Its rapid wage growth relative to productivity may remain a barrier for it to participate in post-pandemic reconfigurations of the global supply chain. This growth model came to a halt when rising global yields and falling commodity prices meant Indonesia could no longer afford the import growth needed to sustain rising consumption. On the other hand, high absolute demand (due to too much stimulus) and structural tightening in the labor market ("the Great Recession") play relatively smaller roles, at least for the moment.
The current boom is especially beneficial
Commodity price indices
S&P index
Terms of trade adjusted*
Trade balance
In fact, it can be argued that the exchange rate is the most decisive factor in recent years, as evident from Bank Indonesia's rate hike in 2018 in the absence of a significant increase in inflation and the maintenance of positive real policy rates since then (Exhibit 6). As it turns out, Indonesia's non-depreciating potential growth had been falling in the past decade - eventually falling to just below 4% before picking up again just before the pandemic. This is clearly evidence of Indonesia's diminished vulnerability, although there are two key caveats that we will discuss in subsequent chapters.
Indonesia has broken away from the “Fragile Five” pack, and the market has rewarded it accordingly …
Net annualized bond inflows
Net annualized equity inflows
Since 2018, BI has maintained positive real policy rates as a buffer against depreciation risks …
CPI inflation YoY
BI policy rate*
IDR/USD exchange rate
Real O/N rate differential, ID-US IDR/USD exchange rate (rhs)
Actual ― Modeled*
Net monthly portfolio inflows
Every investment boom in recent history has been limited by the availability of foreign exchange.
Every investment boom in recent history has been limited by the availability of foreign exchange …
FX loans (rhs)
Growth (de-trended)
FX liquidity index*
IDR/USD exchange rate
Non-depreciative potential GDP growth*
Actual GDP growth
BoP : Current account
A common narrative that has emerged recently is that Indonesia has shed a key vulnerability: the high level of foreign ownership of its government bonds, which has fallen from nearly 40% before the pandemic to around 20% (Exhibit 12) . However, these numbers hide a few underlying risks, and the fiscal stimulus of the past two years is not quite the "free lunch" this narrative seems to suggest. This explains why net bond liabilities have actually increased, in contrast to the overall improvement in NIIP (Exhibit 10).
But the chances of this happening are quite slim, not only because of the Fed's upcoming rate hikes, but also because investor appetite for EM bonds – not just Indonesia's (Exhibit 7) but EMs in general (Exhibit 5) – is not what it used to be before the pandemic. Government revenue growth in 2021 has been exceptionally strong and the deficit is likely to fall below 5% of GDP, much better than the mid-term outlook (5.8%). More encouragingly, this growth has been driven by natural resource revenues as well as taxes, and the multi-year decline in Indonesia's tax/GDP ratio appears to have finally been halted (Exhibit 15).
All this bodes well for 2022, where the government is already planning to implement several measures to increase income as part of the Tax Harmony - among them (1) an increase. Coupled with a fairly conservative spending target, this could push the deficit closer to 4% of GDP – not quite a return to normality, but a somewhat quicker exit from it. We note in particular that the fiscal deficit is not so far away from the size of the private sector's savings that we estimate for 2022 (Exhibit 19).
This implies that (1) the CA balance would probably end up close to neutral (ie 0% of GDP); and (2) the fiscal deficit can be financed primarily by the financial sector (both banks and non-banks) as well as private individuals, without much dependence on foreign inflows or BI intervention.
Despite overall NIIP improvement, net gov’t bond liabilities have widened since the pandemic …
Net international investment position
Gov’t external debt, by currency
Private external debt, by currency
BI increasingly takes the lead in buying government debt amid reduced demand from banks and foreigners.
BI increasingly takes the lead in buying gov’t debt amid reduced demand from banks and foreigners …
Gov’t bonds outstanding*, by ownership
Money supply growth
Implied money velocity*
Stimulus was needed to offset loan contraction, but will have to wind down as credit expands again
Strong revenue growth and tax reforms could drive fiscal normalization slightly ahead of schedule
Commodity price index, ToT-adjusted
Non-tax
The fact that core inflation has remained low therefore appears to be an anomaly that may return to normal levels over the next few quarters. The government's decision to keep energy prices low for the time being is not expected to jeopardize consumer demand during the initial recovery, especially given the possibility that global energy prices could decline in the future. Also, it is no longer so expensive for the government to maintain the price gap between global and domestic energy prices.
Unlike in the past, when fuel price policy could clearly affect sovereign ratings, the burden of subsidizing energy prices is now mostly/partially borne by the respective SOEs (Exhibit 18) – Pertamina for liquid fuels and domestic LPG, and PLN for electricity. Energy prices, as we mentioned at the beginning, have an ability to stay higher for longer compared to other commodities, while the two SOEs have a limited capacity to sustain these losses. So, while energy prices remain unchanged for now (except for non-subsidized items), the chance of an adjustment may increase if oil/coal prices remain high through H2-22.
Even without an adjustment in energy prices, inflation is very likely to rise, albeit much less abruptly. In addition to the above-mentioned loan growth, imported inflation and increase in aggregate demand, there is also the wildcard of food prices. First, higher incomes in cities would lead to an increase in aggregate demand.
Second, since these workers helped with agricultural work during their time in the villages, their move to the cities may also change the balance between food supply and demand in favor of higher food prices.
Inflation has been kept in check amid global pressures, but it is likely to increase alongside loan growth
Inflation
Admin’d prices*
Imported WPI
Loan growth (de-trended)
Core inflation
Food prices have moved in line with producer prices, implying relatively limited role of gov’t intervention
RICE
BEEF
CPO*
POULTRY
Retail prices
Producer prices
Misalignment of local energy prices (vs. global) poses little fiscal risk, but could be costly to SOEs
Who’s paying for energy?
Current account balance, broken down
Energy subsidy and commodity boom contribute towards the private sector’s substantial net savings
Given the commodity boom, rising growth potential and broadly reduced vulnerability we have seen, it is indeed likely that Indonesia will finally return to the 5% plus growth it is used to in 2022. It is also quite surprisingly how short-lived and limited was the influence of the Delta on economic activities, even though it drastically limited mobility. This shows how much of the economy has moved online – in fact, our offline-only consumption index has only belatedly returned to its pre-pandemic levels, thanks to a rapid increase in mobility.
It also points to the (fingers crossed) diminishing economic impact of successive Covid waves, especially considering that the majority of cases and deaths in Indonesia occurred during the Delta wave. For 2022, the recovery would therefore extend to the sectors to the left of Exhibit 27. Others, notably the auto industry, actually experienced outsized growth in 2021, thanks to government tax incentives.
On the one hand, there are sectors that suffered extreme output loss during the pandemic, namely transport and tourism, which have nevertheless begun a slow recovery despite the on/off-weather mobility restrictions. This has been particularly true for commodity sectors such as coal, perhaps due to the uncertainty of whether the current boom will prove to be short-lived. Indeed, it is quite striking that several manufacturing industries have seen positive investment growth (FDI and DDI) amid the pandemic (Exhibit 25), perhaps driven by many of the same factors that have fueled global inflation recently – supply chain disruptions and increased demand for goods versus services.
In addition to strong revenue growth and a recovery in profit margins, the average debt-to-equity ratio of listed companies has also remained remarkably stable during the pandemic – with neither excess debt nor a deleveraging trend to hamper growth.
Growth has hitherto been led mostly by exports, but domestic demand is regaining the initiative
GDP, by components
Consumer spending and business revenue have rallied after Delta, as have mobility to a lesser extent
BCA Big Data indices*
Consumption index
Business revenue index
Google mobility index
Consumer optimism is starting to spill over into big-ticket purchase, independent of gov’t incentives
Consumer survey
Consumer confidence
Durable goods purchase
Job availability
Car sales
Motorcycle sales
Cement sales
Capital goods imports have been lagging behind, but it is partly an artefact of inflation differentials
Import growth
Raw materials ex. oil/gas
Consumer goods
Capital goods
Capacity utilization and recruitment was near-normal before Delta hit, and may bounce back even stronger
Capacity utilization
Prices sold
Labor recruitment
Manufacturing PMI
Manufacturing sectors have actually seen an increase in investment during the pandemic
Corporate Indonesia (by and large) retains healthy balance sheets, paving the way for future expansion
YoY growth
Debt/equity ratio
Quick ratio
Profit margin
Despite large scarring effects on a few sectors, most industries are on track towards recovery
The massive dose of stimulus given to the global economy may fuel a decade-long boom, but it may just as well lead to a compressed global monetary/business cycle whereby the sugar rush quickly turns into a hangover – if the flattening UST yield curve ( a prospect of coming recession) is any guide. Indonesia's luck with high commodity prices may not last, and it has been clear for some time now that it needs to upgrade its economic capabilities to export more complex products with higher added value. The problem is, as much as Indonesia currently tops the short-term invulnerability league table (Exhibit 4), it languishes when it comes to the long-term productivity table (Exhibit 29 – bottom panel).
The first component, infrastructure, is delayed, partly due to the pandemic, while the sudden rise of climate issues calls into question the coal energy master plan that the government had pursued. In the field of foreign direct investment, the government made a major breakthrough in 2020 by advancing the Job Creation Act, which, among other things, addresses key issues related to labor-employee relations. But the law has recently been declared (conditionally) unconstitutional by the Constitutional Court, forcing the government to make the necessary changes within two years or risk having the law overturned altogether – even if the law and the resulting regulations remain in force. place for now.
Around the same time, the issue of the minimum wage — which has receded from view in recent years — is rekindling thanks to Jakarta Mayor Anies Baswedan's decision to raise it much faster than predetermined Job-based formulas. The Law of Creation. But Indonesia's low labor productivity growth, especially relative to its wage growth (Exhibit 30-bottom panel), undermines its competitiveness in this regard. One piece of evidence is Indonesia's rather low ranking as a future sourcing option for fashion companies from the US (Exhibit 31) - fashion/.
It appears that targeted industrial policies aimed at developing downstream industries ("downstreaming") from Indonesia's exports - e.g.
Indonesia has the potential to diversify away from low-complexity (commodity) exports …
Complexity Outlook Index (COI)
Economic Complexity Index (ECI)
Indonesia had seen rapid increase in wages relative to labor productivity during the past decade …
Labor compensation
Labor productivity
Do you intend to increase sourcing from the following
Repo Rate
This is what we call a "moderately prudent" scenario: assuming a moderately favorable global environment and prudent macroeconomic policies that seek to optimize the trade-off between growth and vulnerability. This translates into a modest weakening of the Rupiah's fundamentals to around 14,660 (year-end) against the USD. Note that while this is a step back from the massive surpluses of H2-21, it is still a historically large surplus, in line with what we had in 2011 and between Q3-20 and Q2-21.
This will probably result in a narrow CA profit of around DKK 1.1 billion. USD or 0.08% of GDP. Thanks to Indonesia's reduced vulnerability, BI may only need to raise rates by an additional 50-100bps over our baseline forecast – rather than the steep 175bps hikes we saw in both 2013 and 2018. The risk of such an event is likely to be highest in H1-22, and it is also somewhat inconsistent with the global cooling scenario.
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