Indonesia

GDP growth is projected to be 5.1% in 2024 and 5.2% in 2025. Domestic demand remains driven by private consumption and gross capital formation growth will strengthen in 2024 and 2025. Headline inflation is expected to fall slightly below 3% in 2024 and remain unchanged in 2025, within the central bank’s revised target corridor (1.5-3.5%). Heightened global uncertainty and lower commodity prices have reduced nominal merchandise exports. Although the current account deficit is growing, international reserves are expected to be broadly stable.

Following an unexpected policy rate rise in April, prompted by currency weakening, monetary policy easing is projected to start in late 2024, as disinflation continues. With a new administration taking office in October 2024 committed to additional social spending, fiscal policy is projected to be mildly expansionary, although complying with the 3% of GDP constitutional deficit limit. Longer-term fiscal sustainability would be helped by further tax-base broadening and improved tax compliance and efforts to ensure efficient government spending, including through tightly focused support for vulnerable households. Supporting the transition to net-zero and enhancing energy security should remain priority goals.

Investment grew modestly in the second half of 2023, and public consumption fell, but private consumption growth remained steady. The net trade contribution also increased, reflecting strong exports. However, these favourable developments and the improvement in the terms of trade will not persist. The price of commodity exports has fallen by roughly a half over 2023. Except for agriculture, which is stagnating, GDP growth in every sector has been robust. Indicators of tourist arrivals and spending are near their pre-pandemic record levels. Industrial production rose by 4.0% in the second half of 2023 relative to the first half. Businesses and consumers remain confident. Unemployment fell to 5.3% in the third quarter of 2023. Annual inflation has increased to 2.9% in March 2024, from 2.3% in January. Annual core inflation stood at 1.8% in March 2024. However, food prices have increased again. The Indonesian Rupiah depreciated moderately against the US dollar between January and mid-April 2024, although it remained stable against other Asian currencies.

Fertiliser prices peaked in mid-2022 following the onset of Russia’s war of aggression against Ukraine but have decreased significantly since then. El Niño effects contributed to a local crop decline of about 20% and an increase in rice prices in the second half of 2023. The price of Indonesia’s commodity exports (principally comprising coal, palm oil and metals) has dropped after boosting the trade balance in 2023. The bilateral trade balance with China – Indonesia’s main trading partner – in 2023 was positive for the first time since 2011.

With the surge in domestic inflation, and policy tightening in other countries, Bank Indonesia raised its policy rate from 3.5% to 5.75% between August 2022 and January 2023. The intervention proved effective, helping to bring down inflation and support the Rupiah. The policy rate was raised further in October 2023 amidst rising global uncertainty, and to 6.25% in late April 2024 amidst growing pressures on the Rupiah. The mid-range of the central bank’s CPI inflation target has been reduced from 3% to 2.5% (with a ±1% corridor), effective from 2024. Bank Indonesia is expected to make the first rate cut in the last quarter of 2024, provided lower inflation is maintained and US policy interest rate cuts reduce pressure on the exchange rate. The switch to a more accommodative monetary policy is likely to be cautious and gradual, the policy rate reaching 5.0% by the end of 2025.

After providing fiscal support of 6.5% of GDP during the pandemic, the government has embarked on fiscal consolidation since 2022, and the deficit dropped to 1.7% of GDP in 2023. Extending the school lunch programme, as proposed by the newly elected President, combined with the funding of other electoral proposals, will make the fiscal stance mildly accommodative in 2024 and 2025. The fiscal support will increase the deficit in 2024, likely above the 2024 budget target of 2.3% of GDP, but below the constitutional 3% deficit limit. Over the medium term, further government investment (notably to complete the transfer of the capital city to Nusantara) will add to government spending.

Improved business and consumer confidence and higher government spending will support domestic demand and output growth in 2024 and 2025, along with lower interest rates in 2025. The trade surplus is expected to turn into a moderate deficit in 2024 and 2025, partly due to lower export prices. Strong domestic demand and a resilient labour market are projected to put some pressure on core and headline inflation. Nonetheless, headline inflation is expected to be slightly below 3% in 2024 and 2025.

The economy remains dependent on international demand for commodities, notably from China, despite diversification efforts and a push to expand downstream manufacturing. Weaker than projected growth in China would hit exports. However, low trade ties with Europe (accounting for around 10% of exports), make the country somewhat less affected by disruptions in the Red Sea than other Asian economies. Domestic political or financial risks remain limited as the upcoming government is likely to follow broadly the policies of its predecessor, and the financial system is healthy.

According to its long-term strategic plans, Indonesia aims to become a high-income country by the centenary Independence anniversary in 2045. The strategy includes industrial and trade policies, including export restrictions, that support the development of downstream industries so that key local commodities are processed domestically instead of exported in raw form. This is notably the case for nickel ore, with Indonesia the world’s largest producer, which is a key input for electric batteries and vehicles. These policies are subject to considerable implementation risks and have raised tensions with trading partners. Efforts to foster productivity and competitiveness more broadly are needed, including by removing distortions and increasing clarity in business regulation and finance. Further improvement in the governance of state-owned enterprises is required, including through more independent oversight. Significant steps have been taken to improve social safety nets in the past decade, with compulsory social insurance since 2015 and unemployment benefits since 2021, but coverage remains largely limited to workers in large and medium firms. Further reducing duality between larger and smaller firms, and between the formal and informal economy, would enhance inclusiveness, reduce gender gaps, strengthen resilience and help to prepare for population ageing. Expanding the formal economy and the reach of social insurance would also reduce the need for ad-hoc poverty assistance and energy subsidies. The latter should be more targeted and more automatic. A further shift away from the informal economy would help broaden the tax base, improve tax compliance and provide fiscal space to invest in physical infrastructures (including decarbonised transports and energy) and human capital (health, education, skills, research).

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