A sustained recovery that will moderate

Indonesia has shown relatively strong GDP growth rates over the past two decades, averaging +5.2% in the 2000s and +5.4% in the 2010s. However, it was severely affected by the Covid-19 pandemic and related mobility restrictions, suffering a -2.1% full-year contraction in 2020 (the lowest growth rate since 1998). 2021 saw a moderate recovery, with GDP growing by +3.7%. The momentum continued in 2022 with GDP growing by +5%. Both the consumer sector and external trade continued to recover on the back of consumer confidence strengthening and a global commodities boom. However, as an export-oriented economy, Indonesia is weighed down by slowing global demand, as well as the negative impact of higher inflation and tightening monetary policies (though less so than in other regions). We expect GDP growth to take a step down in 2023 (+4%) before recovering mildly in 2024 (to +5%).

Fiscal policy shifted to a tighter deficit after a fiscal balance, reaching around 2% of GDP in the 2010s, and then rose to around 6.0% of GDP in 2020 and 2021. The deficit is estimated at 3.8% of GDP in 2022, reflecting recent increases in direct taxes (a higher bracket of 35% for personal income tax and increased standard rate of VAT from 10% to 11%), as well as new commodity export levies. We forecast that the budget deficit will further narrow to the equivalent of 3% of GDP in 2023.  

In terms of monetary policy, Bank Indonesia (BI) started a tightening cycle and increased its policy rate by 25bps to 5.5% in December 2022 — its fifth consecutive incremental increase. Inflationary pressures will peak by Q1 2023 so BI is likely to cut the policy rate by the end of 2023. As external demand and global prices for key commodity exports ease, BI's focus in 2023 will pivot towards supporting the recovery of the rupiah against the US dollar.

Indonesia’s business environment is ranked above average in our assessment of 185 economies. The Heritage Foundation’s Index of Economic Freedom survey 2022 assigns Indonesia rank 66 out of 185 economies (it climbed from 2017 to 2020, but went down since 2021), given its good performance in government spending, fiscal health and tax burden, though weaknesses remain in government integrity, judicial effectiveness and labor freedom. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators survey indicates that government effectiveness, regulatory quality and rule of law have improved since 2011. Though the government has taken policy actions to achieve net-zero emissions by 2060, environmental sustainability remains in bad condition, considering Indonesia's coal-dominated energy mix and industry reliance on natural resources.

The next presidential election will take place in February 2024, which will test the political stability Indonesia has achieved in recent years and challenge the wave of liberalizing reform. Indonesia has traditionally been inclined towards the protectionism of key industries and natural resources. Over his two terms in office, the current present Joko Widodo (known as Jokowi) has pushed consensus on this issue further towards acceptance of higher levels of foreign investment, especially in industries downstream of primary goods extraction. However, protectionist views still persist strongly among the political class. After the election, there is the risk that the next government could tighten laws on foreign ownership and investment.