SINGAPORE, April 21, 2022 – The Indonesian economy is on track to a firm recovery as a result of effective pandemic containment measures and policy support. In light of ongoing pandemic uncertainties, the authorities are encouraged to continue to ramp up the vaccination rate and recalibrate policy measures toward supporting the recovery momentum. Accelerating structural reforms is crucial for strengthening the country’s resilience and growth potential post-pandemic.

These conclusions are highlighted in the 2021 Annual Consultation Report on Indonesia published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was based on AMRO’s Virtual Annual Consultation Visit to Indonesia from October 25 to November 19, 2021, and data and information available up to February 15, 2022.

Recent developments and outlook

Thanks to robust exports and stronger domestic demand, real GDP rebounded by 3.7 percent in 2021, and is expected to expand further by 5.2 percent in 2022. Domestic demand recovery is expected to lift inflation from an annual average of 1.6 percent in 2021 to a still low rate of 2.8 percent in 2022.

Stellar export performance and an increase in foreign direct and portfolio investment inflows have supported the rupiah. Gross international reserves have increased to USD144.9 billion, equivalent to 8 months of imports, as at December 2021.

Policy response to the pandemic

Bank Indonesia’s policy mix continues to support economic recovery. The central bank has kept its policy rate at a record low of 3.5 percent following six rate cuts since the start of the pandemic. A low interest environment, coupled with Bank Indonesia’s quantitative easing measures and fiscal-monetary policy synergy to support economic recovery from the pandemic, have underpinned loose liquidity conditions in the banking system.

As the banking sector remains sound, macroprudential regulations on automotive and property loans have been relaxed, in sync with the government’s tax incentives for car and home purchases, under a policy package coordinated by the Financial System Stability Committee[1] to support recovery. Efforts have been stepped up to digitalize payment systems and enhance financial inclusion.

The government increased the fiscal support package to about 4.4 percent of GDP in 2021 to combat the impact of the Delta variant outbreak, of which 88.4 percent, or about 3.9 percent of GDP, was disbursed. The 2022 Budget with a total spending of IDR2,714 trillion, or about 14.9 percent of GDP, aims to sustain the recovery momentum in view of the continuing uncertainty surrounding the pandemic.

Bank Indonesia has contributed to the financing cost of pandemic-related healthcare spending and humanitarian aid by buying government bonds through private placement at variable interest rates in 2021-2022.

To support medium-term fiscal consolidation and restore fiscal discipline post-pandemic, the government has pushed through parliament a comprehensive tax reform package, including a higher value-added tax rate and a new carbon tax, the latter being a signal of its commitment to the climate change agenda.

Risks and vulnerabilities

Risks to the near-term outlook continue to stem from COVID-19 resurgences, especially the emergence of more infectious variants. Renewed waves of infection, accompanied by re-tightening of containment measures, would weigh on Indonesia’s recovery momentum and deepen the disparity across sectors.

Deteriorating sentiments among global investors, triggered by changes in the monetary policy stance of central banks in advanced economies, could heighten volatility in Indonesia’s financial markets. However, reduced foreign holdings of government bonds, a strengthened external position, and low inflation, should help mitigate possible spillovers.

Indonesia’s elevated debt-service burden, partly driven by higher government borrowing during the pandemic, would increase further with the expected tightening of the U.S. Federal Reserve (Fed)  monetary policy, reducing the room for much-needed capital spending. The reduced fiscal space could be a major constraint on growth when Indonesia restores the fiscal rule of a maximum budget deficit of 3 percent of GDP in 2023.

Fiscal-monetary policy synergy has been strengthened in response to the ongoing pandemic with Bank Indonesia’s contribution to the financing cost of healthcare spending and humanitarian aid until 2022. A smooth exit from this arrangement underpinned by the implementation of the tax reform package and continued fiscal-monetary policy synergy is crucial to maintain market confidence and support economic recovery post-pandemic.

Policy recommendations

Faster vaccination, especially in rural and remote areas, and enhanced healthcare capacity, are essential to protect the population and mitigate the risk of a resurgence of infection.

To provide continued support to affected businesses, it is important to set a sufficient size for the loan guarantee programs for micro, small and medium enterprises (MSMEs), and corporates moving forward.

Policy measures to improve financial inclusion should be complemented with concerted efforts to build a prudent business framework for banks to lend to MSMEs, including the promotion of proper bookkeeping and strengthened risk management among these enterprises.

Looking ahead, in light of increased external headwinds, AMRO supports Bank Indonesia’s continuous recalibration of its policy mix by adopting a prudent and measured normalization of the monetary policy to safeguard stability, while maintaining an accommodative macroprudential policy and accelerating the digitalization of payment systems, as well as financial deepening, to support sustainable economic recovery. Meanwhile, Indonesia’s resilience to external headwinds would be strengthened by its continuous engagement in bilateral, regional, and multilateral financial cooperation.

AMRO welcomes the tax reform package, as the additional revenue will support infrastructure spending amid fiscal consolidation in the post-pandemic period.

Ongoing reforms in the areas of financial deepening, investment environment, and digitalization will boost growth and productivity.

From a longer-term perspective, efforts to mitigate the impact of climate change will contribute to the achievement of Indonesia’s sustainable development goals.

[1] The Financial System Stability Committee consists of the Ministry of Finance, Bank Indonesia, Financial Services Authority and Deposit Insurance Agency.

About AMRO

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute towards securing macroeconomic and financial stability of the ASEAN+3 region, comprising 10 members of the Association of Southeast Asian Nations (ASEAN) and China; Hong Kong, China; Japan; and Korea. AMRO’s mandate is to conduct macroeconomic surveillance, support the implementation of the regional financial arrangement, the Chiang Mai Initiative Multilateralisation (CMIM), and provide technical assistance to the members.

About AMRO’s Annual Consultation Report

The Annual Consultation Report was prepared in fulfillment of AMRO’s mandate. AMRO is committed to monitoring, analyzing and reporting to its members on their macroeconomic status and financial soundness. It also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.