Indonesia Investment Summit 2015: Challenges & Pillars of the Economy
In his presentation at the Indonesia Investment Summit 2015, organized in Jakarta on 15-16 January, Standard Chartered Bank Senior Economist Fauzi Ichsan said that despite the challenges amid global uncertain times, there remains plenty room and opportunity for Indonesia to grow robustly on the long-term. In fact, by 2030 Ichsan believes that Indonesia will be among the world's top ten countries in terms of largest economies. For investors it is important to understand the challenges and key pillars of economic growth.
According to Ichsan, Indonesia has three key pillars that support the country’s economic growth. However, in the post-commodities boom era, the country needs to adjust to new economic realities and hence alter its economic growth model to accelerate future economic growth.
1. Domestic/Household Consumption
The first pillar of economic growth is domestic consumption. Indonesia contains the world’s fourth-largest population (250 million) and has been experiencing solid economic growth for a decade thus giving rise to an expanding consumer class (the country’s middle class currently numbers about 75 million). Household consumption accounts for about 55 percent of Indonesia’s total economic growth and was the primary reason why the country was still able to post an impressive GDP growth rate of 4.6 percent (y/y) amid the global financial crisis in 2009. As such, domestic consumption functioned as a cushion against the weakening external situation. Given that household debt in Indonesia is still relatively low at 18 percent of GDP, which is among the lowest worldwide, and that household debt as a proportion of income (26 percent) is one of the lowest in Asia, it indicates that banking penetration in Indonesia is still low. As such, credit growth will further support household consumption in the next decade. It is also interesting to note that domestic consumption is rather confined to the island of Java (Indonesia’s most populous island).
2. Commodities
Indonesia is an important global player regarding commodities as the country is blessed by an abundance of commodities (for instance coal, crude palm oil, geothermal energy, and gas), particularly on the islands of Kalimantan, Sumatra and Sulawesi. Being a major (mainly raw) commodity exporter, Indonesia benefited tremendously from the commodities boom in the 2000s. However, these lucrative foreign exchange earnings ceased when commodity prices started to decline in the late 2000s, and particularly after 2011. Moreover, Ichsan is pessimistic that the world will see a rebound of commodity prices in the foreseeable future. Whereas many analysts expect to see such a rebound, Ichsan believes that commodity prices will have a hard time growing due to the emergence of the US shale gas revolution (giving rise to a significant rise of production of oil and natural gas in the USA). As global oil prices are closely related to prices of other commodities, Indonesia is expected to miss out on higher foreign exchange earnings from the export of crude palm oil, coal and gas. Indonesia’s dependence on commodity exports was once fruitful (in the 2000s) but has now jeopardized the country’s economic stability. This is the reason why the government has been pushing for more domestic smelting facilities and is also why it hopes to develop a manufacturing industry.
Ichsan added that Indonesia’s commodities’ sector is plagued by corruption: “Whereas the degree of corruption in, for example, the consumer goods and finance sectors is low, natural resources have a high degree of corruption. When it involves extracting mining/mineral products from the ground, matters become politicized and hence corruption looms.”
3. Economic & Political Optimism
The last pillar of economic growth involves optimism about the new Joko Widodo-led administration and its power to tap the full potential of the economy. Ichsan stated that “if Indonesia can post solid economic growth (5-6 percent y/y) for about a decade with unconducive infrastructure, think about what economic growth can be like provided that the lack of quality and quantity of infrastructure has been overcome?” President Widodo showed his commitment to implement structural reforms by scrapping fuel subsidies for gasoline. This move saves the government billions of US dollars which can now be reallocated from fuel consumption to structural economic growth. Infrastructural development is high on Widodo’s agenda and therefore about 60 percent of the saved funds will be allocated to infrastructure development. Ichsan said that such infrastructure development leads to employment, a further rising middle class and property inflation.
One reason why investors are content to see that Widodo obtained the presidential seat is that he is a former businessman (furniture business) and thus knows what it takes to create a conducive environment for business (in this respect he is markedly different from Indonesia’s past presidents). Similarly, Indonesia’s Vice President Jusuf Kalla has a long and successful history in business.
According to Ichsan, the current government is stable despite the tight race in the legislative and presidential elections of 2014 which have led to a minority coalition of Widodo in parliament. But as there are no real ideological differences between the two camps in parliament (referring to those political parties that supported Widodo and those that supported Prabowo Subianto during the presidential race), problems can be resolved. Would both camps be divided by ideological differences, for example secular versus Islamic parties, then governance would have become much more complicated.