INDONESIA - OECD.org

1 3. DEVELOPMENTS IN INDIVIDUAL OECD AND SELECTED NON-MEMBER ECONOMIESOECD ECONOMIC outlook , VOLUME 2018 ISSUE 2 PRELIMINARY VERSION OECD 2018131 INDONESIAE conomic growth is projected to remain above 5% in 2019-20. Rising incomes will liftprivate consumption. Tighter financial conditions will weigh on firms investment butongoing infrastructure investment will provide support. Slower growth in tradingpartners will be a drag on exports, but improvements in regulations and connectivity,along with greater price competitiveness from currency depreciation, should supportgains in market share. Inflation is set to remain relatively subdued notwithstanding therupiah depreciation and higher fuel prices.

2 Higher import prices have widened thecurrent account INDONESIA has raised interest rates by 175 basis points since mid-May tocontain capital outflows. Further pre-emptive tightening is projected as US interest ratesrise. The budget deficit is set to narrow slightly. Reforms to improve the efficiency ofspending, shift social assistance towards targeted transfers and further lower costs ofdoing business would support inclusive economy is growing at a healthy paceConsumption growth has picked up, thanks to ongoing job creation and expandinggovernment social programmes. Confidence indicators have edged down most recently butstill point to continued growth. Low headline inflation, at around 3%, is also supportingreal income growth.

3 Core inflation is also low and administered energy prices are frozen for2018-19. Investment growth has eased from high levels but remains supported byinfrastructure have grown faster than export markets. Increased imports of capital goodsand higher oil prices pushed the trade balance into deficit during 2018. Consequently, thecurrent account deficit has widened but it remains moderate, at of GDP in the firstthree quarters of The Manufacturing Purchasing Managers Index is a survey-based leading indicator. An index above 50 indicates an overall increaseand below 50 an overall decrease in economic :CEIC; Markit; and OECD Economic outlook 104 2 balance, Net balance, Consumer confidence Manufacturing PMI Household and firm sentiment remains positive 1001020 10 505101520201320142015201620172018 Y o y % changesExport volumesExport marketsExports have grown faster than export markets3.

4 DEVELOPMENTS IN INDIVIDUAL OECD AND SELECTED NON-MEMBER ECONOMIESOECD ECONOMIC outlook , VOLUME 2018 ISSUE 2 PRELIMINARY VERSION OECD 2018132 Monetary and fiscal policies are prioritising stabilityIn the course of 2018, capital outflows have pushed up bond yields and lowered equityprices, tightening financial conditions. Yields on US-dollar-denominated debt have beendriven higher by rising US interest rates, but the spread for Indonesian debt has widened onlyslightly. Rupiah depreciation adds to the cost of servicing foreign-currency-denominated the coal price is high, palm oil and rubber prices have :Demand, output and prices1 2 &XUUHQW SULFHV ,'5 WULOOLRQ*'3 DW PDUNHW SULFHV 3 ULYDWH FRQVXPSWLRQ *RYHUQPHQW FRQVXPSWLRQ *URVV IL[HG FDSLWDO IRUPDWLRQ )]

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6 DEVELOPMENTS IN INDIVIDUAL OECD AND SELECTED NON-MEMBER ECONOMIESOECD ECONOMIC outlook , VOLUME 2018 ISSUE 2 PRELIMINARY VERSION OECD 2018133 Bank INDONESIA has raised policy rates by 175 basis points since mid-May to stem capitaloutflows. So far, bank lending rates which are high relative to deposit rates are littlechanged, thereby limiting the effect of this tighter monetary policy on the domestic , Bank INDONESIA will likely need to increase interest rates during the projection periodas US interest rates rise. Allowing additional gradual rupiah depreciation would reduce thesteepness of the required policy tightening. Bank INDONESIA has also been introducing newfinancial instruments to facilitate hedging, including a new overnight benchmark interest rateand interest rate swaps.

7 Additional financial market deepening would enhance fiscal deficit is projected to narrow, which will widen the buffervis- -visthe3%-of-GDP deficit cap and reduce borrowing. Improving the effectiveness of publicspending could support growth. The international oil price has increased since the lastbudget but further increases in the subsidy for diesel should be resisted to avoid crowdingout other spending. Restarting energy subsidy reform would free up additional funds forbetter targeted social assistance. More cost-reflective fuel prices would lower fuel demand,curbing imports and improving environmental outcomes. Improving tax compliance, byinvesting in tax administration, would help fund infrastructure and social government has announced a range of measures to curtail imports, including:mandating increased use of biodiesel and hiking withholding taxes on 1 147 importedgoods (mostly consumer goods).

8 Boosting exports by streamlining regulations andreducing port waiting times, for example, would better support the reform momentum could make the economy more resilient andinclusive amid rising global trade tensions. Continuing to reduce the cost of doingbusiness, fight corruption and relax the negative investment list would help attract foreigndirect investment. The new Online Single Submission system for licensing is welcome andshould be improved based on user feedback. Experimenting with relaxed employmentregulations and a discounted minimum wage for youth in special economic zones couldincrease formal will remain solidGDP growth is projected to remain above 5% in the next two years. Income growth willsupport a pick-up in consumption growth.

9 Investment growth is expected to remainrobust, partly due to infrastructure investment projects that are already underway. Slowingtrading partner growth will increasingly weigh on exports. Nonetheless, recent exchangerate depreciation will curb imports and improve export competitiveness, supportingoutput growth and helping to narrow the current account deficit. Earlier improvements toregulation and infrastructure will also support export growth. Higher import prices,including for oil, will likely increase inflation somewhat. Nonetheless, inflation is projectedto remain inside the target band, which in 2020 will be lowered to between 2% and 4%.A key downside risk to the projections is that capital outflows intensify, which wouldlead to further depreciation and likely require tighter monetary policy.

10 Domestic demandwould be softer if banks passed on more of the policy interest rate hikes to lending INDONESIA is less integrated in global value chains than other countries in theregion, heightened trade tensions would slow growth through lower exports as well asindirectly via sentiment and commodity prices. A decline in oil prices would ease costpressures, boost growth and narrow the current account deficit. Conversely, a rebound inthe prices of commodities that INDONESIA exports would raise incomes.