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Indonesia Economic Quarterly Update Continuity amidst volatility Shubham Chaudhuri Lead Economist World Bank 23 June 2010 Jakarta Indonesia What I’ll be talking about CONTINUITY: Indonesia’s economy continues to perform well… Quarterly GDP growth has continued in line with decade-averages Inflation continues to be subdued …and the fiscal position continues to be strong …AMIDST VOLATILITY: Financial markets have been more volatile because of developments in Europe …and commodity prices have continued to be volatile …AND THE CONTINUING CHALLENGES this implies Indonesia is more exposed than many other economies to global financial market and commodity price volatility Commodity price movements matter for Indonesia Understanding Indonesia’s high lending rates, interest spreads and NIMs Continuity… GDP growth remains robust… Indonesia’s economy continued to grow at a trend rate in Q1, driven by strong investment growth Economy expanded by 1.3% QoQ in Q1, or by 5.7% YoY A record drop in government consumption was offset by strong investment and private demand growth Indonesia’s major trading partners also continued to recover in Q1 Indonesian GDP growth 4 Per cent Per cent 8 Year on year (RHS) Per cent Per cent 8 3 6 2 4 1 2 0 0 6 QoQ seas. adjust (LHS) Average (LHS)* 1 4 2 0 Mar-03 4 YoY Growth (RHS) 3 2 Major Trading Partner GDP growth Quarterly Growth (sa, LHS) -1 -2 -2 -4 -3 -6 0 Dec-04 Sep-06 Jun-08 Mar-10 Sources: BPS via CEIC, World Bank Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Continuity… …and domestic indicators remain strong Other economic indicators have remained stable at high levels Consumer indicators are near record highs Industrial indicators are strong 120 BI Retail sales (RHS) 800 '000 80 150 60 110 30 600 60 400 Mar-07 Mar-08 Per cent, yoy Mar-09 Mar-10 Per cent, yoy Industrial Production 20 30 20 10 10 0 0 40 200 Motor vehicles (RHS) 20 -10 -20 0 Apr-06 230 190 80 Motor cycles (LHS) BI Consumer Survey Index (LHS) 100 Mar-06 '000 Index Index -10 Cement Electricity -20 0 Apr-07 Apr-08 Apr-09 Apr-10 -30 Mar-07 Sources: CEIC, World Bank -30 Dec-07 Sep-08 Jun-09 Mar-10 Continuity… …and mainly based on consumption and services Private consumption and services continued to contribute the most to GDP growth… 4 Percentage pont Q4 Percentage point Q1 4 Q4 Priv. cons. 0.6 0 Discrepency (incl. stocks) 0.4 0.2 0.6 Agric. Manufacturing Mining & construct Other 0.4 0.2 -2 Gov't. cons. 0.0 0.0 Comms. & transport Imports -4 0.8 Retail trade 2 0 1.0 Q1 0.8 Investment -2 Percentage point Percentage point Exports GDP 2 1.0 -4 Sources: BPS via CEIC, World Bank -0.2 -0.2 Continuity… ...as has been the case over the last decade …Private consumption and services continued to contribute the most to GDP growth 12 Percentage point Percentage point Net exports Stocks & Discrep. Investment Government Priv Cons GDP 12 8 Percentage point Percentage point Services Mining GDP 8 Industry Agriculture 8 6 6 4 4 4 4 0 0 2 2 0 0 -4 -4 8 1993-95 2000-05 2006 2007 2008 2009 Sources: BPS via CEIC, World Bank 1993-95 2000-05 2006 2007 2008 2009 Continuity… Inflation continues to track historic lows… Though headline inflation picked up slightly in May to 4.2% YoY… …core inflation remained near decade lows, at 3.8% in the year to May The rise in headline inflation was mainly driven by food prices, which were the only component of CPI to grow above historical averages in the first 5 months of 2010… …while core inflation remained low due to low capacity utilization levels and appreciation of the rupiah, which limited imported inflation Inflation is expected to pick up in the 2nd half of 2010, as demand and credit growth continue to recover, and administered prices are moved closer to economic costs 4 Per cent Per cent Inflation YoY (RHS) 3 16 12 Core Inflation (RHS) 2 8 1 4 0 0 Inflation MoM (LHS) -1 May-07 Source: BPS -4 May-08 May-09 May-10 Continuity… …and the fiscal position remains strong …with Indonesia continuing to set a global record pace in reducing its public debt-to-GDP ratio Indonesia 80 Percent to GDP Percent to GDP 80 External Debt/GDP 2009 70 60 60 50 Vietnam India Malaysia 40 Thailand Indonesia 30 40 30 20 2008 50 Korea 10 Domestic Debt/GDP 70 Philippines 2007 2006 20 China 10 0 2005 0 2005 2006 2007 2008 2009 0 10 20 30 40 50 60 Percent Continuity… …with continuing modest budget deficits… The revised 2010 budget approved by the DPR targets a deficit of 2.1% of GDP 2010 budget revision (IDR Tln) Transfers Others Social Revised Proposed Revised Subsidies Budget Int. payments Capital Materials Personal 0 50 100 Sources: BPS via CEIC, World Bank 150 200 250 300 350 Continuity… …which may come in even lower than targeted… Alternative projections of revenue and projected weaker disbursement suggest the budget deficit will be significantly smaller than current government projections, about 1.0% of GDP in 2010 and as low as 0.4% in 2011 Per cent 35 Per cent 30 30 Tax revenue growth Forecasts 25 25 20 20 15 15 10 10 Nom. economic growth (GDP deflator) 5 The pickup in commodity prices is likely to support slightly stronger government revenue growth in 2010 The choice of price measure for nominal growth (deflator versus CPI) has a significant impact on revenue projections By the end of Q1 2010, only 5 percent of allocated capital expenditure has been spent compared with 10 percent in 2009 35 5 Nominal economic growth (CPI) 0 0 -5 -5 2001 2003 2005 2007 2009 2011 Q1 actual spending vs revised budget (APBN-P) (%) 25 2008 2009 2010 20 15 10 5 0 Personal Materials Capital Sources: BPS via CEIC, World Bank Int. Subsidies Social payments Others Total CG Transf. Total Continuity… …if we use the GDP deflator as a price gauge Nominal GDP calculated using the GDP deflator instead of CPI leads to significant reductions in the budget deficit The national accounts implicit price deflators offer a broader measure of prices than the CPI The relationship between the CPI and economy-wide prices in Indonesia weakened after 2004, largely due to an acceleration in investment prices that was not captured by the CPI… …but was captured by the GDP deflator, which as a result has a closer correlation with overall prices in Indonesia As a result, using the GDP deflator rather than CPI improves the forecast of government tax revenues 2010 0.0 2011 0.0 -0.5 -0.5 -1.0 -1.0 -1.5 -1.5 WB projections with slower (CPI) inflation WB projections APBN projections -2.0 -2.5 Per cent of GDP Per cent of GDP -2.0 -2.5 Continuity…. The outlook remains broadly positive Outlook remains for gradual pick-up in growth Continued strong private domestic demand and investment are expected to drive growth, offsetting any drag from imports outpacing exports A slowdown in major trading partner growth should not impact Indonesia too much Inflation is expected to accelerate in second half of 2010 on solid domestic demand, credit growth, a more stable exchange rate and rising commodity prices 2009 2010 2011 Gross domestic product (Annual per cent change) 4.5 5.9 6.2 Consumer price index (Annual per cent change) 4.8 5.1 6.3 Balance of payments (USD bn) 12.5 6.1 5.1 Budget balance (Per cent of GDP) 1.6 1.0 0.4 -0.9 5.0 4.3 Major trading partner growth (Annual per cent change) Sources: BPS, CEIC, World Bank. World Bank projections …amidst volatility Downside Risks have Increased External factors have increased risks to the outlook… Weak demand from OECD economies due to debt crisis could slow down recovery in Indonesia’s MTPs Increased risk aversion due to debt crisis could increase financial market volatility and capital outflows Ongoing commodity price volatility could affect real economy forecasts and the budget …some of which call for the immediate attention of policy makers: Addressing large capital inflows and outflows Implementing policies to reduce vulnerability to commodity price shocks …amidst volatility Capital outflows pushed markets down in May Indonesian equities and bonds weakened in May due to large capital outflows that also put the rupiah under pressure Increased risk aversion due to European events triggered $5.7bn of net foreign capital outflows in May, 90% of this in SBI sales The JCI fell by 5.5% on the month, yields on five year IDR sovereigns rose by 50 basis points, and Indonesian EMBI USD bond spreads widened by 100 basis points. The rupiah weakened by 1.8% against the USD 45,000 IDR billion IDR per USD 25,000 8,000 9,000 90000 IDR billion IDR billion 75000 Net Foreign Purchases of SBI (RHS) 60000 5,000 -15,000 -35,000 45000 30000 15000 10,000 Net Foreign Capital Inflows (LHS) IDR/USD (RHS) 45000 0 30000 -15000 11,000 12,000 15000 13,000 0 IDR Appreciation -55,000 Jan-07 Mar-08 Apr-09 May-10 -30000 Foreign holdings of SBI outstanding (LHS) Jan-07 Mar-08 -45000 Apr-09 May-10 …amidst volatility Financial markets vulnerable to capital outflows After a record month of $4bn of net capital inflows in April, May’s $5.7bn in net capital outflows demonstrated Indonesia’s vulnerability to volatile capital flows Compared to late 2008, Indonesia’s financial markets are more exposed now to a sudden reversal of capital flows due to the high percentage of foreign holdings of equities, bonds and SBIs Reserves fell by $4bn in May as BI bought rupiah to smooth out exchange rate volatility caused by capital outflows 90% of the outflows were SBI sales; new BI policies may help stem some of this going forward Capital Inflows in prior 12 months Foreign Holdings of Bonds 80000 Financial sector is more vulnerable to a sudden reversal of capital flows Short-Term Debt* Total FX Reserves May 2010 ...but short term external leverage is little changed 9500 60000 Total Reserves (LHS) 40000 IDR/USD (RHS) 10500 11500 ...and the reserves cushion is deeper IDR Appreciation USDbn 0 100 200 * For 2010, short-term debt and corporate external short term debt reflect March numbers 8500 Sept 2008 Foreign Holdings of Stocks Corporate External ST Debt* IDR per USD USD million 20000 Jan-07 12500 Nov-07 Sep-08 Jul-09 May-10 …and some challenges this implies Indonesia particularly exposed to global volatility Open capital account, relatively large presence of non-resident investors in local financial markets Importance of commodity prices for Indonesia’s economy Share (%) of commodities in exports Reasons Annual 70 1. Share of aggregate value added 26% 2. Share of total exports 63% 3. 14% Share of GDP Per cent Per cent 70 60 60 50 50 4. Share of total im ports 34% 40 40 5. 6% 30 30 6. CPI w eight (raw foods, h/hold energy) 48% 20 20 7. 74% 10 10 8. Share of total Governm ent revenues 23% 0 0 9. 8% Share of GDP Poverty Basket CPI Share of tax revenues 10. Market capitlisation of Com m odity shares on IDX* 18% …and some policy challenges Real economy, budget vulnerable to commodity price shocks Volatility of commodity prices affects real economy and price forecasts in Indonesia as well as budget projections consider 3 scenarios of commodity price shocks on the economy (+30%, +15% and -15%) We found commodity price movements have a large impact on prices, and a more subdued impact on the real economy The poverty rate declined slightly with an increase in commodity prices 2010 2011 -15% Baseline 15% Exports 14.3 15.0 15.6 Im ports 18.7 18.3 Trade Balance 14.3 GDP -15% Basline 15% 16.2 10.5 11.1 11.7 12.3 17.9 17.5 11.9 11.6 11.4 11.2 14.2 13.6 13.2 16.7 13.2 9.1 5.3 5.8 5.9 6.0 6.1 6.1 6.2 6.4 6.5 GDP Deflator 9.3 9.3 9.9 10.2 11.5 12.2 13.2 13.9 Nom inal GDP 15.7 15.9 16.5 16.9 18.3 19.2 20.4 21.3 CPI 5.0 5.1 5.3 5.5 6.0 6.3 6.5 6.7 Core inflation 4.2 4.3 4.5 4.7 5.8 6.0 6.1 6.3 Poverty CPI 6.5 6.8 7.1 7.4 6.8 7.2 7.5 7.8 Poverty rate 13.2 13.0 12.9 12.8 12.4 12.2 12.0 11.9 Sources: World Bank 30% 30% …and some policy challenges High lending rates, NIMs may stifle investment Indonesia has the highest NIMs in the region, driven by high lending rates 10 8 High and volatile historical inflation and bond yields increase the risk premium lenders charge on loans 4 A deeper financial sector with a more competitive market structure, lower inflation volatility, improved corporate reporting, and higher bank-level efficiency could help reduce rates and NIMs going forward 18 Lending Rates (RHS) High deposit-side competition but low lending competition for banks in Indonesia leads to high deposit and lending rates, as well as NIMs Micro-level inefficiencies such as high operating costs combined with the noncompetitive market structure may also contribute to higher NIMs Percent Percent 14 Deposit Rates (RHS) Net Interest Margin (LHS) 6 10 BI Policy Rate (RHS) 2 6 2 Jan-06 Nov-06 Sep-07 Jul-08 May-09 Mar-10 2006-2010 Average Lending Rate Indonesia Philippines Deposit Rate Thailand Malaysia 5yr yield CPI Percent 0 5 10 15 20 Indonesia Economic Quarterly Update Continuity amidst volatility Shubham Chaudhuri Lead Economist World Bank 23 June 2010 Jakarta Indonesia