91560 July 2014 Hard choices INDONESIA ECONOMIC QUARTERLY Hard choices July 2014 Preface The Indonesia Economic Quarterly (IEQ) has two main aims. First, it reports on the key developments over the past three months in Indonesia’s economy, and places these in a longer- term and global context. Based on these developments, and on policy changes over the period, the IEQ regularly updates the outlook for Indonesia’s economy and social welfare. Second, the IEQ provides a more in-depth examination of selected economic and policy issues, and analysis of Indonesia’s medium-term development challenges. It is intended for a wide audience, including policymakers, business leaders, financial market participants, and the community of analysts and professionals engaged in Indonesia’s evolving economy. The IEQ is a product of the World Bank’s Jakarta office and receives editorial and strategic guidance from an editorial board chaired by Rodrigo Chaves, Country Director for Indonesia. The report is compiled by the Macroeconomic and Fiscal Management Global Practice team, under the guidance of Shubham Chaudhuri, Practice Manager, Ndiame Diop, Lead Economist, and Ashley Taylor, Senior Economist. Led by Alex Sienaert, Country Economist, and with responsibility for Part A, editing and production, the core project team comprises Arsianti, Magda Adriani, Masyita Crystallin, Fitria Fitrani, Ahya Ihsan, Yus Medina, Elitza Mileva (Part A lead), Michele Savini Zangrandi and Violeta Vulovic, with additional editing by Peter Milne. Administrative support is provided by Titi Ananto. Dissemination is organized by Farhana Asnap, Indra Irnawan, Jerry Kurniawan, Desy Mutialim and Nugroho Sunjoyo, under the guidance of Dini Sari Djalal. This edition of the IEQ also includes contributions from Alex Sienaert (Section B.1, ICP 2011), Magda Adriani, Mubariq Ahmad, Iwan Gunawan and Paul van Howagen (Section B.2, forest fires and El Niño), Vivi Alatas, Edgar Janz and Matthew Grant Wai-Poi (Section C, inequality). Key data and input were received from Mark Ahern, Enda Ginting, Grace Hadiwidjaja, Amri Ilmma, Taufik Indrakesuma, Puguh Imanto, The Fei Ming, Liliana Olarte, Cindy Paladines, Anh Nguyet Pham, Carlos Pinerua, Astrid Rengganis Savitri, Djauhari Sitorus and Daim Syukriyah. The report also benefited from discussions with and in-depth comments from Ernest Bethe, Michael Brady, Jim Brumby, Cristobal Ridao-Cano, Werner Kornexl, Yue Man Lee, Azrin Rasuwin, Rinsan Tobing and George Henry Stirrett Wood. Thanks are due to Neil McCulloch and David Gottlieb of the Australian Department of Foreign Affairs and Trade for their contribution and comments on the inequality section, and Dody Ruswandi and Harmensyah (BNPB), William Sabandar (BPREDD), Dedi Hariri (WWF), Muhammad Evri (BPPT), Suwarsono (LAPAN), Paul Lemaistre (WRI), Rini Octavia, Muhammad Hanifuddin and Gita Febriyanti for their contributions to the forest fires section. This report is a product of the staff of the International Bank for Reconstruction and Development/The World Bank, supported by funding from the Australian Government under the Support for Enhanced Macroeconomic and Fiscal Policy Analysis (SEMEFPA) program. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent, or the Australian Government. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The photographs for the Executive Summary, section A (Arsianti) and C are copyright of the World Bank and section B is copyright of Dedi Hariri, WWF-Indonesia. All rights reserved. For more World Bank analysis of Indonesia’s economy: For information about the World Bank and its activities in Indonesia, please visit www.worldbank.org/id. In order to be included on an email distribution list for this Quarterly series and related publications, please contact madriani@worldbank.org. For questions and comments relating to this publication, please contact asienaert@worldbank.org. Table of contents PREFACE .................................................................................................................................3  TABLE OF CONTENTS .........................................................................................................4   EXECUTIVE SUMMARY: HARD CHOICES ....................................................................... I  A. ECONOMIC AND FISCAL UPDATE ............................................................................... 1  1.  Global financial market conditions have improved but commodity price softness remains ...................... 1  2.  Indonesia’s recent growth moderation has been led by weak net exports .................................................. 2  3.  Inflation has remained moderate, but there are upside risks....................................................................... 5  4.  Current account adjustment ongoing, portfolio inflows at a decade high .................................................. 6  5.  Indonesian asset prices strengthen but credit conditions tighten ..............................................................11  6.  The fiscal sector continues to be under pressure ....................................................................................... 13  7.  The pace of poverty reduction has slowed ................................................................................................. 20  8.  Fiscal risks have shifted into focus ............................................................................................................. 21  B. SOME RECENT DEVELOPMENTS IN INDONESIA’S ECONOMY ........................ 22  1.  El Niño, forest fires and haze: the imperatives for concrete action ........................................................... 22  a.  Underlying causes of recurring forest and land fires ............................................................................................. 22  b.  What the 2014 El Niño may bring .......................................................................................................................... 24  c.  The lesson from the February-March 2014 fires in Riau........................................................................................ 25  d.  The imperative for more, concrete action .............................................................................................................. 28  2.  New purchasing power parity-adjusted estimates of Indonesia’s economy ............................................. 29  a.  The results for Indonesia: a “Top 10” economy .................................................................................................... 29  b.  Limitations and what the new data do not tell us ................................................................................................... 31  c.  Implications for policymakers................................................................................................................................. 31  C. INDONESIA 2015 AND BEYOND: A SELECTIVE LOOK ........................................... 33  1.  Inequality and opportunity in Indonesia .................................................................................................... 33  a.  Overview: rising inequality matters to the people of Indonesia ............................................................................ 33  b.  Inequality in Indonesia is high and the gap between rich and poor is widening ................................................. 34  c.  Increasing inequality is being driven partly by higher wage and non-wage inequality........................................ 36  d.  Unequal opportunities during childhood also contribute to higher inequality .................................................... 38  e.  Lack of proper protection from shocks also makes it harder for households at the lower end of the distribution to climb up............................................................................................................................................................... 41  f.  Inequality can also lead to lower growth, slower poverty reduction, and more conflict ....................................... 43  g.  There is wide demand for action and a number of key policy messages are emerging ....................................... 44  APPENDIX: A SNAPSHOT OF INDONESIAN ECONOMIC INDICATORS ................ 46  LIST OF FIGURES Figure 1: There is a need to reinvigorate Indonesia’s growth and poverty reduction, and combat inequality ...................................................................................................................... I  Figure 2: Global commodity prices, especially metals, continue to decline .................................... 2  Figure 3: International sovereign borrowing conditions have improved, with further liquidity tightening deferred for now ......................................................................................... 2  Figure 4: Real GDP growth moderated further in 2014 Q1… ........................................................... 3  Figure 5: …driven by a small negative contribution from net trade ................................................. 3  Figure 6: A decline in mining and quarrying activity contributed to the growth slowdown on the production side ............................................................................................................ 4   Figure 7: High-frequency data provide mixed signals for Q2 .......................................................... 4  Figure 8: Price pressures remained contained in the second quarter of 2014 .................................. 6  Figure 9: A favorable harvest brought down domestic rice prices.................................................... 6  Figure 10: The current account remained stable, but the basic balance is still negative ................. 7  Figure 11: Import values continued to weaken, driven by capital goods and raw material ............. 7  Figure 12: Commodities were responsible for weakening exports… ............................................... 7  Figure 13: …with commodity volumes dropping by 17.3 percent yoy, driven by minerals ............. 7  Figure 14: Manufacturing exports are staging a modest comeback ................................................. 8  Figure 15: Decade-high portfolio inflows were driven by government borrowing and renewed appetite for EME assets .............................................................................................. 9  Figure 16: Increasing private external debt has driven much of the rise in gross external financing needs in recent years .................................................................................................... 9  Figure 17: Both export volume and price declines were observed for Indonesia’s major commodities in Q1 2014 ............................................................................................. 10  Figure 18: Provinces most exposed to the commodity sector recorded a significant slowdown in Q1 2014 ....................................................................................................................... 10  Figure 19: A slowdown in deposit growth has contributed to the weakening in credit growth ..... 12  Figure 20: Banks have not so far fully passed on the increase in domestic currency funding costs to borrowers ............................................................................................................... 12   Figure 21: Nominal revenue and expenditure growth have both slowed since mid-2012… .......... 14  Figure 22: …with declining revenue/GDP being the main driver of the larger budget deficit in 2013 ............................................................................................................................. 14  Figure 23: Weaker revenue growth is broad-based but importantly includes oil and gas revenue collection… ................................................................................................................ 14  Figure 24: … which has been impacted by the trend decline in oil production and fluctuations in the oil price................................................................................................................. 14  Figure 25: January-May 2014 saw improved non-oil and gas income tax growth and a weaker VAT performance ...................................................................................................... 15  Figure 26: The price gap between subsidized and market petrol prices remains elevated… ....... 16  Figure 27: …which will significantly increase fuel subsidy spending in 2014 ................................ 16  Figure 28: …reducing the current subsidy price gap and yielding sizable savings relative to a no- change scenario ......................................................................................................... 17  Figure 29: Key line ministries face significant budget cuts ............................................................ 17  Figure 30: For 2014 through May, disbursement of core government spending remains low ....... 18  Figure 31: The pace of poverty reduction in the last three years has been the slowest in over a decade… .................................................................................................................... 20   Figure 32: …and the latest August labor market data, for 2013, point to slowing employment growth ........................................................................................................................ 20  Figure 33: Satellite hotspot densities indicate the frequency of fires over 2001-10, by district ...... 23  Figure 34: Burned areas by land-use category in Riau ................................................................... 26  Figure 35: Indonesia’s economy is the tenth largest, measured on a PPP basis…........................ 30  Figure 36: …but per capita expenditure at PPP remains comparatively low ................................. 30  Figure 37: Inequality in Indonesia has been steadily rising since 2000.......................................... 35  Figure 38: Indonesia has experienced the second-fastest increase in inequality in the region after China .......................................................................................................................... 36  Figure 39: The richest households have seen much higher growth in consumption than poorer households ................................................................................................................. 37   Figure 40: Increasing consumption inequality is being driven partly by increasing inequality in labor incomes ............................................................................................................. 37   Figure 41: Wage and consumption premiums have been rising for highly educated workers ...... 38  Figure 42: Jobs increasingly require more education...................................................................... 38  Figure 43: There are stark differences in opportunities in life for children in Indonesia… .......... 39  Figure 44: …and major gaps in opportunity exist between rural children born into the poorest decile and urban children born into the richest decile ............................................. 39  Figure 45: Most rural children without access to health, education and transportation services are deprived on more than one dimension to a greater extent than urban children ...... 40  Figure 46: Children from poorer households start further behind in life, but the gap is closing .. 40  Figure 47: Opportunity gaps between urban and rural households are closing, but at a slower pace ............................................................................................................................ 40  Figure 48: Enrolment rates of children with less educated parents are converging… .................. 41  Figure 49: …and children born to parents with no education are achieving greater educational attainment .................................................................................................................. 41  Figure 50: 75 percent of poor households do not move out of poverty or vulnerability over a three year period.................................................................................................................. 42  LIST OF APPENDIX FIGURES Appendix Figure 1: Quarterly and annual GDP growth.................................................................. 46  Appendix Figure 2: Contributions to GDP expenditures ............................................................... 46  Appendix Figure 3: Contributions to GDP production................................................................... 46  Appendix Figure 4: Motor cycle and motor vehicle sales ............................................................... 46  Appendix Figure 5: Consumer indicators........................................................................................ 46  Appendix Figure 6: Industrial production indicators ..................................................................... 46  Appendix Figure 7: Trade volumes ................................................................................................. 47  Appendix Figure 8: Balance of payments........................................................................................ 47  Appendix Figure 9: Exports of goods .............................................................................................. 47  Appendix Figure 10: Imports of goods ............................................................................................ 47  Appendix Figure 11: Reserves and capital inflows .......................................................................... 47  Appendix Figure 12: Inflation and monetary policy........................................................................ 47  Appendix Figure 13: Monthly breakdown of CPI ........................................................................... 48  Appendix Figure 14: Inflation comparison across countries .......................................................... 48  Appendix Figure 15: Domestic and international rice prices.......................................................... 48  Appendix Figure 16: Poverty and unemployment rate .................................................................... 48  Appendix Figure 17: Regional equity indices.................................................................................. 48  Appendix Figure 18: Selected currencies against USD ................................................................... 48  Appendix Figure 19: 5-year local currency govt. bond yields ......................................................... 49  Appendix Figure 20: Sovereign USD bond EMBIG spread ........................................................... 49  Appendix Figure 21: Commercial and rural credit bank credit growth .......................................... 49  Appendix Figure 22: Banking sector indicators .............................................................................. 49  Appendix Figure 23: Government debt ........................................................................................... 49  Appendix Figure 24: External debt.................................................................................................. 49  LIST OF TABLES Table 1: Under the baseline scenario, Indonesia’s growth is projected at 5.2 percent in 2014 ..... III  Table 2: In the base case, GDP is expected to grow at 5.2 percent in 2014 and 5.6 percent in 2015 5  Table 3: In the base case, a current account deficit of 2.9 percent of GDP in 2014 is projected .... 11  Table 4: Electricity tariffs are rising significantly for most large user categories, bar low- consumption households… ....................................................................................... 17  Table 5: The World Bank has revised up its projection of the Budget deficit to 2.8 percent of GDP ............................................................................................................................ 19  Table 6: The estimated damage and losses of the forest fires in Riau, February-March 2014, reach USD 935 million ......................................................................................................... 27  Table 7: ICP 2011 key results for Indonesia..................................................................................... 31  Table 8: The richest 20 percent of households now account for nearly half of all consumption in household surveys ...................................................................................................... 35  Table 9: The composition of the richest quintile of income earners is relatively sticky; more mobility in other quintiles ......................................................................................... 37  LIST OF APPENDIX TABLES Appendix Table 1: Budget outcomes and projections .................................................................... 50  Appendix Table 2: Balance of payments ......................................................................................... 50  Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance ......................... 51  Appendix Table 4: Indonesia’s development indicators at a glance .............................................. 52  LIST OF BOXES Box 1: Recent challenges in Indonesia’s commodity export sector ............................................... 10  Box 2: Weak revenue performance has had a marked negative impact on the fiscal balance in recent years ................................................................................................................ 13  Box 3: Peat, peatland and peat fires ................................................................................................ 23  Box 4: El Niño and ENSO............................................................................................................... 25  Box 5: The challenge of measuring inequality and comparing across countries ........................... 35  Box 6: Main findings from new research on risk and risk management in Indonesia .................. 42  Hard choices Indonesia Economic Quarterly Executive summary: Hard choices The people of Indonesians voted for their next Figure 1: There is a need to reinvigorate Indonesia’s Indonesia, the world’s President on July 9. With official growth and poverty reduction, and combat inequality third most populous results expected by 22 July, the (real GDP growth, percent; poverty rate, percent; 0-100 scale Gini) democracy, have voted country is looking ahead to the 25 45 for a new President… inauguration of a new President in Inequality (Gini coefficient, RHS) October. 40 20 35 …who will take office Indonesia now faces hard policy facing hard choices choices. The past decade of solid 30 necessary to address growth has contributed to 15 25 rising fiscal pressures considerable development progress. Official poverty rate (LHS) and to implement Indonesia now has the world’s 10th 10 20 much-needed reforms largest economy in purchasing 15 to deliver on the power parity-adjusted terms, GDP (LHS) economy’s enormous according to recently-released 5 10 potential figures. However, there remains a 5 clear risk that the recent moderation in economic growth could intensify. 0 0 2000 2002 2004 2006 2008 2010 2012 2014 Against a backdrop of weakening revenue growth and rising energy Note: Poverty rates are March BPS estimates; 2014 GDP subsidy spending, this would further growth: World Bank projection; Gini data to 2013 constrain development expenditures Source: BPS; World Bank staff calculations in critical areas such as infrastructure, social protection and health. As highlighted in the World Bank’s recent 2014 Indonesia Development Policy Review (Avoiding the Trap), there is therefore a need for policymakers to make the hard choices over urgently needed policy reforms and investments and to follow through with their implementation to increase the level of sustainable growth, to reverse the recent deceleration in the rate of poverty reduction (Figure 1) and to ensure the broader sharing of prosperity with all Indonesians. J u ly 2 0 14 T HE W ORL D BA NK | BAN K DU NIA I Hard choices Indonesia Economic Quarterly The need for reform in The new Government will face an evolving global environment, as the tail winds of the past part reflects a changing decade – rising commodity prices and demand and low global financing costs – have waned. global economic However, in the near term, the global economy, after a slower-than-expected start this year, environment; hard is forecast to pick up speed. Most of the acceleration will come from high-income countries, choices need to be in particular the U.S. and the Euro Area. Stronger growth in advanced economies means made if the economy is higher demand for developing country exports, but only to the extent that they can compete to benefit from in global markets. At the same time, global financial conditions have improved so far this improving global year, with the delay in the tightening of monetary policy in advanced countries. However, demand and to adjust ongoing declines in commodity prices will cut into incomes and government revenues in to the continued commodity exporters like Indonesia. The price of Indonesia’s top six exports, accounting for softness of Indonesia’s 50 percent of total export revenues, continues to soften, falling by 8.6 percent in 2014 key commodity through June, led by coal (down 15.2 percent). The recent volatility of oil prices, due in part prices… to the turmoil in Iraq, highlights the ongoing vulnerability of Indonesia’s fiscal position to higher international oil prices. …as well as ensure that Real GDP growth in Indonesia moderated to 5.2 percent year-on-year (yoy) and 4.3 percent the continuing cyclical quarter-on-quarter at a seasonally-adjusted annualized rate (qoq saar) in the first quarter of moderation in 2014. In contrast to Q4 2013, when economic activity received a significant boost from net domestic growth does exports, domestic demand remained robust, while the net trade contribution to growth was not become structural negative. Temporary election-related consumption spending may have played a role in supporting domestic demand in the first quarter, along with the continued strength of construction investment. As discussed below, the World Bank’s baseline expectation remains for a moderate re-acceleration in economic growth through 2015, but without more policy measures to support investment and productivity growth the risks of a more structural deterioration in growth will mount. A stable Q1 2014 The overall current account deficit was stable, at 2.1 percent of GDP, in the first quarter of current account deficit 2014. However, Indonesia’s external adjustment process appears to have slowed. The partial has masked challenges mineral export ban, introduced in January, has caused a significant decline in export volumes. to the external This, coupled with weaker global commodity prices, has put export revenues under strain, adjustment process proving to be a continuing drag on the overall current account. A renewed, largely seasonal, widening in the current account balance is expected in the second quarter. External financing has been ample in 2014 to date, as portfolio capital inflows into Indonesia (and other emerging economies) have benefited from prolonged accommodative monetary conditions in advanced economies and a recovery in global risk appetite, lifting offshore investor holdings of domestic government bonds to a record high. Indonesian asset prices Partly due to the larger foreign capital inflows, Indonesian bond and equity prices have risen have picked up, but over 2014, recovering most of the losses incurred in the second half of last year. Bank bank credit conditions liquidity in local currency, however, remains relatively tight and is likely to result in a further have continued to decline in credit growth. At the same time, lower growth expectations may feed through into tighten a further weakening of credit demand. The World Bank’s 2014 Looking forward, lower government consumption than previously expected (following the growth outlook for 2014 Budget revision), slower credit growth and continued weakness in commodity-related Indonesia is revised income growth are likely to constrain GDP growth in the second half of 2014. In the base slightly down to 5.2 case, the World Bank projects real GDP growth of 5.2 percent in 2014, a small downward percent revision of 0.1 percentage points from the March 2014 IEQ forecast. The changes to the short-term outlook mainly reflect weaker-than-expected Q1 trade data. While economic adjustment to weaker terms of trade and the prospect of higher global interest rates is well underway, this is by no means complete. External pressures could yet re-emerge in the absence of a pronounced improvement in export performance, or due to weaker external financing inflows, if global risk appetite reverses. Additional downside pressure on growth could come from an intensifying credit contraction, if this results in further weakness in property prices, which in turn reduces real construction activity. J u ly 2 0 14 T HE W ORL D BA NK | BAN K DU NIA II Hard choices Indonesia Economic Quarterly Table 1: Under the baseline scenario, Indonesia’s growth is projected at 5.2 percent in 2014 2012 2013 2014p 2015p Real GDP (Annual percent change) 6.2 5.8 5.2 5.6 Consumer price index (Annual percent change) 4.3 6.9 5.8 4.9 Current account balance (Percent of GDP) -2.8 -3.3 -2.9 -2.4 Budget balance* (Percent of GDP) -1.9 -2.2 -2.4 n.a. Major trading partner real GDP (Annual percent change) 3.4 3.5 4.0 3.9 Note: * Government figures, realized (2012-2013) and approved Revised 2014 Budget balances Source: BI; BPS; Ministry of Finance; World Bank staff calculations The revised 2014 Responding to macroeconomic changes, subdued revenue growth, and rising energy subsidy Budget was approved costs, the Government proposed a substantially revised 2014 Budget. The deficit under the in the context of revised Budget approved by Parliament on June 18 was 2.4 percent of GDP, up from 1.7 increasing fiscal percent under the original Budget. Significant budget cuts of IDR 43 trillion for line pressures, resulting in ministries were approved, along with the postponement to 2015 of the payment of rising a higher fiscal deficit energy subsidy arrears of around IDR 50 trillion. Although further movement on the and gross financing politically-sensitive issue of fuel subsidy reform is still awaited, the Government has needs announced important electricity tariff adjustments. However, even with the announced cost- saving measures, World Bank macroeconomic projections suggest a larger fiscal deficit of 2.8 percent of GDP. This would be close to the legal 3 percent of GDP limit, and remains vulnerable to any further rise in oil prices or weakening in the Rupiah. The need to improve further the quality of spending and enhance revenue mobilization is therefore becoming critical if Indonesia is to achieve its development priorities. Progress in this area will be important to sustain investor confidence, helping to ensure that the Government’s additional financing needs are adequately met over the second half of 2014. One of the important Indonesia has made significant progress in reducing poverty over the past decade. However, priorities for fiscal with a slow-down in the pace of poverty reduction, alongside a rapid rise in wealth, the gap policy reform is to between the rich and the poor has grown. In 2002, the average consumption per person of support the the richest 10 percent of households was 6.6 times that of the poorest 10 percent; by 2013, inclusiveness of future this had risen to 10.3 times. This is a concern, first, because the rise in inequality reflects growth, mitigating the limited access to good job opportunities, and hence limits current growth and poverty trend of rising reduction. Second, it raises equity concerns, since all Indonesians should have access to the inequality seen in same opportunities. Third, rising inequality may also carry risks for future economic growth Indonesia in recent and social cohesion. With concerted action, Indonesia can arrest the rise in inequality, years including through “win-win” policies, which not only combat inequality, but also support poverty reduction, such as upgrading rural infrastructure, expanding access to quality education and improving labor market mobility. El Niño conditions Safeguarding hard-fought poverty reduction and social protection progress in Indonesia calls could worsen the for continuously enhancing the management of disaster risks and further building resilience. forthcoming forest fire This edition of the IEQ examines one such disaster risk: forest and land fires. Although “season”, posing an Indonesia has long experienced such fires, they have become increasingly regular and large- early challenge for the scale in recent decades, reflecting a complex interplay of natural and man-made factors. For new Administration, example, the severe fires in February-March 2014 resulted in significant environmental and calling for appropriate economic damage and losses, estimated at USD 935 million for Riau province alone. The contingency planning significant chance of El Niño conditions setting in towards the end of 2014 raises the risk that the next fire season will be severe, which could pose an immediate major challenge for the new Administration. Measures such as implementing a systematic approach to determining the start of the fire season and timely triggering of stand-by emergency status could play an important role in mitigating this risk. J u ly 2 0 14 T HE W ORL D BA NK | BAN K DU NIA III Hard choices Indonesia Economic Quarterly A. Economic and fiscal update 1. Global financial market conditions have improved but commodity price softness remains Emerging markets are After a weaker-than-expected start to 2014, the global economy is forecast to pick up speed to benefit from a pick- more or less in line with earlier expectations. Most of the acceleration will come from high- up in global demand income countries, in particular the U.S. and the Euro Area, supporting demand for and improved financial developing country exports. At the same time, global financial conditions have improved conditions, although further, with the delay in the tightening of monetary policy in advanced countries. However, non-energy commodity declines in commodity prices, especially metal prices, will cut into incomes and government prices remain soft revenues in commodity exporters like Indonesia, whose fiscal position will also be adversely impacted from recent rises in oil prices. Despite a first-quarter According to the World Bank’s June projections1, global economic activity is expected to setback, high-income expand by 2.8 percent this year, strengthening to 3.4 percent in 2015. In spite of the economy growth, as weather-related first-quarter weakness, the U.S. economy is gaining momentum and the well as import demand, Euro Area is strengthening as well. As a result, high-income country import demand growth is firming… is expected to more than double in 2014 to 4.2 percent from 1.9 percent in 2013, and rise further to 4.8 percent in 2015. The average GDP growth rate of Indonesia’s 13 major trading partners, weighted by export share, is forecasted at 4.0 percent in 2014 and 3.9 percent in 2015. Thus, the outlook for Indonesia’s exports – which are somewhat less focused on high income countries than some regional peers – remains unchanged for 2014 and is slightly down for 2015 compared with the March 2014 IEQ. … but, at the same Although overall global demand has been improving, its positive impact on Indonesia’s time, commodity exports has been offset by the continued decline in many global commodity prices, with the prices, in particular exception of crude oil. In the second quarter of 2014, among Indonesia’s main export metals, are falling commodities, the prices of coal, natural gas, rubber, copper and gold decreased considerably 1 World Bank, June 2014, “Global Economic Prospects – Shifting priorities; building for the future” http://www.worldbank.org/en/publication/global-economic-prospects. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 1 Hard choices Indonesia Economic Quarterly compared with both the first quarter of this year and the second quarter of last year (Figure 2). Crude palm oil prices declined in Q2 2014 relative to a quarter earlier as well. Base metal prospects, in particular, are dependent on the economic outlook of China, which accounts for almost 45 percent of global metal demand. At the same time, global oil prices rose between March and June 2014, with the Indonesian crude price up by almost USD 2. As a net oil importer, Indonesia’s terms of trade and fiscal position (through the large share of fuel subsidy spending) are likely to be negatively affected by the oil price increase. Global financial Finally, Indonesia and most other emerging market economies (EMEs) faced more benign conditions have international financing conditions in the first half of 2014 than expected earlier in the year. improved Investors now expect the accommodative monetary conditions in the US, Japan and Europe to remain in place for longer. Moreover, in June the European Central Bank introduced new credit easing measures to prevent deflation. In addition, the macroeconomic adjustment policies of many developing countries have reduced vulnerabilities, supporting capital inflows. Reflecting these factors, EME sovereign borrowing costs have fallen considerably since February, both because of declining high income benchmark yields and a compression in EME credit spreads (Figure 3). In the first quarter of 2014, Indonesia received the highest net portfolio inflows in a decade in USD terms (see Section 4). Figure 2: Global commodity prices, especially metals, Figure 3: International sovereign borrowing conditions have continue to decline improved, with further liquidity tightening deferred for now (index, January 2012 = 100, 3mma) (percent) 120 8 110 7 EMBIG yield LNG Brent oil 6 100 5 90 EMBIG spread Copper 4 80 Palm oil 3 70 2 60 Coal 1 US 10-year yield Rubber 50 0 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Note: LNG indicates liquefied natural gas (Japan import price) Source: JP Morgan Source: World Bank 2. Indonesia’s recent growth moderation has been led by weak net exports The cyclical Real GDP growth in Indonesia moderated to 5.2 percent yoy and 4.3 percent qoq saar in the moderation in growth first quarter of 2014 (Figure 4). This slowdown was in line with the path of macroeconomic has continued in 2014 adjustment projected in the March 2014 IEQ. However, in contrast to 2013 Q4, when Q1, as expected economic activity received a significant boost from net exports, in 2014 Q1 domestic demand remained robust while the net trade contribution to growth was slightly negative. Looking forward, lower-than-earlier-expected government consumption, on account of the revised Budget, slower credit growth and weaker commodity-related income growth are likely to constrain growth in the second half of 2014. Private consumption Domestic demand growth increased to 5.3 percent yoy in Q1 2014, from 5.1 percent in Q4 spending, likely partly 2013, and contributed 4.5 percentage points to overall GDP growth (Figure 5). Private boosted by election- consumption grew by 5.6 percent yoy and 5.8 percent qoq saar. The pick-up in growth from related spending, 5.3 percent yoy in Q4 2013 was caused by higher non-food consumption, which was likely supported growth in driven in part by temporary, election-related spending. Government spending in Q1 2014 2014 Q1… grew by 3.6 percent yoy, down from 6.4 percent in Q4. Gross fixed capital formation continued to grow at a relatively moderate pace of 5.1 percent yoy, up from the 4.4 percent J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 2 Hard choices Indonesia Economic Quarterly yoy in the previous quarter but still well below its 2010-2012 average of 8.8 percent yoy. Moreover, in sequential terms fixed investment growth decelerated somewhat: 3.9 percent qoq saar in Q1 2014 versus 4.4 percent in Q4 2013. Building investment growth remained robust, contributing 4.7 percentage points to year-on-year fixed investment growth. Spending on foreign transportation equipment continued to decline in year-on-year terms for a fifth consecutive quarter, while spending on foreign machinery and equipment registered positive growth for the first time in four quarters. Figure 4: Real GDP growth moderated further in 2014 Q1… Figure 5: …driven by a small negative contribution from net (real growth yoy and qoq saar, percent) trade (expenditure components’ contribution to real GDP growth yoy, percentage points) Statistical discrepancy* 9 Net exports 8 Gross fixed capital formation Year-on-year 14 Government consumption expenditure Quarter-on- 7 Private consumption expenditure quarter (saar) 12 6 Gross domestic product 10 5 8 4 6 3 4 2 2 0 1 -2 0 -4 Jun-10 Jun-11 Jun-12 Jun-13 Jun-10 Jun-11 Jun-12 Jun-13 Source: BPS; World Bank staff calculations Note: * Statistical discrepancy includes inventories Source: BPS; World Bank staff calculations … while net exports In contrast to Q4 2013 when net exports were the main driver of growth, in Q1 2014 the contributed negatively contribution of net exports to year-on-year growth was -0.1 percentage points (Figure 5). to growth in the same The growth rate of real exports of goods and services dropped markedly in the first quarter period of 2014, with a contraction of 0.8 percent yoy compared with growth of 7.4 percent yoy Q4 2013. Based on trade volume data, the decline in real exports in Q1 was due to lower coal exports as well as a virtual halt in the exports of ores, slags and ashes, consistent with the reported impact of the January partial ban on unprocessed mineral exports. At the same time, import volumes decreased by 0.7 percent yoy after declining by 0.6 percent in Q4. In line with the weaker From the production perspective, the mining sector contributed the most to the slowdown mineral exports, the in year-on-year real GDP growth in Q1 2014 (Figure 6). The contribution to year-on-year mining sector proved a growth of the other sectors of the economy remained broadly stable in Q1 2014. The weak drag on growth performance of mining and quarrying was expected, as the partial ban on unprocessed mineral exports took effect in mid-January 2014. The decline in mining output, together with the continuous weakness in commodity prices, has had markedly different impacts across Indonesian provinces, with the ones relatively more dependent on mining seeing the largest slowdown in provincial GDP growth (see Box 1). High-frequency A number of monthly economic activity indicators, such as the Bank Indonesia (BI) indicators continue to consumer confidence survey, the HSBC Purchasing Managers Index (PMI) for Indonesia, as provide mixed signals well as motorcycle and cement sales, point to a slight improvement in economic conditions in Q2 2014 (Figure 7). However, car sales declined significantly in April and May, likely on account of their higher sensitivity to the general economic slowdown as well as the Rupiah depreciation, compared with motorcycle sales for example. Overall, the high-frequency data do not provide a clear indication of the level of domestic demand in the second quarter of the year. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 3 Hard choices Indonesia Economic Quarterly Figure 6: A decline in mining and quarrying activity Figure 7: High-frequency data provide mixed signals for Q2 contributed to the growth slowdown on the production side (seasonally adjusted data, January 2013 = 100) (contributions to real GDP growth yoy, percent) Other Services BI consumer confidence Transport and Comms Cement sales Trade, Hotels and Restaurants Car sales 10 Construction 115 Motorcycle sales Manufacturing Mining & Quarrying 110 8 Agriculture GDP 105 6 100 4 95 90 2 85 0 80 Jun-10 Jun-11 Jun-12 Jun-13 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Source: BPS; World Bank staff calculations Source: CEIC; World Bank staff calculations The World Bank’s 2014 In the base case, the World Bank projects real GDP growth for Indonesia of 5.2 percent in growth outlook for 2014 and 5.6 percent in 2015. From a regional perspective, Indonesia’s expected 2014 Indonesia is revised performance is above the average of 4.7 percent for East Asia excluding China and down slightly to 5.2 Indonesia projected by the World Bank, while the 2015 figure is equal to the regional percent, with growth average (Global Economic Prospects, June 2014). The latest 2014 GDP growth projection projected to pick up to includes a downward revision of 0.1 percentage points from the March 2014 IEQ forecast. 5.6 percent in 2015 The changes to the short-term outlook reflect the worse-than-expected 2014 Q1 trade data, which will reduce the projected contribution of net exports to growth over the year. In addition, the lower GDP forecast accounts for slower government consumption growth which reflects the IDR 43 trillion of spending cuts contained in the revised Budget (see Section 6). Following the likely pre-election increase in spending, private consumption growth is expected to moderate somewhat. Relatively tighter credit conditions and slower commodity-related income growth are the key factors behind the projected slight slowdown in consumption expenditure in the second half of 2014. The fixed investment forecast of 4.7 percent growth has been revised to reflect Q1 2014 data, with downside risks to the outlook increasing given the recent trends in credit growth (see Section 5). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 4 Hard choices Indonesia Economic Quarterly Table 2: In the base case, GDP is expected to grow at 5.2 percent in 2014 and 5.6 percent in 2015 (percentage change, unless otherwise indicated) Annual YoY in Fourth Quarter Revision to Annual 2013 2014 2015 2013 2014 2015 2014 2015 1. Main economic indicators Total Consumption expenditure 5.2 4.9 4.9 5.4 4.8 5.1 0.1 0.0 Private consumption expenditure 5.3 5.0 5.1 5.3 4.7 5.4 0.1 0.0 Government consumption 4.9 4.2 3.7 6.4 5.0 3.2 -0.2 0.0 Gross fixed capital formation 4.7 4.7 6.4 4.4 5.0 6.8 0.2 -0.2 Exports of goods and services 5.3 0.3 6.5 7.4 0.2 6.7 -5.0 -0.5 Imports of goods and services 1.2 0.2 5.3 -0.6 1.4 4.9 -3.2 -0.1 Gross Domestic Product 5.8 5.2 5.6 5.7 5.1 5.7 -0.1 0.0 2. External indicators Balance of payments (USD bn) -7.3 -2.0 0.9 - - - 0.9 -0.8 Current account balance (USD bn) -29.1 -25.6 -23.6 - - - -1.3 -3.4 As share of GDP (percent) -3.3 -2.9 -2.4 - - - 0.0 -0.3 Trade balance (USD bn) -6.1 -3.1 -4.3 - - - -0.2 -6.9 Capital & financial acc. bal. (USD bn) 22.4 25.3 24.5 - - - 3.8 2.6 3. Fiscal indicators Central gov. revenue (% of GDP) 15.7 15.4 - - - - -0.1 - Central gov. expenditure (% of GDP) 18.0 18.2 - - - - 0.1 - Fiscal balance (% of GDP) -2.2 -2.8 - - - - -0.2 - Primary balance (% of GDP) -1.1 -1.4 - - - - 0.0 - 4. Other economic measures Consumer price index 6.9 5.8 4.9 8.1 4.6 5.1 -0.4 -0.3 GDP Deflator 4.4 5.7 5.3 7.1 4.8 5.3 -0.9 0.0 Nominal GDP 10.4 11.2 11.2 13.2 10.1 11.3 -1.0 0.0 5. Economic assumptions Exchange rate (IDR/USD) 10563 11800 11800 - - - -200 -200 Indonesian crude price (USD/bl) 106 106 103 - - - 1 1 Major trading partner growth 3.5 4.0 3.9 - - - 0.0 -0.2 Note: Export and import figures refer to volumes from the national accounts. Exchange rate is an assumption based on recent averages. Revisions are relative to projections in the March 2014 IEQ Source: MoF; BPS; BI; CEIC; World Bank projections 3. Inflation has remained moderate, but there are upside risks Both headline and core In the second quarter of 2014, price pressures remained contained, with headline inflation inflation stabilized in gradually declining to 6.7 percent yoy in June and core inflation stabilizing at around 4.8 Q2 2014 percent in May and June (using the new 2012-base CPI series from BPS) (Figure 8). Relatively tight credit conditions in recent months (see Section 5) have possibly offset some of the impact on inflation of the significant Rupiah depreciation of the second half of 2013 and pick up in private consumption growth in Q1 2014. The year-on-year inflation rate will decline considerably in July as the subsidized fuel price increase of 22 June 2013 drops out of the base, but upside risks to the outlook remain. Food inflation has also Food price inflation has remained below 7.5 percent since March 2014 (according to the remained low, with rice 2012-base series), well below the highs observed last year. The prices of several key foods, prices declining owing such as rice and chilies, have declined, reflecting relatively favorable weather affecting to a good harvest positively both production and distribution. Declining domestic rice prices have narrowed the gap between domestic and international prices (Figure 9). However, there are upside risks to rice prices in the near term, for example, associated with possible El Niño weather conditions later this year (see Section B.1). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 5 Hard choices Indonesia Economic Quarterly Figure 8: Price pressures remained contained in the second Figure 9: A favorable harvest brought down domestic rice quarter of 2014 prices (inflation rates yoy, percentage change) (wholesale rice prices, IDR per kg) Percent IDR/Kg 12 110 10,000 Price gap (LHS) Food Domestic 90 medium 9,000 10 quality Food * 70 (RHS) 8,000 8 Headline 50 7,000 6 30 6,000 Core 10 5,000 4 Core * -10 4,000 Vietnam 15% broken (RHS) 2 -30 3,000 Jan-13 May-13 Sep-13 Jan-14 May-14 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Note: * The solid lines for core and food inflation plot the 2007-base Note: Price gap refers to the difference between domestic and and 2012-base series spliced together; the dotted lines show yoy foreign rice prices growth rates computed using only the available 2012-base series Source: BPS, Cipinang Wholesale Rice Principle Market; World Source: BPS; World Bank staff calculations Bank staff calculations The baseline outlook Looking ahead, strong base effects will drive headline inflation down in the second half of for inflation is 2014, as the one-off rise in price levels due to the June 2013 subsidized fuel price increase moderate, although drops out of year-on-year comparisons. The World Bank projects an average annual inflation there are upside risks rate of 5.8 percent in 2014, dropping to 4.9 percent in 2015. These forecasts account for a small increase in the CPI caused by the electricity tariff adjustment introduced by the Government this year, as well as some expected upward pressure on food prices caused by El Niño. However, the possibility of further administered price reforms remains an upside risk to inflation, given the considerable fiscal strains (see Section 6). Another risk is the scale of this year’s effect of El Niño on food prices, and the Government’s response, in particular to a rice supply shock.2 4. Current account adjustment ongoing, portfolio inflows at a decade high Setbacks to the current A stable overall current account deficit and portfolio inflows at a ten-year high characterized account adjustment Indonesia’s balance of payments in the first quarter of 2014. However, there are signs that process have emerged the current account adjustment process is facing a number of challenges. As expected, the partial raw mineral export ban, introduced in January, caused a significant decline in overall export volumes. This, together with the ongoing moderation in global commodity prices, has resulted in weak exports being a continued drag on the overall current account so far this year. At the same time, as mentioned above, the strong recovery in capital flows to emerging markets led to a surge in portfolio flows and a decline in external financing pressures for Indonesia over the first half of 2014. However, the medium term picture outlined in previous IEQs remains; international borrowing costs are expected to increase, highlighting the need to support continued external adjustment and high quality financing inflows in order to limit Indonesia’s vulnerabilities to future episodes of global market volatility. The current account The current account deficit came in at 2.1 percent of GDP in both Q4 2013 and Q1 2014, deficit remained totaling USD 4.2 billion in Q1 (Figure 10). Beyond the stable headline number, however, around 2 percent of there were significant differences in the drivers of the current account in the two quarters. GDP in Q1 2014 While in Q1 2014 the current account balance improved by 0.7 percent of GDP versus Q1 2 The response mechanism of the Government to rice price shocks has been streamlined. A revised Ministerial Decree 06/M-DAG/PER/2/2012, issued in 2012, established clear criteria according to which the Government's Food Security Committee may authorize the National Food Agency (BULOG) to import rice. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 6 Hard choices Indonesia Economic Quarterly 2013, the recent adjustment was supported by the continuing weakness in imports which declined by USD 2.7 billion yoy, against a downturn in exports of USD 800 million yoy. In contrast, the 1.4 percent of GDP improvement in year-on-year terms recorded in Q4 2013 came from both import compression and an increase in exports. Smaller services and income deficits, which decreased by a cumulative USD 1.4 billion between Q4 2013 and Q1 2014, supported the stability of the current account deficit despite the smaller goods trade surplus. The weakness in The value of imports declined by 6.3 percent yoy in the first quarter of 2014. Raw materials imports was led by raw led the slowdown, dropping by USD 2.4 billion between Q4 2013 and Q1 2014 and materials contributing 5.0 percentage points to the total yoy decrease (Figure 11). Capital goods imports also continued to decline in year-on-year terms, in line with the less-than-robust fixed investment growth (see Section 2). Finally, consumer goods, which constitute approximately 14 percent of imports, decreased in year-on-year terms for the first time since Q3 2012, falling by 3.0 percent. Figure 10: The current account remained stable, but the Figure 11: Import values continued to weaken, driven by basic balance is still negative capital goods and raw material (balance of payments main account balances, USD billion) (growth and contributions to growth, percent yoy) Consumer Goods Raw Materials Current account Direct investment Capital Other Portfolio Other investment 25 15 Imports Overall balance Basic balance 20 10 15 5 10 0 5 -5 0 -10 -5 -15 -10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-12 Mar-13 Mar-14 Note: Basic balance = net FDI + current account balance Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations Figure 12: Commodities were responsible for weakening Figure 13: …with commodity volumes dropping by 17.3 exports… percent yoy, driven by minerals (growth and contributions to growth yoy, percentage points) (growth and contributions to growth yoy, percentage points) 10 Non commodities Other Commodities Rubber Export value Ores, slags and ashes 5 50 Vegetable oils Coal Oil and gas 0 Commodities -5 0 -10 -15 -50 -20 Mar-12 Mar-13 Mar-14 Mar-12 Mar-13 Mar-14 Note: Commodities exclude commodities-related manufacturing Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 7 Hard choices Indonesia Economic Quarterly The new regulations Exports of Indonesia’s six main commodities declined by approximately USD 4.2 billion limiting raw mineral between Q4 2013 and Q1 2014, contributing 4.4 percentage points to the 2.5 percent yoy exports weighed drop in exports (Figure 12). In year-on-year terms, commodity exports weakened by 8.3 heavily on commodity percent, mainly driven by falling volumes (down 17.3 percent yoy). Four-fifths of the decline exports… in commodity export volumes came from ores, slags and ashes (Figure 13), which ground to a halt with the introduction of the partial mineral export ban in January 2014. … while there are At the same time, Indonesia’s Figure 14: Manufacturing exports are staging a modest tentative signs of the manufacturing exports have comeback long awaited pick up in gained some momentum (growth of 6mma of manufacturing export values yoy, percent) manufacturing exports since March 2014 (Figure 14). China Indonesia This compares with a general moderation in growth rates 20 Malaysia Thailand for some regional peers and a 15 pick-up in Malaysia which started a year ago. However, 10 if Indonesian manufacturing 5 firms are to take greater advantage of the Rupiah 0 depreciation since mid-2013, -5 and from the anticipated continued pick-up in demand -10 from high-income economies, long-standing -15 May-12 Nov-12 May-13 Nov-13 May-14 bottlenecks, for example, relating to logistics costs and Source: CEIC; World Bank staff calculations infrastructure quality, need to be addressed. Monthly data indicates Monthly customs trade data indicated a marked deterioration in the trade balance in April a likely deterioration in 2014, when imports outweighed exports by close to USD 2 billion. The deterioration came the goods trade about with an approximately equal increase in non-fuel raw material imports and decrease in balance in Q2, with non-oil and gas exports (in particular coal and vegetable oils). While May 2014 customs trade income payments also data show a small positive balance of USD 69.9 million, the second Q2-to-date customs likely to push the trade balance remains in negative territory. A potential additional strain on the Q2 current current account deficit account is posed by the fact that the second quarter of the year tends to see a rise in outflows wider on the income account associated with dividend payments. As a result of these factors, the current account deficit in the second quarter is expected to widen significantly from the levels seen in the previous two quarters, with Bank Indonesia recently signaling its expectation of a current account deficit on the order of 4 percent of GDP.3 Direct investment The capital and financial account balance remained well in surplus in Q1 2014, with a net recovered somewhat in inflow of USD 7.8 billion against USD 8.8 billion in Q4 2013. However, the composition of the first quarter while inflows changed substantially from Q4 2013, when portfolio and other investment inflows portfolio investment offset unusually weak net direct investment (due largely to an outbound transaction). In the surged to a decade- first quarter of 2014, net direct investment recovered somewhat, to USD 3.0 billion, and high… portfolio investment recorded a decade-high net inflow of USD 9.0 billion. At the same time, the volatile “other investments” sub-account balance turned negative, with net outflows of USD 4.1 billion, due primarily to a shift offshore of private deposits (USD 2.4 billion) and loan repayments by the Government (USD 1.4 billion). 3 http://www.thejakartapost.com/news/2014/07/16/bi-warns-capital-outflows.html J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 8 Hard choices Indonesia Economic Quarterly ...on the back of The decade-high portfolio inflows recorded in Q1 2014 were fuelled by renewed investor renewed appetite for appetite for emerging market assets (as discussed above), including Indonesian bonds and EME equities and equities. Net government debt liabilities inflows were significant and totaled USD 5.6 billion, bonds above the recent peaks seen in quarterly inflows in 2010 and 2011. USD 2.4 billion flowed into foreign currency bonds and USD 3.2 billion into domestic currency government bonds. Net private equity liabilities were also significant at USD 2.1 billion – the most since Q1 2013. Net offshore purchases of Rupiah-denominated government bonds, SBIs and equities remained strong into the second quarter of 2014 as well, albeit tapering off in June. Annual gross external Issues of current account financing should be read in the context of overall gross financing financing needs are needs. Total external debt-to-GDP remains moderate, at 32.4 percent of GDP in Q1 2014 above USD 80 billion (as measured by BI), but external debt levels and amortizations grew strongly, particularly for the private sector, from 2011-2013 (Figure 16). Consequently, gross external financing needs have risen over recent years both to finance the current account deficit and to meet external debt amortizations. Indeed, of the estimated total gross external financing needs in 2013 of USD 83 billion (based on BI data), the current account deficit generated only 35 percent, while private and public sector debt amortization generated 50 percent and 15 percent respectively. Short-term external funding pressures could therefore emerge not only as a result of current account financing becoming more challenging (whether because of a renewed widening in the current account or reduced foreign investment inflows), but also if there were to be a marked rise in private external debt rollover costs, or a decrease in the availability of external financing more broadly. Figure 15: Decade-high portfolio inflows were driven by Figure 16: Increasing private external debt has driven much government borrowing and renewed appetite for EME assets of the rise in gross external financing needs in recent years (USD billion) (USD billion) Private sector liabilities Private external debt amortizations 10 Public external debt amortizations Govt IDR liabilities 100 Current account deficit 8 Govt USD liabilities Total gross external financing requirements Monetary authority liabilities 80 6 Portfolio 4 60 2 40 0 20 -2 0 -4 -6 -20 Mar-11 Mar-12 Mar-13 Mar-14 2009 2010 2011 2012 2013 2014 Q1 Source: CEIC; World Bank staff calculations Note: External debt amortizations comprise total external debt maturing in 1 year or less as of the first month of the year Source: BI; Ministry of Finance (DGDM); CEIC; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 9 Hard choices Indonesia Economic Quarterly Box 1: Recent challenges in Indonesia’s commodity export sector Commodities are a major constituent of Indonesia’s exports, with crude oil, crude palm oil (CPO), rubber, gas, coal and other minerals accounting for more than half of Indonesia’s exports by value in 2013. The raw commodity sector also accounted directly for around one-fifth of real GDP growth between 2002 and 2012. Furthermore, estimates based on the 2008 Input-Output table indicate that, through a multiplier effect, a unit increase in the output of the raw commodity sector is associated with a 1.5 unit increase in total output. The multiplier is even larger for the processed commodities sector, where a one unit increase is associated with a 2.1 unit increase in total output. Indonesia’s commodity exports are facing significant headwinds, with declining global commodity prices and the regulations issued in January 2014 imposing a ban on certain raw mineral exports and export taxes on all unprocessed mineral exports. Overall, the share of (raw) commodities in the value of total exports has declined from 60 percent in 2011 to 53.3 percent in 2013, and further down to 50 percent in the first quarter of this year. As discussed above, the observed impact of the unprocessed mineral export ban has been negative from a trade perspective.1 Copper concentrate exports have effectively ceased since February 2014, as Freeport and Newmont, responsible for 97 percent of Indonesia’s copper concentrate exports, halted exports. Similarly, trade data shows that the exports of raw nickel, bauxite, lead and zinc, the other major minerals affected by the policy, declined by a factor of five. As a result, the share of ores, slags and ashes (the statistical definition most closely accounting for raw minerals which is available on a timely basis) dropped from 2.9 percent of total exports in Q1 2013 to 0.7 percent a year later. Figure 17: Both export volume and price declines were Figure 18: Provinces most exposed to the commodity sector observed for Indonesia’s major commodities in Q1 2014 recorded a significant slowdown in Q1 2014 (Q1 2014 to Q1 2013 export value growth decomposition by volume and (percentage changes) price, year-on-year, percent) Percent Price Volume Value Percent 0 2 4 6 8 10 12 0 20 20 Commodity price index change, percent 2.1 -5 10 10 0 0 -10 Papua National -10 6.2 -10 -15 -20 -9.0 -13.1 -20 -20 East -20.4 Kalimantan Riau -30 -30 -25 Aceh -40 -40 Kepri -50 -50 -30 West Papua -60 -54.7 -57.6 -60 -35 Rubber CPO Crude Gas Coal Copper Nickel Q1 2014 GDP growth, percent yoy oil Source: BPS; World Bank staff calculations Note: Commodities include oil, gas, rubber, crude palm oil, coal, copper, nickel, aluminum, lead, zinc and iron ore. The commodity price index, for each province and at the national level, is weighted by each commodity’s share in provincial and national GDP Source: BI; BPS; World Bank; World Bank staff calculations Apart from the direct effect on export revenues, the unprocessed mineral export ban and lower global commodity prices are likely to have additional macro-economic and social consequences. For instance, according to monthly BPS trade data, the demand for imported trucks, excavators and cranes, which are used in the mining sector, declined by 60 percent between Q1 2012 and Q1 2014, resulting in lower imports of capital goods. In addition, the unprocessed mineral export ban has contributed to higher regulatory uncertainty in the sector, with potential legal challenges and reports of ongoing negotiations on some of the key regulations, especially those surrounding the export tax. The increased uncertainty may in turn reduce future investment in the commodity sector. Finally, the decline in employment, incomes and new investment stemming from the slowdown in commodity exports, and production, is expected to affect some provinces of Indonesia disproportionately more than others. The regions subject to the greatest risk are those where commodity sectors make up a large share of output and where the main commodities have seen the largest price decline. According to Bank Indonesia estimates of Q1 2014 provincial GDP (Regional Economic Report (Laporan Nusantara), May 2014), Aceh, East Kalimantan, Kepri, Papua, Riau, and West Papua have seen year-on-year GDP growth rates significantly below the national average (Figure 18). Note: 1 See the March 2014 IEQ for an extensive discussion of the potential impact of the partial mineral export ban. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 10 Hard choices Indonesia Economic Quarterly The World Bank’s Looking ahead, the current Table 3: In the base case, a current account deficit of projection remains for account deficit is projected at 2.9 2.9 percent of GDP in 2014 is projected a gradual narrowing of percent of GDP or USD 25.6 (USD billion unless otherwise indicated) Indonesia’s current billion in 2014, unchanged from 2013 2014 2015 account deficit over the March 2014 IEQ forecast. This Overall Balance of Payments -7.3 -2.0 0.9 2014 as a whole is predicated on continued As percent of GDP -0.8 -0.2 0.1 weakness in exports, weighed Current Account -29.1 -25.6 -23.6 down by weaker commodity prices As percent of GDP -3.3 -2.9 -2.4 and the unprocessed mineral Goods trade balance 6.0 6.7 5.8 export ban. The current account Services trade balance -12.1 -9.8 -10.1 deficit is projected to decrease to Income -27.0 -28.1 -26.2 2.4 percent of GDP in 2015, Transfers 4.0 5.6 6.8 reflecting H1 2014 data, versus a Capital and Financial Accounts 22.4 25.3 24.5 projection of 2.1 percent of GDP As percent of GDP 2.6 2.6 2.6 in the March 2014 IEQ. The “basic Direct Investment 13.7 12.6 12.9 balance”, i.e. the sum of the Portfolio Investment 9.8 15.1 12.4 current account balance and net Other Investment -1.1 -2.5 -0.8 direct investment, is forecasted to Memo: remain negative through the Basic Balance -15.4 -13.0 -10.7 forecast horizon, albeit declining As percent of GDP -1.6 -1.5 -1.1 from -1.5 to -1.1 percent of GDP Note: Basic balance = current account balance + net FDI between 2014 and 2015. Source: CEIC; World Bank staff calculations 5. Indonesian asset prices strengthen but credit conditions tighten Indonesian financial Partly as a consequence of larger foreign capital inflows, financial asset prices in Indonesia asset prices have have generally risen since the beginning of this year, recovering most of the losses incurred picked up, while credit in the second half of 2013. However, most of the improvement in 2014 so far occurred in has continued to the first quarter. At the same time, bank liquidity in domestic currency remains relatively tighten tight, contributing to the ongoing decrease in credit growth. The credit growth slowdown and lower property prices have become a downside risk to the economic outlook. At the same time, lower growth expectations may feed through into a further weakening of credit demand. The Rupiah weakened The Rupiah weakened by 2.7 percent against the US Dollar from the end of March to July against the US dollar in 15, 2014, reversing some of the first-quarter gain of 6.8 percent. The recent depreciation the second quarter of reflects the above-mentioned pressures on the current account balance in the second 2014, after quarter, and occurred despite strong capital inflows. Liquidity in the onshore currency strengthening in the market has increased with average onshore spot market volumes of USD 1 billion per day first three months of this year, versus less than USD 0.8 billion in the first half of 2013. Compared with mid-May the year 2013, before the capital reversal episode which followed the Federal Reserve’s announcement of the possibility of reduced asset purchases, the Rupiah was 20.1 percent weaker against the US dollar on July 15, 2014. However, in real effective (trade-weighted) terms, there has been a more moderate depreciation of 10 percent through May 2014. Equity and bond prices Despite a decline in June, Indonesian local equity and bond prices have risen this year, with have risen this year offshore investors becoming significant net buyers of both equities and government bonds, as discussed in Section 4. As of July 14, 2014, local equities were up 5.3 percent since the end of March and up 16 percent year to date, reversing most of the loss incurred in 2013. Since the start of January, offshore investors have purchased IDR 41.4 trillion (or close to USD 3.6 billion) of local equities and IDR 87.9 trillion (or slightly more than USD 7.6 billion) of Indonesian local currency government bonds. The 10-year government bond yield decreased modestly, by 39 basis points in the first quarter of 2014 but increased by 6 basis points between end-March and mid-July. At 8.3 percent on July 15, 2014, it is still much higher than its level in mid-May last year (5.6 percent), following the subsequent abrupt rise in domestic yields. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 11 Hard choices Indonesia Economic Quarterly Figure 19: A slowdown in deposit growth has contributed to Figure 20: Banks have not so far fully passed on the increase the weakening in credit growth in domestic currency funding costs to borrowers (growth yoy, percent) (percent) 45 Net interest margin Deposit rate 40 14 Lending rate 35 12 30 Credit 10 25 20 8 15 6 Deposits 10 4 5 2 0 0 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations Credit growth Credit growth has weakened and slow growth in loan approvals indicates that this trend will continues to likely persist. Credit growth declined to 18.6 percent yoy in April 2014, from 21.4 percent in decelerate… December 2013 (Figure 19). In the same period, ex post real credit growth, adjusted by realized CPI inflation, dropped by 1.8 percentage points to 10.5 percent yoy. Credit growth adjusted for the effect of changes in the exchange rate decreased from 17.3 percent yoy in December to 15.8 percent yoy in April, with dollar lending only growing by 4.9 percent yoy in March after a recent high of 10.4 percent yoy last November. New loan approvals in May declined by 12.1 percent yoy (3mma), after decreasing by 1.2 percent in March, and compared with 17.9 percent yoy growth (3mma) in May last year. …constrained mainly Tighter funding conditions due to weaker deposit growth appears to be the main factor by credit supply behind the slowdown in bank credit. Deposit growth has decelerated faster than loan growth conditions… since 2012 (Figure 19). This is despite a rise in the average deposit interest rate from around 5.6 percent in June last year to more than 8 percent in March 2014. The loan to deposit ratio (LDR) of the banking system was 90.8 in April, only slightly below the BI upper threshold for individual banks of 92 percent, above which banks’ minimum reserve requirements are increased. As highlighted in the March 2014 IEQ, the LDRs of smaller banks are higher than those of larger banks, pointing to market segmentation in access to third party funding. …with mixed signs While credit supply has clearly become more constrained, the recent evidence on credit regarding credit demand conditions is mixed. Since May 2013, banks have been unable or unwilling to pass demand the increase in the cost of funding to borrowers, as shown by the decrease in lending spreads, amid rising deposit rates (Figure 20). This may indicate either weaker credit demand at higher lending rates, or banks’ being cautious to extend credit at higher rates so as not to trigger rising non-performing loans. Property prices Residential property price growth rate has fallen further to 7.9 percent yoy in March 2014 continue to weaken compared with 11.5 percent last December, according to the 14-city BI index. Lower loan- amid signs of slower to-value ratios for second (or more) homes, introduced in March 2013, and tighter market property-related bank liquidity continue to drive the decline in property demand, particularly for middle-end credit residential homes. Industrial and office rental and selling price growth also both declined from around 30 percent yoy in December 2013 to 15 percent, in March 2014 (4-city BI index). Apartment selling and rental price growth are also down. One reason for the drop in property price growth is the decline in bank property financing. Overall property loans grew at 23 percent yoy in April, down from 27 percent yoy at the end of 2013. Several banks have reportedly limited their property sector credit. As discussed above, a weakening outlook for property prices represents a downside risk to the near-term growth outlook to the extent that it feeds through into softening construction investment in particular. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 12 Hard choices Indonesia Economic Quarterly The corporate sector, Beyond credit conditions and property sector developments, the Indonesian corporate especially sector is currently facing four major hurdles: rising electricity and labor costs, tightening manufacturing firms, is market liquidity and the weaker Rupiah. The last factor is perhaps the most material for also adjusting to the corporate margins and profitability. The corporate profitability of manufacturing companies, sizeable depreciation such as producers of textiles and shoes, for which most inputs are imported, are particularly of the Rupiah over the impacted by the weaker Rupiah. The currency depreciation has also adversely affected past year… consumer goods companies such as food and beverage producers. The real depreciation of the Rupiah and improved high-income country demand do, however, present upside possibilities for the export earnings of Indonesian manufacturing companies (as discussed in Section 4 above). 6. The fiscal sector continues to be under pressure Parliament approved a Responding to macroeconomic changes, subdued revenue growth, and rising energy subsidy revised Budget for costs, the Government proposed a substantially revised 2014 Budget. The deficit under the 2014, with the deficit revised Budget approved by Parliament on June 18 is 2.4 percent of GDP. Significant increased in response budget cuts of IDR 43 trillion for line ministries were approved (down from IDR 100 to continued fiscal trillion under the Government’s original proposal) along with the postponement to 2015 of pressures… the payment of rising energy subsidy arrears of around IDR 50 trillion. The additional net financing need from the approved higher deficit of IDR 66 trillion in 2014 is expected to be financed mostly by the issuance of Government bonds. Without policy measures and including energy subsidy arrears, the Government had projected that the fiscal deficit could reach approximately 4.7 percent of GDP.4 …caused in part by The revised 2014 Budget lowers expected revenues relative to the original Budget by IDR weaker revenue 31.8 trillion (or 1.9 percent). This is mostly due to a reduction in non-oil and gas tax collection performance revenues of IDR 24.3 trillion (4.8 percent less than in the original budget) and a lowering of expected value-added tax (VAT) by IDR 17.4 trillion (a downward revision of 3.5 percent). Despite significantly lower oil production of 818,000 barrels per day (bpd) compared with the original Budget (870,000 bpd), revised projected oil and gas tax and non-tax revenues are higher than in the original Budget, mostly due to the depreciation of the Rupiah. The revised 2014 Budget does not assume any significant revenue policy changes in 2014 and focuses mostly on tax administration improvements to secure the 2014 tax revenue target, for example through e-invoice VAT and income tax filing. Expected weak revenue performance continues the trend of recent years (Box 2). Box 2: Weak revenue performance has had a marked negative impact on the fiscal balance in recent years While much of the recent concern regarding fiscal trends has been on the expenditure side, weakening revenue performance is also a major source of fiscal pressure. The growth of both nominal expenditures and revenues has slowed sharply since mid-2012 (Figure 21). Decomposing the change in the central government fiscal balance in recent years, in 2011 and 2012, most of the rise in the deficit-to-GDP originated from increasing expenditures, mainly through subsidies. But in 2013, weaker revenues-to-GDP accounted for most of the increase in the fiscal deficit, declining by 0.9 percentage points of GDP versus a 0.6 percentage point of GDP fall in expenditures (Figure 22). Total nominal revenue growth has fallen significantly over the last three years, from 21.6 percent growth yoy in 2011, to 10.5 percent yoy in 2012, and 6.8 percent yoy in 2013. Nominal GDP growth has also fallen over this period, but not by as much: nominal GDP was up 15.1 percent in 2011, 10.9 percent in 2012, and 10.4 percent in 2013. As a result revenue-to-GDP has dropped down from 16.3 percent and 16.2 percent in 2011 and 2012 to 15.3 percent in 2013, the lowest level since 1998/1999. A summary measure of the performance of revenues is “buoyancy”. This measures the responsiveness of total revenues to aggregate income growth, defined as the ratio of the percentage change in nominal revenues to the percentage change in nominal GDP. Total revenue buoyancy was 1.4 in 2011, declining to 0.9 and 0.5 in 2012 and 2013, respectively. 4 http://finance.detik.com/read/2014/06/09/172547/2603338/4/kalau-apbn-tak-diubah-defisit- anggaran-2014-bisa-469-pdb. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 13 Hard choices Indonesia Economic Quarterly Figure 21: Nominal revenue and expenditure growth have Figure 22: …with declining revenue/GDP being the main both slowed since mid-2012… driver of the larger budget deficit in 2013 (12-month sum, percent yoy) (annual change in percentage points of GDP) Revenues Change in budget balance 60 Change in revenues Expenditures 2 Change in expenditures 50 Nominal GDP 40 1 30 0 20 -1 10 -2 0 -3 -10 -4 -20 -5 May-06 May-08 May-10 May-12 May-14 2003 2005 2007 2009 2011 2013 Source: Ministry of Finance; World Bank staff calculations Source: Ministry of Finance; World Bank staff calculations A major driver of weaker revenues has been oil and gas revenues (both tax and non-tax) (Figure 23). Income tax growth from oil and gas has slowed sharply, growing 6.3 percent yoy in 2013, down from 14.2 percent and 24.2 percent in 2012 and 2011, respectively. Non-tax oil and gas revenues, meanwhile, contracted outright in 2013, by 1.1 percent, having previously grown by 6.4 percent yoy (2012) and 26.7 percent yoy (2011). Revenues from the sector have been impacted by a steady downward trend in oil production during the last two decades as well as bouts of price volatility (e.g. in 2008/9), but tax and non-tax revenue collection in recent years has been mostly impacted by lower production of both oil and gas, rather than prices which have been generally favorable in Rupiah terms (Figure 24). The softening of overall revenue growth has extended beyond oil and gas revenues. Non-oil and gas income tax growth was sharply weaker in 2012 (up 6.6 percent yoy) and 2013 (up 8.5 percent) compared with 2011 (up 20.1 percent), though the relative performance as measured by the tax buoyancy of non-oil and gas income tax revenues remained stable in 2012 and 2013 (at 0.6). Along with the general decline in nominal GDP growth, the significant fall in non-energy commodity prices since 2011, impacting corporate profitability and incomes, has been one driver of the falling revenue growth from this source. Figure 23: Weaker revenue growth is broad-based but Figure 24: … which has been impacted by the trend decline importantly includes oil and gas revenue collection… in oil production and fluctuations in the oil price (contribution to overall nominal revenue growth, percentage points) (non-tax revenues and income tax in percent of GDP; oil price in thousands of IDR/bbl; oil lifting in thousands of bbl per day) Non-tax revenues oil and gas (LHS) 25 All other revenues Income tax oil and gas (LHS) Intl. trade taxes Oil price (RHS) 20 Oil and gas revenues (tax and non-tax) Oil lifting (RHS) Income tax (non-oil and gas) 7 Percent of GDP Thousands 1400 15 6 1200 VAT 5 1000 10 4 800 5 3 600 2 400 0 1 200 0 0 -5 2003 2005 2007 2009 2011 2013 2011 2012 2013 Source: Ministry of Finance; World Bank staff calculations Note: The right vertical axis measures both the oil price in thousands of IDR/bbl and oil lifting in thousands of bbl per day Source: Ministry of Finance; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 14 Hard choices Indonesia Economic Quarterly Year-to-date revenue The medium-term weakening in Figure 25: January-May 2014 saw improved non-oil and collection in 2014 revenue growth discussed in Box gas income tax growth and a weaker VAT performance continues the declining 2 continued into the first quarter (nominal growth in January-May over the year-ago period, percent) trend of the previous of 2014 but with a slight 35 2011 2012 2013 2014 year improvement in collection of 30 income tax from non-oil and gas 25 and international trade taxes in 20 April and May. All other major 15 components of revenues 10 experienced a decline in year-on- 5 year nominal growth relative to 0 the corresponding period in -5 previous years (Figure 25). Data -10 for the first quarter indicate -15 Income Income VAT Excises NTR revenues-to-GDP at similar levels -20 tax (oil tax (non- to the corresponding periods in and gas) oil and the previous three years, gas) suggesting that the collection Note: NTR represents non-tax revenues performance was mainly driven by Source: Ministry of Finance; World Bank staff calculations the growth of the tax base. VAT receipts decelerated quite markedly (up 7.8 percent yoy in Jan-May 2014), likely impacted by import compression (see Section 4). Substantially higher On the expenditure side, revised expenditures are up only by IDR 34 trillion (or 2 percent energy subsidy costs more than in the initial Budget). However, this masks substantial line ministry budget cuts to also contributed to the offset higher energy subsidy costs which continue to put considerable pressure on the fiscal higher fiscal deficit in sector. Despite the average 33 percent increase in subsidized fuel prices in June 2013, energy the approved revised subsidy costs have continued to increase, driven in particular by the weaker Rupiah since 2014 Budget… mid-2013, which has again widened the gap between regulated and market prices (Figure 26). According to the revised 2014 Budget, in the absence of fuel subsidy reform, energy subsidy spending will increase by IDR 68 trillion relative to the original Budget, reaching IDR 350 trillion (or 3.5 percent of GDP). Fuel subsidy spending is revised up by IDR 36 trillion to IDR 246 trillion, while the electricity subsidy increases by IDR 32 trillion to IDR 104 trillion (despite significant tariff increases, discussed below). However, these are still well below the Government’s Budget revision proposals as, under the approved Budget, the payment for accumulated energy subsidy arrears of IDR 50 trillion is carried forward to 2015 (Figure 27). In addition, the approved Budget assumes a slightly stronger exchange rate (IDR 11,600 per USD versus 11,700 proposed by Government). …and the extent to The approved revised Budget lowers subsidized fuel volume to 46 million kiloliters versus 48 which the subsidized million kiloliters initially proposed by the Government. This assumption appears optimistic, fuel quota binds will as this is below actual subsidized fuel consumption in 2013, of 46.4 million kiloliters. For affect the fiscal outturn 2014, the Government intends to focus on quantitative restriction measures (controlling the volume of fuel consumption) such as stricter enforcement of the ban on subsidized fuel use for government, state and mining, non-passenger sea transportation vehicles and the conversion program from fuel to gas. Past experience suggests that these measures face implementation challenges and have limited effectiveness.5 In contrast to previous years, however, the revised 2014 Budget includes a revision to Article 14, which narrows the Government’s flexibility in managing energy subsidy spending. In the initial Budget Law, the Government was allowed, subject to Parliament’s approval, to adjust energy subsidy spending according to realization and changes in macroeconomic projections and energy subsidy parameters. In the revised Budget Law, the reference to energy subsidy parameters was removed and the macroeconomic assumptions on which changes in energy subsidy spending are allowed are explicitly limited to two indicators: the oil price (ICP) and exchange rate. This means that the Government no longer has the flexibility to adjust energy subsidy 5 http://www.antaranews.com/berita/438835/pemerintah-optimistis-kuota-bbm-46-juta-kiloliter. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 15 Hard choices Indonesia Economic Quarterly spending due to changes in energy subsidy parameters, including the quota. By adding to pressure to control the volume of consumption, this change may make the quota more binding than has previously been the case. If it were to bind, this would shave approximately 0.1 percentage points off the World Bank’s baseline projection of a 2.8 percent of GDP budget deficit in 2014 (discussed below). Figure 26: The price gap between subsidized and market Figure 27: …which will significantly increase fuel subsidy petrol prices remains elevated… spending in 2014 (Rupiah) (trillion Rupiah) Subsidy gap 500 ES arrears to be carried over to 2015 USD/IDR Unsubsidized petrol price (Pertamax, IDR/liter) FS arrears to be carried over to 2015 Subsidized petrol price (IDR/liter) 400 Electricity subsidy (ES) 14,000 Fuel subsidy (FS) 12,000 300 10,000 200 8,000 100 6,000 4,000 0 APBN APBN-PAPBN-P 2,000 + 0 arrears Jun-06 Jun-08 Jun-10 Jun-12 Jun-14 2010 2011 2012 2013 2014 Note: Subsidized petrol (Premium, RON 88) is lower octane than Note: APBN represents original Budget, APBN-P represents unsubsidized petrol (Pertamax, RON 92) revised Budget Source: Ministry of Finance; World Bank staff calculations Source: Ministry of Finance; World Bank staff calculations Progress on electricity Following tariff adjustment for large industrial and business groups in May, the Government tariff adjustment introduced further tariff adjustment for six additional customer groups as part of the 2014 continues Budget revision, effective on July 1, 2014. The adjustments will be phased in over July, September, and November, and, together with the increases announced in May, result in a significant rise in electricity tariffs for most large user categories (Table 4). Through this additional tariff adjustment, the Government projects a saving of IDR 8.5 trillion for the state budget in 2014, but electricity subsidy spending remains significant, as discussed above, at a projected IDR 103.8 trillion in 2014 under the revised Budget, up 45.5 percent from the original Budget (APBN), and up 3.8 percent from realized spending in 2013 (Figure 28), due to higher input costs.6 Full-year subsidy cost savings can be illustrated by hypothetically applying the tariff adjustments announced in both May and July to the full-year (2014), which suggests annual savings relative to a no-change scenario on the order of IDR 37.2 trillion. However, with automatic price adjustment mechanisms having been introduced for only some users as part of the new regulations in May (but not July), these savings remain vulnerable to renewed upward pressure on electricity supply costs, notably from any further Rupiah depreciation or higher international energy costs. The impacts of the tariff increases on costs, firms’ responses, and prices, will vary according to firm and industry structures but given the sizable quantum of the increases over the year these merit further examination. 6 http://nasional.kontan.co.id/news/banggar-sepakati-subsidi-listrik-ap billion-p-2014. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 16 Hard choices Indonesia Economic Quarterly Table 4: Electricity tariffs are rising significantly for most Figure 28: …reducing the current subsidy price gap and large user categories, bar low-consumption households… yielding sizable savings relative to a no-change scenario (base and new final tariffs once phased-in, as announced in May and July) (trillion Rupiah and Rupiah/kilowatt hour, kWh) Final tariffs as Total electricity subsidy Base announced in: Tariff IDR trillion IDR /kWh tariff Average cost (RHS) (IDR/kWh) change (IDR/ 1600 kWh) May July (%) Average revenue (RHS) regn. regn. 140 1400 HH R-1 (1300 VA) 979 -- 1,352 38.1 120 HH R-1 (2200 VA) 1,004 -- 1,352 34.7 1200 HH R-2 (3500-5500 VA) 1,145 -- 1,352 18.1 100 1000 HH R-3 (>6600 VA)* 1,352 1,530 -- 13.1 Industry I-3 (>200 kVA; 80 864 -- 1,200 38.9 800 unlisted) 60 600 Industry I-3 (>200 kVA; 864 1,200 -- 38.9 listed) 40 400 Industry I-4 732 1,191 -- 62.7 (>30000 kVA) 20 200 Business B-2 1,352 1,530 -- 13.1 0 0 (6600 VA-200 kVA)* Business-B-3 1,117 1,264 -- 13.1 (>200 kVA)* Government P-1 1352 1530 -- 13.1 (6600 VA-20 kVA)* Government P-2 1026 -- 1200 17.0 (>200 kVA) Government P-3 997 -- 1352 35.6 (street lighting) Note: Figures are new final tariffs (following phasing-in), as Note: *2014-1: No tariff change case; 2014-2: following regulated announced in the May and July regulations (regn.), respectively; increases “HH”: households; listed status refers to stock exchange listing; * Source: World Bank staff calculations denotes automatic tariff adjustment, where new tariffs will no longer be subsidized and instead determined from inflation, exchange rates, and oil prices every month by PLN Source: Ministry of Energy and Mineral Resource Regulation No. 9/2013; World Bank staff calculations The revised Budget In the absence of sufficient Figure 29: Key line ministries face significant budget cuts included IDR 43 policy-based cuts, the revised (budget cut in IDR trillion; budget cut as share of original budget, percent) trillion in line ministry Budget includes IDR 43 Nominal budget cuts (LHS, IDR trillion) budget cuts to restrain trillion in across the board line Percent of initial Budget (RHS) the budget deficit, in ministry budget cuts, 14 14 the absence of fuel accounting for 7 percent of 12 12 subsidy reform line ministries’ total original 10 10 Budget allocations. The 8 8 approved cuts are less than 6 6 half of the proposed cuts of IDR 100 trillion in the 4 4 Government’s draft revised 2 2 Budget and are targeted to cut 0 0 spending on areas such as travel, meetings, and seminars as guided by a Presidential Regulation.7 However, the cuts also affect some key capital spending line ministries such Source: Ministry of Finance; World Bank staff calculations as the Ministry of Public Works and Ministry of Transport (Figure 29). The Ministry of Public Works experienced the largest budget cuts, of close to IDR 10 trillion (nearly 12 percent of its initial Budget) and representing 23 percent of the total budget cuts, followed by the Ministries of Defense and of Transport. It is not clear that these cuts can realistically be sustained in future budgets, adding to future fiscal risks. 7 Presidential Instruction No. 4/2014. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 17 Hard choices Indonesia Economic Quarterly Five months into 2014, By the end of May 2014, IDR Figure 30: For 2014 through May, disbursement of core nearly one third of the 605 trillion or 32 percent of the government spending remains low revised Budget has revised Budget allocation had (share of revised Budget, percent) been disbursed with been spent, a slightly higher 50 2011 2012 2013 2014 energy subsidy, social disbursement rate than in and interest payment previous years. This is partly 40 disbursement rates driven by higher energy subsidy moving above recent and interest payments due to 30 levels the weaker Rupiah, and higher social spending due to timely 20 disbursement of health social security premiums to the social 10 security agency (Badan Penyelenggara Jaminan Sosial, 0 BPJS). However, the execution of capital spending continues to be challenging. By May, disbursement of capital expenditure remained at 11 Source: Ministry of Finance; World Bank staff calculations percent of the revised Budget, lower than previous years (Figure 30). A recent Constitutional On May 22, 2014, the Constitutional Court issued a ruling on how the Parliament (DPR) Court ruling limits works with the Government in preparing the Budget. The court granted two out of four Parliament’s role in the petitions made by several civil society groups and its ruling limits DPR’s role in engaging at discussion of State the technical level of the budget, and also abolishes DPR’s authority in attaching Budget at the technical disbursement conditions to budget line items (known as bintang). These decisions are seen as level a positive development, with the vice-minister of the National Development Planning Agency stating, for example, that the revocation of parliamentary authority in State Budget implementation and warrant blocking (bintang) will support budget disbursement acceleration efforts. It is also expected that this ruling can help to elevate the involvement of the DPR in the budget preparation to a policy and program level. The ruling was made effective immediately, beginning with the 2014 revised Budget preparation. The World Bank has Taking into account recent macroeconomic developments, and the recently approved revised revised upward its Budget, the World Bank has revised up its fiscal deficit projections for 2014 to 2.8 percent of projection of the fiscal GDP in the baseline scenario (Table 5), from 2.6 percent at the time of the March 2014 IEQ. deficit in 2014 to 2.8 However, this projection does not include energy subsidy arrears of IDR 50 trillion and also percent of GDP assumes incomplete budget execution by line ministries (with capital expenditure in 2014 now projected to decline from preliminary 2013 levels). Including energy subsidy arrears and assuming full line ministry budget execution would lift the projected fiscal deficit to as high as 4.0 percent of GDP. The World Bank expects revenue collection in 2014 to continue moderating and has revised down its revenue projection by 2.6 percent, due mainly to lower expected tax revenues, through lower oil and gas production, a slowdown in VAT collection (due to expected moderation of private consumption and imports) and reduction of the corporate income tax collection due to the unprocessed mineral exports ban. The revised Budget The larger planned fiscal deficit results in a substantial increase, of IDR 66.1 trillion, in the substantially increases net financing need for the remainder of 2014. Amortizations of official foreign loans have gross financing needs also risen by IDR 5.4 trillion, reflecting the weakening of the Rupiah. The Government plans but securities to meet the overall rise in gross financing needs primarily through higher securities issuance, financing through along with higher official program loan disbursements. The gross securities financing target mid-July had reached for 2014 is increased by IDR 60.7 trillion to IDR 430.2 trillion. Prior to the increase in the just over 60 percent of financing target, securities issuance had been well ahead of target, with IDR 231.9 trillion the revised full-year worth of bonds issued in the first half of the year. Second half issuance also got off to a target strong start, with a maiden Euro-denominated issue of EUR 1 billion worth of 7-year bonds, J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 18 Hard choices Indonesia Economic Quarterly which was nearly seven times over-subscribed, and priced to yield under 3 percent. As of July 11, the Government had issued IDR 280.9 trillion of bonds in 2014, representing 65 percent of the revised full-year issuance target. Securities financing thus remains on track for 2014, but the increased supply does raise financing risks, and the continued resilience of domestic yields will depend in part on continued strong offshore investor purchases of domestic bonds. Foreign investors have overtaken banks as the largest institutional ownership category of domestic currency, tradable government bonds, with a 34.3 percent share of the total; offshore investors have taken up 54 percent of the IDR 85.6 trillion increase in domestic government bonds outstanding in 2014 through 11 July.8 Table 5: The World Bank has revised up its projection of the Budget deficit to 2.8 percent of GDP (IDR trillion, unless otherwise indicated) 2013 2014 2014 Prelim. Revised Budget IEQ Mar 2014 IEQ Jul 2014 Actual Budget A. Revenue 1,430 1,667 1,635 1,581 1,540 1. Tax revenues 1,072 1,280 1246 1,216 1,188 Income Tax 503 586 570 561 543 Oil and gas 89 76 84 95 87 Non-oil and gas 414 510 486 466 456 VAT 383 493 476 448 440 2. Non tax revenues 353 385 387 362 351 B. Expenditures 1,639 1,842 1,877 1,845 1,821 1. Central government, o/w 1,126 1,250 1,280 1,259 1,229 Personnel 221 263 259 261 244 Material 168 216 178 184 169 Capital 172 184 186 185 165 Interest payments 113 121 135 126 136 Subsidies, o/w 355 334 403 416 410 Energy subsidies 310 282 350 370 363 Fuel subsidies 210 211 246 267 259 Electricity subsidies 100 71 104 103 104 Non Energy 45 52 53 46 47 Grants 1 4 3 4 3 Social 92 92 88 55 85 Other 4 37 28 29 17 2. Transfers to the regions 513 593 597 586 593 C. Primary balance -97 -54 -106 -138 -145 D. Overall balance -210 -175 -241 -264 -281 as percent of GDP -2.3 -1.7 -2.4 -2.6 -2.8 Key economic assumptions Economic growth (percent) 5.7 6.0 5.5 5.3 5.3 CPI (yoy, percent) 8.4 5.5 5.3 6.2 5.8 Exchange rate (IDR/USD) 10,542 10,500 11,600 12,000 11,800 Crude oil price (USD/barrel) 106 105 105 105 106 Oil production ('000 barrels/day) 825 870 818 n.a n.a Subsidized fuel consumption (mil. KL) 46.4 48.0 46.0 47.9 47.8 Source: Ministry of Finance; World Bank staff calculations 8 All figures in this paragraph are from the Directorate General of Debt Management, Ministry of Finance. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 19 Hard choices Indonesia Economic Quarterly 7. The pace of poverty reduction has slowed The Government’s The official poverty rate, as measured by the national statistics agency (Badan Pusat Statistik, poverty target for 2014 BPS) for March 2014 was 11.3 percent, representing a marginal 0.1 percentage point decline is likely to be missed, from 11.4 percent in March 2013. This continues the slowing trend in poverty reduction due to a slowing rate of over the last five years, where annual poverty reduction has been below 1 percentage point poverty reduction each year, with only modest poverty reduction recorded especially for the last three years. The near-zero decline in 2014 is the smallest in over a decade, with the exception of the nearly 2 percentage point increase in 2006 due mainly to food price shocks (Figure 31). With poverty currently at 11.3 percent, the Government’s 2014 target of 8-10 percent under the current medium-term development plan (Rencana Pembangunan Jangka Menengah, RPJM, 2009- 14) is unlikely to be met when the September 2014 poverty rate is announced (expected in January 2015). Contributing factors There are a number of reasons for slowing poverty reduction.9 One important factor is that are that the remaining as poverty approaches 10 percent, the remaining poor are further and further below the poor are increasingly poverty line, meaning that higher consumption growth at the bottom of the income hard to reach, and that distribution is required to maintain previous rates of poverty reduction. Moreover, not only economic growth is economic growth slowing, but the poor and vulnerable have participated less in this continues to be growth than wealthier Indonesians, contributing to the widening in inequality discussed in unequally shared… Section C. …amid signs from the Another factor that may be weighing on poverty reduction is slowing employment growth. most recent labor data New labor market data released by BPS in May 2014 shows that total employment stood at of slowing employment 112.8 million in August 2013, down by 0.2 percent from the year previously (Figure 32). The creation drop is attributable to stagnant formal employment growth in 2012-2013, following strong growth from 2010-2012. Consequently, the unemployment rate edged higher to 6.2 percent in August 2013, up from 6.1 percent in 2012, while the share of the working age population in employment fell by a full percentage point, to 62.7 percent. Figure 31: The pace of poverty reduction in the last three Figure 32: …and the latest August labor market data, for years has been the slowest in over a decade… 2013, point to slowing employment growth (percent) (millions of people, and net employment growth, percent) Million Percent 2.5 20 200 10 18 180 Total population 15+ (LHS) 2.0 8 Poverty rate (RHS) 16 160 1.5 14 140 Employed (LHS) 6 1.0 12 120 Labor force (LHS) 0.5 10 100 4 0.0 8 80 Net employment 2 6 60 growth (RHS) -0.5 4 40 0 -1.0 2 20 Change in poverty rate (LHS) -1.5 0 0 -2 2004 2006 2008 2010 2012 2014 2001 2003 2005 2007 2009 2011 2013 Source: BPS; World Bank staff calculations Note: calculations based on backcasted weights from 2010 population census, as applied by BPS beginning in February 2014, which implied a revision of the 2011, 2012 and 2013 series Source: BPS; World Bank staff calculations 9 See the December 2013 IEQ for a detailed discussion of Indonesia’s slowing poverty reduction. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 20 Hard choices Indonesia Economic Quarterly 8. Fiscal risks have shifted into focus International risks to The World Bank’s baseline scenario for Indonesia’s outlook is one of a slight moderation Indonesia’s outlook in GDP growth and a continuing improvement of the current account balance. There are have become more several international and domestic risks to the base case. Although short-term risks in balanced in the short international financial markets, stemming from the normalization of monetary policy in term advanced countries, have become less pressing, they have not been eliminated. Over the medium-term, further episodes of volatility can be anticipated, as markets approach high- income monetary policy decision points. In contrast, the conflict in Iraq and its potential to affect global oil prices poses an immediate downside risk. A net oil importer, Indonesia stands to lose from rising oil prices as higher oil prices would add to the fiscal deficit through the dominant direct impact on higher fuel subsidy spending. Finally, as a major commodity exporter, Indonesia continues to be sensitive to developments in China, that is the country’s ongoing process of economic rebalancing while aiming to minimize financial stability risks. The transition to a While the growth outlook has not changed significantly from the March 2014 IEQ, some new Government, and near-term risks, especially those related to Indonesia’s fiscal position, have risen. Private its near-term policy consumption spending and fixed investment, in particular buildings, may decelerate more priorities, particularly than projected in the base case, if credit conditions and property prices deteriorate more in relation to the fiscal than currently expected. Once the official Presidential election result is confirmed, position, will frame investor attention will shift to the policy priorities of the new Government, particularly in the near-term relation to energy subsidies given the weakening fiscal balance. Any new reform in fuel domestic risks subsidies, along with a larger-than-projected impact of the increase in electricity tariffs, constitutes an upside risk to consumer price inflation. The effect of El Niño on food prices, which comprise 35 percent of the CPI basket, is another upward risk to inflation and a potentially significant negative risk to the consumption of the poor. As in many other Looking beyond the more benign near-term global outlook, and the domestic political EMEs, sizeable transition, the medium- to long-term economic outlook is also subject to considerable concerns regarding uncertainty. After three strong post-crisis years, real fixed capital formation growth has the trajectory for weakened markedly since 2012. Amidst softer commodity prices, investment is likely to future potential output ease further as capital costs rise and international liquidity tightens. As in many other remain EMEs, despite the potential “demographic bonus” of the next two decades, working age population growth is also slowing. All of these factors represent significant risks to potential output growth. They also place a great premium on policy reforms targeting faster productivity growth as the foundation of higher income growth to enable Indonesia to continue to move up through middle-income status.10 10For further discussion see World Bank (2014), Indonesia Development Policy Review 2014: “Avoiding the Trap”, http://www.worldbank.org/en/news/feature/2014/06/23/indonesia-2014- development-policy-review. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 21 Hard choices Indonesia Economic Quarterly B. Some recent developments in Indonesia’s economy 1. El Niño, forest fires and haze: the imperatives for concrete action Forest and land fires, Indonesia has experienced annual large-scale forest and land fires since 1982,11 together with while not new to significant environmental damage and economic impacts. In fact, forest fires are not a new Indonesia, have been phenomenon in Indonesia - historical records compiled by the Ministry of Forestry1 indicate occurring with that the occurrence of forest fires, albeit on a smaller scale, and the notion of an annual fire- increasing frequency prone dry season between May and November, existed at least as far back as the Dutch and on a larger scale colonial period. But while fires may be nothing new, the occurrence of very large-scale fires with annual regularity is a more recent trend. This section provides a brief overview of this complex issue, drawing on the major fires in Riau province (east Sumatra) in early 2014 as a case study, particularly in light of the heightened near-term forest fire risks due to possible El Niño conditions later this year. a. Underlying causes of recurring forest and land fires The causes of forest Several studies have documented the underlying causes of forest fires in Indonesia. For fires in Indonesia are example, the Center for International Forestry Research (CIFOR) conducted a study into the well understood… underlying causes and impacts of fires across Southeast Asia, including examining traditional land development practices in both the highlands and lowlands of Sumatra. The study identified several underlying causes, including land preparation for agriculture, illegal logging, insecure land tenure of the community, and land speculation.12 … and include Peat fires are also a major trigger for new forest fires, in addition to having their own degraded peatland economic, social and environmental effects (see Box 3). On the island of Sumatra, most peat is found along the eastern coast, where six large remaining forest areas can be identified. 11 Ministry of Forestry, 25 September 2013, “History of Forest Fires in Indonesia”. 12 CIFOR, March 2001, “The underlying causes and impacts of fires in Southeast Asia”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 22 Hard choices Indonesia Economic Quarterly Five of these are in the province of Riau. Overall, 72 percent of former closed-canopy peat forest, once covering 6.5 million hectares (ha.) of Sumatran lowlands, was assessed to have been lost by 2010. Today, degraded forest covers 2.4 million ha., with around 1.5 million ha. converted into agricultural and plantation land. Satellite data indicates The occurrence of fires in peatland areas can be depicted using frequency maps of hotspots, that peatland areas i.e. points that have significantly warmer temperatures than their surroundings. Using have a higher satellite data over 2001 to 2010, it is evident that areas along the eastern coast of Sumatra in prevalence of hotspots, the provinces of Jambi, Riau and North Sumatra, as well as in the southern part of Central which are associated Kalimantan, have the highest frequency of hotspots, which are associated with fires (Figure with fires 33). Overlaying hotspot maps with land cover maps highlights that areas with higher hotspot density coincide with peatland. Figure 33: Satellite hotspot densities indicate the frequency of fires over 2001-10, by district Note: Satellite data from MODIS (Moderate-resolution Imaging Spectroradiometer) Source: World Bank, February 2012, “Thematic Paper 4: Patterns In Drought and Peatland Fire in the Lowlands of Sumatra and Kalimantan”. Box 3: Peat, peatland and peat fires Peat is an accumulation of partially decayed vegetation or organic matter. Peat forms when plant material, usually in wetland areas, is inhibited from decaying fully where flooding obstructs the flow of oxygen from the atmosphere, slowing the rate of decomposition. Peat is characterized by its wet environment. Drought will, however, increase evaporation and lower the groundwater table and soil moisture content. Consequently, drought increases the vulnerability of peatland to fire risks, exacerbated if the soils are drained. Drainage of peatland can enhance agricultural productivity and improve the accessibility of the terrain. However, drainage enhances soil exposure to oxygen, which consequently oxidizes, resulting in accelerated subsidence of peat soils. Draining peatland also increases its vulnerability to fire, as it reduces the moisture content and stimulates oxygen supply. Peat has a high carbon content and once ignited it smolders and can even burn underground, provided there is a source of oxygen. Peat fires can burn almost indefinitely or at least until the fuel is exhausted or the oxygen supply is interrupted. These smoldering fires can burn undetected for very long periods (months, years, and even centuries) propagating through the underground peat layer. Peat fires are emerging as a global threat with significant economic, social, and ecological impacts, not only because of the haze they create, but also because of major resulting CO2 emissions. Over 100 peat fires in Kalimantan and East Sumatra have continued to burn since 1997. Each year, the peat fires in Kalimantan and East Sumatra ignite new forest fires above the ground. Water management in developed peatland is essential not only to find a balance between drainage levels and cultivation practices but also to reduce fire risks, and to protect peat soils for future generations. Source: International Peat Society (2014), see http://www.peatsociety.org J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 23 Hard choices Indonesia Economic Quarterly While infrequent forest Increasing demand for plantation land for pulp wood and cash crops, especially oil palm, has and peatland fires led to the opening of more forest areas covering peatland, coupled with the drying of occur naturally, it is peatland by the building of canals to make the land cultivable. At the same time, fires have now recognized that also been used as a method of land clearing by both small-holders and large corporations. the problem of Patterns of fire occurrence over the past ten years clearly show that most of the burning is frequent, large scale deliberate at the margins of the forest, taking advantage of wind direction to burn areas still fires in Indonesia is covered by forest or shrubs, and burning in a direction away from already cultivated areas. due to human More than half of the forest and peatland fires that occurred in Riau in 2013 were located intervention within concession areas, i.e., land already licensed to large companies. Sixty percent of those burns, however, originated from company areas occupied by small-holders. Clearing land using The law prohibits the use of fires as a land clearing method and treats this as a criminal act.13 fires is the cheapest Research shows, however, that some large corporations prefer to risk penalties rather than method, with costs using alternative, more costly methods of land clearing.14 By law, concession-holders are averaging only about responsible for fires that occur within their concession area, no matter who starts the fires. twenty percent of non- Enforcement of these laws and regulations is extremely challenging, and while small-holders burning methods tend to be blamed whenever fires occur, the situation is far from clear. Forest and peat land Some medium-size investors use contract ‘farmers’ in large groups—between 100 and 200 fires can also be linked workers/families per group—to occupy forested land areas of about 2 ha. per worker or with organized family, cut the trees and burn them on the spot, while heavy equipment is employed for appropriation of land landscaping and preparing the land for oil palm plantation. Deterring this type of practice has proven to be difficult in the face of strong economic incentives. Within one to two months, occupied areas typically become small plantations claimed by small-holding settlers who live in enclaves inside the forest area. As time progresses, most of these small-holdings change hands and become owned by medium-size companies. In the case of independent small-holdings, it is estimated that a hectare of oil palm plantation that costs less than IDR 2 million in investment may change ownership after 4 to 5 years (after the first fruit is proven) for a value in the range of IDR 30-35 million. High expected financial gains, coupled with weak law enforcement capacity, have thus become the main cause of forest and land fires. It is also important to recognize, however, that another driver behind forest and land fires is conflict over land. Albeit on a far smaller scale, these are cases where fire is used as weapon in disputes or as a way to seize disputed land.15 b. What the 2014 El Niño may bring 2014 is predicted to be The International Research Institute for Climate and Society foresees a 70 percent chance of an El Niño year with El Niño (see Box 4) occurring this year from July to August onwards, increasing to 80 potentially severe percent by September. Historically, El Niño brings significant climate-related problems to droughts southeast Asian countries, with India, Indonesia, the Philippines and Australia often experiencing deficient rainfall or drought. Given the region’s large population, its dependence on agriculture and its reliance on small-scale subsistence farms, any climatic anomaly affecting agricultural yields has potentially serious implications for food security.16 13 See Law No. 32/2007 on the Protection and Management of Environment, and Government Regulation No. 4/2001 on the Management of Environmental Degradation and/or Pollution Linked to Forest or Land Fires. 14 CIFOR, 2014, “Fact File on Fire and haze in Southeast Asia”. 15 This paragraph draws upon CIFOR, 2 July 2014, Presentation at the Jakarta Foreign Correspondents Club Seminar on Forest Fires. 16 USDA Foreign Agricultural Service, June 2014, “Southeast Asia: Historical El Niño-related Crop Yield Impact”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 24 Hard choices Indonesia Economic Quarterly Box 4: El Niño and ENSO El Niño is a natural phenomenon in the equatorial Pacific Ocean caused by a prolonged increase in the sea’s surface temperature. In the tropical Pacific Ocean, the trade winds usually blow from east to west, gathering warm water as they go and depositing it in the west in the form of typhoons and thunderstorms. This process creates a temperature imbalance with cold water in the east and warm water in the west (around Indonesia). As a consequence, warm water flows to the South American coast and trade winds start to weaken and sometimes reverse direction completely. This phenomenon is also often referred to as the ENSO (El Niño Southern Oscillation). El Niño occurs when the surface water temperature in the central and eastern parts of the ocean rises and the temperature in the western part falls, causing a decrease in evaporation and a reduced moisture supply from the east, with consequently less cloud formation and less rain. Typically, this anomaly happens at irregular intervals of 2 to 7 years, and lasts 9 months to 2 years. Primary effects of El Niño are alterations in weather patterns, such as changes in temperature, rainfall, storm tracks and currents. For example, during El Niño the temperatures will generally be higher, and from June to August eastern Indonesia will often suffer droughts as the rain zone moves eastwards to the islands along the equator in the Pacific Ocean. The effects on rainfall of El Niño are strongest in the period from September to November when almost all of Indonesia is drier than usual. In December-February, East Indonesia stays drier. Source: International Research Institute for Climate and Society (IRI); Indonesian Meteorology Climatology and Geophysics Agency (Badan Meterologi Klimatologi dan Geofisika, BMKG); Royal Netherlands Meteorological Institute(Koninklijk Nederlands Meteorologisch Instituut, KNMI) Historically, El Niño is There have been 20 El Niño Southern Oscillations (ENSOs) in the 120 years since 1877. associated with rainfall The most recent ENSOs are closely associated with forest fires in Indonesia. The massive deficits in Indonesia, fires of 1982-83 coincided with ENSO, and were the starting point of large regularly triggering large-scale recurring forest fires in Indonesia. The 1991 ENSO fires helped to generate new interest in forest fires trying to understand the role of human activity in causing and contributing to the fires, while the 1994 ENSO forest fires triggered an ASEAN regional response with the establishment of a special committee and a legally binding trans-boundary haze pollution agreement. The 1997 ENSO forest fires have thus far been the most significant in terms of size and impact. For the first time, the Government appealed for international assistance to combat the fires.17 c. The lesson from the February-March 2014 fires in Riau Riau province, which When considering the risks of forest fires associated with any future El Niño conditions, the experienced severe recent economic costs and lessons from the February and March 2014 fires in Riau are recent forest fires in instructive. In Riau and Central Kalimantan, the two provinces with the highest potential for February to March peatland fires, major peatland fires are reported in dry periods nearly every year. In 2014 is one of Kalimantan these fires are concentrated in only a few very dry months. In Riau, however, Indonesia’s two most this is not as regular, as dry months are less predictable and less severe. This leads to the fire-prone, along with practice of taking maximum advantage of even a brief rainless period to clear land with fire Central Kalimantan (as in February and March 2014). Regardless of public There are sufficient datasets and expertise in Indonesia to analyze the spread and impact of debate over who forest fires and rapidly map them against land-use designation and concession boundaries. A started the fires, the rapid analysis carried out by scientists from the Indonesian Space Agency (Lembaga distribution of burned Penerbangan dan Antariksa Nasional, LAPAN) and the Agency for the Assessment and areas and boundary Application of Technology (Badan Pengkajian Dan Penerapan Teknologi, BPPT) using a practical overlaps can be easily and widely-used technique called Normalized Burned-area Ratio (NBR) can reveal critical mapped information that is useful to determine the typology of the fires and their impact on the landscape. 17Neil Byron and Gill Shepherd, April 1998, “Indonesia and the 1997-98 El-Niño: Fire Problems and Long Term Solutions” (Natural Resources Perspective. Overseas Development Institute). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 25 Hard choices Indonesia Economic Quarterly The fires in Riau in The fires in Riau over January to March 2014, which burned more than 176,000 ha., February-March 2014 occurred predominantly in lowland coastal areas and at the margins of peat-swamp forest burned more than (Figure 34). Around 24 percent of the burned area was swampy bushes (logged-over forest), 176,000 ha. while around 22 percent was on secondary swamp forest. Overlaying this with a land-system map reveals that 143,000 ha. of the burned areas fall in land classified as peatland. Further overlays with forest utilization license maps reveal that 1,300 ha. of the burned areas were in natural forest designated for utilization, and 68,500 ha. in areas designated as industrial forest, and another 30,000 ha. in areas with palm oil plantation licenses. This analysis is consistent with previously documented patterns of fires where these start from lowland forest and plantation margins where plantation expansion may be ongoing. Figure 34: Burned areas by land-use category in Riau (burned-area mapping and anatomy of the fire-affected areas) Source: LAPAN and BPPT (2014) The total damage and According to World Bank estimates, the total damage and loss from the February-March losses caused by the 2014 Riau fires is estimated at USD 935 million, or 2.8 percent of Riau province GDP (as forest fires in Riau in projected by the regional government). Total damage is estimated to be USD 73 million (7.8 February-March 2014 percent of the total damage and loss), and total losses are estimated at USD 862 million (92.2 alone is estimated at percent of the total). Damage is a proxy for the amount of financing needed for USD 935 million reconstruction and rehabilitation, while the losses represent the reduction in economic activities and income that arise in the following months or years as a result of the disaster (Table 6). Over 73 percent of all damage and losses are of a private nature, primarily occurring in forest concession areas and palm oil crops owned by private firms.18 Forestry and Forestry and agricultural crops suffered most during the fire with damage and losses agricultural crops estimated at USD 301 million and USD 260 million, respectively. This impact was associated suffered most, followed with the burning of 34,300 ha. of forestry land and 25,400 ha. of agricultural land, with palm by manufacturing and oil plantation and dry-land agriculture comprising 75 percent and 25 percent of total then the trade sector agricultural land, respectively. The direct damage to forestry was relatively limited, as calculated from replanting costs. However, the losses were significant based on the number of destroyed trees and their sales value. Manufacturing losses were also significant, at USD 219 million. The loss of industrial forest in Riau results in a major loss for the surrounding sawn-timber, plywood, and pulp and paper manufacturers. Some manufacturers have limited if any alternative sources for their main raw materials, in this case timber. The trade sector is estimated to have suffered losses of 10 percent of total provincial trade sector annual output, 18The assessment was conducted in early April 2014 using the methodology designed by the UN Economic Commission for Latin America and the Caribbean (ECLAC) to determine the value of lost assets, and assess the impact on each sector. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 26 Hard choices Indonesia Economic Quarterly oil and gas and mining sector activities halted their activities for more than a week, and local and international travelers cancelled or postponed their visits to Riau. Furthermore, because of the thick smoke haze, airports and seaports were closed for several days, and land transportation was reduced for days. Table 6: The estimated damage and losses of the forest fires in Riau, February-March 2014, reach USD 935 million (estimated damage and losses, USD million) Disaster effects Ownership Damage Losses Total Public Private Forestry 9 292 301 133 168 Agricultural crops 64 196 260 91 169 Mining 0 12 12 0 12 Trade 0 76 76 0 76 Manufacturing 0 219 219 0 219 Tourism 0 20 20 0 20 Transportation, communication 0 22 22 6 16 Health 0 11 11 8 4 Environment* 0 0.1 0.1 0.0 0.1 Humanitarian and fire-fighting costs 0 14 14 13 1 Total 73 862 935 251 684 Note: *Environment loss estimates capture direct biodiversity losses only, and exclude emissions Source: World Bank staff calculations Overall, the Riau fires The Riau fires are estimated to have caused a decline in provincial GDP growth for several are estimated to have years. For 2014, the regional government of Riau had expected to post regional GDP caused a material growth of 3.0 percent, with 6.0 percent growth of non-oil-and-gas GDP and a 0.7 percent decline in provincial contraction of oil-related GDP. However, based on the impact assessment summarized GDP growth above, Riau’s 2014 regional GDP growth may be lowered by 0.4 to 0.6 percentage points, to approximately 2.5 percent yoy, all else equal. Non-oil sectors (which account for 63 percent of provincial GDP) were impacted the most, with their losses projected to reduce non-oil GDP growth from 6.0 to 4.9 percent. With Riau one of Indonesia’s “big five” regions in terms of regional GDP, along with DKI Jakarta, East Java, West Java, and Central Java, such impacts are also of national economic interest. However, the assessed Due to limited time and resources, the assessment did not include the education sector (e.g. losses do not cover disruption to schooling). It also only partially captured the health effects of the disaster, important impacts, focusing on public spending on medicine and health equipment, but not the longer-term such as longer-term human health consequences of exposure to the smoke haze arising from the fires. Studies on health and the health impacts of forest fires, related to the increase of fine particulate matter levels, environmental costs… have demonstrated that in the long run health-related economic impacts appear to be substantial, second only to timber losses.19 In addition, due to forests having multiple functions it is difficult to state the true economic value of all goods and services provided from forest resources. Notably, for example, the economic impact of the environmental losses in this assessment only includes the value of the loss of biodiversity related income, and does not capture the release of emissions from the fires. …and recurrent fires Comprehensive forest fire impact assessment should also consider the major, longer-term pose longer-term risks risks to the crude palm oil (CPO) industry, in Riau and nationally. Indonesia is now the to the CPO industry in world’s largest CPO producer and the industry generates over USD 15.8 billion20 of annual Indonesia and to the export earnings. Many industry players have become more proactive in implementing country’s reputation in sustainable production including adopting a no-deforestation and no-burning policy in land international markets preparation for their plantations. However, while plantation owners undertake preventive 19 See, for example, R. Ritmaster and W.L Adammowicz, May 2001, “Economic Analysis of health effects from forest fires in Chisholm, Canada”. 20 Indonesia’s CPO export revenues in 2013 were USD 15.8 billion (BPS). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 27 Hard choices Indonesia Economic Quarterly measures to protect their productive crops, the pattern of fires also remains consistent with the pattern of plantation expansion, typically using the local community to carry out burning for land preparation (as discussed above). This practice of using local communities as a proxy makes it difficult to establish that companies certified as applying sustainable production are not involved in driving the land burning, a situation which may jeopardize the overall global reputation of the industry. d. The imperative for more, concrete action Forest fires are a Economic impact assessments, such as that for Riau above, show clearly that the potential major, costly risk with costs of forest fires are large. Though less easily quantified, they also bring long-term risks to significant economic, business and Indonesia’s international reputation. Other, major long-term risks, though not social and the focus of the brief discussion of this section, include the threat to climate change goals, environmental environmental sustainability, and (through economic, social and environmental impacts), impacts… poverty reduction. The risks and costs of large-scale, regular forest fires, therefore, are significant, and consequently should be considered as part of Indonesia’s wider disaster risk prevention and mitigation strategy. …and are largely When it comes to natural disasters, Indonesia tops the list of the world’s most vulnerable preventable, unlike countries to multiple hazards, such as earthquakes and tsunamis, volcanic eruptions, floods, many other disasters droughts and landslides. Annual disaster-related national fiscal spending, mainly for post- that continue to occur disaster reconstruction to rebuild damaged public assets and provide financial assistance to in Indonesia disaster-affected populations, reaches an average of USD 500 million per year.21 Most of this spending is used to respond to natural disasters that cannot be prevented. But, unlike earthquake and volcano occurrences, the number of land and forest fires in Indonesia can be significantly reduced. In the Riau fires of early 2014, the Government had to spend USD 13 million on fire-fighting during the two months immediately after the fires got out of control. The communities involved in land clearing by burning typically receive about USD 5 per person per day, similar to the rate for typical post-disaster cash-for-work programs. Using this level of payment as an example, when planned properly through a community empowerment approach—which has worked well in disaster prevention, response and recovery in other areas in Indonesia—the USD 13 million spending for two months could have been used to employ more than 30,000 community members for three months to undertake fire prevention and land preparation, all without the use of fires for land clearing. The need to tackle El Niño this year could be of the severity of El Niño in 1997, when massive forest fires forest fires is urgent; El occurred. A likely peak of the dry period is predicted in October to December 2014, at the Niño and the fire time when the newly-elected president will take office. As the transition between season will likely administrations can be a time when policy-making slows down, it is imperative that the coincide with the early outgoing and incoming administrations work closely together to ensure that massive fires are weeks of the new prevented. For example, systematic steps to determine the start of the fire season using administration parameters such as a drought index, the occurrence of hot spots (with higher thresholds), and a decrease in the air quality index, need to be defined. The Government at both the national and subnational levels could trigger a stand-by emergency status much earlier using well-established practices in disaster management under Law No. 24/2007 on Disaster Management that have been applied by the National Agency for Disaster Management (Badan Nasional Penanggulangan Bencana, BNPB). Triggering stand-by emergency status early would enable the Government to mobilize stand-by (on-call) funds quickly from the state budget without the need for specific parliamentary approval, enabling preventive measures through intensified law enforcement, and the involvement of local communities. Progress on such measures over the next few months can help to ensure that fires and haze do not impose major environmental and economic losses, and burden the fresh start of the new administration. 21World Bank/GFDRR, October 2011, “Indonesia: Advancing a National Disaster Risk Financing Strategy – Options for Consideration”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 28 Hard choices Indonesia Economic Quarterly 2. New purchasing power parity-adjusted estimates of Indonesia’s economy Comparing the size of How large is Indonesia’s economy relative to that of other countries? To make such economies and average comparisons, it is necessary to convert values into common units. One option is to use expenditures at market market exchange rates: for example, to compare the size of Indonesia’s economy to that of exchange rates can be the US, Indonesia’s GDP in Rupiah can be converted into US Dollars using the market misleading… exchange rate (about 12,000 IDR per USD, at the time of writing). However, the market exchange rate may not be a good measure of the relative purchasing power of one dollar in the US versus that of one dollar, converted into Rupiahs, in Indonesia, because it does not adjust for different price levels. If goods and services, particularly non-traded ones, are generally cheaper in Indonesia than in the US, then using market exchange rates would under-estimate the value of goods and services produced by Indonesia, and hence under- estimate of the size of its economy. The International Comparison Program (ICP), an international initiative hosted by the World Bank, tackles this problem of accurately comparing the value of the goods and services produced by different economies. In June 2014, the full results were released from the latest round of estimates, launched in 2011 (“ICP 2011” or the 2011 Round). This section examines these results for Indonesia. …relative to using What is needed is a measure that adjusts for differences in price levels between different comparisons based on countries. Purchasing power parity (PPP) estimates, i.e. the ratio of the prices in national purchasing power currencies of the same good or service in different economies, can be used to provide cross- parities (“PPP”)… country estimates of GDP or expenditure using a common price level.22 For example, if it turned out that, given prevailing prices in Indonesia, the volume of goods and services that could be purchased with one dollar in the US in 2011 could be purchased with only IDR 3,607 in Indonesia (not IDR 8,770, the market exchange rate value of one US Dollar in 2011), then the estimated goods and services produced by the Indonesian economy, adjusted for differences in purchasing power, would be almost three times larger than when using the market exchange rate. There are theoretical reasons to expect PPP conversion rates to be an important determinant of market currency exchange rates, especially over longer periods, but at any one time there is little reason to expect them to capture PPP, making international economic comparisons on a market exchange rate basis potentially misleading. ...as comprehensively ICP 2011 provides new estimates of PPP conversion factors across most of the world’s estimated by ICP 2011 economies. This is the first comprehensive update since the 2005 Round, and involved major improvements in methodology, as well as the addition of new countries to the study (199 countries were included in 2011, compared with 146 in 2005). The methodological differences between the ICP 2005 and 2011 estimates, and shifts in economies over time, make it very difficult to compare the data across years. Rather, the 2011 ICP results should be seen as the new best estimate of the differences in purchasing power across economies. a. The results for Indonesia: a “Top 10” economy The global context: The results of ICP 2011 for Indonesia (summarized in Table 7) should be placed in the developing economies global context.23 Developing countries’ share of the global economy is much bigger than account for a greater previously estimated. Middle income economies’ share of global GDP is 48 percent when share of the world using PPPs and 32 percent when using exchange rates. Six of the world’s twelve largest economy economies were in the middle income category (based on the World Bank’s definition). When combined, the twelve largest economies account for two-thirds of the world economy, and 59 percent of the world population. Roughly twenty-eight percent of the world’s population lives in economies with GDP per capita expenditures above the PPP$ 13,460 world average and 72 percent are below that average. The median yearly per capita expenditures for the world is PPP$ 10,057. 22 For a complete overview of PPP concepts, and of ICP 2011 methodology, see http://icp.worldbank.org. 23 This paragraph is drawn from the ICP 2011 press release, available at http://www.worldbank.org/en/news/press-release/2014/04/29/2011-international-comparison- program-results-compare-real-size-world-economies. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 29 Hard choices Indonesia Economic Quarterly On a PPP basis The ICP 2011 estimate of Indonesia’s PPP exchange rate to the US Dollar in 2011 was Indonesia’s economy is 3,607, resulting in an estimated PPP-based GDP of PPP$ 2.06 trillion. On this basis, estimated to be the 10th Indonesia was the tenth largest economy in the world (Figure 35), and the largest developing largest in the world– country economy behind only the “BRICs” (Brazil, Russia India and China). Indonesia the largest developing accounted for 2.3 percent of total global expenditure (versus 3.6 percent of the global economy after the population). By contrast, using market exchange rates, Indonesia was the nineteenth largest BRICs… economy in the world in 2011, accounting for only 1.2 percent of total global expenditure. The difference is driven by cheaper prices in Indonesia, with the index of prices used for the computation standing at only 53 percent of the global price index. …and consumption On average, Indonesians are relatively better off, when compared with average consumption per person is 13 percent in the US, for example, than would appear based on commonly-used, market exchange-rate that of the US, versus based comparisons. At market exchange rates, consumption expenditure per capita in under 6 percent when Indonesia in 2011 was just 5.5 percent of that in the US, but this rises to 12.9 percent on a comparing using PPP basis. However, even adjusting for relative prices, per capita consumption in Indonesia market exchange rates remains comparatively low (Figure 36), ranking 127th on a PPP basis out of 187 countries for which data are available (and 126th at market exchange rates). Figure 35: Indonesia’s economy is the tenth largest, Figure 36: …but per capita expenditure at PPP remains measured on a PPP basis… comparatively low (largest twenty economies by PPP expenditure, share of world expenditure, (total and per capita PPP expenditure, 2011) percent, 2011) 25 Per capita Share of world expenditure, PPP 60,000 expendi- ture 20 50,000 US Share of world expenditure, market exchange rates 40,000 15 JPN 30,000 10 20,000 5 CHN 10,000 IDN IND 0 0 Italy Spain Korea Australia Taiwan Germany Brazil France Iran Turkey Russia China India Japan Mexico US UK Canada S. Arabia Indonesia -10,000 Log of total expenditure 1 10 100 1,000 10,000 100,000 Source: ICP Note: Full ICP sample excluding three outliers; bubbles indicate population size Source: ICP; World Bank staff calculations On a PPP basis, In the regional context, ICP 2011 estimates support the contention that Indonesia is the Indonesia’s economy giant of south east Asian economies, but unlike its global economic size ranking, there is remains the giant of little difference between estimates based on market exchange rates and those on PPP, with ASEAN, and Indonesia’s economy estimated to contribute just under 40 percent of total ASEAN GDP. expenditure per person This is because PPP-estimates increase the estimated GDPs of Indonesia’s ASEAN peers by is closer to the regional generally similar margins. Expenditure per person in PPP terms in Indonesia is average approximately equal to the population-weighted ASEAN average (of PPP$ 8,549 in 2011). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 30 Hard choices Indonesia Economic Quarterly Table 7: ICP 2011 key results for Indonesia Domestic Relative size of Expenditure per capita economic Memo: economy structure PPP Value Comparison with Share (world = (US$ = US (=100) 100) 1.000) Based Based Based Based Based Based Based Based on on on on on XRs on XRs on XRs on XRs PPPs PPPs PPPs PPPs Overall GDP 8,539 3,511 17.2 7.1 2.3 1.2 100% 100% 3,607 Actual Individual Consumption 4,805 2,044 12.9 5.5 2.0 1.1 56% 58% 3,731 Individual Consumption by Households 4,110 1,917 12.0 5.6 2.1 1.1 48% 55% 4,092 Individual Consumption by Government 637 127 20.8 4.1 1.3 0.5 7% 4% 1,745 Collective Consumption by Government 564 189 11.2 3.8 1.6 0.8 7% 5% 2,947 Gross Fixed Capital Formation 2,701 1,122 29.8 12.4 3.1 1.7 32% 32% 3,645 Source: ICP b. Limitations and what the new data do not tell us The results are The ICP 2011 results have some important limitations, which this section briefly reviews. statistical estimates First, the PPP adjustment factors are statistical estimates. They represent the best effort to only, subject to pinpoint the true figure, within an error band. The resultant adjustments are then applied to uncertainty… data, such as domestic currency-denominated output and population, that are also estimates subject to measurement errors. Given this imprecision, as well as the dynamic nature of economies, it is best to focus on the qualitative implications of the estimates (e.g. adjusting for relative price levels shows that Indonesia’s economy is very much bigger than the estimate obtained using market exchange rates), rather than on the quantum of the estimates (e.g. Indonesia has a PPP$ 2.06 trillion economy and is certainly larger than Mexico’s). …they should not be Second, because of methodological differences between the surveys, and because of shifts in used to infer relative relative prices across time, differences between the results of the 2005 and 2011 ICP rounds economic performance cannot be used to infer Indonesia’s economic performance over time. For example, the fact since the 2005 ICP that Indonesia’s PPP-adjusted GDP was estimated at $707.9 billion in 2005, compared with Round… $2.06 trillion in 2011, does not mean that the economy grew by $1.4 trillion (191 percent) in the intervening years. For such comparisons across time, the best estimate is the official statistical (BPS) estimate of real GDP growth, which shows that Indonesia’s economy expanded by a total of 41 percent in real terms from 2005-2011. …and they generate A third limitation is more general. ICP 2011 provides a more accurate way of comparing expenditure price levels, and the relative expenditure on goods and services, across economies. The information only, not a resultant data are thus subject to the usual limitations of GDP for making welfare complete picture of comparisons, for example, in terms of ignoring both distributional issues—inequality (as welfare discussed in Section C)—and other determinants of welfare, such as environmental quality. c. Implications for policymakers ICP 2011 confirms the The ICP 2011 results are clearly relevant for Indonesia’s policymakers, in at least four key global relevance of ways. First, they confirm that Indonesia’s economy is globally significant. Indonesia is the Indonesia’s world’s 10th largest producer of goods and services, making its ongoing economic economy… development directly relevant to the global economy, with clear potential to act as a regional, and global, “growth pole” (in line with the findings of the World Bank’s 2011 Global Development Horizons report). J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 31 Hard choices Indonesia Economic Quarterly …points to solid Second, they suggest that Indonesia may have made more progress in catching up to living progress made in standards in advanced economies than suggested by previous estimates of PPP per capita lifting living standards expenditure. While this is clearly positive, it does not change the need to make more relative to the US… progress in raising average living standards, and in addressing vulnerability and inequality. The emphasis now should be on supporting the continued progress, that can help Indonesia decisively avoid falling into a “middle income trap” (as discussed in the World Bank’s recent Indonesia 2014 Development Policy Review, summarized in the March 2014 IEQ). …and will inform Third, the ICP 2011 results will be considered in future global, PPP-based, estimates of updated estimates of poverty in Indonesia, which should adjust for the relative purchasing power of the poor poverty in Indonesia… along conceptually similar lines to the international dollar adjustments for expenditures described in this note. However, the new ICP 2011 PPPs cannot be automatically mapped into new poverty estimates, because they do not necessarily capture the prices faced by the poor (price adjustments to make international poverty rate comparisons should specifically reflect the relative costs of poor households’ consumption baskets across countries). The PPPs based on the 2005 ICP Round will thus continue to be used for the World Bank’s global poverty statistics, but the 2011 Results will eventually inform future updates. PPP estimates can also play an important role in identifying and understanding the consumption of the emerging middle classes in countries like Indonesia.24 …as well as being a Fourth, ICP 2011 shows that price levels in Indonesia are well below the global average. useful input for long- Following the recent release of the detailed ICP data, it will be important to examine the key term macroeconomic sources of these price differences. This may also shed insights on how relative price management differences across sectors, for example, between investment and consumption, are influencing economic structure and may be reflective of deeper policy issues. As Indonesia’s economy continues grow and develop, it is reasonable to expect prices generally to converge with higher world prices. This, in turn, would feed into trend real currency appreciation (by reducing foreign currencies’ purchasing power in Indonesia). Thus, it will be important to consider the broader implications of these new estimates for expectations of future price growth and the impact on the exchange rate. 24See, for example, Homi Kharas, 2010, “The Emerging Middle Class in Developing Countries”, OECD Working Paper 285. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 32 Hard choices Indonesia Economic Quarterly C. Indonesia 2015 and beyond: A selective look 1. Inequality and opportunity in Indonesia a. Overview: rising inequality matters to the people of Indonesia Inequality was a major Inequality was a key issue in the run-up to the recent Indonesian presidential election. Major media issue in the lead national and international media outlets reported on rising inequality in Indonesia. Both up to the Indonesian presidential candidates made public statements about their concerns about this trend and presidential election stated their strategies to combat it during the first televised presidential debate on economic development and national welfare. The majority of survey A survey conducted by Lembaga Survei Indonesia in 2014 found that, while most respondents think that respondents are prepared to tolerate some degree of inequality, the majority feels that Indonesia has become Indonesia is significantly more unequal than it should be and that the country has become too unequal more unequal in recent years.25 Those surveyed had a strong preference for greater equality of incomes and were willing to accept slower overall economic growth to achieve it. The survey found that people greatly underestimate how much of total national income goes to the rich. Little is known about Past academic and policy research has tended to focus more on poverty than inequality. inequality in Indonesia Alongside other research institutions paying greater attention to inequality, the World Bank and its underlying has launched a research project on inequality in Indonesia. The research is still underway and drivers; further analysis will be published in 2015. This section presents some of the initial findings on why is key for the design of inequality is growing in Indonesia and why it matters for policy. Further work will explore appropriate policies the causes of inequality in order to identify how government policy can be shaped to mitigate or reverse this trend. Inequality in Indonesia Inequality, as measured by the Gini coefficient, increased by 11 percentage points between has been steadily rising 2000 and 2013. The true level of economic inequality in Indonesia is likely to be even higher since 2000 because the data used to measure it do not adequately represent rich households. Even so, 25 Lembaga Survei Indonesia, 2014, Inequality Perceptions Survey. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 33 Hard choices Indonesia Economic Quarterly the measured level of inequality is much higher than most people think, and strikingly higher than they would like it to be according to the above-cited survey. Unequal access to Members of rich Indonesian households have access to assets, such as real estate and stocks, assets and good job which have allowed their wealth to grow quickly. At the same time, with better education, opportunities is driving they are able to find better jobs to boost their incomes. Those from poorer households, inequality, however, lack financial assets and can only improve their income through work. Most of the undermining current jobs created in Indonesia since 2001, and indeed most current jobs, are in low productivity growth and poverty sectors, resulting in low real labor incomes, particularly for the poor and the vulnerable. In reduction addition, these workers have restricted access to formal worker protection. Limited access to good job opportunities also undermines current economic growth, since Indonesia is not maximizing the productive potential of its current labor force, exactly at the time when the demographic dividend is peaking. As they struggle to move upwards, many households are vulnerable to shocks and unexpected events and, without coping mechanisms, are at risk of falling back into poverty. Unequal opportunities According to World Bank estimates, one-third of inequality is due to circumstances that are during childhood also beyond the control of individuals, such as their birth place and the education of their compromise future parents—that is, due to inequality of opportunities. Many of these differences originate growth and poverty during childhood, for example, if children grow up without proper housing, water and reduction sanitation, or quality health and education services. Failing to realize the full potential of all Indonesian children today compromises future economic growth, as well as further poverty reduction. Inequality is not a Other countries have achieved economic growth without significantly increasing their necessary part of the inequality levels. Historically, Japan, South Korea and Taiwan all saw strong growth over a development process… number of decades with low inequality. Indonesia, on the other hand, experienced the largest increase in inequality in the region between the 1990s and the 2000s, after China. During the same period, countries like Thailand, Vietnam and the Philippines have all enjoyed periods of strong growth with stable or declining inequality. …and the vast majority About 83 percent of surveyed Indonesians believe that it is ‘urgent’ (39 percent) or ‘very of Indonesians want urgent’ (44 percent) that the Government tackles inequality.26 The forthcoming World Bank the new government to report on inequality will provide policy options based on the analysis of the drivers of tackle the problem of inequality and lessons learned from other countries, building on current policies and inequality programs. In general terms, key policy priorities include increasing access to productive livelihoods, ensuring access to quality basic education, health, water and sanitation for all, and expanding social protection. b. Inequality in Indonesia is high and the gap between rich and poor is widening Inequality in Indonesia Inequality in Indonesia as measured by the Gini coefficient (see Box 5) changed little has been steadily between 1980 and 1996. It fluctuated between 32 and 34 points, rising only to 36 in 1996 increasing since 2000 (Figure 37).27 This changed in the wake of the 1997/1998 Asian financial crisis. Urban and wealthier Indonesians were not only the hardest hit by the crisis but also the slowest to recover. Consequently, inequality fell from 36 percentage points in 1996 to 30 by 1999. Following the recovery from the crisis, Indonesia experienced a period of strong economic growth, driven in part by a commodity boom and strong domestic consumption. During this period the Gini coefficient climbed from 30 percentage points in 2000 to 42 by 2013. Comparing consumption levels across households, in 2002 the average consumption per person of the richest 10 percent of households was 6.6 times that of the poorest 10 percent; by 2013, this had risen to 10.3 times. As a consequence, the richest 10 percent now account for nearly a third of all household consumption in Indonesia, and the richest 20 percent for nearly half (Table 8). The poorest 40 percent, on the other hand, account for only a fifth of consumption and their share has been declining over time. 26 See previous footnote. 27 Changes in survey methodology mean the data are not necessarily consistent over time. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 34 Hard choices Indonesia Economic Quarterly Box 5: The challenge of measuring inequality and comparing across countries The Gini coefficient is the most commonly used measure of inequality. It lies between 0 (perfect equality) and 1 (complete inequality), with a typical range of 0.3 to 0.5. Often this is expressed in percentage points between 0 and 100. Gini coefficients are conventionally calculated from either income or consumption distributions. For more information on the Gini coefficient and Theil measures (used for some of the following analysis), see Haughton and Khandker, 2009, “Handbook on Poverty and Inequality” and the March 2011 IEQ. Comparing the Gini coefficients or any inequality measure across countries is very difficult. First, different countries use different welfare measures. Some, such as Malaysia and many Latin American countries, use household income, while others, such as Indonesia and most of Asia, use household consumption. Since richer households do not spend all of their income, but instead save a portion, income Gini coefficients are usually higher than consumption Gini coefficients in any given country. The average difference is 7.5 points; in Indonesia it is around 6 points (based on the average difference between the income and consumption Gini coefficients from 1984 to 1993, the last time income data were available), suggesting the current consumption Gini coefficients of 41 could represent an income Gini coefficients of around 47. Consequently, Indonesian inequality often seems lower than that of other countries which use income Gini coefficients, when it is actually comparable, or perhaps even higher. Even when countries use the same welfare measure, they often define and measure it differently. For example, Indonesia includes imputed housing expenditures for homeowners, one-off durable good purchases, and own-production food consumption. Vietnam does the same but uses annual durable depreciation instead, while India omits imputed rents and own-production consumption altogether. Moreover, the way in which consumption is asked about in a household survey also affects the result. Consequently, comparing inequality over time within the same country is more useful than comparing levels across countries. Most people accurately Over 90 percent of respondents from the above-mentioned Inequality Perceptions Survey said perceive that inequality that Indonesia was ‘unequal’, 40 percent of whom thought that it was ‘very unequal’. These is rising, but levels of people estimated that the richest 20 percent receive 38 percent of total national income, inequality are higher almost four times what they thought was received by the bottom 20 percent (7 percent of than they imagine… national income). While the poor do in fact have about the same share of consumption as the survey respondents believed, the richest 20 percent of Indonesians in national surveys consume almost 48 percent of the total. This is 10 percentage points more than suggested by those surveyed. Figure 37: Inequality in Indonesia has been steadily Table 8: The richest 20 percent of households now account for rising since 2000 nearly half of all consumption in household surveys (household per capita consumption Gini coefficient, percentage points) (share of total household consumption, percent) 45 Asian 2002 2006 2010 2013 Financial 40 Crisis Poorest quintile 10.8 10.2 9.3 8.9 35 Quintile 2 13.7 13.2 12.5 11.8 30 Quintile 3 16.5 16.0 16.1 15 Pre-crisis Post-crisis and 25 Reformasi Quintile 4 20.4 21.4 21.6 20.6 20 Richest quintile 38.5 39.1 40.6 43.7 15 Richest decile 25.2 24.6 26.0 28.7 10 5 0 1980 1987 1993 1996 1999 2002 2005 2008 2011 Source: Susenas; World Bank staff calculations Source: Susenas; World Bank staff calculations …and the measured Indonesia’s actual level of inequality is most likely even higher than the measured level. level likely understates Accurately measuring inequality requires collecting data from a representative sample of all the true level households, from the poorest to the richest. In Indonesia, however, it appears that the richest households are under-reporting consumption or missing from the data altogether. According to the National Socio-economic Survey (Susenas), which is used to estimate inequality, only 5 million people (or 2 percent of the population) consumed more than IDR 2 million per month during 2012, and only 1.3 million (0.5 percent) more than IDR 4 million J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 35 Hard choices Indonesia Economic Quarterly per month. Meanwhile, only around half of the owners of private passenger cars registered with the police are found in Susenas. If half are missing, then the true Gini coefficient is likely to be significantly higher. The World Bank’s forthcoming inequality report will attempt to correct this problem by using non-survey methods to estimate how many Indonesians are at the upper end of the income distribution. Inequality in Indonesia Although comparing levels of Figure 38: Indonesia has experienced the second-fastest is rising more quickly inequality across countries is increase in inequality in the region after China than in regional difficult, due to differences in (annual average change in Gini over 1990- 2011 period, points) neighbors, many of definitions and measurement 0.7 which have stable or (see Box 5), Indonesia stands 0.6 falling inequality apart from many of its 0.5 0.4 neighbors. The country 0.3 experienced the second-fastest 0.2 (and largest) rise in the Gini 0.1 coefficient in the region over 0.0 -0.1 the past two decades, increasing -0.2 by around 0.5 percentage points -0.3 per year between 1990 and -0.4 Laos Malaysia China India Vietnam Cambodia Thailand Indonesia Philippines 2011, almost all of which occurred since 2000. Only China, with an annual rise 0.6 percentage points per year, saw a faster increase (Figure 38). Note: Consumption Ginis for all countries except Malaysia, which uses income. The periods for each country are: Indonesia Moreover, other countries in 1990-2011; Malaysia 1992-2009; Lao PDR 1992-2008; China 1990- the region that also enjoyed 2008; Vietnam 1992-2008; Thailand 1990-2009; the Philippines strong economic growth over 1991-2009; and Cambodia 1994-2008 the same period, such as Source: Kanbur, Rhee and Zhuang, 2014, “Inequality in Asia and the Pacific”, from PovCalNet (available at Vietnam, Malaysia and http://iresearch.worldbank.org/PovcalNet); World Bank staff Thailand, experienced flat or calculations even declining inequality. c. Increasing inequality is being driven partly by higher wage and non-wage inequality The rich have In Indonesia, all households have seen rising real consumption over the past decade, but it benefited far more has been highest for the wealthier, who are pulling away from the rest of the country. from economic growth Between 2003 and 2010, consumption for the poorest 40 percent grew at only 1-2 percent than the rest of the per year, while the richest 10 percent, as measured by the household survey, enjoyed population of consumption growth of 6.5 percent and the second richest 5.5 percent (Figure 39). Growth Indonesia for the bottom seven deciles was below the growth in the national mean. The rich tend to stay Richer households also were much less likely to change their relative position than other rich over time, the quintiles in the distribution. Of the individuals with total personal income in the top 20 mobility of the poor percent of Indonesians aged between 25 and 34 years in 1993, nearly two-thirds remained in has been improving the top quintile 14 years later. Conversely, individuals in all of the other quintiles experienced much greater relative movement over the period, both upwards and downwards (Table 9). The poor, however, had a reasonable chance of moving into higher income levels within their lifetime. Of those in the poorest income quintile in 1993, 65 percent had reached a higher income quintile by 2007; 19 percent even reached the top two quintiles. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 36 Hard choices Indonesia Economic Quarterly Figure 39: The richest households have seen much higher Table 9: The composition of the richest quintile of income growth in consumption than poorer households earners is relatively sticky; more mobility in other quintiles (average annual real consumption growth 2003-10, percent, by household (transition matrix of percent of 1993 income quintiles in 2007 quintiles) decile) 8 07 Q1 07 Q2 07 Q3 07 Q4 07 Q5 Growth in national mean 93 Q1 35 32 15 15 4 6 consumption 93 Q2 34 25 27 9 4 93 Q3 23 25 34 14 3 4 93 Q4 14 15 24 26 21 93 Q5 6 4 8 19 64 2 0 1 2 3 4 5 6 7 8 9 10 Source: Susenas; World Bank staff calculations Note: Total income quintiles for individuals aged 25-34 in 1993, excluding those with zero income Source: IFLS; World Bank staff calculations Richer households Based on 2007 data, on average labor income accounts for just over half of all household have benefited through income, with around another quarter each coming from farm and non-farm businesses. 28 their access to assets… Reported income from capital is minimal. However, many of the rich are not included in survey data, so income in the form of capital gains from stocks and real estates is under- reported. Only wealthier Indonesians have access to these assets, and their returns have been substantial. Between the beginning of 2002 and the end of 2013, the Indonesian Stock Exchange Composite Index increased in nominal value nearly 11 times, averaging compounded increases of 22 percent per year. The corresponding property price index increased in value 12.5 times, averaging 23 percent in annual compounded returns. …and from an Not only have many Indonesians not shared the gains from rising asset markets, the wages increasing capital and salaries upon which they rely have declined as a share of national income. For example, income share while the the labor share of income in manufacturing has been falling; it fell 3-4 percentage points labor income share has between the early 2000s and mid-2000s, reflecting a broader Asian pattern.29 As the poor do been falling not own capital, an increasing capital income share benefits richer households, further exacerbating inequality. Inequality from wages, The labor income Gini Figure 40: Increasing consumption inequality is being salaries and other work coefficient rose from 41 to 45 driven partly by increasing inequality in labor incomes income has also been percentage points for formal (labor income Gini coefficient, percentage points) increasing… sector employees between 2001 50 and 2012, and from 39 to 43 Formal employees among all workers (Figure 40). 45 An increasing trend is observed if only full-time workers are All workers considered. With much of 40 household income dependent on income from working, 35 significant increases in labor income inequality have a large 30 impact on total household 2001 2003 2005 2007 2009 2011 income inequality. Source: Sakernas; World Bank staff calculations 28 2007 Indonesian Family Life Survey. 29 Zhuang, Kanbur and Maligalig, 2014, “Asia’s income inequalities: recent trends”, in Kanbur, Rhee and Zhuang (eds.), “Inequality in Asia and the Pacific”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 37 Hard choices Indonesia Economic Quarterly …driven by a widening The stakes of finding a good job have been rising, which has increased the gap between gap in returns to workers from richer households and those from poorer households. Compared with education workers with a primary education or less, those with junior secondary now enjoy a 20 percent premium, those with senior secondary a 40 percent premium, and those with tertiary earn double (Figure 41). Moreover, the junior secondary and tertiary premium has increased. The gap in wages between the more and less educated then influences consumption inequality. Households whose head has better education have higher consumption, and this gap with poorly educated households has also been increasing over time (Figure 41). Three quarters of all About 19 million net new jobs have been created in Indonesia since 2002. Of these 5.1 new jobs since 2001 million have gone to junior secondary graduates, 11.7 million to senior secondary graduates, have required senior and 6.1 million to tertiary graduates. Jobs held by those with primary education or less have secondary education or actually fallen by 3.8 million in net terms. By 2013, workers with primary education, once a higher majority, became a minority (Figure 42). Declining demand for less educated workers puts downward pressure on their wages relative to those of more educated workers. Figure 41: Wage and consumption premiums have been Figure 42: Jobs increasingly require more education rising for highly educated workers (workers by education level, percent of total) (wage and consumption premiums to higher than primary education, incremental percent over primary education) 2003 2010 Tertiary SMA SMP SD or less 120 100 100 80 80 60 60 40 40 20 20 0 0 SMP SMA Tertiary SMP SMA Tertiary Worker Wage Premium Household Consumption 2002 2013 Note: Worker wage premium represents how much higher wages Source: Sakernas; World Bank staff calculations workers at each level of education receive compared with workers with primary education or less, controlling for experience, gender, work status, location and other factors. Household consumption premium represents the same for per capita consumption and head of household’s education Source: Sakernas; Susenas; World Bank staff calculations d. Unequal opportunities during childhood also contribute to higher inequality Adult inequality often Some inequality is due to circumstances that are beyond the control of an individual, such as stems from unequal gender, ethnicity, birthplace or family background. This type of inequality prevents opportunities during individuals from achieving their potential, which is unfair to them and lowers Indonesia’s childhood; one-third of overall human capital, reducing growth and productivity. Equality of opportunity, therefore, total inequality is due aims to level the playing field so that these circumstances do not unduly influence a person’s to circumstances that chance to succeed. Just three of these factors—the gender of the head of household, his or children are born into her level of education, and where the household lives (urban or rural, which region of or develop soon after Indonesia)—explained 33 percent of total consumption inequality in 2012.30 These 30This is the between-group component from decomposing the Theil Index into between- and within- group components using head of household gender and education, urban or rural location, and region of Indonesia based on island groupings. This estimate is preliminary only, and work is ongoing to better understand how birth circumstances contribute to overall inequality, and how this has evolved over time. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 38 Hard choices Indonesia Economic Quarterly circumstances are measured for adults due to data limitations, but are strongly related to the opportunities the adults faced as children—namely, where they were born and what educational opportunities they had. The forthcoming World Bank inequality report will more accurately quantify the degree of adult outcomes due to childhood inequality of opportunities. Differences in the lives Significant inequality of opportunities can be seen by comparing a child born in Jakarta to of children with non-poor parents who have at least high school education with a child born in a rural area of different background Papua or Maluku to a poor family with little education. The former has only a 6 percent in Indonesia can be chance of lacking proper sanitation, compared with 98 percent for the latter child (Figure very stark 43). These differences extend across all other indicators of opportunity, such as access to clean water, having non-dirt floors in the house, primary school enrolment, birth by skilled attendant and immunization coverage. This is true not only when comparing Jakarta and Papua. Generally, children from poor households in rural areas consistently lag behind children from rich households in urban areas on almost every indicator (Figure 44). Figure 43: There are stark differences in opportunities in life Figure 44: …and major gaps in opportunity exist between for children in Indonesia… rural children born into the poorest decile and urban (lack of access, percent) children born into the richest decile (lack of access, percent) Jakarta children with non-poor educated parents Decile 10, urban Decile 1, rural Rural Papua/Maluku children, poor parents with low education No phone No phone Improper sanitation Improper sanitation No clean drinking water No clean drinking water Dirt floor Dirt floor 16-18 year olds not enrolled 16-18 year olds not enrolled 7-15 year olds not enrolled 7-15 year olds not enrolled Primary school dropouts Primary school dropouts Not fully immunized Not fully immunized Low birth weight Low birth weight Unskilled birth attendant Unskilled birth attendant No antenatal visits No antenatal visits 0 50 100 0 50 100 Source: Susenas 2012; DHS 2007; World Bank staff calculations Note: Deciles are national spatially-adjusted real per capita household consumption deciles Source: Susenas 2012; DHS 2007; World Bank staff calculations Children in remote and Moreover, inequality of opportunities are often experienced on multiple dimensions by the rural areas tend to same children. Children in rural areas are more likely to lack proper access to education, experience inequality health and transportation services than urban children. However, children in rural areas are of opportunities on also more likely to experience a lack of all these opportunities at the same time. Of the 35 multiple dimensions percent of all urban children who lack access on at least one of these dimensions, 20 percent lack access on two (Figure 45, where this is represented by areas within two overlapping circles) and only around 3 percent lack access on all three (the area within three overlapping circles). In contrast, 58 percent of children in rural areas lack access on at least one dimension, but furthermore, a third of them lack access on two dimensions and another third lack access on all three dimensions. The situation is even worse in some areas, for example in Papua, where almost all children who lack clean drinking water, proper sanitation or electricity, are deprived on at least two of these dimensions, and the vast majority on all three. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 39 Hard choices Indonesia Economic Quarterly Figure 45: Most rural children without access to health, education and transportation services are deprived on more than one dimension to a greater extent than urban children (overlapping circles indicate lack of access on two or three dimensions) Lack of opportunity, Urban children Lack of opportunity, Rural children Poor 2% 9% 3% 3% Poor Poor Health Edu- Edu- 1% 5% Access cation 6% cation Poor 8% 2% 2% 7% Health 41% 20% Access 6% 5% Poor 40% Transpor- Poor tation Transpor- 22% tation 26% 50% 18% Note: The size of the circle in the Venn diagrams are proportional to the extent of the lack of opportunity Source: Hadiwidjaja, Paladines and Wai-Poi (2013); Podes; Susenas Some gaps in access to On some dimensions the gap between children from rich and poor families fell between opportunities have 2002 and 2011,31 including for most health, education and housing outcomes and improved over the past opportunities. For example, in 2002 63 percent of children in the poorest consumption decade, leading to decile were delivered by an unskilled attendant, compared with just 11 percent for the richest children having better decile, a 52 percentage-point gap. By 2011, this gap closed to 34 percentage points (Figure outcomes than their 46). Like the gap for rich and poor children, the rural-urban gap has also been closing on parents many dimensions, such as access to clean drinking water, proper sanitation and electrification (Figure 47). However, the rural-urban gap is closing at a slower rate. Figure 46: Children from poorer households start further Figure 47: Opportunity gaps between urban and rural behind in life, but the gap is closing households are closing, but at a slower pace (share of children not delivered by a skilled birth attendant by household per (lack of access, percent) capita consumption decile, percent) 2002 2011 90 Rural Urban 80 70 70 60 60 50 50 40 30 40 20 30 10 0 20 10 0 1 2 3 4 5 6 7 8 9 10 Source: Hadiwidjaja, Paladines and Wai-Poi (2013); Susenas Source: Hadiwidjaja, Paladines and Wai-Poi (2013); Susenas Gaps in access to Substantial and sustained government efforts to expand educational access over the past 40 education have also years have given children from poorer or less educated families a greater chance of achieving been closing, but higher education levels. Enrolment rates among 13-15 year olds (Figure 48) whose parents inequality in the had a primary school level of education or less have increased in the past decade. They are quality of services converging with the already high enrolment rates of children of parents who have a junior persists secondary level of education or higher. Closing school enrolment gaps has provided poor children with opportunities to improve their education outcomes for many years now. 31 Hadiwidjaja, Paladines and Wai-Poi, 2013, “Child Multidimensional Poverty in Indonesia”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 40 Hard choices Indonesia Economic Quarterly Adults whose parents had little education have been increasingly likely to achieve a higher level of schooling themselves. For example, nearly 60 percent of people born between 1952 and 1961 into a household where the parents had no education, also received no education themselves. For those born during 1962-71, this rate dropped to 45 percent, and to just 21 percent for those born 1972-81 (Figure 49). However, measures of access and opportunity, especially in health and education, do not reflect the quality of services received. Children in poorer or more remote areas not only participate less in these services, but when they do, the quality is often lower. Figure 48: Enrolment rates of children with less educated Figure 49: …and children born to parents with no education parents are converging… are achieving greater educational attainment (enrolment rate of children aged 13-15, by parents’ final education , percent) (2007 final educational attainment for children whose parents have no education, percent) Born 1952-61 Parents with no education Primary 60 Born 1962-71 Junior secondary Born 1972-81 Senior secondary 50 Tertiary 100 40 80 30 60 20 40 10 20 0 0 2004 2007 2011 2013 None SD SMP SMA Source: Susenas; World Bank staff calculations Source: IFLS; World Bank staff calculations e. Lack of proper protection from shocks also makes it harder for households at the lower end of the distribution to climb up Households face a Indonesian households have faced a number of negative economic shocks and natural number of risks at the disasters in the last 15 years. The country was the worst affected by the Asian financial crisis individual, household, in 1997-98. During the 2008-09 global financial crisis, it saw growth slow but it fared better local and national than most. Indonesians have also faced periods of high food prices, such as in 2005-06, 2008 levels and 2010. Major recent natural disasters include the 2004 tsunami which devastated Aceh, earthquakes in a number of locations, and the 2010 eruption of Mount Merapi. These economic shocks and disasters highlight the substantial risks that households face on an ongoing basis. Risks specific to particular individuals or households are just as important. These include loss of employment, illness and accidents, death of a spouse, or divorce. For many households, such a shock is sufficient to push them back into poverty. Many households lack When households experience a shock, they need to find a way to respond. However, many the access to proper households lack access to some of the better coping mechanisms that richer households can coping mechanisms use. For example, buying health insurance to cover medical costs during a serious illness or that richer ones have accident means a household is not faced with large financial costs when the event occurs. Those households without insurance face the choice of not treating the individual, using what little savings they have, selling their assets (which their livelihood often depends upon), or reducing spending in a way that negatively affects future generations, such as on education. They can also borrow from friends and family, but in Indonesia this can be inadequate to deal with severe shocks (Box 6), especially if the shock is being experienced simultaneously by many people in the community, as in the case of a natural disaster. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 41 Hard choices Indonesia Economic Quarterly As a consequence, Even when individuals get a Figure 50: 75 percent of poor households do not move out of individuals can good education and find a poverty or vulnerability over a three year period struggle to move good job, the presence of (2010 status of households who were poor in 2008, percent) economically upwards shocks and the lack of 100 because new shocks mechanisms to properly cope Moved out of poverty and send them back down mean that they can find it vulnerability 80 difficult to rise up the income distribution. This is Moved out of poverty but remain particularly so for the poor, 60 vulnerable who have the weakest coping Moved out of mechanisms. Of the poor in 40 poverty but fell 2008, 75 percent failed to exit back in poverty or vulnerability by 20 Always poor 2010 (Figure 50). While this was often due to lack of productive employment, 0 some of it was due to shocks. Note: Poor are those beneath the official poverty line; vulnerable are 15 percent of the poor those between the poverty line and 1.5 times the line actually left poverty in 2009, Source: Susenas; World Bank staff calculations but were poor again in 2010. Without effective means to deal with shocks, the ability to earn more over a sustained period and to climb the distribution remains limited. This applies not just to the poor but to the majority of Indonesians. Risk can also lead Not only can shocks prevent those who find productive livelihoods from rising, but fear of households to make risk—and a lack of mechanisms to effectively deal with it—can mean that people avoid risky safe but low-income but potentially rewarding activities in the first place. This is emphasized in the World Bank’s choices 2014 World Development Report Risk and Opportunity: Managing Risk for Development.32 It observes that “realizing that a negative shock can push them into destitution, bankruptcy, or crisis, poor people may stick with technologies and livelihoods that appear relatively safe but are also stagnant,” pointing out that not only does this prevent people in the bottom half of the distribution from rising upwards, it also adversely affects national development through underinvestment in productive work. Box 6: Main findings from new research on risk and risk management in Indonesia Drawing primarily on original qualitative evidence from four rural and peri-urban sites, a forthcoming World Bank study explores in- depth the risks faced and risk management practices adopted at the household and community level in Indonesia. Three interrelated research questions are studied: which risks and shocks do households and communities face most frequently and severely? Who or what do households rely upon to address these risks and shocks? Which specific household or community-level factors lead to greater exposure to risks and/or use of specific risk management methods? Five key messages emerge from this work. First, the rural poor and near-poor face a wide variety of risks and shocks. Among these, economic and health shocks are the most important. In addition, the study examines a less commonly discussed risk, which arises from the high cost of participating in customary lifecycle rituals. Second, despite the expansion of formal social assistance, informal coping mechanisms, such as borrowing from friends and family, are by far the most common way in which households and communities manage the risks and shocks they face. Third, informal resources shared between households or within communities are often inadequate to manage the most devastating individual and households shocks, or shocks that affect entire communities at once, such as natural disasters. Informal resources are also inadequate when households confront multiple shocks at the same time or in quick succession. Fourth, social assistance, especially in the form of programs that address health and environmental shocks, plays an important role– but coverage and benefit levels remain insufficient. Fifth, building adequate systems that provide protections against risks and shocks is a central concern of policymakers – these findings suggest that there are important uncovered risks in the lifecycle that may be better addressed by formal assistance. Source: World Bank (forthcoming), Informal Risk Management and Vulnerability among the Poor in Indonesia: A Study of Four Villages 32 The report is available at http://www.worldbank.org/wdr2014/. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 42 Hard choices Indonesia Economic Quarterly f. Inequality can also lead to lower growth, slower poverty reduction, and more conflict Rising inequality can In addition to considerations of fairness and equity, inequality also matters for other reasons, slow down poverty including social, political and economic stability. While the poor cannot get good jobs reduction because they lack sufficient education, many non-poor with better education also still cannot find productive work. As mentioned above, most current jobs, and most job creation over the past decade, has been in low productivity sectors and most workers have limited access to formal worker protection. Consequently, people from poorer households struggle to earn their way out of poverty. Higher inequality can Insufficient productive jobs also undermine Indonesia’s current growth by not maximizing also lead to slower the productive contribution of the labor force at the time when the demographic dividend is economic growth… peaking. High inequality can also affect economic growth in other ways. The extent to which households in the bottom 40 percent are unable to move into the middle class could weaken expected future middle class-driven consumption growth. This may also reduce economic growth through a number of other channels, such as low investments in human capital and decreased entrepreneurial activity. Also, inequality of opportunities can impact on the ability of children today to realize their full potential, affecting growth in the future. Some inequality is needed for growth, as differential rewards provide the incentives for hard work and innovation. In Indonesia, preliminary findings suggest that higher levels of inequality at the district level are related to higher growth, but after a certain point, higher inequality may hurt growth.33 …and slower growth Poverty generally falls with economic growth, but the speed of poverty reduction depends can further hamper on how equally growth is shared. If the pattern of growth benefits the rich more than the poverty reduction poor, the pace of poverty reduction slows. Estimates suggest that Indonesia’s strong growth efforts over the last decade could have been sufficient to eradicate poverty. The average growth effect—assuming all households receive the average growth equally—would have reduced poverty from 17.4 percent in 2003 to 0 percent by 2010.34 This would have almost eliminated poverty in Indonesia if all households received average growth equally.35 However, the unequal distribution of this growth meant that poverty fell only 5.4 percentage points instead, to 12.0 percent. The degree of inequality, therefore, affects the extent to which Indonesia can realize its poverty reduction targets. Inequality also When inequality increases, the differences between household standards of living becomes contributes to conflict more noticeable. This may lead to jealousy and conflict. New research on the effects of and social tensions inequality in Indonesia shows that as districts become more unequal they are more likely to experience conflict. On average, a district with a Gini coefficient of 30 experiences around 30 percent more violent incidents than one with a Gini coefficient of 20. For a district with a Gini coefficient of 40, violence increases by 60 percent.36 More conflict is detrimental socially and politically, but can also create another channel by which economic growth and poverty reduction are slowed down. 33 Yumna, Rakhmadi, Hidayat, Gultom, Suryadi, 2014 (forthcoming),“Estimating the Impact of Inequality on Growth and Unemployment in Indonesia”. 34 Based on World Bank research that decomposed historical poverty reduction into contributions from average household consumption growth (the effect if all households received the average growth equally) and from the distribution of that growth (the effect if there was no growth and only the observed change in inequality). Applying this to Indonesia provides both growth and distribution effects, but also a large (negative) residual. However, the most conservative case for the growth effect can be determined by adding all of this residual to distribution, leaving the minimum growth effect on poverty reduction, which is presented here. 35 In reality, poverty would have been low but non-zero, as some non-poor would fall into poverty after suffering shocks. 36 Peirskalla and Sacks (2014), “Research Note: Using NVMS Data to Identify Determinants of Political Violence and Social Conflict”. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 43 Hard choices Indonesia Economic Quarterly g. There is wide demand for action and a number of key policy messages are emerging Surveys suggest that When asked to choose between two distributions of income—one less equal and one more most Indonesians want equal—the majority of surveyed Indonesians chose a more equal distribution.37 On average, greater equality and they said that they would prefer the top 20 percent of Indonesians to have around 29 are willing to accept percent of total national income, and they would like the bottom 20 percent to have 13 slower overall percent of total national income. Their ideal distribution is not perfectly equal: it still has economic growth to those at the top with more than twice as much income as those at the bottom. When given achieve it the choice, survey respondents said that they would prefer slower growth and falling inequality to faster growth and widening inequality. Respondents also had specific ideas on how to reduce inequality. Some 42 percent said providing work opportunities is the most important way to tackle inequality, while 24 percent favored social protection strategies. Other respondents chose education as the best response (18 percent) or overcoming corruption (18 percent). Knowing how to The World Bank’s ongoing research project on inequality, on which this section draws, aims respond requires a to provide a better understanding of the causes of inequality in Indonesia. With such better understanding of diagnostics, Indonesia’s new government and policymakers will be in a better position to inequality... know the range of policy options available to them and the extent to which they will address the main drivers of inequality in Indonesia. … and learning from International experience suggests that rising inequality is neither a necessary outcome of other countries that development, nor is it a common trend across the region over the past decade. Thailand, have reduced Vietnam and the Philippines have all enjoyed broadly similar levels of growth as Indonesia inequality while over a similar period, while seeing stable or falling inequality. Furthermore, the Latin continuing to grow America region—the most unequal in the world—has seen declines in inequality since the late 1990s. Different countries in this region have achieved this in different ways, but there are common lessons and a range of possible policy options.38 Government spending The structure of fiscal policy can be an important determinant of inequality trends within an and taxation policies economy. Some forms of expenditure may primarily benefit the rich, such as fuel subsidies, have an important role while others may benefit all Indonesians. Examples of the latter include investments in to play in addressing primary health care and education, and in infrastructure to better connect villages to cities, concerns over the outlying regions to the center, and Indonesia to international markets. The structure of distribution of income taxation also matters. For example, governments can ask all citizens to pay their fair share. Broadening the tax base to cover more people not only increases the range of growth- promoting and inequality-reducing policies the government can adopt, but it can also lead to a fairer income distribution. Building the As highlighted in the World Bank’s recently released Indonesia 2014 Development Policy foundation for Review, improving local access to services is one of the central priorities for ensuring shared inclusive growth starts prosperity going forward.39 Investments in health and education are not only needed to close with investing in the remaining disparities in access to these services but, going forward, to address the quality basic education substantial disparities in the quality of these services between richer and poorer areas. and health for all Moreover, greater access to clean water, proper sanitation, and quality housing is vital to children… support efforts in health and education. Only when all children receive the best start in life can they maximize their potential, which in turn will allow Indonesia to reap greater economic benefits and, at the same time, reduce inequality. 37 Lembaga Survei Indonesia (2014), Inequality Perceptions Survey. 38 See, for example, World Bank, April 2012, “Inequality in Focus”. 39 World Bank (2014), “Indonesia Development Policy Review 2014: Avoiding the Trap”. The report is available at http://www.worldbank.org/en/news/feature/2014/06/23/indonesia-2014- development-policy-review and is summarized in the March 2014 IEQ. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 44 Hard choices Indonesia Economic Quarterly …ensuring all people Next, educated and healthy Indonesians need productive livelihoods. This means the have access to creation of more skill-based jobs, and ensuring that school graduates have the right skills to productive fill them. This, in turn, requires investments to close Indonesia’s long-standing infrastructure livelihoods… and skills gaps. It also means an open economic environment that promotes the continued rise of Indonesia up the value ladder, including labor regulations that benefit both workers and businesses, a positive investment climate, efficient and transparent rules and regulations for business, and a bureaucracy free from corruption and inefficiency. As set out in the Development Policy Review, the implementation of such a productivity-driven growth strategy is required to unleash the potential of the economy, to boost growth and share prosperity more widely. …and are protected Many Indonesians work hard at school, stay healthy, and get good jobs. But they still face from shocks many risks in life, and shocks can take away their hard-won gains. The Government can help protect households from such shocks, whether to health, employment, or the cost of living. First, this means promoting greater access to insurance to allow those who can afford it to protect themselves, while extending insurance to those who cannot afford it. Getting the new social security programs right will be essential. Second, it is necessary to expand and improve the current social safety net to effectively provide all the poor and vulnerable with the support they need to cope with the many serious risks they face in life. Third, continuously enhancing the management of disaster risks and further building resilience is needed so as to safeguard hard-fought poverty reduction and income gains. J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 45 Hard choices Indonesia Economic Quarterly APPENDIX: A SNAPSHOT OF INDONESIAN ECONOMIC INDICATORS Appendix Figure 1: Quarterly and annual GDP growth Appendix Figure 2: Contributions to GDP expenditures (real GDP growth, percent) (contribution to real GDP growth yoy, percent) Private cons. Gov cons. Investment 4 8 Year-on-year (RHS) Net Exports Discrepancy GDP 8 3 6 6 QoQ seas. 4 2 adjust (LHS) Average (LHS)* 4 2 1 2 0 -2 0 0 -4 Mar-07 Dec-08 Sep-10 Jun-12 Mar-14 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Note: *Average QoQ growth, Q1 2007–Q1 2014 Source: BPS; World Bank staff calculations Source: BPS; World Bank staff calculations Appendix Figure 3: Contributions to GDP production Appendix Figure 4: Motor cycle and motor vehicle sales (contribution to real GDP growth yoy, percent) (seasonally-adjusted sales growth yoy, percent) Agriculture Mining and constr. 80 Manufacturing Comm & transport Trade, hotel & rest Others (inc. services) 60 Motor vehicle sales 8 GDP 40 6 Cement sales 20 4 0 2 -20 Motor cycle sales -40 0 Jun-11 Jun-12 Jun-13 Jun-14 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Source: BPS; World Bank staff calculations Source: CEIC; World Bank staff calculations Appendix Figure 5: Consumer indicators Appendix Figure 6: Industrial production indicators (retail sales index 2010=100) (PMI diffusion index and cement sales seasonal-adjusted growth yoy, percent 180 50 55 BI retail sales index Manufacturing PMI, RHS 160 40 BI consumer survey 52 index 140 30 49 120 20 46 100 10 Cement sales, LHS 43 80 0 60 -10 40 Jun-11 Jun-12 Jun-13 Jun-14 Jun-11 Jun-12 Jun-13 Jun-14 Source: BI Source: BPS; Markit HSBC Purchasing Managers Index J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 46 Hard choices Indonesia Economic Quarterly Appendix Figure 7: Trade volumes Appendix Figure 8: Balance of payments (growth yoy, percent) (USD billion) 20 Capital and financial Current account Errors and omissions Overall BoP inflows 15 15 Imports 10 10 Exports 5 5 0 0 -5 -10 -5 Mar-11 Mar-12 Mar-13 Mar-14 Mar-11 Mar-12 Mar-13 Mar- Source: BPS Source: BI Appendix Figure 9: Exports of goods Appendix Figure 10: Imports of goods (3-month moving average, USD billion) (3-month moving average, USD billion) 20 20 Total exports Total imports 16 16 12 12 Intermediate (ex. oil & gas) 8 Manufacturing 8 Agriculture & forestry Oil & gas 4 4 Capital Consumer Mining & minerals Oil & gas 0 0 May-11 May-12 May-13 May-14 May-11 May-12 May-13 May-14 Source: BPS Source: BPS Appendix Figure 11: Reserves and capital inflows Appendix Figure 12: Inflation and monetary policy (USD billion) (month-on-month and year-on-year growth, percent) 3.5 12 150 5.0 Headline inflation, yoy (RHS) International Reserves (LHS) BI policy rate (RHS) 125 2.5 2.5 Core inflation, yoy (RHS) 8 100 0.0 1.5 4 Headline inflation MoM (LHS) 75 -2.5 0.5 0 Non-resident portfolio inflows, 50 (RHS): -5.0 Equities SUN SBI 25 -7.5 -0.5 -4 Jun-11 Jun-12 Jun-13 Jun-14 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Source: BI; CEIC; World Bank staff calculations Source: BPS; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 47 Hard choices Indonesia Economic Quarterly Appendix Figure 13: Monthly breakdown of CPI Appendix Figure 14: Inflation comparison across countries (percentage point contributions to monthly growth) (year-on-year, June2014) 3.6 Core Administered Volatile Headline Korea* 3.0 USA* China 2.4 Thailand 1.8 Singapore * Malaysia * 1.2 Japan * 0.6 Philippines * 0.0 Indonesia India * -0.6 Jun-11 Jun-12 Jun-13 Jun-14 0 1 2 3 4 5 6 7 8 Source: BPS; World Bank staff calculations *May is the latest available month Source: National statistical agencies via CEIC; BPS Appendix Figure 15: Domestic and international rice prices Appendix Figure 16: Poverty and unemployment rate (percent LHS, wholesale price, in IDR per kg RHS) (percent) 100 Percentage spread (LHS) 10,000 25 Domestic rice, IR-II 20 (RHS) 50 7,000 Poverty rate 15 10 0 4,000 Vietnamese rice 5% broken (RHS) 5 Unemployment rate -50 1,000 0 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 2002 2004 2006 2008 2010 2012 2014 Source: Cipinang wholesale rice market; FAO; World Bank Source: BPS Appendix Figure 17: Regional equity indices Appendix Figure 18: Selected currencies against USD (daily index January 4 2010=100) (monthly index June 2010=100) 250 75 Brazil SET-Thailand 200 100 Indonesia 150 JCI -Indonesia Turkey SGX-Singapore 125 India 100 BSE-india Appreciation South Africa Shanghai-China 50 150 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 48 Hard choices Indonesia Economic Quarterly Appendix Figure 19: 5-year local currency govt. bond yields Appendix Figure 20: Sovereign USD bond EMBIG spread (daily, percent) (daily, basis points) 10 475 60 Indonesia spreads less overall EMBIG index spread (RHS) 8 400 0 Indonesia 6 325 -60 Thailand 4 Philippines 250 -120 Malaysia 2 175 -180 United States Indonesia EMBIG bond spread (LHS) 0 100 -240 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Source: CEIC Source: JP Morgan; World Bank staff calculations Appendix Figure 21: Commercial and rural credit bank Appendix Figure 22: Banking sector indicators credit growth (monthly, percent) (growth year-on-year, percent) 40 100 10 Total bank credit/GDP Loan deposit ratio (LHS) 80 8 30 Commercial and rural bank loans 60 6 20 Non-performing 40 loans (RHS) Return on assets 4 ratio (RHS) 10 20 2 Capital adequacy ratio (LHS) 0 0 0 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Source: CEIC; World Bank staff calculations Source: BI Appendix Figure 23: Government debt Appendix Figure 24: External debt (percent of GDP; USD billion) (percent of GDP; USD billion) 60 300 60 300 Domestic debt, RHS Private external debt, RHS External debt, RHS Public external debt, RHS Total debt to GDP, LHS Total external debt to GDP, LHS 40 200 40 200 20 100 20 100 0 0 0 0 2005 2007 2009 2011 2013 2005 2007 2009 2011 2013 Source: MoF; BI; World Bank staff calculations Source: BI; World Bank staff calculations J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 49 Hard choices Indonesia Economic Quarterly Appendix Table 1: Budget outcomes and projections (IDR trillion) 2009 2010 2011 2012 2013 2014 2014 Preliminar Revised Outcome Outcome Outcome Outcome y Budget budget outcome A. State revenue and grants 849 995 1,211 1,338 1,430 1,667 1,635 1. Tax revenue 620 723 874 981 1,072 1,280 1,246 2. Non-tax revenue 227 269 331 352 353 385 387 B. Expenditure 937 1,042 1,295 1,491 1,639 1,842 1,877 1. Central government 629 697 884 1,011 1,126 1,250 1,280 2. Transfers to the regions 309 345 411 481 513 593 597 C. Primary balance 5 42 9 -53 -97 -54 -106 D. SURPLUS / DEFICIT -89 -47 -84 -153 -210 -175 -241 (percent of GDP) -1.6 -0.7 -1.1 -1.9 -2.2 -1.7 -2.4 Source: MoF Appendix Table 2: Balance of payments (USD billion) 2012  2013 2014 2011 2012 2013 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Balance of payments 11.9 0.2 -7.3 0.8 3.2 -6.6 -2.5 -2.6 4.4 2.1 Percent of GDP 1.4 0.0 -0.8 0.4 1.5 -3.0 -1.1 -1.2 2.2 1.0 Current account 1.7 -24.4 -29.1 -5.3 -7.8 -6.0 -10.1 -8.6 -4.3 -4.2 Percent of GDP 0.2 -2.8 -3.3 -2.4 -3.6 -2.7 -4.5 -4.0 -2.1 -2.1 Trade balance 24.2 -1.7 -6.1 0.8 -2.4 -1.0 -4.1 -2.7 1.6 1.3 Net income & current transfers -22.5 -22.7 -23.0 -6.1 -5.4 -5.0 -6.1 -6.0 -6.0 -5.5 Capital & Financial Account 13.6 24.9 22.4 5.8 12.0 -0.5 8.6 5.5 8.8 7.8 Percent of GDP 1.6 2.8 2.6 2.6 5.5 -0.2 3.8 2.5 4.4 3.8 Direct investment 11.5 13.7 13.7 4.5 4.1 3.6 3.7 5.8 0.5 3.0 Portfolio investment 3.8 9.2 9.8 2.5 0.2 2.8 3.4 1.9 1.8 9.0 Other investment -1.8 1.9 -1.1 -1.2 7.7 -6.9 1.6 -2.3 6.5 -4.1 Errors & omissions -3.4 -0.3 -0.6 0.3 -1.0 -0.1 -1.0 0.5 -0.1 -1.6 Foreign reserves* 110.1 112.8 99.4 110.2 112.8 104.8 98.1 95.7 99.4 102.6 Note: * Reserves at end-period Source: BI; BPS J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 50 Hard choices Indonesia Economic Quarterly Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance 1990 1995 2000 2005 2010 2011 2012 2013 1 National Accounts (% change)    Real GDP 9.0 8.4 4.9 5.7 6.2 6.5 6.3 5.8    Real investment .. .. 11.4 10.9 8.5 8.3 9.7 4.7    Real consumption .. .. 4.6 4.3 4.1 4.5 4.8 5.2    Private .. .. 3.7 4.0 4.7 4.7 5.3 5.3    Government .. .. 14.2 6.6 0.3 3.2 1.3 4.9    Real exports, GNFS .. .. 30.6 16.6 15.3 13.6 2.0 5.3    Real imports, GNFS .. .. 26.6 17.8 17.3 13.3 6.7 1.2    Investment (% GDP) 28 28 20 24 32 32 33 32    Nominal GDP (USD billion) 114 202 165 286 709 846 877 868    GDP per capita (USD) 636 1035 804 1,300 2,984 3,467 3,546 3,468 2 Central Government budget (% GDP)    Revenue and grant 18.8 15.2 20.8 17.8 15.5 16.3 16.2 15.3    Non-tax revenue 1.0 4.8 9.0 5.3 4.2 4.5 4.3 3.8    Tax revenue 17.8 10.3 11.7 12.5 11.3 11.8 11.9 11.5    Expenditure 11.8 13.9 22.4 18.4 16.2 17.4 18.1 17.5    Consumption .. 3.9 4.0 3.0 3.8 4.0 4.1 4.2    Capital .. 4.6 2.6 1.2 1.3 1.6 1.8 1.8    Interest .. 1.4 5.1 2.3 1.4 1.3 1.2 1.2    Subsidies .. .. 6.3 4.3 3.0 4.0 4.2 3.8    Budget balance 0.4 1.3 -1.6 -0.6 -0.7 -1.1 -1.9 -2.2    Government debt 41.9 32.3 85.9 47.0 26.3 23.5 23.3 22.1    o/w external government debt 41.9 32.3 45.1 22.0 9.6 8.0 7.2 6.7    Total external debt (including private sector) 61.0 61.5 87.1 47.1 28.5 26.6 28.8 30.5 3 Balance of Payments (% GDP)    Overall balance of payments .. .. .. 0.2 4.3 1.4 0.0 -0.7    Current account balance -2.6 3.2 4.8 0.1 0.7 0.2 -2.8 -3.3    Exports GNFS 25.6 26.2 42.8 35.0 24.7 26.2 24.1 23.7    Imports GNFS 24.0 26.9 33.9 32.0 21.6 23.3 24.3 24.4    Trade balance 1.6 -0.8 8.9 2.9 3.0 2.9 -0.2 -0.7    Financial account balance .. .. .. 0.0 3.7 1.6 2.8 2.6    Net direct investment 1.0 2.2 -2.8 1.8 1.6 1.4 1.6 1.6    Gross official reserves (USD billion) 8.7 14.9 29.4 34.7 96.2 110.1 112.8 99.4 3 Monetary (annual average % change)    GDP deflator1 7.7 9.9 20.4 14.3 8.3 8.1 4.4 4.4    Bank Indonesia interest key rate (%) .. .. .. 9.1 6.5 6.6 5.8 6.5    Domestic credit .. .. .. 28.7 17.5 24.4 24.2 22.1 Nominal exchange rate (average,    IDR/USD)4 1,843 2,249 8,422 9,705 9,090 8,770 9,387 10,461 1 Prices (% change)    Consumer price Index (eop) 9.9 9.0 9.4 17.1 7.0 3.8 4.3 8.4    Consumer price Index (average) 7.7 9.4 3.7 10.5 5.1 5.4 4.3 7.0 5    Indonesia crude oil price (USD per barrel) .. 17 28 53 79 112 113 107 Source: 1 BPS and World Bank staff calculations, 2 MoF (for 1995 is FY 1995/1996, for 2000 covers 9 months), 3 Bank Indonesia, 4 IMF, 5 CEIC J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 51 Hard choices Indonesia Economic Quarterly Appendix Table 4: Indonesia’s development indicators at a glance 1990 1995 2000 2005 2010 2011 2012 2013 1 Demographics Population (million) 184 199 213 227 241 244 247 250 Population growth rate (%) 1.7 1.5 1.3 1.2 1.3 1.3 1.2 1.2 Urban population (% of total) 31 36 42 46 50 51 51 52 Dependency ratio (% of working-age population) 67 61 55 54 53 53 52 52 2 Labor Force Labor force, total (million) 75 84 98 106 117 117 120 120 Male 46 54 60 68 72 73 75 75 Female 29 31 38 38 45 44 46 45 Agriculture share of employment (%) 55 43 45 44 38 36 35 35 Industry share of employment (%) 14 19 17 19 19 21 22 20 Services share of employment (%) 31 38 37 37 42 43 43 45 Unemployment, total (% of labor force) 2.5 7.0 8.1 11.2 7.1 7.4 6.1 6.2 3 Poverty and Income Distribution Median household consumption (IDR 000) .. .. 104 211 374 421 446 487 National poverty line (IDR 000) .. .. 73 129 212 234 249 272 Population below national poverty line (million) .. .. 38 35 31 30 29 28 Poverty (% of population below national poverty line) .. .. 19.1 16.0 13.3 12.5 12.0 11.4 Urban (% of population below urban poverty line) .. .. 14.6 11.7 9.9 9.2 8.8 8.4 Rural (% of population below rural poverty line) .. .. 22.4 20.0 16.6 15.7 15.1 14.3 Male-headed households .. .. 15.5 13.3 11.0 10.2 9.5 9.2 Female-headed households .. .. 12.6 12.8 9.5 9.7 8.8 8.6 Gini index .. .. 0.30 0.35 0.38 0.41 0.41 0.41 Percentage share of consumption: lowest 20% .. .. 9.6 8.7 7.9 7.4 7.5 7.4 Percentage share of consumption: highest 20% .. .. 38.6 41.4 40.6 46.5 46.7 47.3 Public expenditure on social security & welfare (% of GDP)3 .. .. .. 0.4 0.4 0.4 0.4 0.6 Public expenditure on social security & welfare (% of 4 .. .. .. 2.4 2.4 2.3 2.3 3.3 Spending) 1 Health and Nutrition Physicians (per 1,000 people) 0.14 0.16 0.16 0.13 0.29 .. 0.20 .. Under five mortality rate (per 1000 children under 5 year) 98 67 52 42 34 32 31 .. Neonatal mortality rate (per 1000 live births) 27 26 22 19 16 16 15 .. Infant mortality (per 1000 live births) 67 51 41 34 28 27 26 .. Maternal mortality ratio (estimate, per 100,000 live births) 600 420 340 270 210 .. .. 190 Measles vaccination (% of children under 2 year) .. 63 74 77 75 74 80 .. Total health expenditure (% of GDP) .. 1.8 2.0 2.8 2.9 2.9 3.0 .. Public health expenditure (% of GDP) .. 0.7 0.7 0.9 1.1 1.1 1.2 .. 3 Education Primary net enrollment rate, (%) .. .. .. 92 92 92 93 92 Female (% of total net enrolment) .. .. .. 48 48 49 49 50 Secondary net enrollment rate, (%) .. .. .. 52 61 60 60 61 Female (% of total net enrolment) .. .. .. 50 50 50 49 50 Tertiary net enrollment rate, (%) .. .. .. 9 16 14 15 16 Female (% of total net enrolment) .. .. .. 55 53 50 54 54 Adult literacy rate (%) .. .. .. 91 91 91 92 93 4 Public spending on education (% of GDP) .. .. .. 2.7 3.2 3.4 3.4 3.6 4 Public spending on education (% of spending) .. .. .. 14.5 20.0 19.7 18.8 19.0 1 Water and Sanitation Access to an improved water source (% of population) 70 74 78 81 84 84 84.9 .. Urban (% of urban population) 91 91 91 92 93 93 93.0 .. Rural (% of rural population) 61 65 68 71 75 76 76.4 .. Access to improved sanitation facilities (% of population) 32 38 44 53 57 59 58.8 .. Urban (% of urban population) 56 60 64 70 70 73 71.4 .. Rural (% of rural population) 21 26 30 38 44 44 45.5 .. 1 Others Disaster risk reduction progress score (1-5 scale; 5=best) .. .. .. .. .. 3.3 .. .. 5 Proportion of seats held by women in national parliament (%) .. .. 8 11 18 18.2 18.6 .. Source: 1 World Development Indicators; 2 BPS (Sakernas); 3 BPS (Susenas) and World Bank; 4 MoF and World Bank staff calculations, only includes spending on Raskin, Jamkesmas, BLT, BSM, PKH and actuals; 5 Inter-Parliamentary Union J u l y 2 01 4 T HE W ORL D BA NK | BAN K DU NIA 52 Supported by funding from the Australian Government (Department of Foreign Affairs and Trade, DFAT), under the Support for Enhanced Macroeconomic and Fiscal Policy Analysis (SEMEFPA) program.