Indonesia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diverse natural resources (agriculture, energy, mining)
- Highly competitive thanks to low labor costs
- Growing tourism industry (5.8% of GDP)
- Huge internal market
- Strong banking sector
- Sovereign bonds rated “Investment Grade” by the three main rating agencies
- Large infrastructure investment gap
- Exports of commodities dependent on Chinese demand
- Market fragmentation: extensive archipelago with numerous islands and diverse ethnic groups
- High unemployment and poverty rates sharpening inter-ethnic tensions
- Persistent corruption and lack of transparency
Growth Buoyed by Internal Demand
Growth will remain strong in 2019, driven mostly by private consumption (56% of GDP). Consumption is fostered by population growth, ever growing urbanization, and a rise in per capita GDP, enabling the emergence of a middle class. In 2019, the adverse effects of high inflation on consumption should be mitigated by measures to keep food and energy prices in check, and public spending associated with the election campaigns. Inflation growth stems from higher oil prices, a weaker rupiah, and impacts from natural disasters. It is nonetheless expected to remain within Bank Indonesia (BI)’s target range (4±1%). Private investment will be deterred by rising interest rates combined with worsening investor sentiment, stemming from global protectionism and slower demand from China. Investment growth (32% of GDP) shall nonetheless hold steady thanks to government support for infrastructure projects. Through the infrastructure development program launched by President Joko Widowo’s government in 2016 (225 priority infrastructure projects), projects are financed both publically and via PPP, attracting foreign investors. Moreover, the President’s reform agenda successfully improved the still poor business climate, with Indonesia jumping 33 places in the Doing Business Index since 2016 to reach the 73rd rank in 2019. However, reforms are not complete and some projects have struggled to secure financing (only 26 of 225 were completed as of March 2018 and half of the required USD 327 billion had been collected). The mining sector will contribute positively to growth thanks to the pick-up in crude oil prices after several years of stalling performance. Manufacturing will continue to grow steadily, albeit less vigorously due to dimmer Chinese and global demand. Moreover, exports (23.4% of GDP) of manufactured goods and commodities (oil and gas, palm oil, copra, lignite, and copper) are dynamic, but they are offset by a faster increase in imports. The tourism sector will continue to underperform due to the lack of infrastructure in most regions of the country.
Budget Balance Under Control, Moderate Pressure on Current Account, and Capital Outflow Risk
The budget deficit is constrained by a constitutional limit of 3%. The government has embarked on reforms meant to increase tax collection, repatriate capital kept in foreign accounts (including tax havens), and control expenditure. These will compensate the increase in spending associated with the coming elections, with the control of fuel prices, and with reconstruction efforts in the aftermath of the 2018 tsunami – although spending cuts could be announced after the elections in April 2019. Curtailing of the deficit will maintain public debt at low levels. Nevertheless, the government may encounter financing challenges in a context of global monetary policy normalization associated with higher interest rates and lower liquidity.
The current account deficit will remain high. The higher oil bill will not be compensated by the increased price of exported crude oil and gas. In addition, capital goods import growth, linked to the government’s investment program, will be not compensated by the steady growth of merchandise exports. To mitigate the trade deficit, the government will continue to curb import growth via import permits or import centralization. All in all, the main cause of the current account deficit will continue to lie in the income account because of debt interest payments and the repatriation of dividends. In addition, the context of global monetary tightening induces risk of outflows, as, over the past few years, the current account deficit was financed by FDI inflows and portfolio investments, and public debt was largely funded by international investors. Moreover, the deterioration of the external position further strengthens depreciation pressures on the rupiah. In this context, and although inflation is contained, BI will continue to hike interest rates in 2019 to defend the currency and limit outflows. Although foreign reserves remain at an adequate level, they will be reduced by BI intervention on forex markets.
Popular Joko Widowo on Track to Secure the Presidential Election
In power since 2014, Joko “Jokowi” Widowo enjoys great popularity thanks to the economic progress achieved, his extensive infrastructure program, and his reform agenda. Polls present him as frontrunner for the April 2019presidential elections. For the first time, these elections are concurrent with those of Parliament, which should ensure more collaboration in reforms for the next mandate. All the same, Mr Jokowi will have to contend with a growingly polarised electorate. A climate of civil insecurity, following several suicide bomb attacks in 2018, is certainly not helping. Meanwhile, measures to keep food prices in check are not resonating well with the rural population, many of which are dependent on revenues from the sale of agricultural crops. This part of the electorate is in fact already tilting towards the opposition candidate, Prabowo Subianto (Gerindra Party), a businessman and former commander of Indonesia Special Forces. Previously a contender in 2014, he is supported by ultra-conservative Muslims.