growth of 6.3%-6.8% for the period, reaching 7% or above by 2014, unemployment of 5%-6% by the end of 2014, and a poverty rate of 8%-10% by the end of 2014.                                                                                                                                                                

President Yudhoyono’s economic team in his second administration is led by Coordinating Minister for Economic Affairs Hatta Rajasa. Sri Mulyani Indrawati continued as Finance Minister until May 2010, when she resigned to take a senior position at the World Bank. She was succeeded by Agus Martowardojo, a well-respected banker who had led Indonesia’s largest state-owned bank. In July 2010, Indonesia’s DPR Commission XI approved the appointment of Darmin Nasution as Governor of Bank Indonesia, following a 14-month vacancy of the position after former Governor Boediono stepped down to become Yudhoyono’s running mate. In May 2010, President Yudhoyono established a National Economic Committee to provide strategic recommendations to accelerate national economic development and a National Innovation Committee to provide input and recommendations to increase national productivity, create a culture of innovation, and speed up economic growth.

In May 2011, President Susilo Bambang Yudhoyono launched the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI), to increase infrastructure and investment spending and to provide a roadmap for Indonesia to move up the value-chain and increase the level of innovation. The plan outlines Rp 4,000 trillion ($ 468.5 billion) in potential infrastructure projects in multiple sectors including hydroelectric and solar power, palm oil, new roads including toll motorways, mining , expansion of broadband internet, and nickel, cobalt and aluminum factories.

Indonesia's overall macroeconomic picture is stable. By 2004, real GDP per capita returned to pre-financial crisis levels and income levels are rising. In 2010, domestic consumption continued to account for the largest portion of GDP, at 56.7%, followed by investment at 32.2%, government consumption at 9.1%, and net exports at 1.6%. Domestic consumption has been the main growth driver from the expenditure side during the last half century while government consumption has hovered between 5-10% of GDP for most of that time.

In 2010, Indonesia has seen an increase in manufacturing output and exports, with relatively cheap labor and a complementary large and growing domestic market. Exports of natural resources, such as oil and gas, coal and crude palm oil (CPO) have made up around 50% of Indonesia’s exports and have been key drivers of growth. With the share of total exports to fast-growing emerging markets increasing and demand for commodities likely sustainable, export growth is likely to remain buoyant. In contrast, imports may grow even faster with infrastructure development andstrong domestic demand growth. ,. Net exports will likely continue to diminish and, with higher net income outflows (the counterpart to large portfolio inflows), it is expected the current account will eventually shift into deficit in the medium term.

Following a significant run-up in global energy prices in 2007-2008, the Indonesian Government raised fuel prices by an average of 29% on May 24, 2008 in an effort to reduce its fuel subsidy burden. Energy subsidies had been allocated Rp 223 trillion ($23 billion) in 2008, or 5.6% of GDP. The fuel price hikes, along with rising food prices, led consumer price inflation to a peak of 12.1% in September 2008. To help its citizens cope with higher fuel and food prices, the Indonesian Government implemented a direct cash compensation package for low-income families through February 2009 and an extra range of benefits including an expanded subsidized rice program and additional subsidies aimed at increasing food production. Citing high opportunity costs and poor targeting, the government has continued to signal its intent to reform subsidies. They plan to prohibit private cars from consuming subsidized fuels in Java and Bali beginning April 1, 2012. By 2015, the policy is expected to be implemented nationwide.

Banking Sector:                                                                                                                                                                                  Indonesia has 120 commercial banks (October 2011), of which 10 are majority foreign-owned and 28 are foreign joint venture banks while the number of bank branches has continuously increased from 6,397 in 2000 to 14,510 in 2011. The top 10 banks control about 62.4% of assets in the sector. Four state-owned banks (Bank Mandiri, BNI, BRI, BTN) control about 34.8% of assets (September 2011). The Indonesian central bank, Bank Indonesia (BI), announced plans in January 2005 to strengthen the banking sector by encouraging consolidation and improving prudential banking and supervision. BI hoped to encourage small banks with less than Rp 100 billion (about U.S. $11 million) in capital to either raise more capital or merge with healthier "anchor banks" before end-2010, announcing the criteria for anchor banks in July 2005. In October 2006, BI announced a single presence policy to further prompt consolidation. The policy stipulated that a single party could own a controlling interest in only one banking organization; exceptions would be granted in controlling two banks that do business under different principles, such as commercial and sharia, or one of which is a joint venture bank. Controlling interest is defined as 25% or more of total outstanding shares or having direct or indirect control of the institution.

BI has started to move toward Basel II standards in 2011, which focus on advancing other aspects of the Indonesian Banking Architecture (IBA) and has improved operations of its credit bureau to centralize data on borrowers. The IBA is a joint effort between BI, the Capital Market and Financial Institution Supervisory Board (BAPEPAM-LK), and the Ministry of Finance that was launched in 2004. A cornerstone program of the IBA is the structural reinforcement of the national banking system, aimed at building stronger capitalization for commercial banks to underpin its expansion and accelerate the required consolidation process among Indonesia’s 120+ banks. Another important banking sector reform was the decision to eliminate the blanket guarantee on bank third-party liabilities. BI and the Indonesian Government completed the process of replacing the blanket guarantee with a deposit insurance scheme run by the independent Indonesian Deposit Insurance Agency (also known by its Indonesian acronym, LPS) in March 2007. The removal of the blanket guarantee did not produce significant deposit outflows from or among Indonesian banks. Sharia banking has grown in Indonesia in recent years, but represented only 3.7% of the banking sector, about $14.4 billion in assets as of October 2011.

In October 2011, Indonesia has a new regulator to oversee a growing financial industry. The new regulator, Financial Services Supervisory Authority (OJK), will take over the supervision of banks, brokerages and insurance firms from the central bank (BI) and the capital market watchdog BAPEPAM-LK. By early 2013, OJK will have the power to supervise capital markets and non-banking institutions, while the oversight of commercial banks will start from 2014.

Exports and Trade:                                                                                                                                                                         Indonesia's exports were $158 billion in 2010, a rise of 35% from $116.5 billion in 2009. The largest export commodities for 2010 were oil and gas (17.8%), minerals (14.9%), textile and footwear (8.9%), crude palm oil (8.54%), electrical appliances (8.2%), and rubber products (4.7%). The top destinations for exports for 2010 were Japan (16.3%), China (11.6%), the U.S. (11.1%), Singapore (8.5%), and Korea (8.3%). Meanwhile, total imports in 2010 were $136 billion, up from $96.83 billion in 2009. Indonesia is currently our 28th-largest goods trading partner with $23.4 billion in total (two-way) goods trade during 2010. The U.S. trade deficit with Indonesia totaled $9.5 billion in 2010 ($6.9 billion in exports versus $16.5 billion in imports).

Oil and Minerals Sector:                                                                                                                                                                   Indonesia left the Organization of Petroleum Exporting Countries (OPEC) in 2008, as it had been a net petroleum importer since 2004. Crude and condensate output averaged 944,000 barrels per day (bpd) in 2010, down slightly from 948,000 in 2009. In 2010, the oil and gas sector is estimated to have contributed $23.3 billion to government revenues, or 20.9% of the total. U.S. companies have invested heavily in the petroleum sector. Indonesia ranked third in world liquefied natural gas (LNG) exports production in 2010. Indonesia's oil, oil products, and gasturned positive in 2009 with a $29.4 million surplus, but have been negative since with a 2010 oil and gas trade deficit of $627 million and a deficit of$602 million deficit Jan-Nov 2011.

Indonesia has a wide range of mineral deposits and production, including bauxite, silver, and tin, copper, nickel, gold, and coal. Although the coal sector was open to foreign investment in the 1990s through coal contracts of work, new investment was closed again after 2000. A new mining law, passed in December 2008, opened coal to foreign investment again, although it eliminated the difference between foreign and domestic ownership structures. Total coal production reached 255 million metric tons in 2010, including exports of 198 million tons. Two U.S. firms operate two copper/gold mines in Indonesia, with a Canadian and a U.K. firm holding significant investments in nickel and gold, respectively. Although coal production has increased dramatically over the past 10 years, the number of new metals mines has declined. This decline does not reflect Indonesia's mineral prospects, which are high; rather, the decline reflects earlier uncertainty over mining laws and regulations, low competitiveness in the tax and royalty system, and investor concerns over divestment policies and the sanctity of contracts.

In early 2010, the Government of Indonesia also formally decided to become a candidate country of the Extractive Industries Transparency Initiative (EITI), which will increase accountability and transparency in energy revenue transactions between the government and oil, gas, and mining firms.

Investment:                                                                                                                                                                                          President Yudhoyono and his economic ministers have stated repeatedly their intention to improve the climate for private sector investment to raise the level of GDP growth and reduce unemployment. However, in addition to general corruption and legal uncertainty, businesses have cited a number of specific factors that have reduced the competitiveness of Indonesia's investment climate, including: corrupt and inefficient customs services; non-transparent and arbitrary tax administration; inflexible labor markets that have reduced Indonesia's advantage in labor-intensive manufacturing; increasing infrastructure bottlenecks; and uncompetitive investment laws and regulations. In each of the past three years, the Government of Indonesia has announced a series of economic policy packages aimed at stimulating investment and infrastructure improvements and implementing regulatory reform. A new investment law was enacted in 2007, which contains provisions to restrict the share of foreign ownership in a range of industries. The 2010 iteration of the negative investment list includes long-awaited legal clarifications alongside limited liberalization. The clarifications include a continuous review of closed sectors for increased market access. The decree confirms that investment restrictions do not apply retroactively unless the new provisions are more beneficial to the investor. The changes also clarify that capital investments in publicly listed companies through the stock exchange are not subject to Indonesia's negative list unless an investor is buying a controlling interest.

In 2010, the Overseas Private Investment Corporation (OPIC) updated its 1967 investment support agreement between the United States and Indonesia by adding OPIC products such as direct loans, coinsurance, and reinsurance to the means of OPIC support which U.S. companies may use to invest in Indonesia. Over its 39-year history OPIC had committed more than $2.1 billion in financing and political risk insurance to 111 projects in Indonesia. Currently, OPIC is providing more than $75 million in support to seven projects in Indonesia in the energy, manufacturing, and services sectors and is also now supporting several new renewable resources/clean tech investment funds that are privately-managed and can look to invest in commercially-attractive projects in Indonesia.

On September 2, 2008, the DPR passed long-awaited tax reform legislation. The legislation reduced corporate and personal income tax rates as of January 1, 2009. Corporate income tax rates fell from 30% to 28% in 2009 and to 25% in 2010, with additional reductions for small and medium enterprises and publicly listed companies. The legislation raises the taxable income threshold for individuals, cuts the maximum personal income tax from 35% to 30%, and provides lower marginal personal income tax rates across four income categories. Taxes on dividends also fell from a maximum of 20% to a maximum of 10%. Long-planned labor reforms have been delayed.

The passage of a new copyright law in July 2002 and accompanying optical disc regulations in 2004 greatly strengthened Indonesia's intellectual property rights (IPR) regime. Despite the government's significantly expanded efforts to improve enforcement, IPR piracy remains a major concern to U.S. intellectual property holders and foreign investors, particularly in the high-technology sector. In March 2006, President Yudhoyono issued a decree establishing a National Task Force for IPR Violation Prevention. The IPR Task Force was intended to formulate national policy to prevent IPR violations and determine additional resources needed for prevention, as well as to help educate the public through various activities and improve bilateral, regional, and multilateral cooperation to prevent IPR violations. It has yet to fully realize these aims. In 2007, Indonesia was removed from the U.S. Trade Representative's "Priority Watch" list and placed on the "Watch" list. However, Indonesia was raised back to the Priority Watch List in 2009 due to an overall deterioration of the climate for IPR protection and enforcement and some concerns over market access barriers for IP products. There have not been signs of improvement in recent years. Amendments to the copyright and patent laws are scheduled to be discussed by Parliament in 2012.

Environment:                                                                                                                                                                                        President Yudhoyono's administration has significantly increased Indonesia's global profile on environmental issues, and U.S.-Indonesia cooperation on the environment has grown substantially. Indonesia is particularly vulnerable to the effects of climate change, which include rising sea levels and erosion of coastal areas, increased frequency and intensity of extreme weather events, species extinction, and the spread of vector-borne diseases. At the same time, Indonesia faces challenges in addressing the causes of climate change. Indonesia has the world's second-largest tropical forest and the fastest deforestation rate, making it the third-largest contributor of greenhouse gas emissions, behind China and the U.S. President Yudhoyono pledged at the 2009 G-20 in Pittsburgh to reduce Indonesia’s greenhouse gas emissions by up to 41% below business as usual by 2020, in addition to eliminating fossil fuel subsidies. Indonesia continues expanding its constructive engagement in Southeast Asia, within the G-20 and Major Economies Forum, and in other international bodies to encourage other developing countries to adopt and implement ambitious steps to reduce the impacts of global climate change. In June 2010, President Barack Obama pledged to support U.S.-Indonesia shared goals on climate change through a Science, Oceans, Land Use, Society and Innovation (SOLUSI) partnership and through the establishment of a climate change center. The United States is providing $6.9 million in support – with matching funds from Norway – for the new Indonesia Climate Change Center (ICCC), which will focus on mapping and monitoring of carbon-rich peat lands and tropical forests with expertise from the U.S. Forest Service, bringing the best available science and analysis to policy leaders on key strategies and decisions to mitigate and adapt to climate change.

In 2004, President Yudhoyono initiated a multi-agency drive against illegal logging that has significantly decreased illegal logging through stronger enforcement activities. The Department of Justice-sponsored Environmental Crimes Task Force supports this enforcement effort. The State Department and the U.S. Trade Representative negotiated with the Indonesian Ministries of Trade and Forestry the U.S. Government's first Memorandum of Understanding on Combating Illegal Logging and Associated Trade. Presidents George W. Bush and Yudhoyono announced the MOU during President Bush's November 2006 visit to Indonesia. Implementation of the MOU includes collaboration on sustainable forest management, improved law enforcement, and improved markets for legally harvested timber products. This effort will strengthen the enabling conditions for avoiding deforestation, specifically addressing the trade issues that are involved. The U.S. Government also contributed to the start of the Heart of Borneo conservation initiative to conserve a high-biodiversity, transboundary area that includes parts of Indonesia, Malaysia, and Brunei. The three countries launched the Heart of Borneo initiative in February 2007. In 2009, the Governments of Indonesia and the U.S. concluded a Tropical Forest Conservation Act (TFCA1) agreement, and in 2012 are expected to finalize a new TFCA2 agreement. The agreements reduce Indonesia's debt payments to the U.S. over the next 10 years; these funds will be redirected toward tropical forest conservation in Indonesia.

Through the recently signed Millennium Challenge Corporation (MCC) Compact for Indonesia, the Government of Indonesia will implement a Green Prosperity Project totaling $332.5 million to support environmentally sustainable economic growth through enhancing management of forests, peat lands, and other natural resources and deployment of renewable energy.

In June 2011, the U.S. Environmental Protection Agency (EPA) and Indonesia’s Ministry of Environment signed an MOU, expanding environmental cooperation and formalizing cooperation on the “Breathe Easy, Jakarta” initiative to improve air quality and protect public health.

Indonesia has the world’s greatest repository of marine biological resources and is one of the most important fisheries. It lies at the epicenter of the Coral Triangle, covering just 3 percent of the globe but containing more than half the world’s reefs and three-quarters of all known coral species. Fisheries generate some 20 percent of Indonesia’s GDP, and over 60 percent of the nation’s protein comes from the sea. The number of coastal fishers in Indonesia has increased by over 40 percent in the last 10 years.

President Yudhoyono called for a Coral Triangle Initiative (CTI) in August 2007. The Coral Triangle Initiative is a regional plan of action to enhance coral conservation, promote sustainable fisheries, and ensure food security in the face of climate change. In December 2007, the U.S. Government announced its support for the six CTI nations (Indonesia, Malaysia, Philippines, Timor-Leste, Papua New Guinea, and Solomon Islands), and to date the United States is the largest bilateral donor to the CTI. Indonesia hosted the first-ever World Oceans Conference in Manado, North Sulawesi, May 11-15, 2009. The World Oceans Conference was also the venue for the Coral Triangle Initiative Summit, at which leaders from the six CTI nations launched the CTI Regional Plan of Action.

U.S. support to Indonesia’s globally important marine resources includes USAID’s five year $35 million Marine Resources Program, partnerships on ocean research and exploration, and maritime law enforcement capacity-building.

From June to August 2010, the National Oceanic and Atmospheric Administration (NOAA) research vessel Okeanos Explorer and the Indonesian Baruna Jaya research fleet made a pioneering joint mission to the "Coral Triangle" in the Indo-Pacific region. NOAA works actively with Indonesian marine scientists on research and capacity-building efforts, including developing tsunami early detection systems, deploying ocean instruments that allow scientists to predict long-term climate change, exploring uncharted deepwater habitats, and anticipating and monitoring outbreaks of harmful toxins affecting our food sources. The United States and Indonesia are also working with private sector partners to develop sustainable alternative business models to improve food security and increase incomes in economically disadvantaged coastal communities.

Sources: