Indonesia’s Economy in 2014

The year 2013 exposed a number of weak spots in Indonesia’s economic setup and demonstrated that the country remains vulnerable to capital outflows. At the same time, GDP growth slowed and consumer sentiment was dragged down by higher fuel as well as electricity prices and rising interest rates. In many ways, 2013 was a sobering experience for an economy that overflowed with self-confidence just two years earlier, and it begs the question as to what 2014 holds in store. National elections add a political dimension to uncertainty over Indonesia's immediate future, but they could usher in brighter business prospects and help the economy get back on form.

Macroeconomic Adjustment

After key economic indicators worsened in the course of 2013, there are reasonable expectations that the year ahead should see some trends turn for the better.

GDP: While still strong by global comparison, Indonesia's economy has gradually slowed over the past two years. By the third quarter of 2013, annual GDP growth had declined to 5.6%, down from 6.5% in 2011. The slowdown was at first largely owed to lower global prices for key Indonesian export commodities such as thermal coal, natural rubber, gold and crude palm oil, and more recently also to slowing investment and consumption. Net exports are set to remain subdued going into 2014 amid large stockpiles of rubber and coal in China. Investors will likely remain cautious ahead of presidential elections in July, while household spending – the core pillar of Indonesia's economy – is under the cosh as consumers fret about inflation. If downward pressure on the Rupiah persists, Bank Indonesia (BI) may be compelled to raise interest rates further in early 2014, which could hurt investment and consumption in the short run. On the bright side, public spending is set to buoy GDP in 2014, as the state budget plan foresees an increase of 6.7% over 2013, largely to boost infrastructure development. The second half of the year could see brighter prospects for both investment and household spending, as inflation is expected to come back down which would allow BI to relax its monetary policy. Assuming the world economy continues to strengthen, so should global commodity prices and hence Indonesian exports.

Rupiah: On a downward trend for more than two years, the rupiah's exchange value dropped below 12,000 to the US dollar in November 2013, making it the year's worst performer among Asian currencies. The driving forces behind the Rupiah's depreciation to a four-year low were the worsening trade balance and asset sales by global portfolio investors fearing that the US Federal Reserve would soon begin to reduce quantitative easing. The weaker rupiah in turn stoked imported inflation by driving up the domestic cost of imported goods and materials. The current account deficit reinforced negative sentiment about Indonesia's currency to the extent that traders appeared to disregard repeated rate hikes and other countermeasures taken by the central bank. Approaching the end of 2013 however, a growing number of experts opined that the devaluation no longer fairly reflected the economic fundamentals, which gives rise to hope that the currency might regain some strength in 2013. That said, the government appears quite willing to accept a lower Rupiah as it seeks to bolster exports; it is therefore unlikely that the currency will return to its 2011 strength any time soon.

Trade: Indonesia's current account balance turned negative in late 2011 and has remained in red territory almost ever since, dragged down by poor exports and, more recently, faltering foreign investment. However, the current account gap narrowed slightly in the third quarter of 2013 to $8.5 billion (3.8% of GDP) after hitting $10.0 billion (4.4% of GDP) in the second quarter, mainly because non-oil and gas imports fell more than exports. The combination of a weak currency and elevated interest rates should prove a potent mixture to further reduce the current account deficit in 2014, because a weak Rupiah makes imported goods and services less affordable for Indonesian firms and consumers, while higher borrowing costs constrain domestic demand by tightening credit conditions. It seems reasonable, therefore, to expect the current account deficit to shrink further next year, which should improve investor confidence in Indonesia's economy as a whole.