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SINGAPORE, April 20, 2023 – The Indonesian economy posted a firm recovery in 2022, led by strong domestic demand and robust exports. The authorities are encouraged to constantly recalibrate the policy mix to maintain stability and support economic growth in the face of stronger headwinds. Accelerating structural reforms is critical for Indonesia to transition smoothly to a green and sustainable economy and to adapt to demographic changes, along with ongoing efforts to enhance infrastructure development and improve the business climate.
These conclusions are highlighted in the 2022 Annual Consultation Report on Indonesia published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was based on AMRO’s Annual Consultation Visit to Indonesia from December 5 to 23, 2022, and data and information available up to February 15, 2023.
Recent developments and outlook
The economy grew solidly by 5.3 percent in 2022. The recovery momentum was boosted by strong domestic demand, while exports benefited from elevated commodity prices and higher value-added from downstream natural resource-based industries. Economic growth will likely remain strong at 5.0 percent in 2023, supported by resilient domestic demand amid an expected slowdown in global demand.
While soaring global food and fuel prices were passed on to the domestic market, consumer price inflation was relatively contained due to Bank Indonesia (BI)’s prompt monetary policy response in synergy with policy measures conducted by the government and related institutions, including subsidies of fuels and other necessities. AMRO staff project that the consumer price inflation will moderate to within the central bank’s target range by Q4 2023.
An improved current account balance underpinned by strong exports, coupled with elevated foreign direct investment inflows, supported the rupiah and Indonesia’s balance of payments amid capital outflows in 2022. Gross international reserves stayed high at USD139.4 billion as at January 2023, sufficient to cover about 6.1 months of imports of goods and services and twice the short-term external debt.
Policy response to the pandemic
The central bank has been recalibrating its policy mix in response to external shocks to contain inflation and support growth while ensuring financial stability. BI started its liquidity normalization policy last year by raising the rupiah reserve requirement ratio to absorb excess liquidity. BI also increased its benchmark policy rate to anchor inflation expectations and core inflation. Meanwhile, as banks and financial system remained financially sound, macroprudential policies continued to be relaxed to support economic recovery, in line with other policy measures of the Financial System Stability Committee. Efforts to upgrade payment systems and promote financial inclusion accelerated. Notably, BI launched the real-time retail electronic payment system, BI-FAST, and expanded the use of standardized quick response payments at home and with neighboring countries. In addition, a white paper was published on Project Garuda about central bank digital currency, marking another step toward improving the efficiency of the payment system in the digital era.
The government promptly took policy measures to contain inflation and maintain the people’s purchasing power. These measures included efforts to strengthen the interregional supply and distribution of necessity goods, notably food and food ingredients. To absorb the shock of global commodity price hikes, the government increased the subsidy budget for 2022 and retained subsidized fuel prices. More recently, the government raised several subsidized fuel prices to ease pressure on the budget while providing more cash transfers and wage subsidies to vulnerable groups.
The fiscal position consolidated faster than budgeted on the back of robust tax revenue collection. The 2021 tax reform package, coupled with rebounding economic activity and commodity price windfalls, underpinned a strong revenue performance in 2022. The budget deficit narrowed to substantially below 3 percent of GDP in 2022, one year ahead of the government’s plan. AMRO expects the fiscal deficit to stay below 3 percent of GDP in 2023, supported by continued tax measures and lower expenditure on account of reduced COVID-19 spendings and energy subsidies.
Risks and vulnerabilities
Indonesia’s economic growth is expected to remain solid in 2023, with short-term outlook influenced by positive spillovers from China’s re-opening and a sharper-than-expected global slowdown led by potential recession in some other major trading partners. China’s recent lifting of its zero-COVID policy and reopening of its borders will benefit tourism and exports, and present an upside opportunity for Indonesia. On the downside, as the global outlook dims, inflationary pressures might linger alongside prolonged geopolitical tensions and the protracted energy crisis. Continued monetary tightening, especially by the Fed, could extend uncertainties in global financial markets.
Challenges facing Indonesia in the medium to long term arise from the need to improve the investment climate, supported by infrastructure development and better connectivity. It is also critical for Indonesia to transition smoothly to a green and sustainable economy and adapt to demographic changes.
AMRO supports the authorities’ constant recalibration of the policy mix in response to changing domestic and external developments. As risks to inflation and capital flows persist, the central bank is encouraged to maintain its current monetary policy stance. At the same time, BI should stand ready to ease monetary policy to support the domestic economy if the risk balance tilts toward a sharper global slowdown. In addition, policy measures to deepen domestic financial markets (including the FX market), enhance the payment systems, and promote a green and inclusive economy should continue.
Targeted policy support could be refined. Micro, small and medium enterprises (MSMEs) can gain better access to bank financing through improved bookkeeping in addition to the existing credit guarantee and interest subsidy program. Financial inclusion could be strengthened via fintech along with efforts to raise financial and digital literacy. As the loan restructuring program has been extended until March 2024 for MSMEs and selected sectors, banks should be encouraged to prudently continue the program for viable borrowers only.
Fiscal space could be further rebuilt by implementing revenue-based measures. In particular, the government should continue to implement the 2021 tax reform package. While excess financing has increased recently to provide a fiscal buffer amid ongoing uncertainties, the cost of doing so is not trivial and can be minimized by improving cash and debt management. At the same time, efforts to enhance spending efficiency and effective budget allocation to support sustainable growth should continue.
AMRO welcomes the plan to launch a carbon trading market for coal-fired power plants this year. The newly endorsed Omnibus Law on Development and Strengthening of Financial Sector is expected to reform and strengthen the national pension system and deepen the domestic financial market. A strong pension system can, in turn, support the financing of Indonesia’s infrastructure development, complementing policy initiatives to raise funds from the private sector.
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. AMRO also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.