Executive summary
After two decades of sustained, steady growth, the pandemic triggered a “perfect storm”. GDP contracted in 2020 and some of Indonesia’s vulnerabilities have come to the fore, although unprecedented policy interventions have circumscribed the damage.
The 2020 recession was widespread. Most sectors were hit, while uncertainty over the evolution of the pandemic and depressed confidence held back investment and consumption, with few exceptions such as ICT and healthcare services. Subdued global demand weighed on commodities sectors, notwithstanding improvement in the second half. Construction was also affected, with delays in infrastructure projects.
The social fallout is severe. Formal employment is shrinking, and the crisis is disproportionally hitting vulnerable groups such as informal workers, internal migrants, women and children. Government policies aim at reducing scarring effects and improving the skills of the population.
The healthcare system was put under stress but collapse was avoided. Extra efforts were made to deal with the COVID-19 outbreak and the system proved more resilient than expected, although the number of deaths for monitored patients, as well as among doctors and nurses, is high and the contract tracing system is still rudimentary. The migration of health professionals is also a cause of concern. Moving forward, it is important to continue the fight to eradicate other diseases like tuberculosis, dengue fever and malaria, which remain rampant.
The recovery will be gradual, with considerable downside risks. With no clear signals that the virus is receding, uncertainty surrounds the definitive withdrawal of all prevention and mitigation measures and the successful roll-out of the free vaccination programme. Despite the increasing reliance on e-commerce, private consumption will take time to return to pre-crisis levels due to income losses. Investment growth is set to remain soft, although the new Omnibus Bill for Job Creation is expected to improve the business climate. Sluggish global trade growth will also take its toll.
Fiscal policy has been expansive despite formal constraints. The ceiling on the deficit (3% of GDP) has been temporarily suspended. Slow disbursements limited the initial impact of the 4.3% of GDP fiscal stimulus in 2020 but the situation later improved with an acceleration of spending. The OECD projects the deficit-to-GDP ratio to recede from 6.5% in 2020 to 5.7% in 2021. Further support in the medium term will depend on maintaining easy access to financial markets and raising tax revenue above current levels, which are insufficient.
Monetary policy remains accommodative. Bank Indonesia cut its policy rate five times in 2020 and then again in February 2021, by 150 basis points in total, while quantitative easing and a range of macro-prudential measures were activated to increase liquidity. Inflation is projected to remain low and accommodative monetary policy, accompanied by forward guidance, should continue.
The central bank engaged in a “burden-sharing” scheme with the government. Bank Indonesia bought government bonds directly, bearing the interest cost. The action was consistent with the central bank’s macroeconomic stabilisation mandate and appropriate safeguards were in place. Going forward, it will be important to maintain clarity regarding the boundaries between fiscal and monetary policy and preserve the independence of Bank Indonesia.
Some financial indicators warrant attention. Market stress was at its highest in March 2020. It has since receded but corporates’ foreign currency debt is a risk to financial stability. Despite recent currency strengthening, the spreads over global benchmarks have yet to return to pre-crisis levels. The narrowing of the current account deficit is a positive signal insofar as reduces vulnerability, but investor sentiment towards emerging markets remains fickle and any sudden deterioration may trigger a vicious depreciation/inflation cycle and hinder market access.
Progress in reducing poverty is at risk. Poverty has declined since the turn of the century but started to edge up even before the pandemic hit (Figure 2). Consumption patterns, notably for durable goods, testify to the rise of the middle class. Nonetheless, only a third of Indonesians are economically secure and in urban areas three out of ten live in slums. Poverty remains widespread in rural areas and youth unemployment is the highest in Southeast Asia. Over 26 million people (9.8% of the population) were considered poor when the country started to suffer from the pandemic, which could push up to 10 million more individuals into poverty.
Source: BPS.
State-owned enterprises (SOEs) are assigned a central role in transforming Indonesia into a developed economy. SOEs enjoy favourable operational conditions, but their performance is uneven and their rising leverage represents a hidden fiscal risk.
Even short of large-scale privatisation, there is room for SOE reform. Corporate governance should be improved and boards and management shielded from government interference. The creation of holding companies at the sector level may bring benefits, provided operating companies are given a clear mandate and their financial reporting is transparent.
Trade intensity has diminished and exports remain concentrated in natural resources. Although commerce is increasingly with the rest of Emerging Asia, Indonesia only modestly participates in regional value chains and foreign investors are discouraged by high regulatory barriers and legal uncertainty.
Important and comprehensive agreements open new opportunities. The Regional Comprehensive Economic Partnership, the Indonesia-Australia Comprehensive Economic Partnership Agreement, and possible agreements with the European Union and EFTA will ease the flow of goods, services, investment and people between Indonesia and some of its major partners. Preferential market access is a potential boon for exporters that must be complemented by progress in trade facilitation, product quality and other areas.
Despite progress in transport infrastructure, shortfalls in safety and logistics remain. Road and sea transport fatalities are among the highest in Asia and so are logistics costs. Filling infrastructure gaps to make the most of globalisation requires significant financial resources that should be increasingly sought from private investors, including from abroad. The new sovereign wealth fund can play a facilitating role.
Achieving the Nationally Determined Contribution to the Paris Accord and the Sustainable Development Goals requires ambitious policies to mobilise additional financial and technological resources.
Land use and deforestation contribute to make Indonesia one of the world’s largest emitters of greenhouse gases. The largest mitigation potential may come from extending the moratorium policy on the clearing and conversion of primary forest and peatlands and widening it to include secondary forests.
Decoupling greenhouse gas emissions from economic growth and fulfilling emission reduction targets for 2030 are tough challenges. They require investments in public transport and low-emission technologies and improvements in energy efficiency, to fight air pollution especially in Jakarta and its satellite cities. In many locations, inland and by the sea, pollution from plastic waste is a major challenge. In the post-crisis phase, government and business actions carry the potential to accelerate the green transition.
Demography has been supportive but the window is about to close.
Indonesia has enjoyed a “demographic dividend”, supporting the growth of GDP per capita. The share of the working age population is expected to peak in 2021, remain broadly stable for ten years, and then gradually decline.
Growth objectives for the next 25 years are particularly ambitious. Over the medium term, the 2020-24 Plan aims at achieving GDP growth between 5.4% and 6%, with the long-term goal of making Indonesia a developed country by 2045 – the centenary of Independence.
Educational attainment has improved considerably in the past two decades, but COVID-19 has increased the risk of absenteeism and drop-out. Improved public spending efficiency and starting school earlier could raise educational attainment and learning performance. Greater ICT investment would help reap the benefits of digitalisation.
Skills shortages are many and concern both current and future needs. The importance of securing adequate skills will increase as the economy becomes more knowledge-based. Vocational education and lifelong training should be further promoted to upskill and reskill the workforce, with an enhanced role for social partners.
Increasing employment is crucial to anticipate the end of the demographic dividend. Higher participation is needed from women, internal migrants, diaspora returnees, foreign workers, and disadvantaged groups.
Employment legislation reform aims at helping jobseekers. The recently-approved Omnibus Bill for Job Creation encourages hiring in the formal economy, diminishes firing costs and introduces a risk-based system for authorising environment-sensitive projects. Implementing regulation will be crucial to achieve desired outcomes and should be elaborated in consultation with relevant stakeholders.
Fostering competition, simplifying business regulations and modernising the financial sector would boost productivity. Many anti-competitive measures stymie entrepreneurship. There is scope to improve the regulatory framework, for instance by removing unnecessary restrictions on the entry of foreign multinationals.
Corruption remains a major issue. The overhaul of the national anti-corruption agency presents new challenges and its independence should be preserved. With considerable financial resources earmarked for the recovery, it is important to apply strict public procurement norms and practices.