Indonesia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diverse natural resources (agriculture, energy, mining)
- Low labor costs and demographic dividend
- Growing tourism industry (6% of GDP in 2019)
- Huge domestic 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
Growth will accelerate, but downside risks related to the pandemic persist
Growth is set to accelerate in 2022 due to robust external and domestic demand. However, with a large part of the population still not fully vaccinated (60% in December), the economy remains vulnerable to potential future outbreaks. Delays in vaccine shipments under the COVAX scheme and reluctance among the population) is slowing down the vaccination drive. Domestic consumption (54% of GDP) is expected to recover, supported by improving labor market conditions while mobility restrictions gradually ease. They are extending relaxed rules for automotive and mortgage loans until the end-2022 should spur consumption. That said, an increase in the VAT under the 2022 budget will likely weigh on the recovery. Given higher domestic demand and commodity prices, consumer inflation should pick up but stick to Bank Indonesia’s (BI) 2-4% target range. Policy normalization in the U.S. will likely pressure BI to tighten the policy rate, which has stood at a record low of 3.50% since the beginning of 2021, to maintain sufficiently high positive yields on Indonesian assets to avert disorderly capital outflows. The tourism industry (6% of GDP in 2019 ) should remain weak due to border restrictions. While Bali, one of the popular destinations, reopened for vaccinated tourists from 19 countries, inbound travelers are still subject to a five-day quarantine and COVID-19 testing. The government is taking a relatively cautious approach as the country plans to host the G20 summit in Bali in November 2022. On the other hand, investment (33% of GDP) should rebound in 2022, supported by recent reforms to improve the business and investment climate. The government passed the Omnibus law, including deregulation, changes to foreign investment rules, and labor reforms. Exports of manufactured goods and commodities (23% of GDP) – coal, oil and gas, palm oil, gold, rubber, steel, and electronics - should continue to benefit from high commodity and intermediates prices, as well as the power crunch in China, in which the latter eased imports curbs to support its energy shortage.
Budget deficit set to narrow thanks to tax reforms
The budget deficit is set to narrow as the government seeks to return it below 3% of GDP by 2023 through tax reforms to consolidate public finances. The pandemic led the government to suspend the budget deficit ceiling to support recovery. The Harmonized Tax Law (HPP) implemented in Oct 2021 will help reduce the pandemic-induced tax fall and the fiscal deficit. This will mean increased taxes on the wealthy population and consumption through VAT, set to increase from 10% to 11% by April 2022. The tax reforms come at a time when the government seeks to reduce reliance on the central bank to finance its expenditures under the burden-sharing arrangement, which consists of bond purchases. The central bank will purchase up to USD 30 billion (3% of GDP) in 2021 and 2022. This arrangement has kept government interest costs low to finance pandemic relief measures but increased concerns over a risk of political interference in the monetary policy.
The trade balance will remain in surplus in 2022 due to robust export and high commodity prices. Still, it should narrow as imports are set to rebound after lifting containment measures that impeded domestic consumption in 2021. The surplus in merchandise trade will partly offset the services trade deficit, as international borders are likely to only partially open to tourists in 2022. FDI inflows might gradually recover thanks to the Omnibus law, which adequately finances the current account deficit. Foreign exchange reserves should therefore remain adequate, standing at eight months of imports (as of September 2021).
Large coalition facilitating reforms
President Jokowi was re‐elected for a second five‐year mandate in April 2019. His legislative and governmental coalition – centered around the Indonesian Democratic Party of Struggle (PDIP), gathers several parties and controls 81.9% (471 out of 575 seats) of the lower house. This could help to push his reform agenda further, including two major projects: the relocation of the capital to the province of East Kalimantan and the Omnibus bill. The government estimated its cost at USD 32 billion, of which a fifth would come from the state budget. The project was criticized when the country was recovering from the pandemic, which has depleted public finances. The Omnibus bill passed in October 2020 to cut red tape and spur investments was ruled “unconditionally unconstitutional” a year later. The government was given two years to amend it. On the external front, Indonesia’s stance towards China on the South China Sea should continue to firm up. Beijing reiterated historical rights claims on areas overlapping Indonesia’s exclusive economic zone.