October 25, 2016

Indonesia Economic Quarterly

October 2016

Pressures easing

Ndiamé Diop

Practice Manager, Macroeconomis and Fiscal

Management, South East Asia and the Pacific

Key takeaways

Macroeconomic pressures easing

Thanks to good macro-fiscal management, short-

term macro pressures, in particular fiscal risks and

inflation, have eased. This should support growth:

Low inflation and stable Rupiah => monetary

policy easing

Greater policy predictability

Allows policymakers to focus more on

structural reforms

Fiscal spending reforms key to inclusive growth

Efficient and effective spending of public resources

critical to strengthening human capital and reducing

poverty and inequality. It requires:

Spending resources in the right areas & right

Better fiscal allocation across programs within

sectors (social assistance, agriculture,

education)

Public spending in rural water and sanitation

provides an example: smart spending has

borne results

Recent fiscal reforms are lowering poverty and

inequality

3

Macroeconomic pressures easing

Fiscal spending reforms and inclusive growth

Fiscal policy and welfare

External conditions remain unsupportive to growth

4

Source: World Bank Global Economic Prospects; WDI

World Bank projections for global growth by date of forecast

2

2.5

3

3.5

2013 2014 2015 2016 2017 2018

Jan-15 Jun-15 Jan-16 Jun-16

Average growth (2000-2008)

Actual growth

But key domestic risks have eased, reducing macro-

fiscal pressures

5

Fiscal risk

Tax amnesty take up

Private investor sentiment

Credit growth

Brexit

Commodity prices

US Fed rate hike

Lower global growth

China rebalancing anddeleveraging

Risks

Eased Remain

Domestic

External

Prudent fiscal policy choices and high tax amnesty

take-up reduced fiscal risks

6Source: Ministry of Finance; World Bank staff calculations

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2015

2016

• Expenditure cuts and

expanded fiscal deficit

for 2016 announced in

July

• The draft 2017 Budget

contains more realistic

revenue targets

• Successful

implementation of

Phase I Tax Amnesty

program

Monthly fiscal deficit (% GDP)

Sound macro management and record low global

bond yields helped stabilize the Rupiah

Source: BI;JP Morgan; World Bank calculations

Index, January 4 2016 = 100

96

98

100

102

104

106

108

110

Jan-2016 Apr-2016 Jul-2016 Oct-2016

USD/IDR

JP Morgan EMCI

Improved rice import management helped inflation

moderate further

Source: BI; World Bank staff calculations

Year-on-year growth, percent

0

4

8

12

16

Sep-13 Sep-14 Sep-15 Sep-16

Headline

Rice

BI inflation target

Core

Improved macro-fiscal environment should help near-

term growth

9

There are no signs in the data of a pickup in activity as yet

0

20

40

60

80

100

120

140

160

-40

-30

-20

-10

0

10

20

30

40

Sep-14 Mar-15 Sep-15 Mar-16 Sep-16

Retail Sales Index

Motorcycle Sales

Consumer Confidence Index

3 mma, percent yoy (LHS); consumer confidence index (RHS)

But improved macro-fiscal conditions may help going forward:

Low inflation and stable Rupiah => monetary policy easing

Low fiscal risk => using fiscal policy to stimulate the economy

Greater policy predictability and improved investor sentiment

Source: BI; BPS; World Bank staff calculations

10

Macroeconomic pressures easing

Fiscal spending reforms and inclusive growth

Fiscal policy and welfare

Public spending reforms crucial to greater

access to services and inclusive growth

Source: World Bank staff.

Funding, human capital, Other Assets

Education services, health

services, infrastructure

Student performance,

Maternal mortality

rates

Growth, poverty Inequality, jobs

Re-allocation within the budget can help make growth

more inclusive

12

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

0

20

40

60

80

100

120

DirectTransfers

Education Health Subsidies

Effectiveness Index (LHS) Budget (RHS)

(all HH targeted SA)

(energy only)

Effectiveness at reducing inequality relative to spending

Index (LHS); percent of GDP (RHS), 2012

• Direct social assistance

transfers are the most effective

at reducing poverty and

inequality, followed by

education and health spending

• In 2012, total spending on SA and

health sectors was small relative

to energy subsidies

• Subsidy reform and expansions of

SA programs since 2012 have

helped, however more can be

done

• In addition to increased SA

spending, re-allocation with the

SA budget is needed:

• One rupiah spent on PKH

reduces inequality by 2.5

times more than a rupiah

spent on Rastra, yet

Rastra’s budget is more

than 10 times higher.

Source: Susenas 2012, World Bank calculations.

Note: Effectiveness Index is Change in Market Income Gini to Final

Income Gini / Budget as % of GDP

In agriculture, much of the rising spending goes to

private input subsidies rather than public goods

13

• In 2015, 47% of CG

public spending

was used to

subsidize private

inputs rather than

provide public

goods. Only 3%

was spent on R&D

and extension

services

• Increased central

spending on

agriculture has not

led to similar

increases in

agriculture output

• Reallocation =>

higher productivity

Note: Spending figures refer to realized spending up until 2015 and the revised Budget for

2016. MoA reclassified the majority of its social aid spending to goods and services in 2016.

Source: World Bank COFIS database using MoF data

Central government spending on agriculture and irrigation

IDR trillion (LHS); Year-on-year growth, percent (RHS)

0

1

2

3

4

5

6

0

10

20

30

40

50

60

70

80

90

100

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Extension services Irrigation

Other agriculture subsidies Fertilizer subsidies

R&D MoA non-social aid

MoA social aid

Growth in agriculture

value added

In education, better spending is required to achieve

outcomes

14

• Increasing enrollment

• Improving learning outcomesChallenge

• Teacher certification program

• Large fiscal investment: doubling of teacher pay following certification

Policy response

• Certification required a university degree, other training, and experience

• Requirement to demonstrate competency was dropped

Design

• Many teachers were incentivized to upgrade their qualifications

• But no impact on student learning (test scores)Evaluation

• Teaching has become a popular profession

• Prioritize demonstrated professional competencies over education level and seniority

New opportunity

Example of the teacher certification program

In sanitation, targeted public investments triggered much

larger investment by rural communities

15

Government spending

directed to:

• creating demand for safe

sanitation and hygiene

through community

empowerment and

behavior change

• increasing the supply of

affordable and

aspirational sanitation

facilities by the private

sector

• enhancing the enabling

policy environment

Households purchase

latrines

Investment in rural sanitation, 2 data samples

USD million, LHS; ratio, RHS

Source: World Bank, STBM

0

2

4

6

8

10

12

14

0

10

20

30

40

50

60

70

28 district in East Java 277 districts

Community Contribution

Local Government Spending

Ratio of community togovernment contribution(RHS)

0%

20%

40%

60%

80%

100%

2000 2002 2004 2006 2008 2010 2012 2014

Rural Water Rural Sanitation

…leading to good outcomes: rapid rise in access to

sanitation in rural areas

16

Government is achieving

its goals in WASH (urban +

rural)

• MDG for water supply

achieved (87% in 2015)

• MDG for sanitation

narrowly missed (61% in

2015; the target was

62.4%)

Government now targeting

universal access to

improved water supply and

sanitation services by 2019,

in line with the SDGs

Access to improved water and sanitation, percent

Source: SUSENAS, BPS

17

Macroeconomic pressures easing

Fiscal spending reforms and inclusive growth

Fiscal policy and welfare

Fiscal policy (2012-14) did relatively little to reduce

poverty and inequality…

Baseline Fiscal Policy Impact on

Poverty and Inequality 2012-14

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

Poverty (percentagepoints)

Inequality (points of Gini)

2012 2013 2014 Average

• Indonesian taxes and government

spending reduced poverty by 1.1-1.4

percentage points and the Gini coefficient

by 2.6-3.3 points (over 2012-14)

• Relatively small reductions by international

standards, partly due to:

• personal income tax collection is low

with poor compliance

• social assistance spending is low

• health spending is low and much of it

is not on the primary care which most

benefits poorer households

• education spending is high and has

some impact on inequality, but not to

the degree seen in other countries

• Also partly due to high spending on

energy subsidies which predominantly

benefit richer households. Source : The 2012 result is from a fiscal incidence paper (World

Bank and Ministry of Finance 2015), and the 2013 and 2014

results are from a coming update to that paper. The analysis is

based on the Commitment to Equity framework

(commitmentoequity.org), and applies standard fiscal incidence

analysis to the majority of GoI taxes and spending

…but recent choices are delivering more positive

results: poverty and inequality fell in 2016… thanks to

efforts to stabilize rice prices and social assistance expansion (PKH)

Source: Susenas

Poverty rate, percent (LHS); change in

poverty, percentage points (RHS)

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

0

2

4

6

8

10

12

14

16

18

20

2003 2005 2007 2009 2011 2013 2015

Poverty Rate (LHS)

Change in Poverty, yoy

(RHS)

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

20

25

30

35

40

45

2003 2005 2007 2009 2011 2013 2015

Gini (LHS)

yoy change (RHS)

Gini coefficient, points (LHS); change

in Gini coefficient, points (RHS)