East Asia Update - Indonesia Overview
The Indonesian economy ended 2005 with overall GDP growth of 5.6 percent, the highest rate in nine years. However, by year-end the growth story was mixed. The year had started strong with growth well over 6 percent but by the third quarter, economic activity had slowed as interest rates rose and consumers adjusted to increases in fuel prices (114 percent in October alone, and 143 percent for the year).
The slowdown reflected a difficult economic adjustment needed to bring Indonesian energy prices closer to market prices, a vital step to sustainable and higher longer-term growth. The depth of the slowdown was mitigated by surprisingly strong exports and by an expansionary fiscal policy (including a program of cash transfers to the poor) that held up growth in the 4th quarter.
Expansionary fiscal policy will also limit the pace of contraction during the first half of 2006, before higher consumer and investment spending raise growth in the second half. Currently interest rates are high and likely to remain restrictive for at least the first half, but are expected to fall later in the year as inflationary momentum slows, adding further to the economic recovery. In sum 2006 is likely to be the mirror image of 2005, with the growth cycle bottoming in the first quarter before rising later in the year.
There was also good progress in non-economic areas. The anti-corruption campaign continued with a growing number of prosecutions (and convictions) for corruption, with the Anti-Corruption Commission playing a leading role in this regard, including, most recently, a proposal for fundamental civil service reform. The Supreme Audit Agency continued breakthrough audits (including dissemination of results) on government agencies and public enterprises. In addition a peaceful process of regional direct elections has continued with the electorate frequently rejecting incumbents. Moreover rebuilding in Aceh has gained momentum.
Fifteen months after the Tsunami, houses are being built in large numbers, the school year started on-time, and health services are available in most affected areas. However, Aceh’s greatest hope for sustainable recovery is the peace agreement between the Indonesian Government and GAM, which so far has been implemented without major disruptions. 2006 will be a crucial test for both the success of the reconstruction effort and the peace agreement.
The waning months of 2005 also brought a reshuffle in the Economic Team. Former Finance Minister Boediono took the Economic Coordinating Minister portfolio and the Planning Minister Sri Mulyani moved to Finance. The new team completed two policy packages by end-February, one on infrastructure and the other on investment climate, with a third on financial sector reform under development.
The investment and infrastructure packages address policy issues in corporate regulation, tax, customs, labor and infrastructure that have been under review for some time. However, the packages also demonstrate a willingness to tackle a number of difficult decisions that had been on hold and provide a time-bound matrix with clearly defined Ministerial responsibilities.
The investment package adds additional political commitment through its issuance as a Presidential instruction. Highlights of the investment package include: completion of the investment law and reductions in red tape; business friendly revisions to the tax law; and improved procedures in customs.
The infrastructure package includes continued progress on public private partnerships, including a risk sharing framework (allowing contingent liabilities on budget), improved coordination mechanisms and progress on sectoral issues in anticipation of an Infrastructure Summit.
A third package addressing issues in the financial sector is expected in the next month to address weaknesses in state-owned banks; to deepen the bond market; and to resolve long standing monetary issues between the Ministry of Finance and Bank Indonesia. The reaction to the new economic team has been positive with the Indonesian Rupiah strengthening dramatically and the stock market at historic highs. The recent policy packages have also been well-received. However, as implementation has been problematic in recent years, and there is some uncertainty whether the government will be able to fully deliver on the new policy packages.