Faster Growth Despite Rising External Risks

15 01 2008

indonesia economic forecast 2008

GDP: Accelerating Since the Beginning of the Year

The Indonesian economy picked up its growth pace in 2007. From a growth pace of 6.0 percent in Q1 2007, the economy then expanded by 6.3 percent in Q2 2007 and 6.5 percent in Q3 2007. Nonetheless, in Q4 2007, we expect the Indonesian economy to show slightly slower growth of 6.2 percent as a result of slightly lower-than expected growth in government expenditures and private consumption in that particular quarter. Yet for the whole of 2007, the Indonesian economy is expected to grow by 6.3 percent, or much faster than the 5.5 percent growth pace in 2006.

Compared to other countries in the region, Indonesia is one of the fastest growing economies. Among the “emerging market” countries in Asia, the Indonesian economy ranked fourth in terms of growth over the last three quarters (up to the third quarter of 2007), with only the economies of China, India, and the Philippines growing more briskly than Indonesia’s economy.

Investment has helped drive the Indonesian economy over the last three quarters. Prior to 2006, investment (as measured by gross fixed capital formation) gave only a minimal contribution to economic growth. However, it then picked up significantly in 2007. Looking ahead, investment growth should remain strong. This is because spare capacity has been reduced significantly following the steady rise in domestic consumption since the beginning of this decade.

In the first three quarters of 2007, household spending grew by only 4.1 percent year-on-year. It is even expected to slow down in the fourth quarter to 3.7 percent due to weaker purchasing power and lower interest earnings. However, investment increased by 13.7 percent year-on-year in Q3 2007, and for the whole year it is expected to grow by 13.6 percent.

The relatively sluggish domestic demand in Q2 2007 also affected demand for imported products. In the second quarter of 2007, demand for imported products fell. Indeed, imports grew by only 7.2 percent in Q2 2007, down from 9.2 percent in Q1 2007. Yet in the third quarter of 2007, however, domestic demand started to pick up. This resulted in higher imports. This is reflected in the data that shows a 19.3 percent increase in imports in the first ten months of 2007 to US$59.9 bn, or up from US$50.3 bn in the same period of 2006.

Meanwhile, strong global demand and higher commodity prices pushed up Indonesian exports in the first ten months of 2007. In this period, exports reached US$93.2 bn, or up by 13.4 percent from US$82.3 bn in the same period of 2006. Against this backdrop, the trade balance in the first ten months of 2007 reached US$33.2 bn, or up by 4.0 percent from US$31.9 bn in the same period of 2006.

Inflation: High International Oil Prices Stoked Inflationary Pressures

International oil prices (US WTI) were on an uptrend since the beginning of 2007, climbing around 52.8 percent during 2007. Indeed, prices soared from US$61/barrel at the beginning of 2007 to US$96/barrel at the end of December following the disturbances on the Turkey-North Iraq border. Over the year, the oil price averaged about US$71/barrel.

Unlike in 2005, however, the increase in world oil prices in 2007 did not have a significant impact on the Indonesian inflation figure. This was because the Indonesian government was able to avoid hiking domestic fuel prices as the impact of high oil prices to the 2007 State Budget is still neutral to positive. Note that given the production of crude oil could be maintained at around 900,000 barrels/day during 2007, the increase in international oil prices actually benefited the state budget in 2007.

Increases in the prices of some basic foodstuffs such as rice and cooking oil were actually the main contributors toward the relatively higher than expected inflation in 2007. And inflation in the foodstuffs component peaked at a rate of 12.99 percent y-o-y in September 2007 on the back of seasonal price increases during the Idul Fitri holiday season. However, Bank Indonesia’s consistency in carrying out its monetary policy kept inflationary pressures in check in 2007. As a result, the 2007 inflation rate was relatively unchanged at 6.6 percent y-o-y, compared to the 2006 inflation rate.

Rate (Rp/US$): Slightly Weaker

In 2007, the rupiah weakened slightly relative to the US dollar. From the beginning of January 2007 (with the rupiah trading at Rp 9,090/USD) up to the end of December 2007 (with the rupiah trading at Rp 9,400/USD), the rupiah depreciated by 4.01% relative to the US dollar. At one point, the currency even fell as much as 8.9% to Rp 9,550/USD on August 16 when the sub-prime mortgage crisis in the US created jitters on the global stock markets.

Nonetheless, both improvements in the country’s macroeconomic performance (the Indonesian economy grew by 6.5% in Q3 2007 or its fastest growth pace since the 1997/98 economic crisis) and the Fed’s decision to cut interest rates have helped the rupiah to strengthen towards the end of 2007. The cut in US rates in December 2007 brought the benchmark rate down by 100 bps

since August 2007 to 4.25 percent. This created negative sentiment toward the dollar. As a result, the US dollar weakened against almost all currencies, including the rupiah. Due to the rising capital flows into Indonesia’s financial market, the Rupiah strengthened and stabilized around Rp 9,400/US$ by the end of 2007.

Interest Rate: Down

In 2007, easing inflationary pressures gave the central bank leeway to cut its key benchmark rate (BI rate) by 150 basis points from 9.5 percent in January 2007 to 8.0 percent in December 2007. In the first six months of the year, Bank Indonesia (BI) continued to cut its benchmark rate by 25 basis points at each monthly Board of Governors Policy Meeting (except in April when inflation surged as a result of increases in the price of cooking oil).

Starting June 2007, the Indonesian Central Bank opted to halt its rate cuts due to heightening inflationary pressures and because of the onset of the US sub-prime crisis. But in December 2007, the central bank cut its benchmark rate again by 25 basis points to 8.0 percent when it became clear that inflation would remain benign towards the year-end.

Such aggressive cuts in interest rates were made possible by easing inflationary pressures during 2007 (inflation fell from 6.9 percent y-o-y in September 2007 to 6.6 percent y-o-y in December 2007) as well as the relative buoyancy of the rupiah. Moreover, the Fed rate cuts also gave the central bank more room to cut rates. Indonesia Economic Outlook 2008



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