Indonesia Economic QuarterlyBack on track?

William E. WallaceLead EconomistWorld Bank

16 December 2009Jakarta Indonesia

Indonesia’s economy, back on track?

Indonesia’s real economy has returned to solid growth

But financial markets remain volatile

And longer-term reform is needed to maintain the momentum

Indonesia’s economy in late 2009Back on track

1. Indonesia’s real economy has continued the gradual recovery trend evident mid-year

2. Growth has been far less volatile than elsewhere

3. But financial markets have been more volatile, strengthening by more than most others

4. Inflows of capital in search of Indonesia’s higher yields has driven much of this strength, and present a future risk

Indonesia’s economy in late 2009Growth has returned to pre-crisis averages

Growth picked up further in Q3, continuing the earlier trend

Growth remained broad-based: consumption was robust, investment picked up and net exports contributed positively

Industrial GDP while down year on year picked up in the 3rd quarter in seasonally adjusted terms as compared to services, which were down

(aggregate GDP growth)

Sources: BPS via CEIC, World Bank

0

1

2

3

4

Sep-02 Jun-04 Mar-06 Dec-07 Sep-09

0

2

4

6

8Per cent Per cent

QoQ seas. adjust (LHS)

Year on year (RHS)

Average* QoQ growth

(LHS)

Indonesia’s economy in late 2009…trade flows are recovering…

Unlike the domestic economy, trade flows were significantly disrupted by the global economic downturn

Export values fell by 43%; imports by 56%

The collapse in commodity prices explain most of this decline

Flows have since partially recovered, with the recovery in commodity prices and external demand

Sources: CEIC, Haver Analytics, BPS, JP Morgan, World Bank

4

6

8

10

12

14

Oct-07 Apr-08 Oct-08 Apr-09 Oct-09

4

6

8

10

12

14USD bn USD bn

Exports

Imports

July 08 Feb 09

(monthly merchandise trade flows) (global commodity prices, 100=June 2007)

40

70

100

130

160

190

Oct-07 Apr-08 Oct-08 Apr-09 Oct-09

40

70

100

130

160

190Index Index

Energy

Non-energy

Exports

-30

-20

-10

0

10

20

30

40

50

2005 2006 2007 2008 2009

I ndustrial production

Cement sales

Electricity use by industry

%120

140

160

180

200

220

240

60

70

80

90

100

110

120

2005 2006 2007 2008 2009

BI retailsales index

(SA; RHS)

BI consumer confidence index

(LHS)

Danarakesa consumer survey (LHS)

Index Index

0

20

40

60

80

0

200

400

600

800

Oct-05 Oct-06 Oct-07 Oct-08 Oct-09

'000

Motor vehicles (RHS)

Motor cycles (LHS)

'000

Indonesia’s economy in late 2009…and other indicators remain solid

Other indicators show conditions have stabilized at relatively high levels

(abstracting from the volatility around the Idul Fitri holidays)

Sources: BPS, GAI, PLN, ICA and Astra via CEIC, Danarakesa, World Bank

-3

0

3

6

9

12

15

-1

0

1

2

3

4

5

Jan 07 Jun 07 Nov 07 Apr 08 Sep 08 Feb 09 Jul 09 Dec 09

Inflation MoM (LHS)

Inflation YoY(RHS)

Per centPer cent

Core inflation

(RHS)

Poverty basket inflation RHS)

Indonesia’s economy in late 2009 Inflation paused in Q4

After building momentum in Q3, inflation was unexpectedly weak in October and November

2.4% inflation, is a decade low

The appreciating rupiah, and improved food supply conditions, are allowing retailers to reverse their Ramadan- and Idul Fitri related price rises

Sources: BPS, CEIC, World Bank estimates of poverty basket inflation

-2

0

2

4

6

8

10

12

50

100

150

200

250

300

350

400

Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

IDR trillion (quarterly) Percent QoQ

New Loan Approvals (LHS)

Credit Growth (RHS)

Indonesia’s economy in late 2009…and credit is picking up

New loans bounced back in September to 2008 levels

…despite lending rates remaining high

Sources: BI via CEIC

(Q-o-Q credit growth and credit approvals) (interest rates)

6

8

10

12

14

16

5.00

5.20

5.40

5.60

5.80

6.00

Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09

Lending Rates (RHS)

Net Interest Margin (LHS)

Deposit Rates (RHS)

Percent Percent

BI Policy Rate (RHS)

8500

9500

10500

11500

12500100

150

200

250

06-Oct-08 06-Jan- 06-Apr- 06-Jul- 06-Oct-

IDR trillion IDR per USD

IDR/USD spot (RHS)

Total Foreign Capital Stock (LHS)

IDR Appreciation

Financial markets remain unstableWhile significant capital inflows…

Large flow of offshore funds into Indonesian financial assets recently

USD 6.5 bn since March; USD 2.5 bn in September and October alone

Invested in government bonds (SUNs), SBIs, and the stock market

Supported rupiah’s appreciation against the weakening USD

22% since March, stabilizing around 9.500 per USD from early October

Despite BI allowing reserves to accumulate (to USD 65.8 bn by end November)

Sources: BI, CEIC, and World Bank

Financial markets remain volatile…have supported financial asset prices

This has supported a rally on equity and bond markets to early October

Since then, markets have since tracked sideways

Unlike elsewhere in the region, these flows have not affected other asset prices (eg, urban property)

Sources: CEIC, World Bank

Sources: BI, CEIC, and World Bank

25

40

55

70

85

100

115

25

40

55

70

85

100

115

Jan-08 Apr-08 Jul-08 Oct-08 Feb-09 May-09 Aug-09 Dec-09

Jakarta JCI

Bombay BSE

Shanghai Composite

Thailand SET

Singapore SGX

Index 2 Jan 08 = 100

March 2009

Index 2 Jan 08 = 100

(Regional stock market indices)

0

3

6

9

12

15

18

21

24

0

3

6

9

12

15

18

21

24

Jan-08 Apr-08 Jul-08 Oct-08 Feb-09 May-09 Aug-09 Dec-09

Indonesia

Philippines

Thailand

Malaysia

United States

Percent Percent(local currency bond yields)

Indonesia’s economy in late 2009 Back on track?

Outlook remains for gradual pick-up in growth

Outlook slightly stronger than September: better domestic performance in Q3, improved outlook for trading partners, and higher commodity prices

Support gradual reduction in poverty rates

But significant risks to the outlook remain

Unwinding of global fiscal and monetary stimulus/imbalances could trigger risk aversion once again international capital markets

While domestic developments also risk creating uncertainty for investors

Sources: BPS, BI, CEIC, and World Bank projections

2008 2009 2010 2011

Gross Domestic Product (annual % change) 6.1 4.5 5.6 6.0

Consumer price index (annual % change) 9.8 4.8 5.4 5.9

Poverty rate (% population) 15.4 14.2 13.5 11.4

Balance of payments (USD bn) -1.9 11.8 5.0 3.0

Budget balance (% GDP) -0.1 -2.3 -1.7 --

Major trading partner growth (annual % change) 2.4 -0.9 3.8 3.9

Staying on track into the medium termThe demographic window of opportunity

Indonesia has been enjoying a demographic dividend

But the share of the population at working age is nearing its peak

Between 2020 and 2025 Indonesia’s dependency ratio will begin to rise again, with a growing share of elderly citizens

…making the next decade critical to make the most of the demographic dividend and prepare for an aging population

Sources: BPS and UN statistics

Children (0 to 14)

(LHS)

Working age (15 to 64) (LHS)

Elderly (65 and over) (LHS)

Dependencyratio (RHS)

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

2015

2020

2025

2030

2035

2040

2045

2050

% o

f p

op

ula

tio

n

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

Dep

end

ency

rat

io (

you

ng

an

d

eld

erly

to

wo

rkin

g a

ge)

Staying on track into the medium term…demands many new good quality jobs

The expanding working age population will need new, good quality jobs

The employment rate, after falling for 6 years, trended upward since 2006. Employment rate rose from 61.5% in August 2008 to 62.1% in August 2009.

But most of the labor force…and new jobs are informal

Around 60% of the labor force is informal

And informal jobs generally offer poorer pay and conditions

But the distinction is not sharp: many formal sector workers are little better off than those working informally

Sources: BPS and World Bank

7.1

7.2

7.3

7.4

7.5

7.6

7.7

7.8

7.9

8

8.1

Permanent Employees &

Employers

Fixed Term Contract

Employees

Employees with no Contract

Informal workers (non-agricultural)

Informal workers (agricultural)

(mean log monthly wages)

(Employment % of working age)

58

59

60

61

62

63

64

65

1990 1992 1994 1997 1999 2001 2003 2005 2006 2008

1990-1997 1997-1999 1999-2003 2003-2008%

Staying on track into the medium termIndonesia can afford to spend more on development

Government finances remain in good shape after the crisis

In our view, and in the medium run, larger deficits, supporting investment in social welfare and infrastructure, are sustainable

And more spending on desirable infrastructure and social goods could be achieved through the reallocation of distortionary energy subsidies

But to ensure the quality of spending in a democratic and decentralized Indonesia, government effectiveness has to be enhanced

Source: World Bank projections

Business as usual scenario 2010 2011 2012 2013 2014GDP growth (%) 5.7 6.0 6.2 6.2 6.2

Budget deficit (% GDP) -1.7 -1.4 -1.1 -0.9 -0.8

Public debt to GDP ratio (%) 31.9 30.8 29.2 27.6 26.0

GoI gross financing needed (IDR trillion) 224 228 223 226 258

'Big push' scenario 2010 2011 2012 2013 2014GDP growth (%) 5.6 6.4 6.8 7.0 7.2

Budget deficit (% GDP) -2.6 -2.4 -2.1 -1.9 -1.8

Public debt to GDP ratio (%) 32.8 32.4 31.5 30.4 29.2

GoI gross financing needed (IDR trillion) 284 298 304 324 375

Scenario: Baseline/Business as usual 2010 2011 2012 2013 2014Key macro variables (%)

GDP growth 5.6 6.0 6.2 6.2 6.2GDP deflator growth 8.2 8.2 8.2 8.2 8.2

State Budget (% GDP)State Revenues 15.8 15.9 15.9 16.0 16.0State Expenditures 17.4 17.8 17.5 17.4 17.2

o/w subsidies 3.3 3.4 3.2 3.1 3.0o/w interest payments 1.9 1.8 1.7 1.6 1.5o/w other 12.2 12.7 12.6 12.7 12.7

Budget deficit 1.6 1.9 1.6 1.4 1.2Gross financing need 3.4 3.5 3.1 2.8 2.7Public debt 26.8 25.0 23.3 21.6 20.1

State Budget (IDR trillion)State Revenues 1,003 1,171 1,358 1,572 1,824 State Expenditures 1,105 1,311 1,494 1,710 1,961

o/w subsidies 208 248 274 304 341 o/w interest payments 122 132 144 155 167 o/w other 775 931 1,077 1,250 1,453

Budget deficit 101 140 136 138 137 Gross financing need 218 259 263 276 305 Public debt 1,696 1,838 1,982 2,131 2,298

Key assumptionsCPI growth (%) 5.4 5.9 5.9 5.9 5.9Exchange Rate (Rp/US$) 9500 9500 9500 9500 9500Interest rate of SBI 3 month (%) 6.5 6.5 6.5 6.5 6.5Crude-Oil Price (US$/Barrel) 79.0 83.6 83.6 83.6 83.6Oil Production (barrel per day) 965 970 990 1000 1010

Indonesia Economic QuarterlyBack on track?

William E. WallaceLead EconomistWorld Bank

16 December 2009Jakarta Indonesia