Indonesia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diverse natural resources (agriculture, energy, mining)
- Low labor costs and demographic dividend
- Growing tourism industry (10.3% of GDP)
- Huge internal market
- Sovereign bonds rated “Investment Grade” by the three main rating agencies
- Exchange rate flexibility
- Large infrastructure investment gap / low fiscal revenues (15% of GDP)
- Exposure to shifts in Chinese demand
- Market fragmentation: extensive archipelago with numerous islands and ethnic diversity that potentially leads to unrest (Papua)
- Highly exposed to natural disasters (volcanic eruptions, hurricanes, and earthquakes)
- Persistent corruption and lack of transparency
A mild recovery as the pandemic persists
Growth is expected to recover in 2021, albeit weakly, as the spread of the COVID-19 outbreak lingers and has yet to be contained at the time of writing. This would continue to exacerbate downside pressures on the key growth drivers. Domestic consumption (55% of GDP) has been hit by the pandemic: first, through containment measures that urged the population to stay at home (particularly in cities), and second, with a longer-term impact through a rise in unemployment, as according to the Planning Minister, the unemployment rate could reach 7.7%-9.1% in 2021. As such, the latter would dampen any strong rebound in domestic consumption. Inflation would continue to remain under the Bank Indonesia (BI) 2%-4% target range due to subdued domestic consumption. This would compel BI to remain on an easing path in order to support growth. In 2020, at the time of writing, BI has slashed the policy interest rate four times by 25 bps (100 bps in total) to 4%. The tourism sector, another key driver (10.3% of GDP), should remain sluggish through 2021. While the government is considering the reopening of international borders, despite struggling with a high number of COVID-19 cases, a time frame for a decision has not been set up so far. Even if it does, some requirements should be expected upon arrival (testing, quarantine measures), which might discourage some visitors. Investments (32% of GDP), on the other hand, should bounce back in 2021 and drive the economic recovery, thanks to structural changes made in 2020. Indeed, the government passed the Omnibus law – a part of Jokowi’s cornerstone policies in his second mandate - that includes deregulation, changes to foreign investment rules, and labor reforms. Exports of manufactured goods and commodities (23.4% of GDP) are expected to recover, supported by the economic recovery in China, one of the major trading partners.
Budget deficit set to narrow, partly financed by the central bank
The budget deficit could narrow slightly, as revenues would gradually recover after being hit by containment measures in 2020, although the pace of the recovery would be slower than government spending. Furthermore, the low existing revenue base would add further challenges in financing the expenditures. The parliament agreed to suspend the budget ceiling of 3% of GDP until 2023 and to expand the 2021 budget deficit to 5.7% of GDP (compared to 6.3% of GDP in 2020) in order to support the recovery. In response to this, as “burden-sharing” (an agreement with the central bank that was introduced in 2020, the government might continue to seek BI’s support in financing the budget deficit through direct bond purchases until 2022 if economic growth does not reach the target of 4.5-5.5% in 2021. Moreover, a bill proposed in September 2020 that aims to reform the central bank by adding ministers to its board, with the right to vote during policy meetings, might raise – if passed next year - further concerns among investors regarding BI’s independence.
The current account is set to remain in deficit, which will widen in 2021, as imports should increase from 2020 when containment measures disrupted supply chains and forced households to delay some purchases. Exports, on the other hand, although supported by the recovery in China, should increase at a slower rate, as oil prices should remain subdued and demand from other key partners, such as the U.S. (11.1% total exports) and the EU (10%), should remain sluggish considering their lockdown measures. FDI inflows might gradually recover thanks to the Omnibus law, which would adequately finance the current account deficit. Foreign exchange reserves should remain adequate, standing at 11.0 months of imports as of September 2020.
Pushing the reforms agenda through a large coalition
President Jokowi was re-elected for a second five-year mandate in April 2019. His legislative coalition – the Indonesian Democratic Party of Struggle (PDIP) - received strong support and controls nearly 70% of the lower house (Dewan Perwakilan Rakyat), which could help to push further his reform agenda that includes two major projects: the relocation of the capital to the province of East Kalimantan and the Omnibus bill. The latter was passed and signed in October 2020 and could reform labor, tax, and other major laws in order to cut red tape and spur investments into a post-pandemic economy. It received much disapproval from workers and labor unions, who protested and claimed that these would reduce workers’ rights at a time when the unemployment rate is increasing. On the external front, Indonesia’s stance towards China on the South China Sea should continue to harden, as Beijing reiterated claims of historic rights on areas that overlap Indonesia’s exclusive economic zone.