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Achieving Indonesia’s 8 percent growth goal

The goal now will require much stronger efforts in an era of heightened global competition and worrying global economic trends.

Esther Sri Astuti and Daniel A.Witt (The Jakarta Post)
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Semarang/Washington, DC
Thu, December 19, 2024

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Achieving Indonesia’s 8 percent growth goal Construction cranes operate near skyscrapers at a business district in Jakarta on Nov. 13, 2024. (AFP/Bay Ismoyo)

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resident Prabowo Subianto was right to focus his first trip abroad as President not only on making Indonesia’s influence clear at important international summits but also on attracting new foreign investments to Indonesia. Only large volumes of new investment, both foreign and domestic, will enable him to achieve his ambitious goal of 8 percent annual growth by the end of his term in 2029. While the target harkens back to earlier growth spurts, notably in the 1980s and 1990s before the Asian financial crisis, the goal now will require much stronger efforts in an era of heightened global competition and worrying global economic trends.

Last year’s 13.7 percent increase in foreign direct investment to US$47.19 billion is impressive. Capital is coming here, in the expectation of strong returns. Indonesia is catching up to ASEAN peers in the total volume of investment (Thailand $18.6 billion, Vietnam $23.1 billion). But the competition gets steadily keener every year, with no time for Indonesia to rest on its laurels.

The stagnant growth rate of around 5 percent over the past decade is the starting point of Indonesia's serious problems. How could it not be? In the third quarter of 2024 Indonesia recorded economic growth of 4.95 percent year-on-year (yoy), lower than other ASEAN countries such as Malaysia at 5.34 percent and far behind Vietnam at 7.40 percent. Good macroeconomic policy and policies that encourage the right conditions for investment are needed. Both are important.

Consider macroeconomic policy first. Indonesia must aim for this level of growth while avoiding the twin dangers of adding excessive debt or introducing excessive fiscal stimulus. Some have warned that Indonesia risks overheating its economy and spurring high inflation if it does not keep these guardrails in place.

In addition, Indonesia’s future fiscal burden also shows worrying trends. Fiscal space, as the main driving force of the government’s work, has narrowed as debt has increased, to about 38 percent of GDP in 2024. Although the debt-to-GDP ratio is still below the 60 percent threshold in Indonesia’s fiscal rule, the significant increase in the last decade indicates future risks that need to be anticipated. Dependence on high-cost debt is also a serious problem, considering that Indonesia has the highest bond yield in ASEAN, reaching 7.2 percent for a 10-year tenor, far above the figures for neighboring countries. This not only increases the burden of interest payments but also reduces fiscal capacity for productive spending.

The basics of sound fiscal policy are clear: avoid excessive spending and preserve Indonesia’s fiscal rule. Budget management should be carried out effectively and efficiently and allocated to government programs that have a broad and long-term multiplier effect. Routine spending budgets should be smaller than capital spending budgets for development. Just because an economy can afford more debt does not mean that increasing debt is necessarily wise. Currently, Indonesia lags behind its ASEAN peers in the ratio of revenues to GDP, and further behind the 33.9 percent average of member states of the OECD that Indonesia seeks to join during Prabowo’s term. The forthcoming increase in the VAT rate to 12 percent also highlights the potential tradeoff between tax rates and revenue growth.

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In addition, deflation that occurred for five consecutive months (May-September) in 2024 raises concerns over consumers’ ability to spend; the deflation data reflects economic sluggishness. This situation is further reinforced by the contraction of the Purchasing Manager Index (PMI) of the manufacturing industry in the four months from July-October 2024. The PMI contraction indicates that the manufacturing sector is experiencing a slowdown as orders and sales fall.

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