Analysis: Indonesia: Year in review

Josh Franken, Oxford Business Group | Mon, 12/27/2010 11:00 AM |
As the year comes to a close, Indonesia can look back on 2010 with no small degree of satisfaction. The economy is performing well, foreign investment is on the rise and there is continued political stability. However, concerns linger over rising inflation and the sustainability of the current growth cycle.

Late into the last month of 2010, all indicators were that the targets set by the government for economic development would be met, with GDP on track to expand by 6 percent or more.

Recognition of this growth, and the underlying strength of the economy came late in the year, with Moody’s Investors Service announcing it was considering upgrading Indonesia’s credit ratings, having already issued a positive outlook note for the government’s Ba2 foreign and local-currency bond ratings in June. A further ratings hike would take Indonesia close to being an investment grade economy, reflecting the health of country’s macroeconomic balances and its ability to withstand localized or international shocks.

Though nowhere near to being classified as a shock, Indonesia’s creeping inflation remained an unwelcome reality in 2010. According to figures issued by Bank Indonesia in late December, year end inflation could reach 6.5 percent, far higher than the 2.78 percent recorded in 2009. Having climbed steadily throughout the year, the consumer prices rises reached 6.33 percent as of the end of November, prompting central bank deputy governor Hartadi A Sarwono to say further expected increases in the cost of staples such as palm oil and rice could push inflation higher still.

Though core inflation, which excludes items such as food, stood at 4.31 percent at the end of November, rising consumer demand in a heating economy could see this measure spike, which in turn could force Bank Indonesia’s hand on interest rates. Hartadi told journalists on Dec. 22 that if core inflation topped 5 percent the central bank would have no alternative but to raise rates.

Should Bank Indonesia move, it will be the first time since August 2009 that there has been any change from the 6.5 percent the central bank set as its prime lending rate, a record low for the country.

While Bank Indonesia has kept its own rates at record lows, not all the benefits of this policy have been passed on to the economy, with banks holding their lending rates far above those of the central bank. As the year closed, most lenders were charging between 13 and 14 percent, a rate many analysts felt was up to 4 percent above what would best serve to maintain and indeed increase economic growth in 2011 and beyond.

Up to the end of September, the flow of capital into the economy showed no sign of abating, with foreign direct investment totaling US$6.7 billion, well up on the $1.9 billion for the first nine months of 2009. Meanwhile, the tide of portfolio capital hit $14.45 billion, more than $4 billion above the level for the same period last year.

Most of that $14.4 billion was directed towards either government bonds, which attracted some $10 billion, or to Bank Indonesia’s SBI debt papers, which drew a further $2.37 billion, the balance going into shares on the stock exchange.

That inward flow of investment, combined with the exchange’s appeal to locals, saw the market’s main index up by some 40 percent as the year closed, making the Indonesian exchange one of the most active and best performers worldwide in 2010. Though some experts forecast there will be a slowing of activity and earnings next year, the projection of a further 15 percent or more increase is still a strong one, and well over the 6.3 percent growth forecast for GDP as a whole.

Looking ahead, Indonesia will face a number of challenges going into the new year, with inflation being one of the main concerns. Though the government agreed in mid December to defer reductions on fuel subsidies, price support for petrol will be scaled back starting in March, a move that will both ease pressure on the budget but could also push up inflation. Combined with the ever present threat that climatic conditions could again hit crops, as happened in mid 2010, and global pressures on commodities could increase, there is a degree of uncertainty over next year’s inflation forecasts.

Another threat to Indonesia is the possibility of the global economy, or at least the economies of some of Jakarta’s larger trading partners, slipping back into recession or even just slowing down a gear. With the US economy still recovering from the 2008 economic meltdown, and the recent uncertainty over the fiscal health of the European periphery there is the risk of a further bout of instability. While Indonesia was able to comfortably ride out the last round of stormy economic weather, it will be hoping its there aren’t too many clouds on the international horizon in 2011.