Indonesia Economic Quarterly Back on track?

1. Indonesia Economic Quarterly Back on track? William E. Wallace Lead Economist World Bank 16 December 2009 Jakarta Indonesia

2. 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

3. Indonesia’s economy in late 2009Back on track • Indonesia’s real economy has continued the gradual recovery trend evident mid-year • Growth has been far less volatile than elsewhere • But financial markets have been more volatile, strengthening by more than most others • Inflows of capital in search of Indonesia’s higher yields has driven much of this strength, and present a future risk

4. 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

5. 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 Indonesia’s economy in late 2009…trade flows are recovering… (monthly merchandise trade flows) (global commodity prices, 100=June 2007) Sources: CEIC, Haver Analytics, BPS,JP Morgan, World Bank

6. 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

7. 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 Indonesia’s economy in late 2009 Inflation paused in Q4 Sources: BPS, CEIC, World Bank estimates of poverty basket inflation

8. 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 (Q-o-Q credit growth and credit approvals) (interest rates) Sources: BI via CEIC

9. 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) IDR trillion IDRperUSD 8500 250 9500 200 Total Foreign Capital Stock IDR/USD spot 10500 (LHS) (RHS) 150 11500 IDR Appreciation 12500 100 06 - Oct - 08 06 - Jan - 06 - Apr - 06 - Jul - 06 - Oct - Financial markets remain unstableWhile significant capital inflows… Sources: BI, CEIC, and World Bank

10. 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) Financial markets remain volatile…have supported financial asset prices (Regional stock market indices) (local currency bond yields) Sources: CEIC, World Bank Sources: BI, CEIC, and World Bank

11. 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 Indonesia’s economy in late 2009 Back on track? Sources: BPS, BI, CEIC, and World Bank projections

12. 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 Staying on track into the medium termThe demographic window of opportunity Sources: BPS and UN statistics

13. 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 Staying on track into the medium term…demands many new good quality jobs (Employment % of working age) (mean log monthly wages) Sources: BPS and World Bank

14. 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

15. Indonesia Economic Quarterly Back on track? William E. Wallace Lead Economist World Bank 16 December 2009 Jakarta Indonesia