F

ollowing a downward trend since 2013, Indonesia'€™s GDP growth in the second quarter of this year (2014 Q2) decelerated to 5.12 percent year-on-year (y-o-y) '€” 2014 Q1: 5.22 percent; 2013 Q2: 5.76 percent '€” its lowest level since 2009 Q3, and came in slightly below our and consensus estimates of 5.20 percent (table 2). We attribute the slower 2014 Q2 GDP growth mainly to reduced government expenditure.

Despite expected substantial domestic demand from political-related activities and the advent of the fasting month, 2014 Q2 private consumption was relatively flat at 5.59 percent y-o-y (2014 Q1: +5.61 percent) as shown in table 3, while investment growth also dropped slightly to 4.53 percent y-o-y (2014 Q1: +5.14 percent).

Moreover, the government'€™s austerity program in 2014 Q2 also resulted in a spending contraction of 0.71 percent y-o-y (2014 Q1: +3.58 percent). Additionally, 2014 Q2 real exports also further contracted 1.04 percent y-o-y (2014 Q1: -0.44 percent) due to the sluggish global economic recovery, which has not been fully backed by global demand.

Transportation, electricity and retail were the main sectors that were a drag on 2014 Q2 GDP growth (table 6).

In the short-term, Indonesia'€™s economy should hinge on the government'€™s fuel-subsidy reforms. Our sensitivity analysis reveals that if the government were to raise
subsidized fuel prices by Rp 1,000 (8.5 US cents) per liter in 2014 Q3, the consumer price index for 2014 would increase to around 7.9 percent y-o-y from our base of 5.9 percent, putting domestic consumer spending at risk.

Under this scenario, our 2014 GDP target would go down to 5.05 percent, from our current forecast of 5.25 percent. A fuel-price hike could see our 2015 GDP growth decline to 5.37 percent, from 5.53 percent currently.

On a brighter note, we see medium-term direct investment remaining resilient as Indonesia still presents an attractive consumer market led by a growing young middle-class population, providing incentives for investors to build plants close to the market. Concurrently, a modest improvement in the US and other advanced economies could further provide a boost to manufacturing exports, leading to a recovery in the trade balance going forward.

Thus, we see a little silver lining to bolster growth ahead despite the current dark clouds in the form of possible price shocks stemming from higher fuel prices.