298 M. Chatib Basri and Arianto A. Patunru
TABLE 1 Components of GDP Growth 2000 prices; per annum; per quarter
Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06
YEAR-ON-YEAR Gross domestic product
6.3 5.6
5.6 4.9
4.7 5.2
Non-oil gas GDP 7.2
6.6 6.5
5.7 5.4
5.7
By sector Tradables
4.4 2.8
3.4 3.3
3.4 4.0
Agriculture, livestock, forestry fi sheries 1.1
0.9 3.0
5.5 3.9
5.0 Mining quarrying
4.1 –0.5
1.0 1.9
3.7 5.4
Manufacturing 6.3
4.9 4.5
2.9 3.1
3.1 Excluding oil gas
7.5 6.2
5.7 4.1
3.8 3.4
Non-tradables 8.4
8.9 8.2
6.6 6.1
6.5
Electricity, gas water supply 6.4
6.9 6.6
6.1 5.8
5.7 Construction
7.4 8.2
6.9 6.9
7.2 8.3
Trade, hotels restaurants 9.9
10.0 8.7
6.0 4.7
4.6 Transport
10.3 7.7
5.2 2.6
3.8 7.2
Communication 21.6
25.7 27.4
25.4 23.0
22.8 Financial, rental business services
6.7 8.9
7.9 5.2
5.4 5.1
Other services 4.6
4.4 5.6
6.0 5.4
5.9
By expenditure Household consumption
3.4 3.8
4.4 4.2
2.9 3.0
Government consumption –9.6
–6.7 14.7
30.0 12.8
31.4 Investment
14.1 15.6
9.4 1.8
0.9 –1.0
Building 6.3
7.1 5.8
5.7 7.2
8.3 Machinery equipment domestic
–4.5 –14.3
–22.6 –18.0
–18.9 0.2
Machinery equipment foreign 66.7
67.0 34.2
–10.0 –23.9
–36.0 Transport domestic
43.9 31.3
7.4 –5.4
–51.7 –66.4
Transport foreign 46.1
50.4 23.4
–3.9 39.8
24.9 Other domestic
2.5 1.2
–9.2 –4.4
–12.7 –5.5
Other foreign 53.8
56.3 31.3
1.6 –13.2
–19.3 Exports
11.8 11.2
4.8 7.4
11.0 11.3
Imports 18.8
17.9 10.6
3.7 3.7
8.3
QUARTER-ON-QUARTER Gross domestic product
2.3 1.7
3.1 –2.2
2.1 2.2
By expenditure Household consumption
0.0 1.4
1.7 1.1
–1.2 1.4
Government consumption –24.5
7.4 20.2
33.2 –34.4
25.1 Investment
–1.2 4.8
3.2 –4.8
–2.0 2.8
Building –1.3
2.1 3.0
1.8 0.0
3.1 Machinery equipment domestic
8.0 –18.5
–1.5 –5.4
6.8 0.7
Machinery equipment foreign –1.4
20.0 5.0
–27.6 –16.7
0.9 Transport domestic
11.3 1.5
–8.8 –8.3
–43.1 –29.5
Transport foreign –10.1
23.1 7.1
–19.0 30.8
10.0 Other domestic
–6.2 –5.3
2.6 4.9
–14.4 2.6
Other foreign 7.1
13.2 8.8
–23.0 –8.5
5.3 Exports
–4.7 4.7
5.1 2.5
–1.6 5.0
Imports 0.5
3.2 3.6
–3.4 0.4
7.9
Source: CEIC Asia Database.
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Survey of recent developments 299
Expenditure. On the expenditure side of the national income accounts, eco-
nomic growth continues to depend heavily on consumption spending by gov- ernments, and on exports—thanks to high commodity prices in international
markets. Household consumption has been growing only slowly for some time now, and it is of particular concern that the growth of investment spending has
declined so far as to become negative y-o-y in the June quarter.
a Consumption. Household consumption grew by 3.0 y-o-y in Q2 2006,
much the same as in Q1, and by 1.4 quarter-on-quarter q-o-q. The rebound evident in the q-o-q fi gure, and in the index of retail sales fi gure 1, may be a
consequence of declining infl ation. According to De Gregorio, Guidotti and Vegh 1997, an initial fall in infl ation generates a positive wealth effect that induces
consumers to bring forward their purchases of non-food items, including durable goods and conversely. The fuel price hikes in October 2005 clearly induced con-
sumers to rationalise their demand for motor vehicles and motorcycles, but this effect has been reversed as the infl ation surge recedes fi gure 1.
5
Consistent with this argument, the growth of household consumption in Q2 was driven mainly
by non-food consumption not shown, which accelerated from –1.5 in Q1 2006 to 1.8 q-o-q in Q2.
Government consumption has been growing strongly in y-o-y terms over the last year. It grew extraordinarily rapidly, q-o-q, in Q2 2006, in strong contrast to
the even more drastic decline in Q1. Despite the relatively small contribution of
5 Disaggregated data on purchases by model of motor vehicle not presented here also show that buyers shifted their preference toward cheaper and low energy cars. Major com-
panies like Astra are increasing their production capacity in anticipation of further recov- ery in motorcycle sales interview with Tossin Himawan, director of Astra International.
FIGURE 1 Indicators of Economic Activity sales growth per quarter; 2-month moving average
Feb–05 May–05
Aug–05 Nov–05
Feb–06 May–06
-40 -20
20 40
Cement Motorcycles
Motor vehicles Retail
Source: CEIC Asia Database.
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300 M. Chatib Basri and Arianto A. Patunru
government consumption to aggregate demand, this surge clearly provided a sig- nifi cant impetus to economic growth in the second quarter. These wild quarterly
gyrations seem to refl ect the diffi culty the bureaucracy has in spending money early in the fi scal year, and the corresponding rush to spend allocated amounts
toward the end. Thus government expenditure for 2006 is still far below budget. From January to August 2006, actual central government routine expenditure
amounted to only 37 of the budgeted amount, and for capital expenditure the fi
gure was only 31: in broad terms, only one-third of the budget had been spent during the fi rst two-thirds of the year. As noted by Manning and Roesad 2006:
154, much remains to be done to raise effi ciency on the expenditure side of budg- etary operations.
b Investment. In contrast to the mild slowing of y-o-y household consump-
tion growth over the last four quarters, investment growth has declined dramati- cally, becoming negative in Q2 2006. But the q-o-q picture is less bleak, with a
return to positive growth in Q2. Building construction is buoyant, as suggested by fairly rapid growth in sales of cement fi gure 1, while no clear pattern emerges
in relation to growth of other components of investment. Despite the slowdown of investment growth during the fi rst half of 2006, investment seems likely to
increase in the second half, given strong positive growth of capital goods imports 25 from July to August 2006. Normally there is a lag of about three months
before imported capital goods turn into investment; on this basis we expect invest- ment to begin to pick up by the last quarter of 2006.
According to the Investment Coordinating Board BKPM, foreign direct investment FDI realisations reached 4.29 billion, spread over 702 projects, for
the period January–September 2006; this constituted a 44 decline in value rela- tive to the same period in 2005 BKPM 2006. It appears to represent a signifi cant
loss of momentum, since FDI approvals last year were 94 higher in value than in 2004. On the other hand, this year’s approved FDI projects are forecast to cre-
ate 179,000 jobs, compared with only 119,000 for the same period last year. It is diffi cult to interpret these data, however, since BKPM is now—in the deregula-
tion era—obliged to rely on reports from provincial and local governments to some extent.
The total value of domestic investment approvals for the fi rst eight months of 2006 was Rp 11.8 trillion about 1.3 billion at an exchange rate of Rp 9,000—
a 7 increase over the same period in 2005—spread over 113 projects. The number of jobs forecast to be created is 44,000, compared with 71,000 last year.
These fi gures are even less meaningful than those for FDI, however, since it is not compulsory for domestic fi rms to obtain BKPM approval for their invest-
ments. This is the main reason why the value of domestic approvals is only about one-third that of foreign approvals—in reality, domestic investment far
exceeds foreign investment.
c Imports and exports. Export growth has recovered to the fairly high level of
11.3 y-o-y, in constant price rupiah terms, similar to the rates recorded in the fi
rst half of 2005, whereas import growth has shown a quite different pattern— falling from very high rates in early 2005 to rates well below export growth rates
for the last three quarters shown in table 1. Merchandise exports performed very well in the fi rst eight months of 2006
table 2. Dollar values for this period were well up on the corresponding period
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Survey of recent developments 301
in 2005, with all major categories making strong contributions. Oil and gas, agriculture and mining all benefi ted from high commodity prices Athukorala
2006. More than 63 of the increase in non-oil exports during this period was accounted for by resource commodities, including rubber and rubber products;
mineral fuels; copper; and animal and plant oils and fats. The growth of manu- facturing exports, which comprise nearly two-thirds of total exports, was not as
rapid, and was driven mainly by the paper and cardboard sub-sector. The fact that recent export performance is largely a refl ection of increased commodity
prices raises questions about sustainability. On the other hand, the commodities boom has much to do with China’s rapid economic progress, which shows no
sign of slackening.
Financial markets The capital market.
The Jakarta Stock Exchange JSX index resumed its rapid ascent during the third quarter of 2006. It considerably out-performed other
exchanges in the region in the year to September, increasing by some 42 fi g- ure 2. Positive sentiment in the market appears to have been generated by sta-
ble government, the improved economic growth rate and the steady decline in infl ation.
In addition, the government bond market is becoming deeper and more active. The average monthly volume of trading in 2006 is higher than in 2004 previously
the most active year on record. The investor base is becoming less skewed, with the proportion of bonds owned by foreigners increasing dramatically from 2.7
in December 2004 to 13.4 by July 2006 MOF 2006a.
6
These developments would appear to refl ect the pay-off to sound fi scal and debt management. The
yield curve on government bonds has been shifting downwards in line with the steady reduction in the central bank’s interest rates; the relatively low rate even
6 Previously almost all government bonds were held by banks as a result of their recapi- talisation by the government in 1998–99.
TABLE 2 Merchandise Export Growth and Composition January–August 2006;
Growth Share of Total
year-on-year
Total exports 17.1
100.0
Oil gas 16.8
22.1 Non-oil gas
17.2 77.9
Agriculture 21.7
3.5 Manufacturing
14.6 64.3
Mining other 35.3
10.1
Source: BPS.
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302 M. Chatib Basri and Arianto A. Patunru
on 20-year bonds indicates considerable market confi dence in Indonesia’s long- term prospects.
The foreign exchange market. Notwithstanding its sudden weakening in May
Manning and Roesad 2006: 150, Indonesia’s currency has been stronger than those of its neighbours with the partial exception of the Philippines peso in the
year to September, having been relatively stable since mid-May fi gure 3. Factors that help to explain the rupiah’s recent strength include net capital fl ow resulting
from the relatively high differential between domestic and international interest rates, the favourable terms of trade fl owing from booming commodity prices, and
a generally high level of satisfaction among domestic and global investors with the government’s performance. Performance of the JSX index closely mirrors that
of the rupiah, refl ecting the important role of portfolio investment in infl uenc- ing the exchange rate: when investor confi dence declines, the stock market index
falls under selling pressure, and the rupiah depreciates as funds are shifted off- shore—and conversely.
Infl ation and monetary policy Although the y-o-y infl ation rate was still as high as 14.6 in September 2006
fi gure 4, this fi gure was highly distorted by the fuel price surge in October 2005; infl ation has declined fairly steadily since then, such that the annualised rate
over the last 11 months is only 5.9, which is quite low by Indonesia’s rather soft standards Fane 2005. We tend to believe that the success of Bank Indonesia BI
in keeping money supply growth relatively modest has been a major determinant of this outcome. Given the recent trend in infl ation, together with the govern-
ment’s decision to open up rice imports see below, we consider that BI’s infl a- tion target of less than 8 in 2006 can easily be achieved. Having said that, the
central bank’s eagerness to bring interest rates down is keeping money supply FIGURE 2 Regional Stock Markets
September 2005 = 100
Sep–05 Nov–05
Jan–06 Mar–06
May–06 Jul–06
Sep–06 25
50 75
100 125
150
Jakarta Kuala Lumpur
Manila Singapore
Bangkok
Source: CEIC Asia Database.
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Survey of recent developments 303
growth rates somewhat higher than is consistent with infl ation at the target level. BI cut its policy rate by 50 basis points in August, September and October 2006,
taking this rate down to 10.75 in October compared with 12.5 in May 2006. As a result of this steady downward pressure on rates, cash in circulation has grown
at an average 14.8 p.a. from January through August fi gure 4.
50 60
70 80
90 100
110
Indonesia Malaysia
Philippines Singapore
Thailand
30905 291105 28105 29306 28506 27706 25906
FIGURE 3 Regional Exchange Rate Indices local currency per ; 30 September 2005 = 100
Source: Pacifi c Exchange Rate Service.
FIGURE 4 Rates of Infl ation, Interest and Money Supply Growth
a
p.a.
Oct–05 Dec–05
Feb–06 Apr–06
Jun–06 Aug–06
5 10
15 20
25 30
35 CPI
Currency in circulation SBI 30-day rate
a
CPI: consumer price index; SBI: Bank Indonesia Certifi cate. Source:
CEIC Asia Database.
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304 M. Chatib Basri and Arianto A. Patunru
Although the central bank’s policy rate has been declining over the last few months, commercial bank lending rates have changed very little during 2006. As
a result, the hoped for impact on the real sector of reductions in the policy rate has yet to emerge: indeed, the rate of growth of bank lending has declined stead-
ily since September 2005. For this reason alone there seems little point in pushing interest rates down too quickly. Nor is it helpful to blame banks for their reluc-
tance to lend. Lending outcomes depend not only on supply but also on demand, and the latter is undoubtedly impeded by heavy government intervention in the
labour market, an extortive bureaucracy, and poor security and enforcement of contracts—all of which constrain fi rms’ willingness to undertake investment, and
create risks for banks that lend to fi rms that do choose to invest.
In summary, macroeconomic stability continues to be maintained and there are some signs that growth is starting to pick up. With positive macroeconomic signs
and high commodity prices in international markets, a sense of optimism has started to be felt in some sectors. But although there is signifi cant capital infl ow,
this appears to be limited mainly to portfolio investment, and has had no major impact on investment spending. Indeed, the government needs to stay alert to
the possibility of a reversal of capital infl ow if Indonesia should experience some unexpected economic or political shock. Thus far, however, it has been able to
maintain political stability, and the markets seem to have become less sensitive to political issues, including the second Bali bombing in 2005.
THE BUDGET The budget for 2007, presented by the president to the parliament DPR on 16
August, assumes economic growth of 6.3 next year, which is in line with the latest World Bank projection of 6.2 table 3. Respected economic commentators such
as Faisal Basri and Hadi Soesastro have also argued that the growth assumption is realistic, given the current state of the economy JP, 18806. Others have con-
tended that this assumption is a little too optimistic but, given the possibility of continued economic rebound in the second half of 2006, we too consider that the
economy will grow by more than 6 next year. The budget defi cit as a proportion of GDP is projected to diminish from 1.2 in the revised budget for 2006 to 0.9 in
2007. The markets seem to regard the budget overall as satisfactory, as is refl ected in the stable exchange rate and the rising stock market.
The infl ation rate of the CPI is projected at 6.5 for 2007—within BI’s target range of 6.0 ± 1, but a little higher than the mid-point. This suggests a slight lack
of confi dence on the part of the government in the central bank’s ability to keep infl ation on its recent downward trend, considering that it is already a little below
6 setting aside the one-off effect of increased fuel prices in October 2005, and that global infl ation is relatively low. The interest rate on BI’s 3-month certifi cates
SBIs is projected to average 8.5 p.a. This target should be considered aggres- sive, because the SBI rate will probably still be around 10.5 by the end of 2006;
in turn, this implies that BI will need to cut the interest rate to well below 8.5 for some part of next year. Moreover, these two targets together imply a real interest
rate of only 2 on average during 2007, which seems too low to be plausible. This naturally raises the possibility of exchange rate weakening and a resurgence of
infl ation if BI becomes too aggressive in reducing nominal rates.
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Survey of recent developments 305
TABLE 3 Approved Budget 2006 and 2007 Budget
2006
a
2007 Rp trillion of GDP Rp trillion of GDP
REVENUE AND GRANTS 651.9
20.9 713.4
