Indonesia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diverse natural resources (agriculture, energy, mining)
- Low labor costs and demographic dividend
- Growing tourism industry (5.8% 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 potentially leading to unrest (Papua)
- Persistent corruption and lack of transparency
Steady growth despite external headwinds
Growth is facing external headwinds but will remain strong in 2020. GDP growth slowed to 5.0% year-on-year in the third quarter of 2019, missing the official 5.4% growth target. Consumption (55% of GDP and the main growth driver) is benefitting from population growth, urbanization and a rise in per capita GDP, interconnected factors that are leading to a growing middle class. Inflation remained below Bank Indonesia (BI)’s target range (4±1%) in 2019, as food price increases were muted and oil prices were lower, enabling BI to cut the policy rate interest rate by 25 basis points to 5.0% in October. This rate cut could provide additional support to consumption and sluggish investment, which has been deterred by high interest rates and worsening investor sentiment because of global protectionism and slower demand from China. Investment (32% of GDP) should nonetheless contribute to growth thanks to the government support through the infrastructure development program launched in 2016. The government budgeted USD 30.2 billion (423.3 trillion rupiah) for infrastructure investments in 2020, 2% up from last year. However, this will not be enough to plug the infrastructure gap, President Joko Widodo (Jokowi) will have to implement structural reforms to boost foreign direct investment (FDI). Indonesia jumped 33 places to 73rd in the Ease of Doing Business Index in 2020 thanks to reforms. Nevertheless, reforms are ongoing and some projects remain stalled due to inadequate financing. Coal and mineral mining is benefitting from sustained investments, while manufacturing is expected to expand, albeit less vigorously than in previous years due to weaker Chinese demand and other external headwinds. Exports (23.4% of GDP) of manufactured goods and commodities (oil and gas, palm oil, copra, lignite and copper) are set to decline, while imports will continue to grow due to policy stimulus, weakening the contribution of net exports. The tourism sector will continue to underperform due to the lack of infrastructure in most regions.
Budget deficit on a tight rope with external pressure on current account
The parliament passed a USD 180 billion budget for 2020, along with a 1.8% GDP fiscal deficit. This aims to address domestic issues while anticipating global economic uncertainties. The budget is set to improve domestic environment through investments in infrastructure and human resources, notably in education and villages’ infrastructure. That said, the budget includes tax cuts (income tax and VAT) to boost investment, which raises challenges in tax revenues. Considering tax collections have been sluggish due to weaker company profits, the government may struggle to maintain the budget deficit under control. While the constitutional limit ensures that public debt levels remain low, pressures might emerge if a return to monetary tightening in the US reignites capital outflows, as foreigners own a large proportion of the short-term external debt.
The current account will remain in deficit due to ongoing trade tensions between the US and China. Exports are set to remain sluggish, particularly in commodities (energy and palm oil), as prices remain subdued. Meanwhile, import growth will grow supported by demand, linked to the public investment program. The government is likely to resort to import control measures (import permits, centralisation and tariffs) in case the deficit widens substantially. Trade in goods and services balance is expected to remain in small deficit, though. The current account deficit is mainly driven by the income account due to debt interest payments and the repatriation of dividends. However, the current account deficit is adequately financed by FDI inflows and portfolio investments. On the positive front, portfolio capital inflows should continue to stay throughout 2020, as pressures on the rupiah appear to have eased since the Fed took on a more dovish stance in 2019. Foreign reserves remain at an adequate level, covering 5.8 months of imports.
Seeking political stability through a large coalition
President Jokowi was elected for a second five-year term in April 2019, capitalizing on his track record on reforms despite missing the growth target of 7%. With a focus on domestic issues during his second-term, he reaffirmed the reform agenda, particularly across labor, healthcare and infrastructure to lure foreign investments. That said, his victory was contested by Prabowo’s opposition camp, which resulted in violent protests. Considering Jokowi is seeking to push forward the reform agenda with ease, he formed a broad coalition with Prabowo and key opponents in October 2019, hoping it would weaken critics over the government. This might pave the way for more political stability and help to mitigate risks of political Islam, as it would conciliate Jokowi’s pluralism and Islamist groups backing Prabowo.