December 2018 Strengthening competitiveness INDONESIA ECONOMIC Q UARTERLY Strengthening competitiveness December 2018 Preface The Indonesia Economic Quarterly (IEQ) has two main aims. First, it reports on the key developments in Indonesia’s economy over the past three months, 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 an analysis of Indonesia’s medium-term development challenges. It is intended for a wide audience, including policy makers, 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 A. Chaves, Country Director for Indonesia. The report is prepared by the Macroeconomics, Trade and Investment (MTI) Global Practice team, under the guidance of Ndiame Diop (Practice Manager) and Frederico Gil Sander (Lead Economist). Led by Derek H. C. Chen (Senior Economist and lead author), the core project team comprises Abigail, Arsianti, Dwi Endah Abriningrum, Yus Medina, Alief Aulia Rezza, Ratih Dwi Rahmadanti and Dhruv Sharma. Administrative support is provided by Deviana Djalil. Dissemination is organized by Nugroho Sunjoyo, Jerry Kurniawan, and GB Surya Ningnagara under the guidance of Lestari Boediono Qureshi. This edition of the IEQ includes contributions from Dhruv Sharma (Part A.1 and Box A.1), Alief Aulia Rezza (Part A.2, A.3 and Box A.2), Dwi Endah Abriningrum (Part A.4), Dhruv Sharma and Ratih Dwi Rahmadanti (Part A.5), Yus Medina (Part A.6), Derek H.C. Chen (Part A.7), and Massimiliano Cali with the support and comments from Aufa Doarest, Taufik Hidayat, Bertine Kamphuis, Giorgio Presidente, Muhammad Hazmi Ash Shidqi, Daniel van Tuijll and Ibnu Edy Wiyono, (Part B, Box B.1 and Box B.2), and Abigail (Appendix). The report also benefited from discussions with, and in-depth comments from Ekaterina T. Vashakmadze (Senior Economist, DECPG, World Bank) and Ergys Islamaj (Senior Economist, EAPCE, World Bank) and Janani Kandhadai (editorial assistant). 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 data cut-off date for this report was December 3, 2018. 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. Photographs are copyright of World Bank. All rights reserved. This report is available for download in English and Indonesian via: worldbank.org/ieq. Previous report editions: • September 2018: Urbanization for All • June 2018: Learning more, growing faster • March 2018: Towards inclusive growth To receive the IEQ and related publications by email, please email ddjalil@worldbank.org. For questions and comments, please email dchen@worldbank.org. For information about the World Bank and its activities in Indonesia, please visit: www.worldbank.org/id @BankDunia #IEQBankDunia BankDunia instagram.com/worldbank www.linkedin.com/company/the-world-bank Abbreviations APBN Anggaran Pendapatan dan Belanja Negara (State NRP Nominal Rate of Protection budgets) BI Bank Indonesia N-O&G Non-Oil & Gas BITs Bilateral Investment Treaties NPL Non-Performing Loans BKPM Badan Koordinasi Penanaman Modal (Indonesia NTI Net Trade Index Investment Coordinating Board) BLU Off Budget Fund NTM Non-Tariff Measures BOP Balance of Payments O&G Oil and Gas BPNT Non-Cash Food Assistance OECD Organization for Economic Co-operation and Development BPS Badan Pusat Statistik (Bureau of Statistics) OPEC Organization of the Petroleum Exporting Countries CAD Current Account Deficit PBI-JKN Penerima Bantuan Iuran-Jaminan Kesehatan Nasional (National Health Insurance Beneficiaries) CAR Capital Adequacy Ratio PHT Penjualan Hasil Tambang (mining sales) CG Central Government PKH Program Keluarga Harapan (Family Hope Program) COMTRADE Commodity Trade Statistics Database PMI Purchasing Managers’ Index CPB Central Planning Bureau PNBP Other Non-Tax Revenues CPI Consumer Price Index PPP Public-Private Partnership CPO Crude Palm Oil qoq quarter-on-quarter CPTPP Comprehensive and Progressive Agreement for RCEP Regional Comprehensive Economic Partnership Trans-Pacific Partnership DAK Dana Alokasi Khusus (Special Allocation Fund) RHS Right Hand Side DAU Dana Alokasi Umum (General Allocation Fund) RON Research Octane Number DECPG Development Economics Prospects Group sa Seasonally adjusted DFAT Department of Foreign Affairs and Trade SBI Sertifikat Bank Indonesia (Bank Indonesia Certificate) DKI Daerah Khusus Ibukota (special capital region) SBN Surat Berharga Negara (State securities) DNDF Domestic Non-Deliverable Forward SEMEFPA Support for Enhanced Macroeconomic and Fiscal Policy Analysis DNI Daftar Negatif Investasi (Negative Investment SKKMIGAS Satuan Kerja Khusus Pelaksanaan Kegiatan Usaha List) Hulu Mintak dan Gas Bumi (The Special Taskforce for Upstream Oil and Gas Business Activities) EAP(CE) EAP Chief Economist SNI Indonesia National Standard EFTA European Free Trade Association SOEs State of Enterprises EMBI (G) Emerging Market Bond Index Global STRI Service Trade Restrictiveness Index EMCI Emerging Market Currency Index SUN Surat Utang Negara (Government Bonds) EU European Union TA Tax Amnesty FAOSTATS Database of Food and Agriculture Statistics ToT Terms-of-Trade FDI Foreign Direct Investment TPP Trans-Pacific Partnership FSAP Financial Sector Assessment Program UNIDO United Nations Industrial Development Organization FTA Free Trade Agreement UNCTAD United Nations Conference on Trade and Development GDP Gross Domestic Product USTR United States Trade Representative GoI Government of Indonesia VAT Value Added Tax ICTs Information and Communication Technologies VIX Volatility Index IDR Indonesia Rupiah WDI World Development Indicators IEQ Indonesia Economic Quarterly yoy year-on-year IHS Institute Human Studies IMF International Monetary Fund KAPET Intergrated Economic Development Zones KBLI Klasifikasi Baku Lapangan Usaha Indonesia (Indonesia Standard Industrial Classification) kbpd Kilo Barrels per Day KPPU Komisi Pengawas Persaingan Usaha LGST Luxury Goods Sales Tax LHS Left Hand Side LNG Liquefied Natural Gas LPG Liquid Petroleum Gas MoF Ministry of Finance MSMEs Micro, Small, Medium Enterprises MTI Macroeconomics, Trade and Investment Table of Contents PREFACE ................................................................................................................................... I ABBREVIATIONS ..................................................................................................................... II TABLE OF CONTENTS .......................................................................................................... III EXECUTIVE SUMMARY: STRENGTHENING COMPETITIVENESS ...................................... 1 A. ECONOMIC AND FISCAL UPDATE ..................................................................................... 4 1. Indonesian economic growth eased slightly in Q3 2018 ............................................................................................ 4 2. Prices of energy-related commodities maintained their upward trajectories ............................................................ 8 3. Pressured by higher crude prices, the current account deficit widened further ....................................................... 11 4. Headline inflation continued to ease ........................................................................................................................ 15 5. Macrofinancial conditions remained soft in Q3 .......................................................................................................16 6. Solid revenue collections support strong expenditure growth, but challenges with spending quality remains ...... 20 7. Economic growth outlook and risks ........................................................................................................................ 23 B. BOOSTING EXPORT AND INVESTMENTS IN INDONESIA: AN AGENDA FOR REFORM 28 1. Indonesia needs to boost its global competitiveness to increase resilience to shocks and to reap the opportunities of the current global environment .......................................................................................................................... 29 2. Distortions in the main markets for production factors weigh down export competitiveness and investment flows ................................................................................................................................................................................ 34 3. What Indonesia can do to boost exports and investments ...................................................................................... 44 REFERENCES ......................................................................................................................... 50 FIGURES Figure ES.1: GDP growth eased a little in Q3 .................................................................................................................................. 3 Figure ES.2: Manufacturing sector growth more than offset the moderation in the agriculture sector growth ................................ 3 Figure ES.3: The deficit in the goods trade balances led the deterioration of the current account balance ..................................... 3 Figure ES.4: The Rupiah continued depreciating against the U.S. dollar in Q3, before recovering in Q4 ....................................... 3 Figure ES.5: Headline inflation eased in Q3 despite higher oil pieces ............................................................................................. 3 Figure ES.6: Stronger revenues and expenditures with a net result of lower Government budget deficit are projected for 2018 ...... 3 Figure A.1: GDP growth eased a little in Q3..................................................................................................................................... 4 Figure A.2: Investment growth rebounded as growth in buildings and structures investment picked up ........................................ 5 Figure A.3: Private consumption growth eased on the back of reduced consumption of equipment as well as health and education .................................................................................................................................................................................... 5 Figure A.4: Most high-frequency indicators linked to private consumption eased in Q3 ................................................................. 5 Figure A.5: Global trade growth eased… ......................................................................................................................................... 6 Figure A.6: …as did industrial production ....................................................................................................................................... 6 Figure A.7: PMI outcomes around the world eased ......................................................................................................................... 7 Figure A.8: Global financial market volatility did not dissipate completely in Q3 ............................................................................ 7 Figure A.9: Manufacturing sector growth offset the moderation in the agriculture sector ............................................................... 8 Figure A.10: Three month moving average of Indonesia’s main commodity exports....................................................................... 9 Figure A.11: Non-agricultural commodity prices continued to rally, while agricultural ones remained under pressure ................. 10 Figure A.12: Base metal prices are expected to end 2018 higher than the YTD average .................................................................. 10 Figure A.13: The deficit in the goods trade balances led the deterioration of the current account balance ..................................... 11 Figure A.14: Softer goods exports growth seen in every category .................................................................................................... 12 Figure A.15: Growth of goods imports continued to outpace exports, driven by fuel and consumption goods. .............................. 12 Figure A.16: Stable surplus seen in financial and capital account ................................................................................................... 13 Figure A.17: Net foreign direct investment (FDI) increased, mostly in the manufacturing sector… .............................................. 14 Figure A.18: … but net direct investment was insufficient to cover the current account deficit ...................................................... 14 Figure A.19: Headline inflation eased in Q3, but has been creeping up in Q4 ................................................................................ 15 Figure A.20: A broad-based increase in producer prices contributed to the upward trajectory of the producer price index ........... 16 Figure A.21: Producers faced greater cost pressures as input prices rose the fastest in over three years ......................................... 16 Figure A.22: The Rupiah depreciated against the U.S. dollar in Q3 before recovering somewhat at the start of Q4 ....................... 17 Figure A.23: In real effective terms, the Rupiah depreciated more than most of its regional peers ................................................. 17 Figure A.24: Investor confidence returned in Q3 with bond yields rising much less than in Q2 ..................................................... 18 Figure A.25: Spread between Rupiah denominated bonds and USD denominated bonds peaked in Q3 but began to narrow in early Q4...................................................................................................................................................................................... 18 Figure A.26: The rise in benchmark policy rate has not been fully transmitted into higher lending rates … .................................. 19 Figure A.27: … and credit growth continued to pick up ................................................................................................................. 19 Figure A.28: Banking sector demonstrated continued resilience in the face of monetary policy tightening ................................... 19 Figure A.29: Non-O&G income tax, O&G related revenues and VAT were the main contributors to the high total revenue growth ...................................................................................................................................................................................................20 Figure A.30: Energy subsidies, interest payment, and personnel and material spending were the main contributors to total expenditure growth .................................................................................................................................................................... 21 Figure A.31: Higher disbursements are broad based with fuel and gas subsidies higher than planned .......................................... 21 Figure A.32: The net trade-weighted price index – historical and forecast until 2019......................................................................24 Figure A.33: The current account deficit is expected to widen in 2018 and 2019 as import-intensive investment remains strong and terms-of-trade weaken ........................................................................................................................................................24 Figure A.34: Headline inflation levels are projected to remain well within the target range ...........................................................25 Figure A.35: Stronger revenues and expenditures with a net result of lower Government budget deficit are projected for 2018 .....25 Figure B.1: The current account deficit has widened along with the basic balance ........................................................................29 Figure B.2: The Indonesian Rupiah has depreciated more than other regional currencies ............................................................29 Figure B.3: A tale of two countries: Trade openness in Indonesia vs Thailand ...............................................................................30 Figure B.4: Indonesia’s total exports have lost market share over the past decades .......................................................................30 Figure B.5: The rise and fall of Indonesian manufacturing competitiveness .................................................................................. 31 Figure B.6: Pre-mature de-industrialization in Indonesia? ............................................................................................................. 31 Figure B.7: Indonesia punches below its weight in terms of FDI inflows .......................................................................................32 Figure B.8: Export-oriented FDI outperforms domestic-market oriented FDI in manufacturing but are more likely to leave Indonesia ...................................................................................................................................................................................33 Figure B.9: The declining share of new export-oriented foreign investment in manufacturing and electronics .............................33 Figure B.10: Indonesia has the potential to replace Chinese exports to the US in various products ...............................................33 Figure B.11: Indonesia’s productivity needs to catch up vis-à-vis comparators ...............................................................................34 Figure B.12: Indonesia has increased its trade barriers significantly more than its peers since 2009 ..............................................35 Figure B.13: As trade barriers increased, so did the nominal rate of protection ..............................................................................35 Figure B.14: Indonesia has increased its average applied import tariff rates more than its peers ...................................................36 Figure B.15: Indonesia has increased its application of Non-Tariff Measures across import categories ........................................37 Figure B.16: Some Non-Tariff Measures considerably increase the cost of imports in Indonesia ..................................................37 Figure B.17: Indonesia restricts the import of services more than other countries ..........................................................................37 Figure B.18: Regulatory restrictiveness towards FDI is high in Indonesia ......................................................................................38 Figure B.19: DNI restrictions reduce the entry of foreign plants – particularly exporters - and the exit of domestic plants… ........39 Figure B.20: …and the lower competition reduces performance and wages, and increase prices ...................................................39 Figure B.21: The difficult transition of Indonesia’s horticulture sector ...........................................................................................40 Figure B.22: Indonesia’s domestic-oriented electronics sector ....................................................................................................... 41 Figure B.23: Indonesia lags behind in the strength and scope of its competition regime (2013).....................................................42 Figure B.24: Lack of the right skills bites, particularly for managers ..............................................................................................43 Figure B.25: Power reliability needs to be improved for Indonesian firms ......................................................................................44 Figure B.26: FTAs are a possible boon for the Indonesian economy ..............................................................................................45 Figure B.27: Eliminating foreign equity limits can boost investments across sectors .....................................................................46 Figure B.28: Indonesia does not yet tap into foreign skills to fill domestic gap ..............................................................................46 Figure B.29: Reducing fuel subsidy could improve the current account deficit ..............................................................................47 APPENDIX FIGURES Appendix Figure 1: Real GDP growth .............................................................................................................................................52 Appendix Figure 2: Contribution to GDP growth (expenditure) .....................................................................................................52 Appendix Figure 3: Contribution to GDP growth (production) ......................................................................................................52 Appendix Figure 4: Motor cycle and motor vehicle sales ................................................................................................................52 Appendix Figure 5: Consumer indicators ........................................................................................................................................52 Appendix Figure 6: Industrial production indicators and manufacturing PMI ...............................................................................52 Appendix Figure 7: Balance of payments ........................................................................................................................................53 Appendix Figure 8: BOP: Current account .....................................................................................................................................53 Appendix Figure 9: Exports of goods ..............................................................................................................................................53 Appendix Figure 10: Imports of goods ............................................................................................................................................53 Appendix Figure 11: Reserves and capital flows ..............................................................................................................................53 Appendix Figure 12: CPI inflation ...................................................................................................................................................53 Appendix Figure 13: Monthly breakdown of CPI inflation ..............................................................................................................54 Appendix Figure 14: CPI inflation comparison across countries .....................................................................................................54 Appendix Figure 15: Domestic and international rice prices ...........................................................................................................54 Appendix Figure 16: Poverty and unemployment rates ...................................................................................................................54 Appendix Figure 17: Regional equity indices ..................................................................................................................................54 Appendix Figure 18: Spot exchange rates of selected currencies against USD................................................................................54 Appendix Figure 19: 5-year local currency government bond yields ...............................................................................................55 Appendix Figure 20: Sovereign USD bond EMBIG spread ............................................................................................................55 Appendix Figure 21: Commercial and rural credit and deposit growth ...........................................................................................55 Appendix Figure 22: Banking sector indicators ..............................................................................................................................55 Appendix Figure 23: Government debt ...........................................................................................................................................55 Appendix Figure 24: External debt .................................................................................................................................................55 TABLES Table ES.1: Real GDP growth is expected to rise to 5.2 percent in 2018 with stronger domestic demand ....................................... 2 Table A.1: Indonesia’s Balance of Payments (BOP) ....................................................................................................................... 11 Table A.2: Key components of the consumer price index ............................................................................................................... 16 Table A.3: Key economic indicators ................................................................................................................................................23 Table A.4: Ministry of Finance and World Bank budget projections ..............................................................................................26 APPENDIX TABLES Appendix Table 1: Budget outcomes ..............................................................................................................................................56 Appendix Table 2: Balance of payments .........................................................................................................................................56 Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance ...........................................................................57 Appendix Table 4: Indonesia’s development indicators at a glance ................................................................................................58 BOXES Box A.1: Global economic conditions softened in Q3 ...................................................................................................................... 6 Box A.2: A tale of two groups of commodities................................................................................................................................. 10 Box B.1: A policy reform agenda to boost exports and foreign investments ....................................................................................28 Box B.2: Why trade and investment restrictions have not helped the development of Indonesian horticultural and electronics industries ...................................................................................................................................................................................40 Strengthening competitiveness Indonesia Economic Quarterly Executive Summary: Strengthening Competitiveness After a challenging 10 months of capital outflows, global trade policy (bond inflows were tracking the lowest currency depreciation, higher government bond yields and levels in seven years), added to the widening current mounting pressures from fuel prices, November brought account deficit, led the Rupiah depreciated through respite to Indonesia: global oil prices fell, and capital flows October, with the currency reaching a trough of IDR returned, leading to currency appreciation and lower bond 15,237 per USD on October 30. Year-to-September, the yields. Nevertheless, the global and domestic dynamics currency depreciated 8.2 percent in nominal terms and 7.6 that prevailed for the initial 10 months of 2018 remain percent in real effective terms (Figure ES.4). mostly in place, and this edition of the Indonesian Economic Quarterly highlights the importance of structural reforms Despite high oil prices in Q3, headline consumer price to increase exports and FDI, which will strengthen inflation fell from an average of 3.3 percent yoy in Q2 to Indonesia’s external position. an average of 3.1 percent in Q3 (Figure ES.5). The lower headline reading was largely driven by low administered Indonesia’s economic growth over the past five quarters price inflation on the back of a high base-effect due to the has been driven by investment, especially in the mining electricity tariff hikes last year. and infrastructure sectors. In the third quarter of 2018, GDP growth remained broadly steady at 5.2 percent yoy1, Despite inflation being at a two-year low, Bank Indonesia driven by domestic demand. Gross fixed capital formation (BI) raised its benchmark policy rate twice in Q3 and once accelerated on the back of a rebound in construction in November, by 25 basis points each time. The sustained investment. While private consumption eased slightly, a policy tightening was in response to external conditions surge in government consumption kept total consumption and reflected the Government’s focus on maintaining growth on an even keel (Figure ES.1). As equipment stability. Notwithstanding turbulent global financial investment remained robust, import growth was nearly markets, overall macroeconomic resilience has been double that of exports. As such, net exports continued to maintained, largely due to sound macroeconomic weigh on growth, despite exports expanding for the eighth fundamentals and a coordinated policy framework. consecutive quarter. On the production side, growth picked up in most sectors, except for agriculture and The Government’s fiscal position has also reflected the utilities. As a result, growth of gross value-added priority of stability. Both total Government revenues and accelerated slightly to 5.1 percent yoy from 5 percent in expenditures showed strong growth through October, but Q2 (Figure ES.2). the net result has been a smaller budget deficit compared to the same period in 2017 (Figure ES.6), reducing High crude oil prices through October and continued financing needs and pressures on bond markets. Higher robust growth in equipment investment more than offset revenue collection was mainly driven by income taxes a small improvement in the income balance due to from non-oil & gas, oil & gas related revenues and value currency depreciation and led to a widening of the current added tax (VAT)/luxury goods sales tax (LGST), while account deficit to 2.7 percent of GDP in Q3 from 2.3 expenditure growth was mainly due to higher personnel, percent in Q22 (Figure ES.3). Net foreign direct material and energy subsidy spending. The 2019 Budget investment reached USD 3.9 billion in Q3, but this was signals projects a lower budget deficit of 1.8 percent of still less than half the current account deficit. Overall, with GDP in 2019, underpinned by substantial increases in a narrower financial and capital account surplus, the revenues. The projected fiscal consolidation in 2019 will balance of payments deficit rose to USD 4.4 billion3, further reduce financing needs. bringing reserves down to USD 114.8 billion at the end of Q3. Reserves are sufficient to finance government external Real GDP growth is projected at 5.2 percent yoy this year debt repayments and imports for 6.3 months4. and in 2019, a notch higher than in 2017 (Table ES.1), as stronger domestic demand is expected to more than offset Scarce capital inflows due to tighter monetary policy in the drag from the external sector. Despite projected advanced economies and greater uncertainty around consumer price inflation edging up next year, private 1 Consensus forecast for real GDP growth in Q3 2018 was 5.1 3 As a share of GDP, the balance of payments deficit was 1.7 percent. percent of GDP in Q3. 2 Expressed as a four-quarter rolling sum. As a share of GDP, the 4 Bank Indonesia (August 15, 2018). current account deficit was 3.4 percent of GDP in Q3. December 2018 THE WORLD BANK | BANK DUNIA 1 Strengthening competitiveness Indonesia Economic Quarterly consumption is forecast to strengthen due to increased important for Indonesia to seize the current opportunity social spending and a strong labor market. Gross fixed to rebuild foreign reserves to maintain sizable buffers. capital formation is also expected to remain robust, as More fundamentally, this edition of the Indonesia Economic firms who had remained on the sidelines due to the Quarterly highlights the importance of boosting exports and foreign elections make new commitments. Likewise, Government direct investment to reduce Indonesia’s structural current account consumption is forecast to remain robust as continued deficit, and further enhance external resilience, in addition to reform and revenue growth create space for both fiscal increasing productivity and economic growth. consolidation and additional spending. Indonesia’s current account position in 2018 has all the Table ES.1: Real GDP growth is expected to rise to 5.2 hallmarks of a ‘healthy’ current account deficit: it is of percent in 2018 with stronger domestic demand limited size compared to previous periods and other 2017 2018f 2019f countries, and it is driven by investment rather than Real GDP (Annual percent 5.1 5.2 5.2 consumption. However, Indonesia’s reliance on volatile change) portfolio capital flows to finance its current account deficit Consumer (Annual percent price index change) 3.8 3.2 3.5 have amplified the effects of the recent global turmoil on Current Indonesia’s financial markets. When portfolio flows ebbed (Percent of account GDP) -1.7 -2.9 -2.5 due to no fault of Indonesia, the Rupiah depreciated, and balance bond yields rose. The reliance on portfolio flows are in Government budget (Percent of -2.5 -2.1 -1.8 large part due to the slow growth in exports and limited balance GDP) foreign direct investment, which have contracted over the Source: BI; Central Bureau of Statistics (BPS); Ministry of last quarters. These developments are underscored by Finance; World Bank staff calculations Note: 2017 actual outcome; f stands for World Bank forecast declining shares in global manufacturing and commercial service exports, low levels of FDI in GDP compared to With the current uncertainty in global trade policy, slower neighbors, and low labor productivity. projected growth of major trading partners, weaker terms- Indonesia can grow faster, create more and better jobs and of-trade (ToT), and robust domestic investments boost the structural current account position and its continuing to drive strong import needs, the current financing by accelerating export growth and attracting account deficit is projected to widen to 2.9 percent of more of the global savings pool. Countries such as GDP in 2018, despite the dampening impact of currency Thailand, Vietnam and Malaysia have successfully depreciation on imports and especially the income integrated into global value chains and are attracting balance. These effects are expected to be felt more production investments that are relocating away from intensely in 2019, when the current account deficit is China. expected to moderate to 2.5 percent of GDP5. A policy agenda to boost exports and investments – and Downside risks to Indonesia’s growth outlook remain which would make Indonesia more competitive globally – substantial. Global trade tensions, in particular between entails opening more to trade, global investment and the United States and China, appear to have subsided, but talent. These include: (i) reversing the increase in import could return if ongoing negotiations are not successful. barriers, including tariff and (certain) non-tariff barriers, The possible further escalation of such disputes continue which raise prices to consumers and firms, making them to pose significant risks to Indonesia through a weaker less competitive; (ii) implementing ambitious free trade external sector and dampened commodity prices. At the agreements, which can catalyze policy reforms and same time, the current tightening cycle of the U.S. Federal enhance market access for Indonesian products overseas; Reserve continues to heighten the risk of capital outflows (iii) reducing the significant restrictions to foreign and financial volatility among emerging market investors, which limit investment and competition economies, including Indonesia. harming the competitiveness of the protected sectors; (iv) easing the requirements to bring in critically scarce skills To date, Indonesia has emerged relatively unscathed from from abroad to temporarily fill the domestic skills gap, in the recent volatility plaguing emerging market economies, line with the experience of other countries in the region. largely because of its sound macroeconomic fundamentals These measures, along with closing the infrastructure and and adequate buffers that allowed for a coordinated human capital gaps, will not only strengthen its external monetary, fiscal and exchange rate policy framework. It is position, but will boost Indonesia’s competitiveness and support an acceleration of growth in the coming decade. 5Despite the recent appreciation, the Rupiah is still 3.9 percent weaker for the year as of November 30 (see Section A.5). December 2018 THE WORLD BANK | BANK DUNIA 2 Strengthening competitiveness Indonesia Economic Quarterly Figure ES.1: GDP growth eased a little in Q3 Figure ES.2: Manufacturing sector growth more than (contribution to growth yoy, percentage points) offset the moderation in the agriculture sector growth (contributions to growth yoy, percentage points) Private consumption Government consumption Other services Financial services Investment Net exports Transport & communication Trade, hotels & restaurants Stat. discrepancy* Change in inventories Construction Electricity, gas & water 8 GDP 6 Manufacturing Mining & quarrying 7 Agriculture Gross Value Added* 6 5 5 4 4 3 3 2 2 1 0 1 -1 -2 0 -3 -1 Sep-15 Jun-16 Mar-17 Dec-17 Sep-18 Sep-15 Sep-16 Sep-17 Sep-18 Source: BPS; World Bank staff calculations Source: CEIC; World Bank staff calculations Note: See Figure A.9 Figure ES.3: The deficit in the goods trade balances led Figure ES.4: The Rupiah continued depreciating against the deterioration of the current account balance the U.S. dollar in Q3, before recovering in Q4 (four-quarter rolling sum, percent of GDP) (index, Jan 1 2018 = 100) Income Services trade balance 104 Goods trade balance Current account balance 2 100 1 96 0 USD/IDR -1 92 -2 JP Morgan EMCI 88 -3 -4 84 Q32014 Q22015 Q12016 Q42016 Q32017 Q22018 Nov-17 Feb-18 May-18 Aug-18 Nov-18 Source: CIEC, World Bank staff calculation Source: JP Morgan, BPS and World Bank staff calculations Figure ES.5: Headline inflation eased in Q3 despite Figure ES.6: Stronger revenues and expenditures with a higher oil pieces net result of lower Government budget deficit are (change yoy, percent) projected for 2018 (percent of GDP) 12 Revenue Expenditure Fiscal balance 18.0 10 Administered 15.0 14.8 15.0 15.1 15.0 12.8 13.2 12.5 12.3 8 Food 12.0 6 9.0 Headline 4 6.0 2 3.0 Core 0.0 0 -3.0 -2.2 -1.9 -2 -2.5 -2.5 Budget WB Jun-16 Oct-16 Feb-17 Jun-17 Oct-17 Feb-18 Jun-18 Oct-18 2016 2017 2018 Source: BPS; World Bank staff calculations Source: Ministry of Finance; World Bank staff calculations Note: See Figure A.19 Note: See Figure A.35 December 2018 THE WORLD BANK | BANK DUNIA 3 Strengthening competitiveness Indonesia Economic Quarterly A. Economic and Fiscal Update 1. Indonesian economic growth eased slightly in Q3 2018 Real GDP growth The Indonesian Figure A.1: GDP growth eased a little in Q3 was 5.2 percent in economy grew 5.2 (contribution to growth yoy, percentage points) Q3 2018, marginally percent year-on-year Private consumption Government consumption Investment Net exports lower than the 5.3 (yoy) in Q3 2018, Stat. discrepancy* Change in inventories 8 percent recorded in marginally slower than GDP Q2 the 5.3 percent in Q2 7 2018, but a little above 6 consensus forecasts of 5 5.1 percent. The slight moderation in GDP 4 growth was in part due 3 to a slower 2 accumulation of inventories as well as 1 easing private 0 consumption growth -1 (Figure A.1). Government -2 consumption -3 extended its rapid Sep-15 Jun-16 Mar-17 Dec-17 Sep-18 growth seen in Q2 and accelerated further in Source: BPS; World Bank staff calculations Q3. As in Q2, imports growth nearly doubled that of exports growth, partly reflecting the rebound in investment growth after the one-off slowing in Q2. As was the case in the previous three quarters, net exports continue to weigh on growth, despite robust domestic demand. On the production side, Q3 growth outpaced Q2 growth for most sectors, except for agriculture and utilities. December 2018 THE WORLD BANK | BANK DUNIA 4 Strengthening competitiveness Indonesia Economic Quarterly Fixed investment Growth in gross fixed capital Figure A.2: Investment growth rebounded as growth growth rebounded in formation rebounded to 7.0 percent in buildings and structures investment picked up Q3 in Q3, from a one-off slowing of 5.9 (contribution to growth yoy, percentage points) percent in Q2 (Figure A.2). The Buildings & Structures Vehicles Machine & Equipment Other Equipments transitory deceleration in the previous Cultivated Bio. Res. Intellectual Property 8 quarter was because of the fewer Investment 7 working days this year, as the Muslim 6 festive period in fell entirely in Q2, 5 compared to 2017, when it was 4 spread between Q2 and Q3. The 3 rebound also coincided with robust 2 Q3 nominal capital goods imports 1 growth of 22.5 percent yoy, as well as 0 a steep pick up in investment credit -1 growth (see Section 5). Jun-17 Jun-16 Sep-16 Dec-16 Sep-17 Dec-17 Jun-18 Sep-18 Mar-16 Mar-17 Mar-18 A pick-up in activity in buildings and Source: BPS; World Bank staff calculations structures contributed to the acceleration in investment growth. In terms of contribution to growth, buildings and structures investment contribution increased from 3.8 percentage points (pp) in Q2 to 4.2 pp in Q3. The contribution from vehicles investment eased for the second consecutive quarter from 0.5 pp to 0.3 pp. Figure A.3: Private consumption growth eased on the back Figure A.4: Most high-frequency indicators linked to of reduced consumption of equipment as well as health and private consumption eased in Q3 education (yoy, percent/3mma yoy, percent, LHS; consumer confidence index; (contribution to growth yoy, percentage points) RHS) Non-Profit Institutions Others Restaurant & Hotel Transportation & Comm 40 130 Health & Education Equipments App, Footwear & Maintenance F&B, Other than Restaurant Private Consumption 30 Consumer Confidence Index 120 6 Motorcycle sales 20 110 4 10 100 Retail Sales Index 2 0 90 Passenger Car Sales 0 -10 80 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Source: CEIC; World Bank staff calculations Source: Bank Indonesia, CEIC; World Bank staff calculations Note: Retail sales index in yoy percent terms; vehicle sales in 3-month moving average (mma) percent yoy terms. Private consumption Despite some easing in headline inflation (see Section A.4), private consumption growth eased growth eased to 5.1 to 5.1 percent in Q3 from 5.2 percent on the back of a slight moderation in both household percent as the fillip consumption and non-profit institutions’ consumption growth. Household consumption provided by the Q2 growth eased to 4.9 percent (from 5.0 percent in Q2) as the support from the Q2 festive season festive period spending dissipated. Within the household category (Figure A.3), the contribution to growth dissipated from the consumption of equipment as well as health and education, eased. Meanwhile, consumption of food and beverages, and transport and communication contributed the most to growth. Restaurant and hotel consumption as well as transport and communication grew the fastest. In line with the slight moderation in consumption growth, high-frequency indicators for December 2018 THE WORLD BANK | BANK DUNIA 5 Strengthening competitiveness Indonesia Economic Quarterly consumption, such as the consumer confidence index, motorcycle sales and retail sales were soft in Q3 (Figure A.4). Given concerns about consumption over the past couple of years, it is worth noting that despite the moderation in private consumption growth, it remains a tick above its average growth rate over the past four years. Box A.1: Global economic conditions softened in Q3 Global economic conditions softened in Q3. This was led by slower growth in the Eurozone and China. Eurozone GDP growth eased to 1.7 percent yoy from 2.2 percent in Q2, partly on weak economic growth in Italy, while an uptick in inflation contributed to the tempering of consumption growth. In line with expectations, China’s economy continues its growth moderation at a measured pace , with GDP growth at 6.5 percent in Q3, down from 6.7 percent in Q2. This easing was due to moderating investment and industrial production, as well as the ongoing financial deleveraging as the Chinese Government attempts to improve the quality of its domestic debt.1 In contrast, the U.S. economy, bolstered by fiscal stimulus, roared ahead and expanded 3 percent in Q3. Figure A.5: Global trade growth eased… Figure A.6: …as did industrial production (percent, yoy) (percent, yoy) 7 7 World trade Emerging Asia 6 6 Euro Area imports 5 5 Euro Area 4 4 World 3 3 2 2 1 1 0 0 -1 Advanced economies Euro Area exports -1 -2 Sep-15 Jun-16 Jun-17 Jun-18 Dec-15 Sep-16 Dec-16 Sep-17 Sep-18 Mar-16 Mar-17 Dec-17 Mar-18 Sep-15 Dec-15 Jun-16 Sep-16 Dec-16 Jun-17 Sep-17 Dec-17 Jun-18 Sep-18 Mar-16 Mar-17 Mar-18 Source: CBP World Trade Monitor, World Bank staff calculations Source: CBP World Trade Monitor, World Bank staff calculations Higher frequency indicators of global economic activity painted a mixed picture at the start of Q3, with global trade growth remaining robust at 3.5 percent, despite trade restrictions associated with increasing rising protectionism beginning to take effect (Figure A.5). However, trade growth among emerging economies were substantially stronger than among advanced economies in Q3 2. The Eurozone economies were the main cause of the drag on advanced economy trade growth as U.S. tariffs on steel and aluminum began to take effect. Eurozone exports and import growth eased to a five and six-quarter low, respectively. Meanwhile, global industrial production growth eased to 2.8 percent in Q3, its slowest since Q1 2017, compared to an average of 3.3 percent in Q2 (Figure A.6). Despite industrial production growth in United States recording its strongest outcome since 2011, industrial production in advanced economies also weakened. Industrial production growth in emerging economies moderated to 3.3 percent in Q3, compared to 3.8 percent in Q2, largely due to contractions in Latin America on the back of economic troubles in Argentina. Another indicator of economic activity, Markit’s Composite PMI recorded broad bas ed decreases in Q3 that reflected a moderation in economic activity in line with easing global trade growth and softening industrial production (Figure A.7). The composite global PMI, while remaining in expansionary territory (an average of 53.3 in Q3) fell to its lowest point since the end of 2016. In contrast to the trade outcomes where emerging market economies outperformed advanced economies, the advanced economies Composite PM, despite easing to an average reading of 53.8 in Q3, from an average of 54.7 in Q2 was higher than the Composite PMI for emerging economies which eased to an average of 52 compared to 52.4 in Q2 and 53 in Q1. Against a backdrop of softening global economic growth outcomes and mixed signals with regards to higher frequency indicators policy makers around the world have reacted with varying degrees of urgency. As has already noted, the rapid pickup in GDP growth in the United States has been driven by expansionary fiscal policy. In anticipation of slowing export growth amid trade tensions, Chinese authorities have introduced a raft of measures aimed at stimulating economic activity ranging from cutting reserve requirement ratios (akin to loosening credit conditions), easing restrictions on emissions (as a means of boosting production and investment) and December 2018 THE WORLD BANK | BANK DUNIA 6 Strengthening competitiveness Indonesia Economic Quarterly introducing tax cuts. Thus far, these policies have appeared to have been effective in achieving their stated objectives (See World Bank, 2019). Figure A.7: PMI outcomes around the world eased Figure A.8: Global financial market volatility did not (growth yoy, percent) dissipate completely in Q3 (index, January 1, 2018 =100) 350 U.S. stock market correction Concerns about corporate 58 Q1-18 Q2-18 Q3-18 earnings for companies such 56 300 VIX as Google and Amazon 54 250 U.S. announcement to increase 52 Federal Rate tariffs on steel and aluminum hike 1 50 200 Federal Rate hike 3 48 150 Japan China Global United States Euro Area Emerging Economies Economies Developed MOVE 100 Federal Rate hike 2 Technology stocks sell off 50 Dec-17 Jul-18 Nov-17 Jan-18 Jun-18 Nov-18 Dec-18 Apr-18 Aug-18 Sep-18 Oct-18 Feb-18 Mar-18 May-18 Source: Markit Economics, Haver, World Bank staff calculations Source: Bloomberg; World Bank staff calculations Note: Readings above 50 represent expansions and readings below 50 represent contractions On the monetary policy front, the U.S. Federal Reserve continues to reiterate its commitment to normalizing interest rates while central banks in many emerging economies have also tightened their monetary policy stances in an attempt to manage capital flow volatility as well as currency volatility. In the Eurozone, the European Central Bank has reaffirmed its commitment to end quantitative easing, despite the tepid economic activity outcomes in recent months. Alongside Indonesia, many central banks in emerging Asian countries have also raised interest rates to mitigate the adverse impact caused by significant bouts of exchange rate volatility coupled with depreciation and compounded by capital outflows 3. Managing macrofinancial conditions remained a challenge for policy makers as equity market volatility (as represented by the VIX index) and bond market volatility (as represented by the MOVE index) did not completely dissipate in Q3 after the jitters seen in Q2. The beginning of Q4 saw significant volatility in the VIX index due to weaker than expected corporate earnings by major tech companies such as Google and Amazon (Figure A.8). The upward trend in oil prices continued in Q3 despite easing global demand due to moderating economic activity. The World Bank’s crude oil price index rose to its highest level since December 2014. More broadly, the World Bank’s energy price index also r ose 41.4 yoy to reach its highest level since Q4 2014. The renewed set of U.S. sanctions4 on Iran, effective from November 4, may place further pressure on energy prices5. In contrast, non-energy prices (as measured by the World Bank’s non-energy price index) fell 0.8 percent in Q3 against the 8.7 percent increase in Q2. 1 World Bank (2019). 2A dichotomy appears to be emerging with advanced economy trade growth which, in Q3, was significantly slower than trade growth in emerging economies. Imports growth in advanced economies averaged 1.1 percent yoy and exports growth averaged 2.4 percent yoy. In contrast, emerging economies trade outcomes were more positive with imports growth surging to an average of 7.6 percent in Q3, and exports growth accelerating to an average of 4.4 percent in Q3. 3 The Reserve Bank of India has raised interest rates twice since June 2018 (for a total increase of 50 basis points), the Philippines central bank by a total of 100 basis points, and Bank Indonesia by a total of 75 basis points (see Section A.5). 4 https://www.businesstimes.com.sg/energy-commodities/oil-prices-fall-on-signs-of-rising-global-supply 5 Global oil prices plunged in November, with Brent going from a peak of USD 86 per barrel on October 4 to USD 58 on November 23 (See Section A.2). Growth of Real Government consumption growth accelerated to 6.3 percent yoy from 5.2 percent in Q2. Government The Q3 outcome was in part due to nominal material spending growth surging 26.3 percent yoy consumption surged compared to 8.8 percent in Q2. This was the fastest pace of growth in material spending since in Q3 as nominal Q1 2017 and was largely driven by spending associated with the Asian games. Nominal material spending personnel spending also picked up to 16.7 percent yoy from 12.6 percent in Q2. Social spending spiked growth decelerated significantly to 4.3 percent yoy compared to 67.6 percent in Q2. This was expected given that the outcomes in Q1 and Q2 were driven mainly by the advance roll out of December 2018 THE WORLD BANK | BANK DUNIA 7 Strengthening competitiveness Indonesia Economic Quarterly the Government’s subsidized social assistance program (PBI) as well as the widening of the coverage of the Family Hope program (PKH). Net exports once In line with slower global trade, both exports and imports growth eased marginally in Q3, again subtracted however, imports still grew nearly twice as fast as exports, which led to an overall drag on GDP from growth growth from net export growth. Exports growth eased slightly to 7.5 percent in Q3 from 7.6 percent in Q2, while imports grew 14.1 percent, down from 15.3 percent in Q2. The exports growth outcome was driven by plunging oil and gas (O&G) exports that were partially offset by stronger exports of non-O&G products. Due to spending associated with the Asian Games, services exports growth almost doubled to also record its fastest pace of growth since Q4 2017. Imports growth continued to be driven by non-O&G imports, while imports of O&G products imports weakened to the slowest growth since Q3 2017, partly due to the biofuel mandate that began on September 16. On the production In gross value-added terms, Figure A.9: Manufacturing sector growth offset the side, most sectors growth picked up slightly from moderation in the agriculture sector grew faster than in 5.0 percent in Q2 to 5.1 percent (contributions to growth yoy, percentage points) Other services Financial services Q2, except for the in Q3 (Figure A.9). Most sectors Transport & communication Trade, hotels & restaurants agriculture and saw stronger growth compared 6 Construction Electricity, gas & water Manufacturing Mining & quarrying utility sectors to Q2, except for the agriculture Agriculture Gross Value Added* 5 and utility sectors (Figure A.9). Agriculture sector growth 4 moderated to 3.6 percent, partly due to a base effect from a 3 bumper harvest season last year 2 and lower production of food crops and commodities, such 1 palm oil and rubber this year. The manufacturing sector 0 recorded an uptick in activity -1 (4.3 percent yoy compared to 3.8 Jun-16 Jun-17 Jun-18 Sep-15 Dec-15 Mar-16 Sep-16 Dec-16 Mar-17 Sep-17 Dec-17 Mar-18 Sep-18 percent in Q2). The mining and quarrying sector also continued Source: CEIC; World Bank staff calculations to pick up with growth rising Note: Gross Valued Added is derived as the sum of the value added in the from 2.6 percent in Q2 to 2.7 agriculture, industry and services sectors. If the value added of these sectors is calculated at purchaser values, gross value added is derived by percent in Q3, on the back of subtracting net indirect taxes from GDP. strength in global commodity prices. Despite the strength in investment activity, particularly in building and structures, the construction sector accelerated only modestly to 5.8 percent in Q3 from 5.7 percent in Q2. 2. Prices of energy-related commodities maintained their upward trajectories Prices of key The prices of Indonesia’s key export commodities in Q3 followed trends observed in previous commodities follow quarters. Prices for coal, crude oil, and liquified natural gas (LNG) rose, booking an average yoy the trend exhibited growth of 31.0 percent, nearly equal to that in Q2. On the other hand, prices of rubber and in the last quarters crude palm oil (CPO) eased further by 17.0 percent, continuing the downward trend seen since the beginning of the year. Prices of base metals were relatively stable, documenting a mere 2 percent decline (See Box A.2). 6 https://www.reuters.com/article/us-singapore-siew-indonesia/indonesia-imposes-mandatory-use-of-b20-biodiesel-in-drive-to-cut-fuel-bill- deputy-minister-idUSKCN1N5160 December 2018 THE WORLD BANK | BANK DUNIA 8 Strengthening competitiveness Indonesia Economic Quarterly Partly due to the 100 million ton Figure A.10: Three month moving average of Indonesia’s increase in the coal export quota main commodity exports beginning in September this year, (export volume index, January 2016 = 100; index for metal in RHS) coal exports rose to 7.3 percent 130 Coal Rubber Oil 500 yoy in Q3, slower than the 12.9 Gas Metal 450 percent in Q27. Export of base 120 metals also recorded an increase of 400 128.3 percent in Q3, lower than 110 350 the growth of nearly 300 percent 300 booked in the second quarter. The 100 250 surge in mineral exports was 200 largely due to the Government 90 partially lifting the export ban on 150 unprocessed minerals in 2017, in 100 80 place since 20148. 50 70 0 Exports of the country’s other key Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 commodities, on the other hand, Source: CEIC; World Bank staff calculations was weaker. The volume of O&G Note: Data for CPO is not available. Export volumes of base metals are not presented due to significant jump observed in 2018. exports recorded a yoy contraction of 22.2 percent as swaps of ownerships of several oil blocks resulted in sharp changes in the amount earmarked for export9. In terms of volumes, export of oil (including refined products) and gas declined from 35.4 million barrels (mbbls) and around 300 million British thermal unit (mmbtu) respectively in Q3 2017, to 28.7 mbbls and around 267 mmbtu in Q3 2018. The volumes of exported rubber contracted yoy by nearly 7 percent, partly caused by the bearish demand for the commodity following the trade war between China and the United States (Figure A.10). 7 In its attempt to narrow the current account deficit, the Government has increased the export quota of coal by 100 million tons with effect from September 2018. While the industries were only able to meet around 25 percent of the additional quota, the total increase in export volume is nevertheless less than 25 million tons because a portion of the additional coal production is being used to meet the Domestic Market Obligation (see http://pubdocs.worldbank.org/en/823461540394173663/CMO-October-2018-Forecasts.pdf). In addition, industries could be responding to the higher quota cautiously in an effort to avoid oversupplying the market and adversely affect the prices (see https://www.montelnews.com/de/story/indonesia-cuts-november-coal-price-by-3/950238) 8 Indonesia partially lifted the non-processed mineral export ban at the beginning of 2017. Accordingly, the country has since been steadily increasing its volume of mineral export. Before that, since January 2014, miners needed to at least process their ore and concentrate before permissions to export are granted. 9 The government recently granted Pertamina permission to operate 12 oil blocks that were previously operated partly by foreign oil companies. As a result, the output from those fields are now processed (and later consumed) domestically, hence reducing the total export of oil. December 2018 THE WORLD BANK | BANK DUNIA 9 Strengthening competitiveness Indonesia Economic Quarterly Box A.2: A tale of two groups of commodities In line with the trend that began at the end of Q1 2018, prices for Indonesia’s key export commodities continued to move in different trajectories. Prices of non-agricultural commodities such as coal, crude oil, and LNG maintained their upward trend. ( Figure A.11). In contrast, ample availability and weak demand continued to weigh on rubber and CPO prices. Coal prices rose an average of 23.7 percent yoy in Q3, after a jump of 31.3 percent in Q2, driven by a surge in demand from China and India in preparation for the high demand for electricity during winter. Relatedly, in September 2018, China's Ministry of Ecology and Environment trimmed its pollution reduction target to 3 percent from 5 percent for the period October 2018 through to March 2019, opening the door for a substantial increase in the use of coal for power production in the country's northern provinces. Meanwhile, the bullish mood for crude oil continued as prices reached a four-year high at the end of Q3, translating into 45.5 percent yoy growth, which partly reflected supply fears as sanctions were imposed on Iran. However, the upward path in crude oil prices reversed in the middle of Q4 with oil prices plunging. Brent oil prices fell from a peak of USD 86 per barrel on October 4 to USD 58 on November 23. One of the main reasons for the reversal was that the U.S. allowed exemptions for major importers of oil (such as India) to continue buying oil from Iran. Furthermore, global economic activity moderated in Q3 and eased demand pressures that led to additional downward pressure on prices. Meanwhile, LNG prices also enjoyed a new multi-month high in Q3, surging 23.5 percent, due to massive growth demand in China and demand revival in South Korea. On the agricultural commodities, rubber prices continued to be in the bearish territory as global trade policy uncertainty dampened sentiment. Prices in Q3 declined further yoy by 19.5 percent after a 17.2 percent fall in Q2, and are likely to fall further due to ample supply, as tapping in key growing areas has started. On the other hand, the price of CPO slipped further by 15.2 percent, following the fall of other vegetable oils, such as soybean, rapeseed, and sunflower oil. Moving forward, the World Bank (2018) expects the prices of rubber and CPO to remain under pressure. Coal prices are projected to be stable, while base metal and prices are expected to make slight gains. The average price of oil in 2018 is still expected to be higher than it was year ago, despite significant declines seen in November 2018. ( Figure A.12). Figure A.11: Non-agricultural commodity prices Figure A.12: Base metal prices are expected to end 2018 continued to rally, while agricultural ones remained under higher than the YTD average pressure (index January 2016 = 100) (index January 2016 = 100) 260 Crude oil Avg Q2-18 Avg Q3-18 Oct-18 2018 (F) YTD Avg 250 Rubber 220 Coal 200 180 Base Metals 150 140 100 CPO 100 50 LNG 60 0 Jul-16 Jul-17 Jul-18 Jan-16 Apr-16 Jan-17 Apr-17 Jan-18 Apr-18 Oct-18 Oct-16 Oct-17 Rubber Base Coal Crude Oil LNG CPO Metals Source: World Bank Pink Sheet; World Bank staff calculations Source: CEIC, BPS; World Bank staff calculations Note: LNG stands for Liquified Natural Gas; CPO stands for Crude Palm Oil December 2018 THE WORLD BANK | BANK DUNIA 10 Strengthening competitiveness Indonesia Economic Quarterly 3. Pressured by higher crude prices, the current account deficit widened further The current account Amid high crude oil prices in Figure A.13: The deficit in the goods trade balances led the deficit widened as Q3 and continued robust deterioration of the current account balance the goods trade growth in equipment (four quarter rolling-sum, percent of GDP) balance went into investment10, Indonesia’s Goods trade balance Services trade balance Income Current account balance deficit, while the current account deficit widened services deficit to 2.7 percent in Q3, wider than 2 increased Q2’s 2.3 percent11 (Figure 1 A.13). On a quarterly basis, the 0 current account deficit was 3.4 percent of GDP in Q3, larger -1 than the deficit of 1.8 percent -2 seen in Q3 2017 (Table A.1). -3 The current account deficit widened on the goods trade -4Q32014 Q32015 Q32016 Q32017 Q32018 balance turning to a deficit and a larger service trade deficit. Source: CIEC, World Bank staff calculation Overall, as the surplus at the financial and capital account was not sufficient to offset the deficit recorded in the current account, the balance of payments booked a deficit of USD 4.4 billion. After three consecutive quarters of BOP deficits, BI’s international reserves fell to USD 114.8 billion at the end of Q3, but are still sufficient to finance Government external debt repayments and imports for 6.3 months12. Table A.1: Indonesia’s Balance of Payments (BOP) (USD billion unless otherwise indicated) Q3-2017 Q4-2017 Q1-2018 Q2-2018 Q3-2018 Nominal GDP 262.9 257.9 258.2 263.9 262.5 Overall Balance of Payments 5.4 1.0 (3.9) (4.3) (4.4) As percent of GDP 2.0 0.4 (1.5) (1.6) (1.7) As percent of GDP, four-quarter rolling sum 1.5 1.1 0.3 (0.2) (1.1) Current Account (4.6) (6.0) (5.5) (8.0) (8.9) As percent of GDP (1.8) (2.3) (2.1) (3.0) (3.4) As percent of GDP, four-quarter rolling sum (1.3) (1.7) (2.0) (2.3) (2.7) Goods trade balance 5.3 3.1 2.3 0.3 (0.4) Services trade balance (2.1) (2.3) (1.7) (1.9) (2.2) Income (7.8) (6.6) (6.3) (6.4) (6.2) Capital and Financial Accounts 10.2 (6.8) 2.3 4.5 4.2 As percent of GDP 3.9 2.7 0.7 1.7 1.6 As percent of GDP, four-quarter rolling sum 3.0 2.9 2.4 2.3 1.7 Direct Investment 7.6 4.3 3.1 2.7 3.9 Portfolio Investment 4.0 2.0 (1.2) 0.1 (0.1) Other Investment (1.4) 0.7 (0.2) 1.7 0.2 Source: Bank Indonesia; World Bank staff calculations Total imports Nominal growth in total imports of goods and services continued to outpace that of total continued to outpace exports for the fourth consecutive quarter. Total exports grew by 10.7 percent yoy in Q3, slower total exports… than the 22.6 percent growth booked in the same quarter last year, driven slightly more by 10 Equipment investment has a high import content, which drives up imports of capital and intermediate goods. 11 Expressedas a four-quarter rolling sum. 12 Bank Indonesia (August 15, 2018). December 2018 THE WORLD BANK | BANK DUNIA 11 Strengthening competitiveness Indonesia Economic Quarterly exports of services. Total imports, on the other hand, accelerated to 23.8 percent in Q3 from 21.3 percent in Q3 last year … driven by the Growth of goods imports more than doubled that of exports in Q3. Goods imports growth strong growth of upped 25.5 percent in Q3, from 22.4 percent Q3 2017, driven by strong consumption and goods imports. investment13. Meanwhile, goods exports growth eased substantially to 10.0 percent in Q3 from 24.3 percent in Q3 2017. The moderation in the goods exports growth was partly due to a high base effect observed in Q3 2017, as well as slower global growth and global trade. Accordingly, the goods trade balances went into deficit for the first time since Q2 201414. Figure A.14: Softer goods exports growth seen in every Figure A.15: Growth of goods imports continued to outpace category exports, driven by fuel and consumption goods. (contributions yoy growth, percent) (contributions yoy growth, percent) Other goods Other manufactures Other merchandise Textile & textile products Processed commodities Capital goods Coal Oil & gas Fuel & lubricants Agriculture & other mining Total exports Intermediate goods excluding fuel Consumption goods excluding fuel 24 Total imports 24 20 20 16 16 12 12 8 8 4 4 0 0 -4 -4 -8 -8 -12 -12 Q22016 Q32016 Q42016 Q12017 Q22017 Q32017 Q42017 Q12018 Q22018 Q32018 Q22016 Q32016 Q42016 Q12017 Q22017 Q32017 Q42017 Q12018 Q22018 Q32018 Source: CEIC and Bank Indonesia; World Bank staff calculations Source: CEIC and Bank Indonesia; World Bank staff calculations Notes: The “other manufacturing” category includes paper, paper materials, furniture, plastics, processed foods, chemicals, and “other” goods The slowing of Compared to both Q2 2018 and Q3 2017, the yoy growth of goods exports in Q3 2018 slowed goods exports across nearly all categories. Exports of coal15, other manufacturing products (including paper growth in Q3 was and paper products and processed foods), textiles and motor vehicles, in particular, saw softer broad-based… growth (Figure A.14). The continued contraction of palm oil and processed rubber exports contributed to the negative contribution of the processed commodities category. On the O&G front, despite slightly lower production16, growth of exports was relatively stable at 18 percent, 13 Goods imports grew 25.0 percent in Q2 2018, while that of exports grew 11.7 percent. 14 Back in Q2 2014, growth of goods imports was relatively high, driven by higher demand for consumption goods for both fasting month and Lebaran festivities. On the other hand, growth of goods exports was hampered by sluggish demand for main Indonesia commodities, especially coal and palm oil, as well as the decision by the government of Indonesia to ban the export of unprocessed mineral. 15 Shipments of coal is reportedly down in particular for China as the country started to limit the coal imports while also give more preference to high-calorific coal (which is not the trait of Indonesian coal). The value of coal exports has been also by the relatively lower price of coal at the end of Q3, as the Government of Indonesia increased its export quota by 100 million tons. 16 The special task force overseeing upstream oil and gas activities in Indonesia (SKK Migas) announced that the lifting oil and gas in Q3 slowed by 1.5 percent qoq (quarter to quarter) from 791 kbpd (kilo barrels per day) to 780 kbpd partly because of unplanned shutdown in two important fields at Plaju and Dumai. Vice Minister of Energy and Mineral Resources also revealed that the swap of Mahakam oil fields that was previously owned by Total to Pertamina has partly affected the export figures. Gas production, on the other hand, improved both qoq (6.8 percent) and yoy (21.2 percent). December 2018 THE WORLD BANK | BANK DUNIA 12 Strengthening competitiveness Indonesia Economic Quarterly similar to that in Q3 2017. Apart from exports to the United States17, India18, South Korea19, and Vietnam20, those to the other ten top destinations recorded slower growth than in Q2 2018. … while higher oil Goods imports has been persistently growing more than 20 percent yoy over the last five prices supported quarters (Figure A.15). Its main drivers, imports of fuel and consumption goods, grew firmly goods imports yoy at 56.7 percent and 36.0 percent, respectively. The surge in prices were partly behind the growth escalation21 in fuel imports. Similarly, imports of consumption goods accelerated further to the highest yoy growth in at least the past six years. This is despite the steady depreciation of the Rupiah, in both nominal and real terms and the Government policies to increase the consumption goods import tax22. Meanwhile, the growth of capital goods imports moderated to 22.7 percent, slightly lower than 24.1 percent of growth in Q3 2017. Deficit in the The services account deficit widened to USD 2.2 billion in Q3 2018, slightly higher than the services account deficit of USD 1.9 billion reported in the previous quarter. Growth of services imports slightly widened accelerated by 13.3 percent in Q3, in line with higher imports of goods and the uptick of the demand of services due to hajj pilgrimage activities. An even larger services trade deficit was restrained by higher services exports as the number of foreign travelers to Indonesia increased during the Asian Games events held in Jakarta and Palembang. The financial Despite the volatile external Figure A.16: Stable surplus seen in financial and capital account surplus backdrop, the financial and account remained relatively capital account posted a relatively (USD billion) Equities SBI stable stable surplus of USD 4.2 billion SUN Govt global bonds (1.6 percent of GDP) in Q3 from Main net portfolio inflows 6 USD 4.5 billion (1.7 percent of 5 GDP) in Q2, but far less than 4 USD 10.3 billion (3.9 percent of 3 GDP) documented in Q3 last 2 year. The figure reflects a pickup 1 in net foreign direct investment 0 -1 (FDI) inflows to USD 3.9 billion -2 from USD 2.7 billion in the -3 previous quarter, leaving the Jul-17 Jul-18 Jan-17 Jan-18 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 basic balance (which is the sum of current account balance and total Source: CEIC; World Bank; World Bank staff calculations of net FDI) relatively unchanged, albeit still negative. Net portfolio inflows in Q3 totaled USD 1.1 billion, more than reversing the USD 0.6 billion outflow in Q2, but, significantly lower than the USD 4.2 billion that entered Indonesia in Q3 last year (Figure A.16). The resurgence was driven by a reversal in flows from the purchase of Rupiah denominated sovereign bonds (SUN) and this provides some evidence that investor confidence in Indonesia had begun to return in Q3. Pressures on the equities side also eased with outflows from the equity markets falling to USD 0.1 billion in Q3 2018 from USD 1.7 billion in the previous quarter. Private sector outflows from debt securities reached about USD 1 billion versus net inflows of USD 0.8 billion in Q2, consistent with a reduction in non-resident 17 Driven mainly by exports of textiles and footwears. 18 Driven by exports of coals, rubber and palm oil. 19 The main driver is exports of non-precious metals and copper. 20 Exports of vehicles parts and parts of electrical equipment drove the growth. 21 Prices of oil and the refined products increased 56.0 percent and 45.2 percent yoy, respectively. Meanwhile, the volume of the imported oil and refined products grew 3.2 percent and 9.6 percent, respectively. 22 https://finance.detik.com/berita-ekonomi-bisnis/d-4199347/pajak-impor-barang-konsumsi-naik-hingga-10-kapan-berlaku December 2018 THE WORLD BANK | BANK DUNIA 13 Strengthening competitiveness Indonesia Economic Quarterly holdings of Government bonds particularly in September, when the situation in Turkey deteriorated. This has since stabilized and started to rise more meaningfully in recent weeks, partly reflecting attractive valuations amid some stability in the external backdrop (See Section A.5). Net foreign direct Net FDI totaled USD 3.9 billion in Q3, upped from USD 2.7 billion in Q2 (Figure A.17). The investment rose from figure was nevertheless lower than the USD 7.4 billion recorded in Q3 201723. Manufacturing, Q2 wholesale trade, agriculture, fisheries, as well as the financial intermediation sectors were the main recipients of the direct investment in Q324. Despite the increase in value, albeit very slow25, net direct investment (direct investment in Indonesia less Indonesian direct investment abroad) in Q3 has not been sufficient to finance the current account deficit since Q1 2018 (Figure A.18). Figure A.17: Net foreign direct investment (FDI) increased, Figure A.18: … but net direct investment was insufficient to mostly in the manufacturing sector… cover the current account deficit (USD billion) (four quarter rolling-sum, percent of GDP) 10 2 5 0 0 Other Financial Intermediation -5 Wholesale & retail trade, Vehicle repair, -2 household goods Manufacturing -10 Mining and Quarrying Net direct investment Current account balance Agriculture, Hunting, and Forestry Basic balance -4 Q32011 Q12012 Q32012 Q12013 Q32013 Q12014 Q32014 Q12015 Q32015 Q12016 Q32016 Q12017 Q32017 Q12018 Q32018 -15 Total Jun-17 Jun-18 Sep-16 Dec-16 Sep-17 Dec-17 Sep-18 Mar-17 Mar-18 Source: CEIC and Bank Indonesia; World Bank staff calculations Source: CEIC and Bank Indonesia; World Bank staff calculations 23 Significant direct investment in Q3 last year was seen going into few Indonesian ‘unicorn’ startups that are believed to be v alued more than USD 1 billion. 24 Direct investment outflows in Q3 2018 was valued at USD 1.9 billion, higher than in Q2 2018 (USD 1.2 billion) and Q3 2017 (USD 1 billion) as an Indonesian company reportedly acquired a coal mining company in Australia. 25 Indonesia attracts relatively little FDI compared to peers. Over 2013-2017, FDI into Indonesia averaged 2.1 percent of GDP. This is significantly lower than, for instance, Malaysia (3.5 percent), Brazil (3.7 percent) and Vietnam (5.7 percent). See Part B for a more detailed discussion. December 2018 THE WORLD BANK | BANK DUNIA 14 Strengthening competitiveness Indonesia Economic Quarterly 4. Headline inflation continued to ease Inflationary Headline consumer price inflation Figure A.19: Headline inflation eased in Q3, but has pressures eased in eased to an average of 3.1 percent yoy been creeping up in Q4 Q3 largely on the in Q3, from an average of 3.3 percent (change yoy, percent) back of lower in Q2 (Figure A.19). The lower 12 administered price headline reading was largely driven by Administered inflation low administered price inflation on 10 the back of a high base-effect due to last year’s electricity tariff hikes. 8 Administered price inflation dropped 6 from an average of 3.5 percent in Q2 Headline to 2.4 percent yoy in Q3, as pressures 4 from last’s year electricity tariff hikes dissipated further, offsetting the 2 Core increase in non-subsidized fuel Food prices26. Moreover, administrated 0 prices related to transportation, Nov-16 May-17 Nov-17 May-18 Nov-18 communication, and finance services Source: BPS; World Bank staff calculations recorded lower price hikes compared Note: Food prices are a weighted average of the raw and processed to Q2, thus containing the upward food price components of CPI. pressures in Q3. Core inflation ticked Core inflation, which excludes inflation from volatile goods and administered prices, edged up up, as tuition fees in in Q3 to 2.9 percent yoy from 2.7 percent in Q2, partly due to larger increases in college fees 2018 were increased and services prices this year. Bank of Indonesia reported higher increases in tuition fees at all more than in the past education levels, including universities, for the new school year that began in Q3 201827. Education, recreation, and sport prices rose 3.5 percent yoy in Q3 from 3.4 percent in Q2. This partly contributed to the moderation in consumption of education and health related categories (see Section A.1). Headline inflation On a monthly basis, headline inflation moved notably higher, to 3.2 percent yoy in November moved higher in from 2.9 percent in September, led by higher core, administrated price, and volatile good November, but inflation. Core inflation rose to 3.0 percent yoy in November compared to 2.8 percent in remains well within September. Upward adjustment of various non-subsidized fuels led to higher administered with the target range price inflation in November. Volatile good inflation rose due to price increases in unsubsidized fuels and higher food prices. The latter was driven by a small hike in raw food prices such as red chili, onion, and rice, as well as prepared food prices. Headline inflation continued to be well within the BI target range of 2.5 percent to 4.5 percent despite these upward adjustments. 26 The price of Pertamax (RON 92) was raised twice in Q3 2018, from IDR 8,900 per liter to IDR 9,500 per liter in July and further to IDR 10,400 per liter in October. The Government also hiked the RON 94 price (to IDR 12,250 from IDR 10,700), Pertadex (to IDR 11,850 from IDR 10,500); Dexlite (to IDR 10,500 from IDR 9,000), non-subsidized solar (to IDR 9,800 from IDR 7,700), and non-subsidized kerosene (to IDR 12,870 from IDR 11,550) https://www.pertamina.com/id/news-room/announcement/daftar-harga-bbk-tmt-10-oktober-2018. 27 https://www.bi.go.id/id/moneter/koordinasi-pengendalian-inflasi/highlight-news/Pages/Analisis-Inflasi-TPIP-Juli-2018.aspx December 2018 THE WORLD BANK | BANK DUNIA 15 Strengthening competitiveness Indonesia Economic Quarterly Table A.2: Key components of the consumer price index (average change yoy, percent) Categories Q1-17 Q2-17 Q3-17 Q4-17 Q1-18 Q2-18 Q3-18 Oct-18 Nov-18 Headline 3.7 4.3 3.8 3.5 3.3 3.3 3.1 3.2 3.2 Core 3.4 3.2 3.0 3.0 2.7 2.7 2.9 2.9 3.0 Clothing 2.9 2.8 2.4 3.5 4.0 3.8 3.5 3.5 3.6 Health 4.0 3.8 3.4 3.1 2.8 2.9 3.0 3.0 3.1 Education, recreation and sports 2.7 2.8 2.9 3.3 3.4 3.4 3.5 3.2 3.1 Administered 4.5 9.5 9.3 8.7 5.4 3.5 2.4 2.7 3.1 Housing, utilities, fuel 3.4 5.7 5.7 5.2 3.8 2.4 2.1 2.4 2.5 Transport, communication and finance 3.0 5.4 4.7 4.5 1.6 1.8 1.6 2.1 2.6 Volatile 3.8 2.7 0.9 -0.1 3.3 4.7 4.7 4.5 4.3 Raw food 3.9 2.9 1.4 1.0 3.5 4.8 4.7 4.4 4.3 Processed food, beverages, tobacco 5.1 4.6 4.3 4.2 4.1 4.1 4.1 4.0 4.0 Source: BPS; World Bank staff calculations Figure A.20: A broad-based increase in producer prices Figure A.21: Producers faced greater cost pressures as input contributed to the upward trajectory of the producer prices rose the fastest in over three years price index (50 = no changes from previous month, monthly) (change yoy, percent) 20 30 80 Expansion 18 Mining & Quarrying (RHS) Agriculture: food crops 16 Sept-15: 64.8 70 Oct-18: 64.7 14 20 12 Manufacturing Input prices 10 60 8 10 6 Agriculture 4 50 2 Producer price index Contraction 0 0 40 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Source: CEIC; World Bank staff calculations Source: IHS Markit, Nikkei Producer prices The producer price index climbed 4.2 percent in Q3 compared to an increase of 3.8 percent yoy continued to trend in Q2, continuing an upward trend observed since the beginning of 2018. The Q3 outcome was upwards in Q3 due to broad-based price increases in the food, manufacturing, agriculture food crops, and mining and quarrying sectors (Figure A.20). This was the fastest growth since Q3 2014. Rupiah depreciation and rising raw material prices contributed to the fastest input price growth in over three years in October (Figure A.21). 5. Macrofinancial conditions remained soft in Q3 Macrofinancial Indonesia’s macrofinancial conditions continued to deteriorate in Q3 with the Rupiah further conditions weakening and bond yields rising, broadly in line with the sustained volatility in global financial deteriorated in Q3 markets, despite some moderation compared to Q2 (see Box A.1). Consequently, Bank before Indonesia (BI) raised its benchmark policy rate twice in Q3, by 25 basis points each time. Partly demonstrating signs due to sound economic fundamentals and the resilience of the financial sector, two broad of a recovery in early measures of financial system soundness – the non-performing loan (NPL) ratio and the capital Q4 adequacy ratio (CAR) – remained broadly stable. December 2018 THE WORLD BANK | BANK DUNIA 16 Strengthening competitiveness Indonesia Economic Quarterly The Rupiah Partly reflecting the ongoing global financial market volatility (see Box A.1), the weakening of depreciated in both the Rupiah carried over from Q2 into Q3 (Figure A.22), depreciating 4.2 percent against the real and nominal U.S. dollar – less than Q2’s 4.8 percent drop. When compared to other emerging market terms in Q3 economies, as represented by JP Morgan’s Emerging Market Currency Index (EMCI), the depreciation in the Rupiah was broadly similar until the end of Q3 when the EMCI recovered more than the Rupiah to post an overall Q3 loss of 3.7 percent (compared to the 8.6 percent rout in Q2). In year-to-date terms28, the Rupiah has depreciated 5.6 percent in nominal terms, while emerging market currencies have depreciated 10.2 percent. Figure A.22: The Rupiah depreciated against the U.S. Figure A.23: In real effective terms, the Rupiah dollar in Q3 before recovering somewhat at the start of Q4 depreciated more than most of its regional peers (index, Jan 1 2018 = 100) (percent change) 104 6 Q2 2018 Q3 2018 YTD (Jan-Nov 2018) 4 100 2 0 96 -2 USD/IDR -4 92 -6 JP Morgan EMCI -8 88 -10 Japan India Thailand China Malaysia Singapore Korea Vietnam Philippines Indonesia 84 Nov-17 Feb-18 May-18 Aug-18 Nov-18 Source: JP Morgan, BPS and World Bank staff calculations Source: JP Morgan Real Effective Exchange Rate, CPI based (2010=100), and World Bank staff calculations Note: Downward movement represents depreciation The Rupiah continued depreciating in Q4 with the currency crossing the IDR 15,000 threshold on October 3, the first time since the height of the Asian financial crisis in June 1998. However, the downward trend appears to have reversed since then, with the currency paring back losses in the lead up to the U.S. mid-term elections on November 6. The gains were more attributable to weakness in the U.S. dollar, associated with the Democrats successfully claiming a majority in the U.S. congressional lower house and the potential challenge it might create for the current administration’s stimulatory fiscal policy stance29. BI’s announcement that it would allow domestic non-deliverable forward (DNDF) transactions as a means of maintaining Rupiah stability (effective from 1 November)30 also potentially underpinned some of the currency’s recovery. In real effective terms31, only the Indian Rupee fell more than the Rupiah’s 4.1 percent depreciation in Q3 (Figure A.23). In year-to-date and real effective terms, it has depreciated 3.9 percent. In Q3, bond yields As in H1 2018, bond yields continued increasing in Q3, however, at a significantly gentler pace rose but at a than in Q2 (Figure A.24). In Q3, 10-year bond yields rose 19 basis points compared to 122 basis points in Q2. This smaller rise in bond yields was also seen with that of other emerging markets, 28 As of November 30, 2018 29 https://www.cnbc.com/2018/11/07/forex-markets-dollar-us-midterm-elections-in-focus.html 30 DNDF is an exchange rate hedging instrument for banks and corporations to mitigate the risk of exchange rate fluctuations. Unlike other forward transactions, DNDF transactions will use the Rupiah, rather than USD; encouraging business people and investors to buy more Rupiah. See https://www.bi.go.id/en/ruang-media/siaran-pers/Pages/sp_207318.aspx for more information. 31 Real effective exchange rates are based on trade weighted averages of bilateral exchanges rates and adjusted by consumer prices. December 2018 THE WORLD BANK | BANK DUNIA 17 Strengthening competitiveness Indonesia Economic Quarterly shallower trajectory with the Emerging Markets Bond Index Plus (EMBI+) ending Q3 in neutral territory in terms than they did in Q2 of losses and gains, compared to a rise of 73 basis points in Q2. The more moderate upward pressure on EM bond yields in general was due to dissipating uncertainty and volatility associated with particular emerging markets – Turkey and Argentina – especially towards the end of Q3. Figure A.24: Investor confidence returned in Q3 with bond Figure A.25: Spread between Rupiah denominated bonds yields rising much less than in Q2 and USD denominated bonds peaked in Q3 but began to (percent) narrow in early Q4 (percent) 9.5 4.5 10 Indonesia 10 year 9 9.0 4.0 8 8.5 Indonesia 5-year (IDR) 7 8.0 3.5 U.S. 10 year (RHS) 6 currency risk 7.5 3.0 5 Indonesia 5-year (USD) 7.0 4 2.5 credit risk 3 6.5 EMBI+ 2 6.0 2.0 USA 5-year 1 Oct-18 May-18 Jul-18 Jun-18 Aug-18 Sep-18 Nov-18 0 Nov-17 Feb-18 May-18 Aug-18 Nov-18 Source: JP Morgan, CEIC, World Bank staff calculations Source: Bloomberg, CEIC, World Bank staff calculations Note: EMBI+ is a JP Morgan emerging market bond index yield to maturity In a sign hinting of a possible recovery in investor confidence in Indonesian assets (and particularly the currency), the spread between the Rupiah- and USD-denominated bonds peaked (compared to the spread throughout 2018) in early September before narrowing in Q4. Decomposing the spread in order to apportion risk stemming from currency movements and credit-related risk reveals that, as was the case in Q2, the main risk is currency related due to exchange rate volatility (Figure A.25). The spread between USD-denominated Indonesian bond yields and U.S. bond yields remained stable, while the spread between Rupiah denominated Indonesian bond yields and USD denominated Indonesian bond yields widened in Q3 before beginning to narrow. Furthermore, a Government bond auction on 6 November was oversubscribed by three times which confirms the hypothesis about the recent, gradual return in confidence. On average, Government bond auctions in Q4 (until the end of November) were oversubscribed by an average of 2.5 times, higher than in Q3 (2.2) and Q2 (2.1). December 2018 THE WORLD BANK | BANK DUNIA 18 Strengthening competitiveness Indonesia Economic Quarterly Figure A.26: The rise in benchmark policy rate has not Figure A.27: … and credit growth continued to pick up been fully transmitted into higher lending rates … (yoy growth, percent) (percent) 13 7 14 Consumption lending rate Credit growth 12 6 Consumption loans 12 10 Investment loans 5 8 7 Day Reverse Repo Rate (RHS) 11 6 Working capital Working capital lending rate 4 4 Investment lending rate 10 3 2 Sep-17 Jan-18 May-18 Sep-18 Sep-17 Jan-18 May-18 Sep-18 Source: CEIC, Bank Indonesia, and World Bank staff calculations Source: CEIC, Bank Indonesia, and World Bank staff calculations Monetary policy Monetary policy tightening Figure A.28: Banking sector demonstrated continued tightening continued continued in Q3 with BI raising its resilience in the face of monetary policy tightening in Q3 policy rate twice, by 25 basis (percent) 24 3.6 points each time (Figure A.26). Capital Adequacy Ratio However, in contrast to the Q2 focus on Rupiah stability, in Q3, BI explicitly highlighted an 23 3.3 additional objective of narrowing the current account deficit32. In contrast to the policy rate, lending 22 3.0 rates have been still trending downwards, benefitting from the Non Performing Loans previous easing cycle, with the 21 (RHS) 2.7 average lending rate falling to 33 11.0 percent in Q3 compared to 11.1. in Q2. Consequently, credit 20 2.4 growth has strengthened, reaching Sep-15 Jun-16 Mar-17 Dec-17 Sep-18 an average of 11.8 percent yoy in Source: CEIC and Bank Indonesia Q3 (Figure A.27), the highest in nearly 4 years, with credit extended for working capital loans and investment loans picking up sharply – 13.6 percent yoy and 11.4 percent yoy. In a sign of the banking system’s resilience, the depreciating currency and monetary policy tightening do not appear to have had an adverse impact on non-performing loans, which hovered around the 2.7 percent mark in Q3 (broadly similar to the outcomes in Q2). The CAR also pointed to a resilient banking system and averaged 22 percent in Q3 – similar to where it was in Q2 and well above the benchmark 8 percent threshold (Figure A.28). 32 As seen in the press releases accompanying the Board decisions in August and September 2018. The August press release: https://www.bi.go.id/en/ruang-media/siaran-pers/Pages/sp_206618.aspx, and the September: https://www.bi.go.id/en/ruang-media/siaran- pers/Pages/sp_207318.aspx. 33 The average includes consumption lending rates, lending rates for working capital, and lending rates for investment loans. December 2018 THE WORLD BANK | BANK DUNIA 19 Strengthening competitiveness Indonesia Economic Quarterly 6. Solid revenue collections support strong expenditure growth, but challenges with spending quality remains Better revenue Both total Government revenues and expenditures continue to show strong growth in the year- collection leads to to-October this year. Revenue collection was mainly driven by income taxes from non-O&G lower deficit despite and O&G-related revenues, and VAT/LGST, while the robust total Government expenditure higher spending growth was mainly due to higher personnel, material, and energy subsidy spending. The net result is a significantly smaller budget deficit, compared to the deficit over the same period in 2017. The 2019 budget signals the Government’s priorities to boost revenue collection to support higher spending. As a result, the budget deficit is projected to be lower at 1.8 percent of GDP in 2019, compared to the expected deficit of 2.1 percent according to the 2018 outlook. Total revenues The year-to-October 2018 Central Figure A.29: Non-O&G income tax, O&G related continue to grow Government revenue continued to revenues and VAT were the main contributors to the strongly as seen grow strongly: 23 percent this year high total revenue growth earlier this year yoy compared to the 10.4 percent (contribution to growth, January–October yoy, percentage points) Other International trade taxes over the same period in 2017, Excises VAT/LGST excluding revenue from the Tax Income taxes N-O&G O&G related revenues Amnesty Program35 (see Figure Total revenues 23.0 A.29). 25 20 All revenue components 15 10.2 10.8 10.4 contributed positively to total 10 revenue growth. Revenue from 5 non-O&G income tax36 and from 0 VAT37 continued to show -5 -0.6 significant contribution, of 9.2 and -10 -9.7 4.4 percentage points, respectively. -15 In addition, O&G-related revenue 2013 2014 2015 2016-TA 2017-TA 2018* (income tax, dividends, and Source: Ministry of Finance; World Bank staff calculations royalties) also showed a positive Note: O&G related revenues refer to oil and gas income tax, contribution to total revenue of 4.6 dividends and royalties (non-tax revenues), N-O&G stands for non- percentage points, though less than oil and gas income tax; VAT/LGST stands for Value added tax/luxury goods sales tax; “Other” includes: land/property taxes, in 2017. The increase in O&G other tax revenues; non-oil and gas non-tax revenues; other non-tax revenue was partly due to higher revenues (profits of public enterprises, revenues from Public Service global commodities prices, Agency [BLU], and other non-tax revenues [PNBP]34); and grants. 2017-TA means that total revenues exclude redemption fees collected particularly that of oil and coal. As under the Tax Amnesty Program. 2018* is a yoy comparison against of end-October 2018, revenue 2017-TA. from excises recorded double-digit growth – 10.4 percent yoy compared to 9.4 percent in 2017 for the same period, the fastest growth since 2013. This is driven by both higher effective tobacco excise tariffs and production.38 34 Other non-tax revenue (PNBP) includes revenue sharing from the sales of coal (Penjualan Hasil Tambang/PHT) and Oil and Gas upstream activities. The big contribution of “other” component to the total revenue growth in 2018 was partly due to increase of those commodities price while in 2016 it was partly due to the higher O&G lifting. 35The Tax Amnesty Program was a one-off Central Government income tax revenue program that ran from Q3 2016 until Q1 2017. 36 This is mainly driven by robust collections of corporate income taxes as improvement in compliance. In the year to October, income taxes from imports (Article 22 Import) and corporates (Article 25/29) grew by 28 percent and 25 percent yoy in nominal terms, respectively. Article 22 Import is a payment made by companies related to their certain import transactions, which can be seen to be part of corporate income taxes for Indonesia. 37 VAT grew by 15 percent yoy as of end-Oct due to higher commodity prices. Meanwhile, gearing domestic demand drove the notable growth of import VAT which seen an increase of 28.1 percent yoy in nominal terms compared to the same period last year. 38The effective tobacco excise tariff increased more than normative tariff at 10.04 percent in the year to October. Meanwhile, the tobacco production also increased by 2.6 percent yoy partly due to some improvement in enforcement (Program Penertiban Cukai Berisiko Tinggi starting in Q3 2017). Furthermore, excises on vaping liquid used in electronic cigarettes came into effect starting October 1, 2018. December 2018 THE WORLD BANK | BANK DUNIA 20 Strengthening competitiveness Indonesia Economic Quarterly Growth in total Total Government expenditure in the year-to-October 2018, including transfers to sub-national Government Governments, rose by 12 percent yoy, doubling the 6 percent increase seen over the same period spending doubled, in 2017 (Figure A.30). Energy subsidies, excluding arrears, increased partly due to higher global driven by energy commodity prices. Spending on interest payments also grew, mainly driven by the Rupiah subsidy spending… depreciation and higher Government bond yields. Similarly, social spending expanded following the expansion of the PKH and early disbursement of subsidized health premium (PBI-JKN), particularly in the first seven months of 2018. Personnel and material spending rose on payments of allowances for pensioners and additional performance allowances to active civil servants during the Eid festivities. Meanwhile, material spending grew partly due to several major events such as the regional elections, the 2018 Asian Games and the World Bank-IMF Annual Meetings in Bali. However, as of end-October 2018, capital spending only grew at 1 percent yoy, slower than the 8 percent in the same period last year, due to a lower budget allocation39. Spending As of October 2018, the Government has disbursed 77 percent of the budget (see Figure A.31), disbursement rate which is the highest in at least the last eight years, but there are still challenges relating to the continues to increase quality of spending. The high disbursements were broad based, but particularly strong for energy but quality issues subsidies and social and personnel spending. In contrast, the execution of capital spending stood remain at only half of the budget (53 percent) for 10 months this year, although this is a slight improvement from 2017. Figure A.30: Energy subsidies, interest payment, and Figure A.31: Higher disbursements are broad based with personnel and material spending were the main fuel and gas subsidies higher than planned contributors to total expenditure growth (January-October expenditure as percent of budget, percent) (January-October expenditure contribution to growth, percentage points) Others* Transfers to SNG 160 Social Non Energy Subsidies 2016 2017 2018* 134 140 Energy Subsidies Interest Payments Capital Material 120 Personnel Total Expenditures 100 79 85 77 77 15 12 80 67 53 10 60 5 6 37 40 5 20 0 0 -2 Electricity* Social Capital Others* Total Expenditures Personnel Fuel & gas* Material -5 -10 -15 -20 2015 2016 2017 2018* Source: Ministry of Finance, World Bank staff calculations Notes: *Fuel and gas for 2018 is not the figure published by the Government’s APBN Kita, as it excludes arrears payments which are added back to “Others” spending category as per the budget classification. *Others from 2017 onwards includes arrears payments from previous energy subsidies Better revenue By end-October 2018, the total Government budget deficit reached IDR 237 trillion, or 73 collection leads to a percent of the targeted budget shortfall, lower both in level and the targeted rate of 75 percent lower deficit for the same period in 2017, when it was IDR 299 trillion, thanks to improved revenue collection. Similarly, the total net financing as of October 2018 was at IDR 320 trillion or 98 percent of the target, which was lower in nominal terms by 16 percent yoy compared to the same period last year. 39APBN Kita November 2018 December 2018 THE WORLD BANK | BANK DUNIA 21 Strengthening competitiveness Indonesia Economic Quarterly Total Central Government debt stock reached IDR 4,479 trillion or 31 percent of GDP by the end of October 2018, and still around half of the 60 percent legal threshold. The debt stock remains mainly denominated in domestic currency at 57 percent and only 10.1 percent has a short-term maturity40, reducing the exposure to exchange-rate and refinancing risks. The 2019 budget In 2019, the Government is aiming for double-digit growth both for revenue and expenditure highlights the with a lower primary and fiscal deficit. Total revenues and grants are projected at IDR 2,165 importance of trillion (13.5 percent of GDP), an increase of 13.8 percent (nominal terms) compared to the boosting revenue 2018 outlook. This is slightly lower than the expected increase of 14.2 percent this year, but collection much higher than the average increase of 3.8 percent from 2014 to 2017. Furthermore, total expenditures are proposed at IDR 2,461 trillion (15.3 percent of GDP) an 11 percent increase relative to the 2018 outlook. This is the largest projected year-on-year increase41 since President Joko Widodo took office in 2014, highlighting the importance of boosting revenue collections to spend more while maintaining a conservative fiscal deficit. Optimistic target of Tax revenues are expected to increase by 11.4 percent in real terms vis-à-vis the 2018 outlook tax ratio at 11.1 (or 15.4 percent in nominal terms), bringing the tax ratio to 11.1 percent of GDP. This is an percent of GDP in optimistic target but not unprecedented, given that real growth in tax revenues has exceeded 10 2019 percent five times in the past 15 years. Non-O&G income taxes, followed by VAT collections, are expected to be the main drivers of revenue growth, as efforts to improve tax compliance continue. Excises are also expected to increase by 6.4 percent in nominal terms from the 2018 outlook, mostly through stronger enforcement42. Faster total The Central Government expenditure in the 2019 budget is still expected to have double digit expenditure growth growth at 12.4 percent (nominal terms) from the 2018 outlook, lower than the average 14.5 expected in 2019, due percent increase in 2017-18. It shows broadly higher allocation for energy subsidies and an to higher energy increase in benefits from the PKH and higher premium and number of beneficiaries for the subsidies, social PBI-JKN. Consistent with expectations of a weaker Rupiah and persistently high crude oil prices programs, and next year, the Government will allocate IDR 160 trillion for energy subsidies, about 69 percent regional transfers but higher than the 2018 Budget, but still a much lower amount (and share of the budget) than pre- slower infrastructure reform levels43. The 2019 allocation is slightly lower than the 2018 outlook, due to the one-time spending growth payment of subsidy arrears to Pertamina and PLN in 2018 for subsidy spending in 2016 and 2017. On social spending, the Government intends to almost double the amount received by each beneficiary household – currently averaging IDR 1.7 million (USD 118) per year – to IDR 3.1 million (USD 215) in 2019. Accordingly, the PKH allocation will double to IDR 34.4 trillion, while maintaining the number of beneficiaries at 10 million poor households. Furthermore, the Government also intends to increase the amount of regional and village fund transfers by 8.3 percent from the 2018 outlook, which is larger than the average 5.5 percent increase in 2017-18. This is mostly due to the increase in Special Allocation Funds (Dana Alokasi Khusus, or DAK) and consistent with the projected overall increase in total expenditures as well as the additional transfer to urban village (Kelurahan) as part of block grant (Dana Alokasi Umum or DAU). Infrastructure is still a priority, but the growth is slower than the annual average of the last four years. The Government plans to spend IDR 415 trillion for infrastructure in the 2019 budget 40As of December 2017, the government projected 10.1, 25.4, and 39.8 percent of total public debt will be due in 1, 3, and 5-years, respectively. http://www.djppr.kemenkeu.go.id/page/load/24 41 Comparing approved budget (APBN) allocations across the years 42 A recent announcement from the Government stated that there will be no increase in tobacco tariffs in the 2019 budget. However, the DG of Customs mentioned that they are optimistic that they can meet the 2019 Budget target. http://ekonomi.metrotvnews.com/makro/gNQMYBvN-target-penerimaan-cukai-masih-sesuai-apbn-2019 43 Pre-reform period refers to a period when the Government still provided subsidies for RON 88 gasoline or before 2015. December 2018 THE WORLD BANK | BANK DUNIA 22 Strengthening competitiveness Indonesia Economic Quarterly coming from the Central Government expenditure, transfers to regional and Government financing, or an increase of 1.1 percent from the 2018 outlook but less than the 18 percent average year-on-year increase between budgets in 2016-18. However, that amount still represents nearly a fifth of total expenditures, much higher than a tenth in 2013-14. 7. Economic growth outlook and risks The outlook Indonesia’s growth outlook remains moderately positive and stable due to sound continues to be macroeconomic fundamentals and stronger domestic demand being projected over the moderately positive, forecasting horizon. However, downside risks remain substantial despite some recent easing in with downside risks financial volatility. remaining substantial 7. Growth projected to Real GDP growth is projected at 5.2 percent yoy this year and in 2019, a notch higher than in reach 5.2 percent in 2017 (Table A.3), as stronger domestic demand is expected to more than offset the drag from 2018 and 2019 as the external sector. Despite consumer price inflation forecast to edge up next year, private stronger domestic consumption is projected to strengthen on increased social spending. Gross fixed capital demand is expected formation is also expected to take off as investors continue take advantage of the still-easy to more than offset domestic financing conditions, particularly in the second half of the year when political the drag from the uncertainties are reduced. Likewise, Government consumption is forecast to remain robust as external sector continued reform and revenue growth create space for both fiscal consolidation and additional spending. Table A.3: Key economic indicators (growth yoy, percent, unless otherwise indicated) Revision from Annual previous IEQ 2017 2018f 2019f 2018 1. Main economic indicators Gross Domestic Product (GDP) 5.1 5.2 5.2 0.0 Private consumption expenditure 5.0 5.1 5.2 0.0 Government consumption 2.1 5.0 5.3 1.0 Gross fixed capital formation 6.2 7.0 7.5 0.2 Exports of goods and services 9.1 7.3 7.2 0.8 Imports of goods and services 8.1 13.8 10.7 4.3 2. Other economic indicators Consumer price index 3.8 3.2 3.5 -0.2 3. Economic Assumptions Exchange rate (IDR/USD) 13381 14200 14250 100 Indonesian crude price (USD/bbl) 51.2 67.7 66.7 4.8 Source: BPS; Bank Indonesia; CEIC; World Bank staff projections Note: 2017 figures are actual outcomes. f stands for forecast. Statistical discrepancies and change in inventories are not presented in this table. All GDP components are based on the latest GDP data. Exchange rate and crude oil price assumptions are average annual data. Revisions are relative to projections in the September 2018 IEQ December 2018 THE WORLD BANK | BANK DUNIA 23 Strengthening competitiveness Indonesia Economic Quarterly The terms-of-trade are projected to deteriorate Indonesia’s terms-of- Barring significant movements in the Figure A.32: The net trade-weighted price index – trade in 2018 is likely prices of Indonesia’s key historical and forecast until 2019 to be weaker than in commodities export in Q4 2018, the (index 2015=100) 160 2017 Indonesia’s terms-of-trade (ToT)44 in 2018 is expected to be lower than it was in 2017 (Figure A.32). Beyond 140 2018, the expected movements of the prices of coal, crude oil, and palm oil – the three commodities with the 120 2017 largest weight in the export basket – 2016 2018 2019 imply a further downward correction in 2019 for Indonesia’s net trade- 100 2015 commodity price index45 is expected46. 80 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Source: BPS; World Bank; World Bank staff calculations Note: Net trade-weighted price index is constructed over Indonesia’s six major export commodities (rubber, base metals, coal, oil, LNG, and palm oil) The current account deficit is expected to widen in 2018 The current account With the current global trade policy Figure A.33: The current account deficit is expected deficit is expected to uncertainty, slower projected growth to widen in 2018 and 2019 as import-intensive widen in 2018 of major trading partners, weaker ToT, investment remains strong and terms-of-trade and domestic investments continuing weaken (percent of GDP) to drive strong import needs, the current account deficit is projected to 0 widen to 2.9 percent of GDP in 2018, -0.5 despite recent policy measures to support exports and to restrict -1 imports. However, with dampening -1.5 impact of currency depreciation weighing on imports and the income -2 -1.8 -1.7 balance, the current account deficit is -2 expected to moderate to 2.5 percent of -2.5 -2.5 GDP in 2019 (Figure A.33). -3 -2.7 -2.9 -3.2 -3.1 -3.5 2012 2013 2014 2015 2016 2017 2018 2019 Source: CEIC and Bank Indonesia; World Bank Staff Calculations Note: 2018 and 2019 are forecasts 44 Terms of trade (TOT) refers to the relative price of imports in terms of exports and is defined as the ratio of export prices to import prices. It can be interpreted as the amount of import goods an economy can purchase per unit of export good. ℎ,, ( )−(, ) 45 The Net Trade-Commodity Price Index (NTI) is defined as: = where ℎ, = ∑(, and i= commodity type; , , )−∑ , t= month; p=period cycle (ex. 5 year average); N = number of commodities; T= base year; E=value of export; I=value of import 46 If future prices are assumed instead of the World Bank forecasts for coal, crude oil and palm oil, the projected ToT for 2018 and 2019 (not presented in the chart) will be marginally weaker. The alternative NTI was calculated using average futures prices of coal (ICE, Newcastle), the average of the three benchmarks of oil, namely Brent, WTI and Dubai (ICE) and palm oil (Malaysian). The prices for the other key commodities were taken from World Bank (2018). December 2018 THE WORLD BANK | BANK DUNIA 24 Strengthening competitiveness Indonesia Economic Quarterly Consumer price inflation is expected to increase modestly in 2019, but within BI’s target range Projected headline Headline inflation is expected to remain Figure A.34: Headline inflation levels are projected inflation revised well within the Government target to remain well within the target range down marginally, but range averaging at 3.2 percent in 2018, (annual average change yoy, percent) 6 remains within the lower than that the 3.8 percent of 2017 target range (Figure A.34). Strong social spending Consumer Price Index along with stronger administrative price inflation as the high base effects of 2017 5 dissipate, are expected to exert some upward pressures in 2019, leading to a Forecast forecast of 3.5 percent. 4 3.8% 3.5% 3.5% 3 3.2% 2 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Source: BPS; World Bank staff calculations Government budget deficit is set to narrow in 2018 Fiscal management Fiscal management in the first Figure A.35: Stronger revenues and expenditures with a net improved; the World nine months of 2018 improved result of lower Government budget deficit are projected for Bank projects a fiscal due to realistic revenue forecasts, 2018 deficit of 1.9 percent and as a consequence, a revised (percent of GDP) of GDP in 2018 budget was not necessary in Revenue Expenditure Fiscal balance 2018, despite it being an election 18 15.0 14.8 15.0 15.1 year. This is a significant 15 12.5 12.3 12.8 13.2 departure from previous years, 12 such as in 2016 when mid-year 9 budget cuts were necessary. Based on revenue realization up 6 to October, total central 3 Government revenues are 0 projected to reach IDR 1,876 trillion, a 12.6 percent increase -3 -2.5 -2.5 -2.2 -1.9 Budget WB compared to 2017, driven largely by projected increases in 2016 2017 2018 collections from income taxes Source: Ministry of Finance; World Bank staff calculations (Table A.4). Meanwhile, total Government expenditures are projected to reach IDR 2,145 trillion, a 6.9 percent increase compared to 2017, driven by increases in social spending. Overall, the World Bank projects a fiscal deficit of 1.9 percent of GDP, 0.3 percentage point lower than the 2018 budget target deficit of 2.2 percent of GDP (Figure A.35). December 2018 THE WORLD BANK | BANK DUNIA 25 Strengthening competitiveness Indonesia Economic Quarterly Table A.4: Ministry of Finance and World Bank budget projections (IDR trillion, unless otherwise indicated) MoF 2017 2018 2018 2018 2019 Outlook Budget 2019 2018 vs vs Budget Budget 2018 (% MoF World 2018 (% change) Actual Budget Budget Outlook Bank deviation) A. Revenues 1,666 1,895 1,903 1,876 2,165 0.44 14.3 1. Tax revenues 1,344 1,618 1,548 1,469 1,786 -4.30 10.4 Oil & Gas Income taxes 50 38 55 66 66 45.3 73.6 Non-Oil & Gas taxes, o/w: 1,101 1,386 1,296 1,207 1,511 -6.5 9.1 Non-Oil & Gas Income taxes 596 817 706 663 828 -13.6 1.4 VAT/LGST 481 542 565 517 655 4.2 21.0 Land and building tax 17 17 17 19 19 0.4 10.0 Other taxes 7 10 8 8 9 -21.4 -11.3 Excises 153 155 156 149 166 0.1 6.5 International trade taxes 39 39 42 47 43 8.7 11.9 2. Non-tax revenues 311 275 349 398 378 26.8 37.4 Natural resources revenues 111 104 169 181 191 63.2 84.0 Oil & Gas 82 80 144 145 160 79.6 98.9 Non-Oil & Gas 29 23 25 37 31 6.6 32.9 Other non-tax revenues 200 172 180 216 188 4.8 9.2 3. Grants 12 1 5 9 0 349.8 -66.6 B. Expenditures 2,007 2,221 2,217 2,145 2,461 -0.2 10.8 1. Central government 1,265 1,454 1,454 1,377 1,634 -0.1 12.4 Personnel 313 366 342 345 382 -6.3 4.3 Material 291 340 320 307 345 -6.0 1.5 Capital 209 204 194 163 189 -5.0 -7.1 Interest payments 217 239 249 253 276 4.5 15.6 Subsidies, o/w: 166 156 228 214 224 46.0 43.6 Energy 98 95 163 151 160 73.0 69.3 Fuel 47 47 109 95 101 131.3 114.7 Electricity 51 48 55 56 59 15.3 24.3 Non-energy 69 62 65 62 64 4.8 4.2 Grants 5 1 1 0 2 0.0 32.9 Social 55 81 80 84 102 -1.2 25.6 Other 9 67 39 11 114 -42.5 69.6 2. Transfers to regions 742 766 764 768 827 -0.3 7.9 C. Overall Balance (341) (326) (314) (269) (296) D. Financing 367 326 314 269 296 1. Debt financing 429 399 387 - 359 2. Investment financing (60) (66) (66) - (76) 3. Lending (2) (7) (6) - (2) 4. Guarantee obligation (1) (1) (1) - - 5. Other financing 0 0 0 - 15 Memo items (as % of GDP) Total Revenues 12.3 12.8 12.8 13.2 13.5 Tax Revenues 9.9 10.9 10.4 10.3 11.1 Non-Tax Revenues 2.3 1.9 2.4 2.8 2.4 Total Expenditure 14.8 15.0 15.0 15.1 15.3 CG Expenditure 9.3 9.8 9.8 9.7 10.2 Transfer to regions and Village 5.5 5.2 5.2 5.4 5.1 Fund Overall Balance -2.5 -2.2 -2.1 -1.9 -1.8 Assumptions: Real GDP growth rate (%) 5.1 5.4 5.2 5.2 5.3 CPI (%) 3.6 3.5 3.5 3.2 3.5 Exchange rate (IDR/USD) 13,384 13,400 14,294 14,200 15,000 Crude-oil price (USD/barrel) 51.2 48.0 70.0 69.5 70.0 Source: Ministry of Finance and WB Staff calculations. December 2018 THE WORLD BANK | BANK DUNIA 26 Strengthening competitiveness Indonesia Economic Quarterly While the outlook for economic growth remains positive, downside risks have increased External risks to the While there recently has been some reprieve from capital outflows from emerging market outlook include economies and further weakening of the Rupiah, downside risks to Indonesia’s growth outlook, protracted and nevertheless, remain substantial. escalating trade disputes, volatility in Uncertainties surrounding global trade policy continue to pose risks to the growth outlook of the financial and large regional economies, such as China. Other regional economies, such as Vietnam and capital markets, Malaysia, which participate in regional supply chains, could also experience negative spillover tightening financial effects from China’s potential slowing. The persistence or escalation of such disputes therefore conditions, and continue to pose significant risks to the Indonesian economy through weaker exports and inadequate buffers dampened commodity prices. for policy stabilization At the same time, the potential continuation of monetary policy tightening of the U.S. Federal Reserve may lead to more capital outflows and financial volatility among emerging market economies, including Indonesia. Higher bond yields and the consequent higher borrowing costs could dampen the nascent credit recovery and hence private investment. Indonesia should To date, Indonesia has emerged relatively unscathed from the recent volatility plaguing emerging take the opportunity market economies, largely because of its sound macroeconomic fundamentals, and adequate to rebuild and buffers that allowed for a coordinated monetary, fiscal, and exchange rate policy framework. strengthen policy Inflation has been stable and low, permitting monetary policy to focus on exchange rate buffers stabilization. Recent fiscal reforms have enhanced compliance and enforcement, leading fiscal revenue growth to reach multi-year highs, thereby allowing the Government to both increase growth-inducing expenditures and undergo fiscal consolidation. Lastly, record-high reserves contributed to the cushioning of the Rupiah’s depreciation, during the protracted period of exchange rate volatility. Given the recent return of capital inflows and appreciating pressures on the Rupiah, it is timely for Indonesia to rebuild foreign reserves maintain sizable buffers to enable further management of exchange rate volatility, should it return in the near future. In similar light, other critical reforms such as those relating to enhancing fiscal revenues and improving the quality of spending must continue to further strengthen fiscal policy. December 2018 THE WORLD BANK | BANK DUNIA 27 Strengthening competitiveness Indonesia Economic Quarterly B. Boosting export and investments in Indonesia: An agenda for reform Indonesia has enjoyed robust economic growth in recent years, underpinned by healthy macroeconomic fundamentals and relatively favorable commodity markets and demographic structure. However, the recent global turmoil has exposed Indonesia’s vulnerabilities , in particular the country’s reliance on volatile portfolio capital flows to finance its current account deficit. These vulnerabilities are partly due to the slow growth in exports and foreign direct investment, which are in turn a reflection of the mounting competitiveness challenges faced by the country. Indonesia’s vulnerabilities are further underscored by declining shares in global manufacturing exports, low foreign investments in GDP, and low labor productivity, which are largely the result of an extensive list of policies that increase the costs and reduce the quality and availability of physical, services and labor inputs to production. These distortions include regulatory bottlenecks, such as trade and investment restrictions; inefficiencies in labor and capital markets, which increase the costs of skilled labor and financing for firms; and infrastructure deficiencies, including energy and transport. A policy agenda to boost exports and investments would need to address these distortions through a series of short- and medium-term reforms (Box B.1). These reforms would also increase the effectiveness of costly tax incentives, which the Indonesian government has been using to attract investments, as the impact of these tax incentives is likely to remain limited in the absence of structural reforms. Box B.1: A policy reform agenda to boost exports and foreign investments A policy reform agenda to boost exports and investments would need to address distortions in key markets through a series of six short-term and four main medium-term reforms. The short-term reforms would include: • reducing import tariffs and (certain) non-tariff measures; • implementing ambitious free trade agreements; • relaxing restrictions on investments • allowing a larger number of critically scarce talent from abroad, • reducing the fuel subsidy, and • increasing the ability of the competition commission t o deter businesses’ anti-competitive practices. The medium-term reforms would include: • embedding competition considerations into Indonesia’s policy -making and strengthening the competition authority; December 2018 THE WORLD BANK | BANK DUNIA 28 Strengthening competitiveness Indonesia Economic Quarterly • strengthening the primary, secondary, and post-secondary education systems; • strengthening energy and transport infrastructure by leveraging private investments in these sectors —including by lowering subsidies to State-Owned Enterprises (SOEs), increasing open tenders by simplifying legal frameworks for public-private partnerships (PPP), and by deepening the local banking and capital markets. 1. Indonesia needs to boost its global competitiveness to increase resilience to shocks and to reap the opportunities of the current global environment Indonesia has been Indonesia has enjoyed a robust economic growth of around 5 percent per annum in real terms enjoying robust since 2012, underpinned by healthy macroeconomic fundamentals, including low levels of fiscal economic growth deficits, public debt, and inflation. While commodity prices have declined from their peak in with healthy 2011, they have remained favorable and are still a key driver of economic expansion. In addition, macroeconomic Indonesia is still reaping the dividends of a demographic structure that allows millions of fundamentals individuals to join the labor force every year. Figure B.1: The current account deficit has widened along Figure B.2: The Indonesian Rupiah has depreciated more with the basic balance than other regional currencies (4-quarter rolling average, percent of GDP) (USD/Local currency – 1 Sep 2017 = 100) Current account balance 115 3 Net direct investment Basic balance 110 2 Malaysia 1 105 Thailand 0 100 -1 Vietnam 95 Philippines -2 Indonesia 90 -3 85 Jul-18 Jan-18 Jun-18 Sep-17 Nov-17 Dec-17 Aug-18 Sep-18 Oct-17 Feb-18 Mar-18 Oct-18 Nov-18 Apr-18 -4 May-18 Source: World Bank staff calculations based on Bank Indonesia data Source: World Bank staff calculations based on Bank Indonesia data However, the slow In spite of this positive macroeconomic performance, the recent global turmoil has exposed growth of exports Indonesia’s vulnerabilities. Indonesia’s current account deficit has expanded through 2018, and FDI have reaching 3.4 percent of GDP in the third quarter of the year (Figure B.1).47 The widening deficit increased is partly due to sluggish exports growth and a sustained growth in imports, particularly capital Indonesia’s reliance goods. The latter are linked to renewed investments in the mining sector following strong on volatile short- commodity prices, and to the Government’s promotion of infrastructure over the past three term portfolios, years. Given Indonesia’s large infrastructure gap and potential for future mining exports, the substantial portions high growth of imports is not alarming. The concern is rather with the low growth of exports of which have exited and with the decline in foreign direct investment (FDI), which in the past quarters have been the country during unable to cover the current account deficit. As a result, Indonesia has increased its reliance on the recent global short-term portfolio flows to finance the current account deficit.48 These flows are more volatile turmoil than FDI, and tend to move out of emerging economies for safe haven destinations during periods of global uncertainty. That was the case over past months due to trade tensions and volatility associated with other specific large emerging economies. This led to the Rupiah This figure is based on a 4-quarter rolling average. 47 This is reflected in the expanding deficit in the basic balance – i.e. FDI - current account deficit – which has reached 1.3 percent of GDP in 48 Q3 2018. December 2018 THE WORLD BANK | BANK DUNIA 29 Strengthening competitiveness Indonesia Economic Quarterly depreciating more against the USD than other regional currencies between March and October 2018 (Figure B.2), despite healthy macroeconomic fundamentals and the tightening of domestic monetary and fiscal policies (see Section A5). Indonesia has great Indonesia has great potential to increase its exports to a level close to that of its regional peers. potential to increase Exports of goods and services comprise around 20 percent of Indonesia’s GDP, half of the 40 its exports to a level percent in 2000 (Figure B.3). This share is considerably lower than Thailand’s, a country that close to that of its has shown little signs of external vulnerability to the recent global turmoil (Figure B.2), as its regional peers exports have grown robustly over the past two decades. Like most countries in the region, exports are a major part of the Thai economy, constituting almost 70 percent of GDP, a share that has remained stable over time. In both Indonesia and Thailand, imports also closely track exports in level and growth, consistent with the need of to import in order to export. Similarly, Indonesia’s export performance in global markets has been lackluster. It has been declining since 2000, except during the commodity boom period (2007–11) (Figure B.4). In 2016—the last year for which comparable global trade data is available—Indonesia’s share in global goods and services exports was 0.81 percent, down from the 2011 share of 0.95 percent and even from the 0.91 percent on the eve of the Asian crisis. This trend contrasts with that of Vietnam and Thailand, whose global market shares have been constantly increasing since 2000. The other main commodity exporter in the region, Malaysia, has seen its global market share gradually reduced, but this is still higher than Indonesia’s, despite the size of its economy being a third of Indonesia’s. Figure B.3: A tale of two countries: Trade openness in Figure B.4: Indonesia’s total exports have lost market Indonesia vs Thailand share over the past decades (exports and imports of goods and services, percent of GDP) (share in world’s exports of goods and services) 80 Thai Exports 1.4% 70 Malaysia 1.2% 60 Thailand Thai Imports 1.0% 50 40 0.8% Indonesian Exports Indonesia 30 0.6% Vietnam 20 0.4% Indonesian Imports 10 0.2% Philippines 0 0.0% 2003 2016 2000 2001 2002 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2017 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: World Bank staff calculations based on World Development Source: World Bank staff calculations based on World Development Indicators and Bank of Thailand Indicators The export potential The potential for the country’s export growth spans across a wide range of sectors as illustrated spans across a wide for example by the cases of horticulture, electronics and maritime transport. Indonesia’s range of sectors as horticulture and electronics exports are much lower and less dynamic than regional peers (see illustrated for Box B.2) despite its endowments of fertile land and abundant labor would bode well to tap into example by the cases these rapidly growing global markets. Similarly, while Indonesia stretches over the world’s of horticulture, largest archipelago, none of its liner shipping companies feature among the world’s top 30 by electronics and market share, compared to a country like Singapore which features two in the top 20 maritime transport (UNCTAD, 2017).49 This potential applies also to port services exports: Indonesian port operators are not active internationally, unlike other regional operators such as Port of Singapore 49 Systematic data on maritime transport exports and imports are not available. December 2018 THE WORLD BANK | BANK DUNIA 30 Strengthening competitiveness Indonesia Economic Quarterly and Philippines’ ICTS, which are the world’s second and seventh largest ports respectively , in terms of investments, spanning dozen of projects around the globe (UNCTAD, 2017). In manufacturing, Much of Indonesia’s decline in Figure B.5: The rise and fall of Indonesian manufacturing Indonesia’s share in global export markets is due to competitiveness global exports and its manufacturing exports, (share in global manufacturing exports) domestic GDP has whose share has declined unlike 1.8% Malaysia declined unlike other those of other export-oriented 1.6% economies in the economies in the region. 1.4% region Indonesia’s market share in 1.2% Thailand global manufacturing exports 1.0% was 0.6 percent in 2016, 0.8% considerably lower than the Indonesia peak of 0.8 percent in 2000 and 0.6% even lower than the 0.7 percent 0.4% Vietnam share in 1993 (Figure B.5).50 The 0.2% Philippines current figure appears to fall 0.0% short of Indonesia’s potential as it is lower than those of almost all other large economies in the Source: World Bank staff calculations based on World Development region, despite Indonesia being Indicators the largest.51 Over the same period, Vietnam and Thailand increased their global manufacturing shares; the former has grown by a factor of 10 since 2000 and has become one of the world’s fastest-growing manufacturing exporters. Indonesia’s stagnation in global manufacturing competitiveness has also been reflected in the reduction of manufacturing share in the GDP. This reduction is typical of countries shifting from middle- to high-income status. However, de- industrialization has predated this shift in Indonesia and manufacturing has begun to shrink at a fraction of the income level at which countries like Malaysia and Thailand started to de‐ industrialize (Figure B.6). This “premature de-industrialization” (Rodrik 2016) is not good news for Indonesia, as it risks undermining the quality of jobs as well as economy-wide productivity growth, which is typically higher in manufacturing than in other sectors (Rodrik 2012). Figure B.6: Pre-mature de-industrialization in Indonesia? (share of manufacturing in GDP vs. per capita GDP) 35 Manufacture as Percentage of CHN1995 CHN2005 CHN2010 CHN1990 THA2010 CHN2000 MYS2000 30 CHN2015 THA1990 THA2000 THA2005 IDN2000 THA2016 MYS2005 PHL1990 PHL2000 THA1995 MYS1995 IDN2005 GDP 25 MYS2010 MYS2015 PHL2005 MYS1990 PHL1995 IDN1995 IDN2010 IND1995 PHL2010 MYS2016 20 IND1990 VNM2005 PHL2016 IDN2016 VNM2000 IDN1990 IND2000 IND2010 15 IND2005 IND2016 VNM1995 VNM2016 VNM1990 VNM2010 10 1000 11000 6000 16000 21000 26000 GDP Per Capita, PPP (Constant US $ 2011) Source: World Bank staff calculations based on World Development Indicators and Diop (2016) 50 During the same period, Indonesia’s share in global commodity exports hovered constantly at around 1.7 percent except fo r a spike in 2007– 11. 51 The only exception is the Philippines. However, in relative terms, Indonesian manufacturing exports punch below the country’s weight even vis-à-vis the Philippines, as the latter’s global share is 70 percent that of Indonesia while its economy’s size is less than a third of Indonesia’s. December 2018 THE WORLD BANK | BANK DUNIA 31 Strengthening competitiveness Indonesia Economic Quarterly Indonesia could also At the same time, Indonesia Figure B.7: Indonesia punches below its weight in terms do more to attract could also do more to attract of FDI inflows and retain FDI, FDI—especially export- (FDI inflows as a share of GDP, avg. 2016–17) which is low relative oriented ones—to secure a 7% to the size of the much-needed source of stable 6% economy – especially external financing and export much needed export- growth. While the share of FDI 5% oriented FDI inflows relative to GDP, which 4% is low by regional standards (Figure B.7), had been growing 3% over the past two decades, it has 2% been receding over the past 3 years.52 Most of the FDI to 1% Indonesia are driven by the 0% desire to extract and/or process natural resources or to serve the large domestic market. On the other hand, in recent years, the Source: World Bank staff calculations based on World Development country has struggled to attract Indicators efficiency-seeking FDI, which typically search for efficient production bases for exports. Attracting these investments is important as they generate a significant number of high-paying jobs and are often a source of new products and production technologies for the host economy. Figure B.8 shows that within manufacturing, export-oriented FDI outperformed domestic market oriented FDI, in terms of growth of labor productivity, average wages, number of new products, and investment rate over the period 2008-15. At the same time, export-oriented FDI are also more likely to leave Indonesia as they tend to be more sensitive to a deterioration in the business climate than other manufacturing FDI, which are more dependent on the large domestic market. Manufacturing FDI in Indonesia are increasingly oriented to serve the domestic rather than the global markets, which signals that Indonesia has lost competitiveness in the sector. In 2014, only 35 percent of new foreign manufacturing plants in Indonesia were export oriented, a significant drop from the 58 percent in 1996 (Figure B.9).53 This drop is even more marked when considering a historically export-oriented sector like electronics, where the share of export-oriented plants of total new foreign plants fell from 67 percent to 17 percent. The decline in export-oriented FDI reduces both overall FDI and exports, and hence foreign exchange earnings, increasing the Indonesia’s vulnerability to external shocks. 52 According to data from the Indonesian investment promotion board (BKPM), FDI declined from 3.3 percent of GDP in 2014–15 to 3.1 percent in 2016–17; while according to Bank Indonesia data for the same period, FDI dropped from 2.2 percent to 1.3 percent of GDP. 53 In addition, data from the medium and large manufacturing plant survey (Statistik Industri) show that export-oriented foreign plants also have a 36 percent higher probability of leaving Indonesia than other domestic-oriented foreign plants over the 2008–15 period. December 2018 THE WORLD BANK | BANK DUNIA 32 Strengthening competitiveness Indonesia Economic Quarterly Figure B.8: Export-oriented FDI outperforms domestic- Figure B.9: The declining share of new export-oriented market oriented FDI in manufacturing but are more likely foreign investment in manufacturing and electronics to leave Indonesia (share of export-oriented plants in total foreign plants, new and old) (percentage change relative to domestic market seeking foreign plants, 2008-2015) 70% 55% 1996 2014 45% 60% 35% 50% 25% 15% 40% 5% 30% -5% 20% 10% Overall manufacturing Electronics Source: World Bank staff calculations based on Statistik Industri data. Source: World Bank staff calculations based on Statistik Industri data. Note: The bars depict the point estimates along with the 95 percent Note: New plants are 3 years old and younger; old plants are older than confidence interval of plant-level regressions of the outcome variables in 3 years. Foreign plants are defined as having more than 50 percent the graphs (computed over 2008-15 period) on a dummy for export- foreign ownership. Export-oriented plants are defined as exporting more oriented plants (defined as exports>50 percent of sales) in the sample of than 50 percent of their sale value. foreign plants included in the data, controlling for 2-digit KBLI sector dummies. If sustained, the Not only are the current global Figure B.10: Indonesia has the potential to replace trade tensions conditions a reminder to Indonesia Chinese exports to the US in various products between the United of the importance of boosting (Expected drop in Chinese exports to the United States vs. States and China exports and foreign investments, Indonesian exports to the United States in 2017, US$ millions) 400 offer a unique but they also offer an unique Potential replacement of Chinese exports opportunity of opportunity for doing so. In Travel Bags boosting exports and particular, the ongoing trade Other Boards 300 foreign investments tensions between the United States Insulated Conductors as Chinese exports to and China have led to the reciprocal Handbags (in $mln) the United States fall increase in import tariffs in both 200 and investors seek to countries on a large share of bypass tariffs by bilateral imports.54 While these Radio Broadcast moving production increases in import tariffs have 100 Printer Parts Bentwood Insulated ignition Furniture to Southeast Asia created uncertainties in global trade New Pneumatic Tires and financial markets, they are also Seamless Gloves generating opportunities for 0 countries to replace exports in the 0 50 100 150 200 Indonesia exportd (in $ mln) two world’s largest markets. The Source: World Bank estimates on the basis of USTR, US census largest potential for Southeast bureau and Kee et al. (2008) Asian economies, including Note: Products in the top-right area have most replacement Indonesia, is to replace China’s potential. exports to the United States given their similarity in export baskets. World Bank calculations suggest that U.S. imports from China in the products subject to tariff measures may decline by almost USD 70 billion (Calì 2018). This drop would include products which are already exported 54 Specifically, between July and September this year, the United States has levied import tariffs of 10 percent and 25 percent on imports from China worth USD 235 billion (the 10 percent rate will be raised to 25 percent as of January 2019). In retaliation, China has raised 25 percent tariffs on the majority of the USD 130 billion worth of imports from the United States. December 2018 THE WORLD BANK | BANK DUNIA 33 Strengthening competitiveness Indonesia Economic Quarterly to the United States by Indonesia and therefore presents a substantial opportunity for Indonesia to replace China. Chinese exports to the United States in these products equal to 1 percent of Indonesian GDP in domestic value-added terms and span a range of goods from travel bags to printer parts and pneumatic tires (Figure B.10). In addition, the trade tensions are also leading to a diversion of investments away from China and the United States, as investors seek to bypass the import tariff hikes. A recent survey suggests that two-thirds of the companies in South China are planning to relocate some portion of their production out of China and half of them are planning to relocate the entire production, as a result of the escalating trade tensions55. Most plan to relocate to Southeast Asia and early evidence suggests that Vietnam and Thailand in particular, are already benefiting from increased investments in response to the trade tensions.56 2. Distortions in the main markets for production factors weigh down export competitiveness and investment flows Taking advantage of Taking advantage of these opportunities would require Indonesia to increase the these opportunities competitiveness of its economy and to fulfill its potential as a world-class investment and would require production destination. The relatively weak performance of exports and foreign investments Indonesia to can be both cause and consequence of the low productivity of Indonesian firms. Even diverse strengthen its industries, such as labor-intensive food processing and capital-intensive non-metallic minerals, competitiveness in Indonesia suffer a competitiveness gap vis-à-vis regional comparators (Figure B.11). Low productivity puts Indonesian firms at a competitive disadvantage vis-à-vis their peers in global markets. In turn, low exports and FDI further reduce firms’ productivity growth by reducing their exposure to global technologies, markets and skills. Figure B.11: Indonesia’s productivity needs to catch up vis-à-vis comparators (median value added per worker, 2015 USD) (a) Food processing (b) Non metallic minerals Indonesia Malaysia Thailand Vietnam Philippines Indonesia Thailand Vietnam Philippines Malaysia 14,000 16,000 12,000 14,000 12,000 10,000 10,000 8,000 8,000 6,000 6,000 4,000 4,000 2,000 2,000 - - Indonesia Malaysia Thailand Vietnam Philippines Indonesia Thailand Vietnam Philippines Malaysia Source: World Bank staff estimates on World Bank Enterprise data Note: Data for Indonesia, Vietnam, Malaysia and the Philippines is from 2015. Data for Thailand is from 2016. In spite of a series of While the Government of Indonesia has undertaken a series of economic policy reforms over economic reforms the past years, key distortions in factor markets still weigh on the country’s competitiveness. over the past years, The government has carried out 16 economic policy packages since September 2015, aiming to 55American Chamber of Commerce in South China (2018). 56For example, China’s GoerTek is shifting production of its wireless earphones AirPods to Vietnam, and Cheng Uei, which supplies chargers and connectors for iPhones and Android smartphones, is evaluating new facilities in Thailand, Vietnam, and the Philippines (Ting-Fan and Li 2018). This shift involved other sectors as well, including auto parts with Japanese companies Yukowo shifting its car antenna components production to Vietnam, and Panasonic moving its car electronics production to Thailand, Malaysia, and Mexico, similar to Daikin Industries moving its compressors production to Thailand and Malaysia (Nikkei Asian Review 2018). December 2018 THE WORLD BANK | BANK DUNIA 34 Strengthening competitiveness Indonesia Economic Quarterly key distortions in reduce the costs of doing business. The reforms spanned from simplifying import and export factor markets still processes to reducing barriers to entry in specific sectors to revising the minimum wage formula. weigh down the While a number of these reforms were steps in the right direction, an extensive list of distortions country’s still harms the competitiveness of Indonesian industries by increasing the costs and reducing competitiveness the quality and availability of key factors of production. These include regulatory bottlenecks, such as trade and investment restrictions, inefficiencies in labor and capital markets, and infrastructure deficiency. Many of these distortions are likely to matter more with growing demands for customization and reduced time-to- market transitions, the increasing role of services inputs in manufacturing production (“servicification”) and the increased use of automation. These factors have put more emphasis on access and connectedness to input and output markets and on the capabilities of workers, firms and countries to adopt new technologies.57 Trade and investment restrictions Indonesia has In the past decade, Indonesia has gradually increased barriers to goods imports, including tariffs increased barriers to and non-tariff measures (NTMs), which raise the costs and reduce the availability of inputs. goods imports, Between 2009 and 2017, Indonesia introduced new import barriers on a far greater share of its including tariffs and imports than other countries in the region (Figure B.12). These have contributed to the increase non-tariff measures in the nominal rate of protection (NRP) of the economy (Figure B.13).58 Domestic food prices more than its peers in 2015 were on average 33 percent higher than would have been the case in the absence of trade restrictions, more than double the NRP in 2008 (Marks 2017). Similar increases in NRP were observed in other major sectors, including those used as intermediates in production, such as crops, livestock, capital equipment and metals. As a result, trade policies impose a rising cost on domestic producers, in addition to that on households. Figure B.12: Indonesia has increased its trade barriers Figure B.13: As trade barriers increased, so did the significantly more than its peers since 2009 nominal rate of protection (shares of import value subject to new import restrictions) (price difference compared to a free trade scenario, percent) 70% 30 2015 NRP 2008 NRP 60% Indonesia 20 50% 10 0 40% -10 30% -20 20% South Korea Thailand 10% Vietnam Malaysia Philippines Singapore 0% 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: Global Trade Alert Source: Marks (2017) https://www.globaltradealert.org/data_extraction (accessed 1 November Note: negative NRP indicates production and/or export subsidy. 2018) 57Hallward-Driemeier and Nayyar (2017). 58The NRP is computed as the difference between the observed domestic price and that which would prevail in the free trade regime, thus providing an estimate of the impact of all trade distorting measures (tariff and non-tariff) on domestic prices. December 2018 THE WORLD BANK | BANK DUNIA 35 Strengthening competitiveness Indonesia Economic Quarterly Indonesia has In the past years, Indonesia has Figure B.14: Indonesia has increased its average increased import hiked import tariff rates, which applied import tariff rates more than its peers tariff rates, thereby increases the cost of production (percentage change in average import tariff rate, overall (2000–17) increasing the cost inputs and consumption goods, in and intermediates (2000–16)) and/or reducing the contrast to the region’s tendency 1.5 Intermediates (2000-16) Overall (2000-17) quality of production towards tariff reduction. Between 0.5 inputs 2000 and 2017, Indonesia has -0.5 increased its average import tariff -1.5 rate by 1.3 percentage points and its -2.5 tariff rate on intermediates by 0.3 percentage points (Figure B.14). -3.5 While the country started from -4.5 relatively low import tariff rates, -5.5 Indonesia’s trend over time -6.5 contrasts with that of most other countries in East Asia, which have substantially reduced their tariff rates. The use of import tariffs has Source: World Bank estimates on the basis of TRAINS data also included the imposition of anti- Note: The graph reports applied Most Favored Nation import dumping measures on a number of tariff, which is the most widely used tariff rate vis-à-vis trading products—including steel and partners. Due to data availability for overall tariffs the starting year for China and Vietnam is 2001; and the end year for Malaysia and yarn—to protect domestic Thailand is 2016 and 2015 respectively. For intermediates tariffs the producers from alleged unfair end year for Thailand is 2015. import competition. Empirical evidence has shown that tariff hikes reduce the productivity and output of firms in the protected sectors, as lower import competition reduces incentives to invest and increase efficiency.59 This evidence applies also to Indonesia, where tariff increases harm the competitiveness of the downstream sectors as well by increasing the costs and/or reducing the quality of production inputs.60 Indonesia has also Indonesia has also increased the application of NTMs on goods imports, which are often increased the justified by health, safety, and environmental concerns, but which can also significantly increase application of NTMs the costs of importing. The increase in the NTM application has been widespread across on goods imports, categories of imports, in particular capital goods and intermediates (Figure B.15). These which are often measures consist of import licenses and checks aiming to ensure that imported goods are safe justified by health, for consumers and do not harm public health or the environment, such as diseases carried by safety, and plant and animal imports, or safety hazards from goods handled by children. While some of environmental these are legitimate concerns, other measures appear to unnecessarily increase the costs of concerns, but which importing. Recent World Bank analysis suggests that a policy measure like the import monopoly can also significantly of a state-owned enterprise (SOE) significantly increases the costs of imports without clear increase importing benefits to the economy (Figure B.16). Similarly, the large import costs of product quality costs conformity requirements suggest the need to review both this requirement across products and the certification system.61 The potential for rationalizing NTMs to reduce the cost of trading is illustrated by the elimination of import licenses in eight large manufacturing product categories 59 Pavnick (2002); Amiti and Khandewal (2013). 60 Amiti and Konings (2007); Narjoko, Anas and Herdiyanto (2018); Rahardja and Varela (2014). 61 An illustration of the costs induced by certain NTMs is last March ’s dispute over high-grade salt, a key input for various manufacturing industries. This was subject to an import quota controlled by the Ministry of Maritime Affairs and Fisheries aimed at protecting domestic producers. The recommended yearly quota of 2.2 million ton was not sufficient to fulfill domestic demand this year in the face of reduced domestic production. The resulting scarcity of salt severely constrained the production of various industries, including food processing and pharmaceuticals, which came close to stopping their production. This led to the issuance of an emergency presidential decree to shift the responsibility for the import quota to the Ministry of Industry (see Reuters (2018) “Indonesia’s salt spat gives industry a shake”, April 6). December 2018 THE WORLD BANK | BANK DUNIA 36 Strengthening competitiveness Indonesia Economic Quarterly at the end of 2015, which World Bank analysis suggests has led to a significant reduction in import costs.62 Figure B.15: Indonesia has increased its application of Figure B.16: Some Non-Tariff Measures considerably Non-Tariff Measures across import categories increase the cost of imports in Indonesia (percentage of imports covered by at least one NTM) (effect of NTMs on import prices in ad valorem equivalent terms) 60% 85 50% 75 Consumption goods 40% 65 30% 55 20% 10% 45 Capital goods 0% 35 Intermediates 25 15 2008 2009 2010 2011 2012 2013 2014 2015 Source: Calì and Puzzello (2018) Note: * indicates estimate is statistically significant at least at the 10 percent level. SPS stands for Sanitary and Phytosanitary standards (applied to food products and other agri goods) and TBT is Technical barriers to trade (applied to manufactured goods) Service imports are Imports of services are also subject Figure B.17: Indonesia restricts the import of services also subject to to substantial barriers, which more than other countries substantial barriers, negatively affect competitiveness by (degree of restrictiveness to services imports; 0 = lowest; 1 = highest) which negatively reducing the quality and increasing Average across countries Indonesia affect the costs of domestic services, many Legal Distribution competitiveness by of which are key inputs to Telecom reducing the quality production. For example, barriers to Maritime transport and increasing the legal service imports include Insurance costs of domestic prohibiting foreign lawyers to set up Commercial banking services, many of a commercial presence or practice Air transport which are key inputs law in Indonesia; in distribution Accounting to production services - foreign investments are Courier Logistics cargo-handling not allowed in a large part of retail Construction distribution, including supermarkets Road freight transport and minimarkets; in maritime Broadcasting transport - foreign companies Logistics storage and… cannot transport goods between Logistics freight forwarding Indonesian ports hence severely Rail freight transport restricting competition in a key Architecture Computer transport sector. Recent evidence Motion pictures shows that higher barriers in services Engineering stifle competitiveness in Indonesian Logistics customs brokerage manufacturing industries that use Sound recording these services more intensively in 0.0 0.2 0.4 0.6 0.8 1.0 production63. This result is in line Source: OECD with the international evidence64 and 62 Calì (2017) estimates that the elimination of importer as well as producer import licenses reduced import prices by 6.7 percent. 63 Duggan, Rahardja and Varela (2013). 64 Arnold, Javorcik, and Mattoo (2011); Arnold et al. (2016). December 2018 THE WORLD BANK | BANK DUNIA 37 Strengthening competitiveness Indonesia Economic Quarterly suggests that these barriers worsen the quality and/or increase the price of domestic services. According to the OECD Services Trade Restrictiveness Index (STRI), Indonesia has a higher- than-average level of barriers to trade in all 22 services sectors among the 44 high- and middle- income countries surveyed (Figure B.17). Among others, these barriers include restrictions on intra-corporate transferees, limitations to foreign entry such as a foreign equity limit, and barriers to competition such as high minimum capital requirements.65 Indonesia has the most restrictive barriers among all countries surveyed in sectors that provide key inputs to producers, such as telecom, distribution, road freight transport, maritime transport, and construction. A host of policy Besides international trade, a host of policy barriers also raises the costs of investing in barriers—many Indonesia, particularly for foreign investors. Indonesia has one of the highest degrees of included in the regulatory restrictiveness towards FDI among the 68 middle- and lower-middle income Negative Investment countries surveyed by the OECD (Figure B.18). Key examples of such restrictions are included List—raise the costs in Indonesia’s negative investment list (Daftar Negatif Investasi, or DNI), in the form of foreign of investing in equity limits, sectoral reservations to micro, small, and medium enterprises (MSMEs), special Indonesia, licenses, and minimum local content requirements. For example, the DNI limits foreign equity particularly for participation to 15 percent of all sectors, in some cases prohibiting foreign investment foreign investors, altogether, such as for onshore oil and gas upstream production installation, power plants below who are banned 1 MW, retail business of car, motorcycle, and commercial vehicles and supermarkets below altogether in some 1,200 sqm. In addition, dozens of sectors across agriculture, industry, and services are reserved sectors exclusively for MSMEs, which effectively rules out foreign investors, as they cannot operate as MSMEs in Indonesia.66 Figure B.18: Regulatory restrictiveness towards FDI is high in Indonesia (FDI regulatory restrictiveness index, 0 = lowest; 1 = highest) 0.400 0.350 0.300 0.250 0.200 0.150 0.100 0.050 0.000 Luxembourg Serbia Poland Morocco Japan Ukraine Greece Finland Switzerland Montenegro New Zealand Chile Portugal Russia Tunisia Norway Cambodia Hungary Germany Czech Republic Malaysia Korea Vietnam Brazil Sweden Philippines Latvia Indonesia Laos Kazakhstan Albania France Estonia Canada Source: OECD These restrictions These restrictions significantly reduce both foreign and domestic investments, reduce entry and significantly reduce performance and increase prices in the sectors to which they are applied. Matching restrictions both foreign and with investments over time across sectors, World Bank (2017a) finds that raising the maximum domestic foreign equity limits allowed in a sector substantially increases the number of both FDI and investments, reduce domestic investment projects.67 The results also suggest that reserving a sector only for MSMEs entry and reduces the number of FDI projects, and requiring minimum levels of local content in performance, and production—recently introduced by Indonesia on some electronics, IT equipment, mobile 65 The STRI is a composite indicator of restrictions across five standard policy categories, which include restrictions on foreign entry, restrictions to movement of people, barriers to competition, regulatory transparency, and other discriminatory measures. 66 Other sectors are open, but in partnership with MSMEs, a much less biting restriction than reserving a sector to MSMEs. 67 The analysis is undertaken with data coded according to the 4-digit KBLI classification, which includes 514 sectors. December 2018 THE WORLD BANK | BANK DUNIA 38 Strengthening competitiveness Indonesia Economic Quarterly increase prices in the phones, and agri-business—negatively affect both foreign and domestic investments.68 These protected sectors restrictions to investments also worsen the competitiveness of the manufacturing sector. By matching the DNI investment restrictions across sectors over time with manufacturing plant- level data, new World Bank analysis shows that these restrictions reduce the competition in the sector. Following the introduction of a DNI restriction (foreign equity limit, SME reservation, or special license), the entry of new foreign manufacturing plants declines, particularly those which are export-oriented, and so does the exit of domestic plants that are less exposed to competition (Figure B.19). This reduced competition benefits incumbent businesses, which increase profits and prices at the expense of the users and consumers of the products (Figure B.20). As competition declines, so does the average plants’ performance, as measured by the reduction in the probability of investing, the labor productivity, the average wages paid, and the quantities produced by the plants. These effects are also consistent with the restrictions reducing the adoption of new production technologies that is typically brought about by foreign plants. The analysis finds that these restrictions also increase the costs of key inputs to production, particularly intermediates and services, thus reducing the profitability of downstream industries as well. Figure B.19: DNI restrictions reduce the entry of foreign Figure B.20: …and the lower competition reduces plants – particularly exporters - and the exit of domestic performance and wages, and increase prices plants… (percent change associated with introduction DNI restriction with the (percent change associated with introduction DNI restriction with the related 95 percent confidence interval) related 95 percent confidence interval) 2% 17% 0% 12% -2% 7% -4% 2% -6% -8% -3% -10% -8% entry exit entry exit entry exit -13% Domestic-mkt Export-oriented seeking -18% Domestic firms Foreign firms Profits Prod Invest. Wages Lab prod Prod qty price Source: World Bank staff estimates on the basis of DNI PerPres and Statistik Industri data. Note: The figures depict the point estimates along with the 95 percent confidence interval of yearly plant-level regressions of the outcome variables in the graphs on a time-varying DNI restriction dummy defined at the KBLI 5-digit level during the period 2008–14 (121,068 observations for domestic plants and 12,314 for foreign plants). These trade and Rather than nurturing Indonesian industries for the global markets, these trade and investment investment restrictions appear to have increased their isolation and reduced their incentives to compete restrictions have globally. Two cases in point are horticulture and electronics, two export-oriented sectors with increased the large growth in global demand, which Southeast Asia has been successfully tapping into. In isolation of recent years, Indonesia has tried to promote the development of both sectors through restrictive industries and investment and trade measures, such as limiting foreign equity participation in horticulture firms reduced their and requiring a minimum local content in electronics production for domestic sale. These incentives to restrictive policy measures have been associated with stagnating exports, in contrast to the high compete globally and growing level of exports and imports of regional peers that have maintained more open trade and investment regimes (Box B.2). 68In the case of foreign investments, the analysis finds that local content requirements reduce only the number of approved (but not yet realized) investments while it does not significantly affect that of realized investments. These requirements appear more pinching for domestic investments, as both approved and realized investments decline as a result of local content requirements. December 2018 THE WORLD BANK | BANK DUNIA 39 Strengthening competitiveness Indonesia Economic Quarterly Box B.2: Why trade and investment restrictions have not helped the development of Indonesian horticultural and electronics industries With the 2010 Horticultural Law (no. 13), Indonesia sought to develop the sector through a combination of restrictions to foreign investors (in the form of 30 percent maximum foreign equity)1 and import barriers with the introduction of licensing requirements and restricted ports of entry. The investment restrictions have reduced the participation of foreign seed companies, which can provide invaluable sources of knowledge in a technologically intensive sector, such as horticulture. Similarly, the trade restrictions have stifled horticulture import growth in recent years (and have increased domestic prices of fruits and vegetables) 2, but have not spurred any significant increase in exports (Figure B.21). On the other hand, by keeping open trade and investment regimes, Vietnam, Thailand and, to some extent, the Philippines have expanded both horticultural exports and imports over the same period. Vietnamese exports in particular, have grown five-fold in the last ten years to USD 5 billion, and imports have grown more than 10-fold to close to USD 3 billion. Trade and investments have played a key role in the development of the sector: foreign companies control 80 percent of the domestic purchases of seed, and 80 percent of domestic supply of fruit and vegetable seeds is imported. The government has established production areas for the top 8 fruits for exports, in which the farmers are provided long-term land ownership and intensive extension services to adopt the planting techniques needed to meet overseas customer demand. In addition, private investment is invited to improve post-harvest and export handling capacity. Figure B.21: The difficult transition of Indonesia’s horticulture sector (exports and imports of horticulture products in USD billions) 6.0 Indonesia 6.0 Philippines Import 5.0 5.0 Import Export 4.0 4.0 Export 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 -1.0 -1.0 -2.0 -2.0 -3.0 -3.0 2003 2014 2001 2002 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2015 2016 2017 2001 2014 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2015 2016 2017 6.0 Thailand 6.0 Vietnam Billions Import 5.0 5.0 Import Export 4.0 Export 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 -1.0 -1.0 -2.0 -2.0 -3.0 -3.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2003 2001 2002 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 World Bank staff calculations based on FAOSTATS. Indonesia has also used investment and sale restriction measures to promote the development of the electronics industry. Since 2013, the government has introduced local content requirements of between 20 percent and 40 percent of the value of the products to market various pieces of electronic equipment domestically.3 These measures aimed to spur the domestic industry by incentivizing domestic value addition. However, these restrictions make it difficult for domestic producers to source the best inputs globally, which December 2018 THE WORLD BANK | BANK DUNIA 40 Strengthening competitiveness Indonesia Economic Quarterly is particularly problematic in an industry whose production is highly fragmented across countries. Rather than addressing the competitiveness factors that have reduced investors’ willingness to use Indonesia as a production basis for their electronics exports (Figure B.9 above), these measures have contributed to turn Indonesia’s electronics industry increasingly domestic oriented . In the past decade both imports and exports have shrunk, and domestic sales have overtaken exports as the largest source of revenues for domestic producers (Figure B.22). While Indonesia has the largest domestic market in the region, it is still small in global terms. 4 Thus, it does not present as sufficiently attractive for producers who want to serve global markets by sourcing the best inputs globally. In fact, the value of Indonesia’s domestic sales is considerably smaller than that of the electronics exports of other countries in the region, such as Vietnam, Thailand, and Malaysia, which have more export-oriented electronics industries, with much larger imports and exports than Indonesia. These figures suggest that it is worthwhile for Indonesia to re-consider this inward-looking strategy to promote the industry. Figure B.22: Indonesia’s domestic-oriented electronics sector (exports and imports of electronics products in USD billions) Indonesia Malaysia Billions USD 90 90 Export Import Domestic 70 Export Import 70 50 50 30 30 10 10 -10 -10 -30 -30 -50 -50 -70 -70 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 90 Vietnam Thailand 80 70 Export Import Export Import 50 30 30 10 -10 -20 -30 -50 -70 -70 2009 2010 2011 2012 2013 2014 2015 2016 2017 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: World Bank staff calculations on COMTRADE for trade data and Statistik Industri and the survey of micro and small manufacturers for Indonesian domestic sale. Note: Data for domestic sale is only for Indonesia and is not available for 2016–17. 1 The Horticultural Law works retroactively, implying that foreign companies needed to divest their majority ownership by 2015 at the latest. While the government has indicated some flexibility with the divestment deadline, foreign companies continue facing regulatory uncertainty. 2 The World Bank estimated that fruit and vegetables prices have been more than 20 percent higher than they would have been in the absence of trade restrictions. 3 These requirements have been introduced through two Ministry of Information regulations (No. 26/2013 and No. 27/2015). 4 For example, the Indonesian market represents just 2 percent of a USD 479-billion global smartphones market in 2017. December 2018 THE WORLD BANK | BANK DUNIA 41 Strengthening competitiveness Indonesia Economic Quarterly By restricting By restricting competition, these Figure B.23: Indonesia lags behind in the strength and competition, these regulatory measures can also help scope of its competition regime (2013) regulatory measures generate dominant positions for (0 to 6 from most to least conductive to competition) can help generate incumbent businesses or facilitate 1.4 dominant positions collusion among them, which for incumbent further stifles competition. The 1.2 businesses or lack of competition harms 1.0 facilitate collusion productivity growth by reducing 0.8 among them, thus the firms’ incentives for product 0.6 harming and process innovation. These productivity, calling anti-competitive practices are 0.4 for the strengthening often in intermediate sectors69, 0.2 of the currently weak thus further dragging down 0.0 competition competitiveness by raising the United Kingdom Japan Chile Australia Ukraine Italy Germany Peru Indonesia Egypt Spain Russia Switzerland France Romania Turkey Brazil Canada Korea Poland Latvia Malta United States Colombia India Hungary Estonia Mexico New Zealand Netherlands South Africa framework and its cost of inputs to production. enforcer, KPPU There is therefore a critical need for strong competition policy and its enforcement. In many Source: World Bank elaboration based on Alemani et al. (2016) countries, national competition authorities help ensure that policymaking takes into account pro-competition concerns and prevent or discourage the anti-competitive conduct of business incumbents. In Indonesia, the effectiveness of competition policy framework and its implementation needs to be strengthened. Indonesia’s Competition Law dates back to 1999—the first law ever developed by the Parliament’s initiative in the post-Suharto era—when it also established a Business Competition Commission (KPPU) mandated to enforce the competition policy. However, both the competition framework and the KPPU still suffer from a number of limitations that make Indonesia’s competition regime one of the least effective of the 49 surveyed by the OECD (Figure B.23). For example, the KPPU is the only competition agency which cannot perform unannounced inspections of the premises of firms investigated for antitrust infringement aimed at gathering evidence. Similarly, the KPPU cannot act against firms located abroad, even if their behavior directly affects competition and/or consumers in domestic markets. As a result, the number of cartels detected by the KPPU has been very limited compared to even smaller economies.70 In addition, the KPPU has limited deterrence powers: at less than USD 2 million, the maximum penalty that the KPPU can levy is significantly lower than most other jurisdictions. Finally, while the majority of KPPU’s advisory opinion activity has focused on anti-competition practices facilitated by government regulations, the impact of such opinions on policy-making remains elusive in the absence of formal feedback mechanisms from the government. Inefficiencies in other factor markets The relatively low The increased automation and sophistication of production technology has raised the quality of labor, importance of skills quality for firms, hence amplifying the need to improve the quality of labor particularly high- in Indonesia, particularly high-skilled labor. The labor force’s quality of skills, particularly that skilled labor, is of high-skilled professionals and managers, is a key concern. The share of firms in Indonesia another key that report adequacy of skills as the top constraint when hiring managers and professionals is constraint on the the highest in the region (Figure B.24). On the other hand, firms searching for unskilled competitiveness of production workers, appear to complain less than their regional comparators about the Indonesian firms inadequacy of available skills. In addition, 80 percent of Indonesian firms complain specifically 69Ivaldi, Jenny and Khimich (2016). 70In Indonesia, in the 2000–17 period, the KPPU investigated only 11 cartel cases, excluding collusion with government officials in public procurement tenders (source: KPPU decisions published online). In comparison, in South Africa, whose economy is three times smaller than Indonesia’s, some 76 cartels were detected and sanctioned between 2005 and 2015, excluding construction projects (World Bank 2016). December 2018 THE WORLD BANK | BANK DUNIA 42 Strengthening competitiveness Indonesia Economic Quarterly about language and managerial skills, a much higher proportion than in peer countries. According to a recent joint Government of Indonesia-World Bank assessment, Indonesia suffers critical shortages of skills in dozens of positions, such as Head of Chemical Manufacturing Control, Biochemistry Supervisor; Microbiology Supervisor, Food Technologist, Chemical Engineer, Cloud Solution Architect and UI/UX Designer.71 This skills’ shortage translates into lower productivity and employment growth72. Indeed, poor management quality is typically associated with low innovation73, which may help explain the low share of firms that generate product or process innovation in Indonesia. The labor skills The problem of labor skills is Figure B.24: Lack of the right skills bites, particularly problem is consistent consistent with the need to improve for managers with the need to the quality of the domestic education (share of firms that cited inadequate skills as the key barrier in improve the quality system and is compounded by the trying to hire each type of worker, percentage) of the domestic limited formal on-the-job training 80 Indonesia Thailand Malaysia Philippines education system undertaken by Indonesian firms, 70 and is compounded especially for skilled employees. The by the limited formal recent rapid expansion in access to 60 on-the-job training education (with the number of 50 undertaken by schools more than doubling in Indonesian firms, 2003–16) has translated into a 40 especially for skilled massive increase in the labor force 30 employees with tertiary and secondary 20 education levels. However, this has not been reflected in a 10 commensurate improvement in the 0 quality of education since 200074. Managers Unskilled production According to international tests, workers more than 55 percent of Indonesians Source: Gomez-Mera and Hollweg (2018) based on WBES data who finish their education are functionally illiterate, a much larger share than registered in Vietnam (14 percent) and the OECD countries (20 percent). Despite these skill shortages, the share of Indonesian firms that employ on-the-job training is one of the lowest among middle- income countries.75 The energy market The subsidization policy for energy markets has reduced domestic energy prices, instead of subsidization policy providing firms what they really need, i.e., more reliable electricity provision. The Government has provided has adopted a long-standing policy of subsidized energy prices, particularly fuels, whose price in perverse incentives Indonesia is among the lowest in the world. While the subsidy was largely removed from the for producers to use national budget in 2015, around 27 percent of it has been reinstated by this year on the old fuel-powered government budget76. However, such policies have provided perverse incentives for firms to machines instead of use inefficient and low productivity fuel-powered machines, rather than more modern providing firms what electricity-powered ones. In fact, Calì et al. (2018) estimate from a panel of Indonesian they really need: manufacturing plants that a 10 percent increase in fuel price raises plant productivity by 1.4 more reliable percent. This result is driven by the switch to more productive and energy-efficient equipment, electricity provision induced by the fuel price increase. At the same time, the reliability of electricity provision 71 Government of Indonesia and World Bank (2018). 72 Firms that report difficulties in hiring managers and high-level employees experience 50 percent lower employment growth; difficulties in finding employees with foreign language, technical, leadership, and management skills are correlated with weaker firm performance and lower productivity among Indonesian firms, see Gomez Mera and Hollweg (2018). 73 Cirera and Maloney (2017). 74 World Bank (2018a). 75 Gomez-Mera and Hollweg (2018). 76 This excludes off-budget subsides, which are mainly absorbed by Pertamina. December 2018 THE WORLD BANK | BANK DUNIA 43 Strengthening competitiveness Indonesia Economic Quarterly remains an issue. While firms’ connection to the grid is widespread, at least on the main islands, Indonesian firms experience significantly longer and more frequent power outages, especially in Central Java, than their counterparts in the region (Figure B.25). This disrupts production and increases energy costs, for example by forcing firms to use generators to secure reliable power supply, which in turn translates into lower productivity, particularly for smaller firms.77 Figure B.25: Power reliability needs to be improved for Indonesian firms a. Average number of outages reported by firms per year b. Average duration of outages reported by firms per year (in hours) 7 8 7.5 6.0 6 7 6 5.7 5 5 4 3.8 4 3 3.0 2.4 2.4 3 2 2 1.7 1.2 1.2 1 1 0 0 Malaysia Philippines Thailand Vietnam Indonesia Thailand Philippines Malaysia Indonesia Vietnam Source: World Bank staff estimation on the basis of WBES data (data for 2015 for all countries except Thailand (2016)) The competitiveness Finally, the competitiveness of Indonesian firms is negatively affected by high transport costs, of Indonesian firms mainly due to congestion and a lack of adequate investment in infrastructure. New data gathered is negatively affected by the World Bank (2018b) show that the largest share of logistics costs for Indonesian by high transport manufacturers is due to transport, mainly road and sea transport, and its share in manufacturing costs, mainly due to sales is higher in Indonesia than in Vietnam and Thailand. Incentives to use road transport as congestion and a opposed to sea transport, including the diesel subsidy and the limited enforcement of road safety lack of adequate rules contribute to the road congestion problem. In addition, large infrastructure gaps exist in investment in ports, particularly in secondary ports, which slow down port operation and/or make ports ill- infrastructure equipped for the demand expected in the immediate future.78 These high costs reduce the ability of firms to fully exploit economies of scale, even within the large island economies of Java and Sumatra. The connectivity penalty is larger in peripheral regions,79 where the Government’s attempt to subsidize private sector development without a broader integration of these regions with the core of the country has largely failed (Rothenberg et al. 2017).80 3. What Indonesia can do to boost exports and investments? Addressing these Addressing the constraints that weigh on Indonesian competitiveness would accelerate constraints would investments, exports, and growth, fulfilling the country’s potential as one of the world’s fastest require a mix of growing economies. The good news is that several of these constraints could be addressed short- and medium- through six specific short-term policy reforms, including reducing import barriers, term reforms implementing ambitious Free Trade Agreements (FTAs), revising the DNI, allowing more 77 Poczter (2017). 78 This is based on detailed work on 18 ports carried out by the World Bank – see World Bank (2015a). 79 World Bank (2015a) 80 A case in point is the Integrated Economic Development Zones (KAPET) which aimed to develop lagging regions in Eastern Indonesia. The scheme includes tax breaks on all production factors, in addition to subsidized facilities, infrastructure, and services (Temenggung 2013). While these subsidies are fiscally costly, there is no evidence of any significant impact on investment or performance (Rothenberg et al. 2017), as these are likely to still be constrained by a lack of connectivity in these regions to markets as well as by a lack of adequate factors of production. December 2018 THE WORLD BANK | BANK DUNIA 44 Strengthening competitiveness Indonesia Economic Quarterly international recruitment of critical skills not readily available in Indonesia at the moment, eliminating the fuel subsidy and revising the Competition Law. Other human capital and infrastructure related bottlenecks would require a medium-term reform agenda. Short-term policies A key measure to One of the key measures for Indonesia to boost exports and investments is to substantially boost exports and reduce import barriers, both tariff and unnecessarily burdensome non-tariff ones. As exporters investments is use imported inputs intensely, this measure would reduce the cost and increase the availability substantially of key production inputs for exports. It would be important to begin by reversing the increase reducing import in the import tariffs of recent years, particularly on intermediates, including a proper review of barriers, both tariff whether the conditions justifying anti-dumping tariffs are still in place. In reforming NTMs, it and non-tariff ones would help to first focus on the most burdensome measures for imports. The objective would be to assess the opportunity of reducing their coverage across goods and the cost of applying them. For example, a review of the SNI certification would help identify the costs and benefits of the certification for various types of goods and possibly to find ways to reduce the cost of the certification itself. In addition, the Indonesian government could increase the transparency of its agencies in the administration of these measures. This could include, for instance, the issuance of recommendation letters for imports of specific goods by line ministries, which can often exert a large degree of discretion in releasing such letters. Indonesia could also Indonesia could also accelerate the Figure B.26: FTAs are a possible boon for the accelerate the conclusion of ongoing Free Trade Indonesian economy conclusion of Agreements (FTAs) negotiations (percentage point change in Indonesia’s economic variables associated ongoing Free Trade and consider joining others with a with various FTAs, by 2030) Agreements and high degree of ambition. FTAs are EU-IDN CPTPP (TPP-15) RCEP consider joining no substitute for unilateral trade and 7% others with high investment reforms, but they do 6% degree of ambition, provide an external mechanism to which could help accelerate domestic reforms as well 5% accelerate domestic as a good opportunity to increase reforms and enhance access to key markets. While 4% access to key Indonesia is close to signing a 3% markets renewed economic partnership agreement with Japan and FTAs 2% with Australia and with the 1% European Trade Association (EFTA) block, other important 0% agreements are still being negotiated, GDP Exports Imports notably one with the EU and the Source: Maliszewska et al. (forthcoming) Regional Comprehensive Economic Partnership (RCEP), which is being negotiated among 16 Asian economies. Recent work based on dynamic general equilibrium modeling suggests the positive impact of both agreements, particularly the EU one, as this would significantly reduce bilateral tariff and non-tariff barriers (Figure B.26). The study suggests that Indonesia could also benefit from joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which has replaced the original TPP. The inclusion of ambitious investment chapters in these “new generation” agreements could also help Indonesia attract foreign investments in the absence of Bilateral Investment Treaties (BITs) that the government has not been renewing upon expiration. In fact, renegotiating BITs appear to be a more effective strategy than terminating them as they provide an important protection to foreign investors against possible changes to the rights agreed upon at the time of investment. To that end, the government could consider introducing additional safeguards in BITs that limit the possible recourse to state-investor dispute settlement. December 2018 THE WORLD BANK | BANK DUNIA 45 Strengthening competitiveness Indonesia Economic Quarterly The revision of the Relaxing restrictions to investments Figure B.27: Eliminating foreign equity limits can DNI is a key step to is another key reform area to boost boost investments across sectors relaxing restrictions FDI and exports. Many such (expected additional investments from the elimination of foreign to investments, and restrictions in a wide range of sectors equity limits, in million USD) the elimination of could be revised through the 2,500 Foreign Domestic foreign equity limits issuance of a new DNI, including alone could generate foreign equity limits, SME 2,000 additional foreign reservations and partnerships, and and domestic minimum local content 1,500 investments of USD requirements.81 For instance, the 6 billion World Bank estimates that removing 1,000 foreign equity limits in all sectors not 500 closed to investments would generate an additional USD 4 billion 0 and USD 2 billion in foreign and domestic investments, respectively. 82 Sectors such as electricity and gas supply, paper products, construction, and tourism and food services would be the largest Source: World Bank staff estimates on the basis of DNI PerPres beneficiaries of these additional and BKPM investment data investments (Figure B.27). Other restrictions not covered in the DNI would need to be addressed through revisions of laws (e.g., Horticultural Law and Education Law) and sectoral regulations (e.g., local content requirements for electronics goods). In addition, as part of a longer-term agenda, it would be opportune to review a host of local government regulations— mainly at the district level—that often deter investments. In the short run, In the short run, Indonesia could Figure B.28: Indonesia does not yet tap into foreign Indonesia could improve the availability of critically skills to fill domestic gap improve the scarce skills—a key constraint to (share of foreign workers in labor force, 2016) availability of firms’ competitiveness—by allowing 43.05% critically scarce skills a larger number of high-skilled 45% by allowing a larger professionals from abroad. This 40% number of high- could be done by deepening the 35% skilled professionals reform initiated by the recent 30% from abroad, Presidential Regulation on workers’ 25% deepening the permits (No. 28/2018), which has 20% 12.35% reform initiated by not been fully implemented yet. 15% the recent More importantly, several of the 10% 4.47% presidential restrictive requirements on hiring 5% 0.06% 0.15% regulation on foreign professionals still remain in 0% workers’ permits place, including the need for approval of the foreign workers’ plan and the stringent foreign-to- domestic worker ratios. Indonesia should consider relaxing these Source: Immigration statistics in each country (for number of foreign visa) and World Development Indicators (for labor force). requirements, which help explain Note: 2016 data for all countries except Vietnam (2015). why only 0.06 percent of the Indonesian labor force is foreign, a fraction of the shares among regional peers (Figure B.28). 81As this issue went to press the Government was debating the opportunity of issuing a revised DNI, which may be forthcoming. 82This computation is based on the estimated response of investments to foreign equity limits from the empirical model mentioned above and described in World Bank (2017). December 2018 THE WORLD BANK | BANK DUNIA 46 Strengthening competitiveness Indonesia Economic Quarterly Eliminating the fuel Another important reform that Figure B.29: Reducing fuel subsidy could improve subsidy is another could be achieved in the short-term the current account deficit important short-term is the elimination of the fuel (estimated change in annual imports from eliminating fuel subsidy, reform, which could subsidy, which could have multiple by product, in USD mln) have positive effects positive effects on Indonesian Upper bound Lower bound 0 on both competitiveness and external manufacturing stability. On the one hand, it would -200 competitiveness and considerably free up fiscal resources -400 external stability for more effective expenditures. In -600 2018, the subsidy is estimated by the government at around 5 percent -800 of central government expenditures -1000 in the budget and 0.7 per cent of -1200 2018 GDP. On the other hand, the increase in fuel price from the -1400 elimination of the subsidy could -1600 spur efficiency gains in the -1800 industrial sector as suggested by the Gasoline Diesel empirical evidence above. While the Source: World Bank staff estimates on the basis of Citi Research elimination of the subsidy would (estimates of economical price), BPS (import data), Agustina et al. (2008) (price elasticities of demand) and Pertamina (fuel generate some inflationary consumption split) pressures, the domestic fuel prices increase would also reduce the demand and hence the imports of diesel, gasoline and LPG, thus improving the country’s external balance. The World Bank estimates that the removal of the subsidy would generate a drop of USD 2–2.5 billion in imports of diesel and gasoline alone (Figure B.29). Revising the existing Revising the existing Competition Law (no. 5/1999) is a key step to make the Indonesian Competition Law is competition framework more effective at identifying and sanctioning anti-competitive behavior. a key step to making The Indonesian Parliament is discussing the revision of the Law, which is a unique opportunity the Indonesian to strengthen the system’s ability to identify and deter firms’ anti-competitive behavior. competition Specifically, the tools to detect and deter cartels should be enhanced, including granting the framework more KPPU the power to conduct unannounced searches to gather evidence of anticompetitive effective at practices; increasing the maximum level of fines; strengthening the ability of the KPPU to identifying and execute them; and introducing the possibility of using leniency for businesses which share sanctioning anti- information to detect and sanction cartels. In addition, the revision could clarify the application competitive behavior of administrative and criminal sanctions to firms and individuals; specify the definition of “business actor” so that it comprises all legal entities operating as a single economic unit in the market; and introduce the concept of settlement to improve the efficiency of the enforcement process. Finally, the system should strengthen KPPU’s ability to prevent anti-competitive mergers by moving from the current post-merger to a mandatory pre-merger notification regime, clarifying the standard of theory of harm and the definition of merger as combining two or more previously independent economic units through a lasting change in control. Medium-term In the medium run, In the medium run, it will be important to embed competition considerations into Indonesia’s it will be important policy-making and to strengthen the technical capacity of KPPU to enforce the competition law to embed and advocate for pro-competition reforms. The former is important as government regulations competition often deter entry and restrict import competition, thus helping to create dominant positions and considerations into facilitate cartel formation. This would require a more effective regulatory governance system. Indonesia’s policy- This could include, for instance, the implementation of Presidential Instruction no. 7/2017, making and to which mandates coordinating ministries to vet new regulations, and responsible ministries to strengthen the conduct impact analysis and hold wide public consultations for the proposed reforms, and the December 2018 THE WORLD BANK | BANK DUNIA 47 Strengthening competitiveness Indonesia Economic Quarterly capacity of the revision of the Law of Making Laws (2011). Including the KPPU in the consultation process KPPU to enforce the would help ensure a more systematic consideration of regulatory impacts on barriers to entry, competition law and expansion, and competition. Furthermore, the KPPU and sector regulators could strengthen advocate for pro- their assessment of Indonesian markets to identify current regulations and government competition reforms interventions that hinder competition, and recommend alternative measure that minimize market distortions. In addition, strengthening the KPPU’s analytical and investigative capacity would also be important to ensure better enforcement of competition rules, especially if the competition law revision entrusts it with more effective investigative and deterrence powers. This would also entail streamlining the KPPU’s procedures for case handling, decision making, and monitoring. Improving the Improving the availability and quality of skilled Indonesian workers is a complex long-term availability and agenda which should be at the core of the government’s strategy to boost exports and quality of skilled investments. This would require improving the education system at all levels. While Indonesia Indonesian workers has managed to strengthen schooling attainment since the early 2000s, student learning remains would require below the levels of peer countries. World Bank (2018a) provides key recommendations to strengthening the increase the quality of primary and secondary education. These include better defining and quality of the enforcing the mandatory qualification criteria for teachers, complementing the existing education system at financing mechanisms for education with a targeted, performance-based transfer for lagging all levels schools and districts, and launching a national education quality campaign to generate public pressure for effective actions to improve student learning. In addition, post-secondary education may benefit from the entry of foreign universities as signaled by the Government’s stated intention earlier this year to open up universities to foreign investment.83 Such reforms along with relaxing restrictions on the hiring of foreign lecturers could improve the higher education system by extending its knowledge frontiers and increasing competition in the supply of higher education services. Improving energy Strengthening energy and transport infrastructure are other key policy agenda elements to and transport increase reliability and reduce the cost of power and transport. To that end, the government infrastructure would should continue expanding infrastructure investments as in previous years—possibly at an even entail reducing SOE greater pace. In addition, leveraging private sector investment can help Indonesia meet its large market dominance, infrastructure needs more effectively. As identified by World Bank (2017b), mobilizing the simplifying legal private sector for infrastructure development will require improvements in: (i) the complex legal frameworks for PPP, and regulatory environment for public-private partnerships, (ii) project planning, appraisal, and and deepening local selection processes, (iii) transparency and efficiency of SOEs that dominate the infrastructure banking and capital sector, including reducing subsidies to SOEs and using open competitive tenders for markets infrastructure projects, and (iv) the depth of local banking and capital markets. These reforms would These reforms would also increase the effectiveness of tax incentives, a tool the Indonesian also increase the government seems increasingly interested in employing to attract investments. The Government effectiveness of estimates that in 2017, tax incentives through VAT, income tax, and import tariffs alone costly tax incentives, amounted to foregone fiscal revenues of over USD 10 billion (Government of Indonesia 2018). which the While the impact of these specific incentives in attracting investments has not been assessed yet, government seems international evidence suggests that they are far less important than other factors, such as the increasingly costs of raw material and intermediates, the transparency of the legal system, the quality of interested in infrastructure, and the availability of skilled labor (UNIDO 2011; World Bank 2018c). In fact, employing to attract the data show that tax incentives are not useful in attracting investments in countries where investments, but these factors are not developed (Van Parys and James 2009). In these cases, tax incentives then with limited become a fiscal cost for the country, which benefit only the investors who pay lower taxes. That evidence of success was the case also for Indonesia’s Integrated Economic Development Zone (KAPET) program, 83 See, for instance, The Strait Times (April 4, 2018). December 2018 THE WORLD BANK | BANK DUNIA 48 Strengthening competitiveness Indonesia Economic Quarterly which provides tax breaks to firms in certain districts in Indonesia’s outer islands. In an evaluation of the program, Rothenberg et al. (2017) find that firms in KAPET districts paid lower taxes, but these tax incentives neither encouraged greater firm entry, nor raised local measures of output or welfare. December 2018 THE WORLD BANK | BANK DUNIA 49 Strengthening competitiveness Indonesia Economic Quarterly References PART A APBN Kita. November 2018. https://www.kemenkeu.go.id/publikasi/apbn-kita/informasi-apbn-kita-2018/ Bank Indonesia. 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When Regional Policies Fail: An Evaluation of Ind onesia’s Integrated Economic Development Zones. Mimeo. Temenggung, D. 2013. Policies to Promote Development and Integration of Lagging Regions: The Indonesian Experience, in The Internal Geography of Trade: Lagging Regions and Global Markets, ed. by T. Farole. Washington, D.C.: The World Bank, 209–27. Ting-Fan, C. and L. Li. 2018. Apple Supplier Seeks to Escape Trade War Fallout with Shift Out of China. Nikkei Asian Review. October 12. The Strait Times. April 4, 2018. “Indonesia to open university sector to 100 percent foreign ownership”. UNIDO 2011. Africa Investor Report. Vienna: UNIDO. Van Parys, S., and James, S. 2009. Why Tax Incentives May be an Ineffective Tool to Encourage Investment? The Role of Investment Climate SSRN Electronic Journal December 2008. World Bank. 2015a. Improving Indonesia’s freight logistics system: A plan of action, Report No: AUS5940. _________. 2016. South Africa Economic Update: Promoting faster growth and poverty alleviation through competition . Washington DC: World Bank. _________. 2017a. Indonesia Economic Quarterly: Upgraded. June. Jakarta: World Bank. _________. 2017b. Indonesia Economic Quarterly: Closing the gap. October. Jakarta: World Bank. _________. 2017c. Indonesia Financial Sector Assessment Program (FSAP). mimeo. _________. 2018a. Indonesia Economic Quarterly: Learning more, growing faster. June. Jakarta: World Bank. _________. 2018b. Survey on the logistics costs of Indonesian manufacturers 2017. mimeo. December 2018 THE WORLD BANK | BANK DUNIA 51 Strengthening competitiveness Indonesia Economic Quarterly APPENDIX: A SNAPSHOT OF INDONESIAN ECONOMIC INDICATORS Appendix Figure 1: Real GDP growth Appendix Figure 2: Contribution to GDP growth (expenditure) (growth quarterly yoy, percent) (contribution to real GDP growth yoy, percentage points) Household cons. Non profit cons. 7 Government cons. GFCF Change in stock Stat. discrepancy 10 Exports Imports Total GDP 8 6 6 Total GDP 4 2 5 0 -2 4 -4 Sep-12 Sep-14 Sep-16 Sep-18 Sep-15 Sep-16 Sep-17 Sep-18 Source: BPS; World Bank staff calculations Source: BPS; World Bank staff calculations Appendix Figure 3: Contribution to GDP growth Appendix Figure 4: Motor cycle and motor vehicle sales (production) (growth yoy, percent) (contribution to real GDP growth yoy, percentage points) Agri. fores. & fish. Industry 6 Services Taxes-subsidies Total GDP 80 5 60 4 40 3 20 Motor vehicle sales 2 0 1 -20 Motor cyle sales 0 -40 Sep-15 Sep-16 Sep-17 Sep-18 Oct-15 Oct-16 Oct-17 Oct-18 Source: BPS; World Bank staff calculations Source: BPS; World Bank staff calculations Appendix Figure 5: Consumer indicators Appendix Figure 6: Industrial production indicators and (retail sales index 2010=100) manufacturing PMI (PMI diffusion index; industrial production growth yoy, percent) Retail sales index (LHS) 250 BI consumer survey index (RHS) 150 55 Industrial production index (RHS) 10 230 120 5 210 90 50 0 190 60 Manufacturing PMI (LHS) -5 170 30 150 0 45 -10 Oct-15 Oct-16 Oct-17 Oct-18 Nov-15 Nov-16 Nov-17 Nov-18 Source: BI Source: BPS; Nikkei/Markit; World Bank staff calculations Note: Manufacturing PMI above 50 indicates expansion December 2018 THE WORLD BANK | BANK DUNIA 52 Strengthening competitiveness Indonesia Economic Quarterly Appendix Figure 7: Balance of payments Appendix Figure 8: BOP: Current account (USD billion) (USD billion) Error & omissions Goods trade Services trade 15 Capital & financial account 12 Primary income Secondary income Current account Overall balance Current account 10 8 5 4 0 0 -5 -4 -10 -8 -15 -12 Sep-15 Sep-16 Sep-17 Sep-18 Sep-15 Sep-16 Sep-17 Sep-18 Source: BI Source: BI Appendix Figure 9: Exports of goods Appendix Figure 10: Imports of goods (USD billion) (USD billion) Total exports (fob) Agriculture Total imports (cif) Oil and gas 20 Manufacturing Mining 20 Consumer goods Raw materials 18 Oil and gas 18 Capital goods 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 Oct-15 Oct-16 Oct-17 Oct-18 Oct-15 Oct-16 Oct-17 Oct-18 Source: BPS Source: BPS Appendix Figure 11: Reserves and capital flows Appendix Figure 12: CPI inflation (USD billion) (growth yoy, percent) Global bonds (LHS) 6 SBI (LHS) 140 8 Thousands Thousands SUN (LHS) Equities (LHS) 7 International reserves (RHS) 6 3 120 Food 5 Non-food 4 Headline 3 0 100 2 Core 1 -3 80 0 Nov-15 Nov-16 Nov-17 Nov-18 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 Source: BI; Ministry of Finance (MoF) Source: BPS; BI; World Bank staff calculations Note: SUN is government securities, SBI is BI certificates December 2018 THE WORLD BANK | BANK DUNIA 53 Strengthening competitiveness Indonesia Economic Quarterly Appendix Figure 13: Monthly breakdown of CPI Appendix Figure 14: CPI inflation comparison across inflation countries (contribution to growth yoy, percentage points) (growth yoy, percent) Processed food Raw Food 5 Clothing Transport Health Education Philippines Housing Headline India 4 Indonesia 3 USA China 2 Korea Japan 1 Thailand 0 Singapore Malaysia -1 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 0 2 4 6 8 Source: BPS; World Bank staff calculations Source: BPS; CEIC; World Bank staff calculations Note: October 2018 data. Appendix Figure 15: Domestic and international rice Appendix Figure 16: Poverty and unemployment rates prices (percent) (wholesale price, in IDR per kg) 20 12,500 11,000 16 Domestic rice, IR64-II 9,500 12 Poverty rate 8,000 6,500 Vietnamise rice, 5% broken 8 Unemployment rate 5,000 3,500 4 Nov-15 Nov-16 Nov-17 Nov-18 2005 2007 2009 2011 2013 2015 2017 Source: Cipinang wholesale rice market; FAO Source: BPS Note: “5% broken” refers to the quality of milled rice. 5 percent being Note: Poverty line based on national poverty line the proportion of grains broken during the processing stage. Appendix Figure 17: Regional equity indices Appendix Figure 18: Spot exchange rates of selected (daily index, September 1, 2015=100) currencies against USD (monthly index, August 2015=100) JSI-Indonesia Shanghai-China BSE-India SGX-Singapore 130 Brazil 160 SET-Thailand 120 150 110 Indonesia 140 100 130 South Africa 90 India 120 80 110 70 Turkey 100 60 90 50 80 40 Dec-16 Jun-17 Dec-17 Jun-18 Dec-18 Nov-16 May-17 Nov-17 May-18 Nov-18 Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations December 2018 THE WORLD BANK | BANK DUNIA 54 Strengthening competitiveness Indonesia Economic Quarterly Appendix Figure 19: 5-year local currency government Appendix Figure 20: Sovereign USD bond EMBIG spread bond yields (basis points) (percent) 9 Indonesia Malaysia Singapore Thailand 8 United States Indonesia - global spread (RHS) 250 Indonesia - EMBIG bond spread 50 7 6 230 0 5 210 -50 4 3 190 -100 2 170 -150 1 0 150 -200 Dec-16 Jun-17 Dec-17 Jun-18 Dec-18 Dec-16 Jun-17 Dec-17 Jun-18 Dec-18 Source: CEIC Source: JP Morgan Appendix Figure 21: Commercial and rural credit and Appendix Figure 22: Banking sector indicators deposit growth (monthly, percent) (growth yoy, percent) Loans to deposit ratio (LHS) 15 Liquidity to assets ratio (LHS) Capital adequacy ratio (LHS) Non-performing loans ratio (RHS) 100 Return on asset (RHS) 5 Loans 12 80 4 9 60 3 40 2 6 Private deposits 20 1 3 0 0 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18 Source: BI; World Bank staff calculations Source: BI; World Bank staff calculations Appendix Figure 23: Government debt Appendix Figure 24: External debt (percent of GDP, LHS; USD billion, RHS) (percent of GDP, LHS; USD billion, RHS) External Public Domestic Private 40 300 40 400 Total ext. debt to GDP % Total debt to GDP % 30 225 30 300 20 150 20 200 10 75 10 100 0 0 0 0 Source: BI; MoF; World Bank staff calculations Source: BI; World Bank staff calculations December 2018 THE WORLD BANK | BANK DUNIA 55 Strengthening competitiveness Indonesia Economic Quarterly Appendix Table 1: Budget outcomes (IDR trillion) 2011 2012 2013 2014 2015 2016 2017 Actual Actual Actual Actual Actual Actual Actual A. State revenue and grants 1,211 1,338 1,439 1,550 1,508 1,556 1,666 1. Tax revenue 874 981 1,077 1,147 1,240 1,285 1,344 2. Non-tax revenue 331 352 355 399 256 262 311 B. Expenditure 1,295 1,491 1,651 1,777 1,807 1,864 2,007 1. Central government 884 1,011 1,137 1,204 1,183 1,154 1,265 2. Transfers to the regions 411 481 513 574 623 710 742 C. Primary balance 9 -53 -99 -93 -142 -126 -124 D. Surplus / Deficit -84 -153 -212 -227 -298 -308 -341 (percent of GDP) -1.1 -1.9 -2.3 -2.2 -2.6 -2.5 -2.5 Source: MoF; World Bank staff calculations Note: Budget balance as percentage of GDP uses the revised and rebased GDP Appendix Table 2: Balance of payments (USD billion) 2017 2018 2014 2015 2016 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Balance of payments 15.2 -1.1 12.1 4.5 0.7 5.4 1.0 -3.9 -4.3 -4.4 Percent of GDP 1.7 -0.1 1.3 1.9 0.3 2.0 0.4 -1.5 -1.6 -1.7 Current account -27.5 -17.5 -17.0 -2.2 -4.6 -4.6 -5.9 -5.6 -8.0 -8.8 Percent of GDP -3.1 -2.0 -1.8 -0.9 -1.8 -1.7 -2.3 -2.2 -3.0 -3.4 Trade balance -3.0 5.4 8.2 4.4 2.7 3.2 0.7 0.7 -1.6 -2.6 Net income & current transfers -24.5 -22.9 -25.2 -6.6 -7.3 -7.8 -6.6 -6.3 -6.4 -6.2 Capital & Financial Account 44.9 16.9 29.3 6.7 5.3 10.3 7.0 2.4 4.5 4.2 Percent of GDP 5.0 2.0 3.1 2.8 2.1 3.9 2.7 0.9 1.7 1.6 Direct investment 14.7 10.7 16.1 2.8 4.4 7.4 4.7 3.3 2.7 3.9 Portfolio investment 26.1 16.2 19.0 6.5 8.1 4.0 2.2 -1.3 0.1 -0.1 Other investment 4.3 -10.1 -5.8 -2.5 -7.2 -1.1 0.1 0.3 1.7 0.2 Errors & omissions -2.2 -0.4 -0.3 0.0 0.0 -0.4 -0.1 -0.6 -0.9 0.3 Foreign reserves* 111.9 105.9 116.4 121.8 123.1 129.4 130.2 126.0 119.8 114.8 Source: BI; BPS; World Bank staff calculations Note: * Reserves at end-period December 2018 THE WORLD BANK | BANK DUNIA 56 Strengthening competitiveness Indonesia Economic Quarterly Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance 2000 2010 2011 2012 2013 2014 2015 2016 2017 1 National Accounts (% change) Real GDP 4.9 6.2 6.2 6.0 5.6 5.0 4.9 5.0 5.1 Real investment 11.4 8.5 8.9 9.1 5.0 4.4 5.0 4.5 6.2 Real consumption 4.6 4.1 5.1 5.4 5.7 4.7 4.9 4.3 4.6 Private 3.7 4.8 5.1 5.5 5.5 5.3 4.8 5.0 5.0 Government 14.2 0.3 5.5 4.5 6.7 1.2 5.3 -0.1 2.1 Real exports, GNFS 30.6 15.3 14.8 1.6 4.2 1.1 -2.1 -1.6 9.1 Real imports, GNFS 26.6 17.3 15.0 8.0 1.9 2.1 -6.2 -2.4 8.1 Investment (% GDP) 20 31 32 33 32.5 32.4 32.4 32.2 32.6 Nominal GDP (USD billion) 165 755 893 918 915 891 861 933 1,015 GDP per capita (USD) 857 3,167 3,688 3,741 3,668 3,532 3,370 3,603 3,878 Central Government Budget (% GDP)2 Revenue and grants 20.8 14.5 15.5 15.5 15.1 14.7 13.1 12.5 12.3 Non-tax revenue 9.0 3.9 4.2 4.1 3.7 3.8 2.2 2.1 2.3 Tax revenue 11.7 10.5 11.2 11.4 11.3 10.9 10.8 10.4 9.9 Expenditure 22.4 15.2 16.5 17.3 17.3 16.8 15.7 15.0 14.8 Consumption 4.0 3.6 3.8 3.9 4.1 4.0 4.5 4.6 4.4 Capital 2.6 1.2 1.5 1.7 1.9 1.4 1.9 1.4 1.5 Interest 5.1 1.3 1.2 1.2 1.2 1.3 1.4 1.5 1.6 Subsidies 6.3 2.8 3.8 4.0 3.7 3.7 1.6 1.4 1.2 Budget balance -1.6 -0.7 -1.1 -1.8 -2.2 -2.1 -2.6 -2.5 -2.5 Government debt 97.9 24.5 23.1 23.0 24.9 24.7 27.4 28.3 30.8 o/w external government debt 51.4 11.1 10.2 9.9 11.2 10.2 12.7 12.3 12.8 Total external debt (including private 87.1 26.8 25.2 27.5 29.1 32.9 36.1 34.3 34.8 sector) Balance of Payments (% GDP)3 Overall balance of payments .. 4.0 1.3 0.0 -0.8 1.7 -0.1 1.3 1.1 Current account balance 4.8 0.7 0.2 -2.7 -3.2 -3.1 -2.0 -1.8 -1.7 Exports GNFS 42.8 22.0 23.9 23.0 22.4 22.3 19.9 18.0 19.1 Imports GNFS 33.9 19.2 21.2 23.2 23.1 22.7 19.3 17.1 18.0 Trade balance 8.9 2.8 2.7 -0.2 -0.7 -0.3 0.6 0.9 1.1 Financial account balance .. 3.5 1.5 2.7 2.4 5.0 2.0 3.1 2.9 Direct investment -2.8 1.5 1.3 1.5 1.3 1.7 1.2 1.7 2.0 Gross official reserves (USD billion) 29.4 96 110 113 99 112 106 116 130 Monetary (% change)3 GDP deflator1 20.4 8.3 7.5 3.8 5.0 5.4 4.0 2.5 4.3 Bank Indonesia interest key rate (%) .. .. .. .. .. .. 6.3 4.8 4.3 Domestic credit (eop) .. 23.3 24.7 23.1 21.4 11.6 10.1 7.8 8.2 Nominal exchange rate (average, 8,392 9,087 8,776 9,384 10,460 11,879 13,392 13,307 13,384 IDR/USD) Prices (% change)1 Consumer price Index (eop) 9.4 7.0 3.8 3.7 8.1 8.4 3.4 3.0 3.6 Consumer price Index (average) 3.7 5.1 5.3 4.0 6.4 6.4 6.4 3.5 3.8 Indonesia crude oil price (USD per barrel, 28 79 112 113 107 60 36 51 61 eop)4 Source: BPS and World Bank staff calculations, using revised and 2010 rebased figures. MoF and World Bank staff calculations, BI, CEIC 1 2 3 4 December 2018 THE WORLD BANK | BANK DUNIA 57 Strengthening competitiveness Indonesia Economic Quarterly Appendix Table 4: Indonesia’s development indicators at a glance 2000 2010 2011 2012 2013 2014 2015 2016 2017 1 Demographics Population (million) 212 243 246 249 252 255 258 261 264 Population growth rate (%) 1.4 1.3 1.3 1.3 1.3 1.2 1.2 1.1 1.1 Urban population (% of total) 42 50 51 51 52 53 53 54 55 Dependency ratio (% of working-age population) 55 51 51 50 50 50 49 49 49 Labor Force2 Labor force, total (million) 98 117 117 120 120 122 122 125 128 Male 60 72 73 75 75 76 77 77 79 Female 38 45 44 46 45 46 46 48 49 Agriculture share of employment (%) 45 38 36 35 35 34 33 32 30 Industry share of employment (%) 17 19 21 22 20 21 22 21 22 Services share of employment (%) 37 42 43 43 45 45 45 47 48 Unemployment, total (% of labor force) 8.1 7.1 7.4 6.1 6.2 5.9 6.2 5.6 5.5 Poverty and Income Distribution3 Median household consumption (IDR 000 per month) 104 374 421 446 487 548 623 697 765 National poverty line (IDR 000 per month) 73 212 234 249 272 303 331 354 375 Population below national poverty line (million) 38 31 30 29 28 28 29 28 28 Poverty (% of population below national poverty line) 19.1 13.3 12.5 12.0 11.4 11.3 11.2 10.9 10.6 Urban (% of population below urban poverty line) 14.6 9.9 9.2 8.8 8.4 8.3 8.3 7.8 7.7 Rural (% of population below rural poverty line) 22.4 16.6 15.7 15.1 14.3 14.2 14.2 14.1 13.9 Male-headed households 15.5 11.0 10.2 9.5 9.2 9.0 9.3 9.0 8.7 Female-headed households 12.6 9.5 9.7 8.8 8.6 8.6 11.1 9.8 9.3 Gini index 0.30 0.38 0.41 0.41 0.41 0.41 0.41 0.40 0.39 Percentage share of consumption: lowest 20% 9.6 7.9 7.4 7.5 7.4 7.5 7.2 7.1 7.0 Percentage share of consumption: highest 20% 38.6 40.6 46.5 46.7 47.3 46.8 47.3 46.2 45.7 Public expenditure on social security & welfare (% of GDP)4 .. 0.4 0.4 0.4 0.5 0.5 0.6 0.5 0.5 Health and Nutrition1 Physicians (per 1,000 people) 0.16 0.14 .. 0.20 .. .. .. .. .. Under five mortality rate (per 1000 children under 5 years) 52 33 32 31 29 28 27 26 25 Neonatal mortality rate (per 1000 live births) 22 16 16 15 14 14 13 13 12 Infant mortality (per 1000 live births) 41 28 26 25 25 24 23 22 21 Maternal mortality ratio (modeled est., per 100,000 live 265 165 156 148 140 133 126 .. .. births) Measles immunization (% of children ages 12-23 months) 76 78 80 82 81 75 75 76 75 Current health expenditure (% of GDP) 2.0 3.5 3.3 3.4 3.4 3.4 3.3 .. .. Domestic general government health expenditure (% of 0.6 1.1 1.0 1.2 1.3 1.3 1.3 .. .. GDP) Education3 Primary net enrollment rate (%) .. 92 92 93 92 93 97 97 97 Female (% of total net enrollment) .. 48 49 49 50 48 49 49 49 Secondary net enrollment rate (%) .. 61 60 60 61 65 66 66 79 Female (% of total net enrollment) .. 50 50 49 50 50 51 51 49 Tertiary net enrollment rate (%) .. 16 14 15 16 18 20 21 19 Female (% of total net enrollment) .. 53 50 54 54 55 56 55 53 Adult literacy rate (%) .. 91 91 92 93 93 95 95 96 Public spending on education (% of GDP)5 .. 3.5 3.6 3.8 3.8 3.6 3.5 3.3 3.0 Public spending on education (% of spending)5 .. 20.0 20.2 20.1 20.0 19.9 20.6 20.0 20.0 Water and Sanitation1 People using at least basic drinking water (% of population) 75 85 86 87 88 89 90 .. .. Urban (% of urban population) 89 94 94 95 96 96 97 .. .. Rural (% of rural population) 64 76 77 78 79 80 81 .. .. People using at least basic sanitation (% of population) 44 60 62 64 65 66 68 .. .. Urban (% of urban population) 66 74 74 75 76 77 77 .. .. Rural (% of rural population) 28 47 49 51 53 55 57 .. .. Others1 Disaster risk reduction progress score (1-5 scale; 5=best) .. .. 3.3 .. .. .. .. .. .. Proportion of seats held by women in national parliament 8 18 18 19 19 17 17 17 20 (%)6 Source: 1 World Development Indicators; 2 BPS (Sakernas); 3 BPS (Susenas) and World Bank; 4 MoF, Bappenas, and World Bank staff calculations, only includes spending on rice distribution for the poor (Raskin), health insurance for the poor, scholarships for the poor, and Family Hope Program (PKH) and actuals; 5 MoF; 6 Inter-Parliamentary Union December 2018 THE WORLD BANK | BANK DUNIA 58 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.