Resilient growth amidst improved fundamentals

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, suffering a -2.1% full-year contraction in 2020. 2021 saw a moderate recovery, with GDP growing by +3.7%. The momentum continued in 2022 with GDP growing by +5.3%. Growth took a small step down in 2023 (likely to +5%), on the back of a resilient consumer sector but slowing external demand. We expect Indonesia to continue to register solid levels of economic growth, nearing +5% in 2024-2025, on the back of a strong consumer base and easing inflation, investment in the context of global supply-chain diversification and a moderate rebound in global demand.

After expanding to around 6% of GDP in 2020, the fiscal deficit has been narrowing in recent years and returned close to the pre-crisis long-term average of around 2% in 2022. Increases in direct taxes, new commodity export levies, removal of income assistance expenditure and higher corporate tax revenue are keeping the fiscal deficit in check. This is likely to help gradually reducing the public-debt-to-GDP ratio.

In terms of monetary policy, Bank Indonesia (BI) started a tightening cycle in the second half of 2022, against inflationary pressures and to stabilize the rupiah. A cumulative 250bps of rate hikes have been applied until October 2023. We expect no further increases as inflationary pressures ease and the rupiah stabilizes against the US dollar and 50bps worth of rate cuts are likely in the second half of 2024.

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 reforms. Indonesia has traditionally been inclined towards protectionism of key industries and natural resources. Over his two terms in office, current President 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, after the election, there is the risk that the next government could tighten laws on foreign ownership and investment, as protectionist views still persist strongly among the political class. That said, in the baseline scenario (based on latest polls), the next president is likely to be current defense minister Prabowo Subianto, who has committed to continue Jokowi’s policies. We would also watch out for potential protests and unrest if the election result is close.