Indonesia was not immune from the weakening of the global economy, despite the launch of an accommodative policy mix, including four benchmark rate cuts by Bank Indonesia (BI). Moreover, the tax revenue shortfall suggested that waning global demand has taken its toll, limiting the government’s space for an expansionary fiscal policy to spur the economy without aggressively widening the fiscal deficit.

Nonetheless, the rupiah exchange rate remained relatively stable with an appreciation trend against the US dollar following the improvement in the balance of payments. This was mainly due to a reverse capital inflow and a narrowing current account deficit, hence the increase in foreign reserves. Thanks to global monetary easing led by the United States Federal Reserve’s dovish pivot and the accomplishment of the government’s various efforts to curb imports, respectively.

Furthermore, consumer price inflation has been successfully managed, hitting the lowest rate of the past 20 years, effectively helping to maintain the public’s disposable income and purchasing power. This was reflected through a solid consumer spending growth rate of around 5 percent. This also has given room for BI to continue to have an accommodative monetary policy going forward.

Outlook

Has Indonesia’s economy bottomed out? Is there light at the end of the tunnel? It is too early to answer such questions, since the recent outlook shows that the economy is at a crossroads. During this time, the government should play an interventionist role to ensure that the potential of Indonesia’s economy is maintained.

One month has passed and 2020 has indicated a considerably promising prospect with some caveats for the economy. Signs of economic vigor come from a continued global monetary easing environment and the government’s agenda of economic reform, encompassing competitiveness enhancement and structural
transformation.

However, uncertainty clouding the global economy will continue in 2020. Without solid precautionary measures from the government, this can drag Indonesia’s economy into a slowdown. The main risks come from the ongoing US-China trade war in spite of a positive outlook after the phase one trade deal, the geopolitical uncertainty related to Brexit as European leaders have warned that the United Kingdom will face a tough battle to get a trade deal by the transition period end, the tensions in the Middle East, and most recently escalating fear of the China novel coronavirus outbreak, which may reduce further global trade volumes and hurt global tourism.

Strategy

To steer the economy back toward an upward trend, the government has planned to adopt breakthrough so-called omnibus bills, focusing on taxation (fiscal incentives) and job creation. These will simplify regulations by replacing overlapping measures and eliminating the issue of departmental protectionism, and strengthening central-local government coordination and legal certainty. The goal is to improve the domestic investment climate and the ease of doing business, thereby encouraging competitiveness, higher investment and ultimately boosting economic growth.

Nevertheless, the omnibus bills alone cannot encourage sustained economic growth. The bills together with the synergy in monetary and fiscal policies, and reinforcement of financial inclusion and deepening, may only work in the short-term. Over the long-term, however, they are more of a supplement for structural transformation, which is the backbone of Indonesia’s future economy. The economic gears need to shift from a heavy dependence on natural resources and commodity-based sectors, to higher value-added and knowledge-intensive sectors. Therefore, industrial revitalization toward more advanced manufacturing and service industries needs to become the focus.

To do so, investment projects have to be effectively optimized through the priority industries, which are labor-intensive and export-oriented, in the Industry 4.0 road map (food and beverages, textiles and clothing, electronic, automotive and chemical), tourism and creative industry, and development of their supporting industries. The development includes the transformation of the primary sectors from upstream to downstream, in order to strengthen import substitution industries, and the education sector to generate high-quality human resources ready to compete in a digital era.

This strategy also demands investment efficiency. Since 2013, Indonesia’s incremental capital-output ratio (ICOR) has been above six, relatively higher than the ICOR of other emerging markets, such as five for China and Malaysia, and four for India, Vietnam and the Philippines. It means that to produce 1 percent growth, Indonesia requires investment to increase by more than 6 percent while other emerging markets need only between 4 and 5 percent.

The cause of Indonesia’s high ICOR is that in investment activities, supporting spending remains higher than substantive spending, and the economy is still low-integrated into the global value chains. While the former can be addressed by the implementation of the omnibus bills, the latter has to be coupled with effective utilization of the Regional Comprehensive Economic Partnership, and acceleration of several ongoing regional and bilateral trade negotiations and reviews. Indonesia needs to look for new and nontraditional export markets outside the US and China, as the International Monetary Fund has projected that the world’s two biggest economies will decelerate further in the next couple of years.

Only by expediting structural transformation will the government successfully attain the vision of Indonesia 2045, transforming the country into the fifth-largest economy in the world.

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The writer is an economist at Bank Mandiri.

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