Reforms take their toll on Indonesia economy
country’s gross domestic product (GDP) grew 5.2% year-on-year (YoY) in the first quarter of 2014, its lowest growth since 2009, compared with 5.7% YoY in the previous quarter.
The main driver of the deceleration was the exports component, which slipped into a 0.8% YoY contraction in the first three months of the year, a sharp fall from the 7.4% YoY expansion in the previous quarter. The main reason behind this decline was the government’s introduction of an export ban on unprocessed mineral ore. The ban, which was first proposed in 2009, was implemented in January this year in order to encourage domestic refining and increase the added value on mineral products.
On the other hand, domestic economic activity was strong in the first quarter of 2014. Private consumption, which makes up around half of the economy, continued to expand, accelerating from a 2.9% YoY increase in the fourth quarter of 2013 to 3.1% YoY in the first quarter of 2014. This trend has been supported by a decline in inflation, from 8.4% YoY in January to 7.3% YoY in March. Domestic investment also was resilient in the period reaching its fastest growth rate in a year.
The significant decline in the currency in the last twelve months — the rupiah depreciated over 18% YoY — should have helped the economy’s exports become more competitive, however, exports surprised on the downside. But at the same time the domestic sector surprised on the upside amid a set of interest rate hikes and subsidy cuts last year that should have hurt consumption and investments. Overall, the downside surprise in exports was greater than the upside surprise in domestic activity.
Real GDP is a measure of the economic output or of the size of the economy — adjusted for inflation or deflation. It is the sum of the values of all final goods and services produced by that country or region over a given time period. The values depend on the quantities (volume) of the goods produced and their prices. Real GDP is a measure that holds prices constant by using a given year’s value (the base date) for all items and services. Then these values are used to calculate GDP for years prior to the base year and subsequent years. GDP can be measured in several ways, and Statistics Indonesia, the government body responsible for national accounts data, publishes GDP by expenditure and sector output. The graph illustrates the expenditure breakdown of GDP, which consists of private consump- tion, government expenditure, fixed capital investments, exports and imports. Exports are a strong driver of growth, but private consumption has traditionally contributed more to GDP growth in the domestic-oriented nation.
Despite being on a downward trend since the first quarter of 2013, Indonesia’s economic growth is expected to strengthen in the long term. The government has introduced various measures in the last twelve months that, despite having had a negative impact on growth in the short term, are meant to reform the economy and create more stable growth in the future. So far this year, the Indonesian rupiah appreciated 5.3% YTD against the US dollar, and investor confidence has been improving again. Both factors should improve in the long term as the government implements structural reforms.
The objective of the export ban, the country’s largest reform so far, is to create a more stable supply chain in the economy. It intends to boost the value of exports and support investments and consumption by forcing firms to manufacture higher value products. The fiscal deficit is another important reform the government has been tackling: subsidy cuts, which cost the government around $20 billion a year, were implemented in June last year in the hope of reducing government expenditure and narrowing the fiscal deficit. However its short-term impact was higher inflation, which rose from 4.3% YoY at the end of 2012 to 8.4% YoY at the end of last year.
Despite the reforms’ negative effect on GDP growth, the trend is not expected to change. Indonesia is having its presidential elections next July, where Jokowi, the presidential candidate of the pro-reform Democratic Party of Struggle, is widely expected to win. The frontrunner has pledged to introduce more reforms such as the gradual elimination of fuel subsidies. As such, long term reforms should be maintained in the medium run, benefiting Indonesia in the future.