Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910701727571
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
SURVEY OF RECENT DEVELOPMENTS
Sadayuki Takii & Eric D. Ramstetter
To cite this article: Sadayuki Takii & Eric D. Ramstetter (2007) SURVEY OF RECENT
DEVELOPMENTS, Bulletin of Indonesian Economic Studies, 43:3, 295-322, DOI:
10.1080/00074910701727571
To link to this article: http://dx.doi.org/10.1080/00074910701727571
Published online: 18 Apr 2008.
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Date: 18 January 2016, At: 20:06
Bulletin of Indonesian Economic Studies, Vol. 43, No. 3, 2007: 295–322
SURVEY OF RECENT DEVELOPMENTS
Sadayuki Takii and Eric D. Ramstetter
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International Centre for the Study of East Asian Development, Kitakyushu
SUMMARY
Notwithstanding improvements in Indonesia’s political and institutional infrastructure, growth remains slower than in pre-crisis years, and there is much discussion about reinvigorating the economy. To this end, the government introduced
its fourth major policy package in June 2007, risking scepticism about its underlying resolve to implement reforms that conflict with the interests of influential
bureaucrats. The abandonment of previous attempts at labour market reform was
perhaps the most conspicuous element of the new package.
Economic growth continued to accelerate, reaching 6.3% in the second quarter.
Most first-half growth was driven by net exports and investment, even though
construction activity slowed noticeably in this period. On the production side,
output of non-tradables continues to outstrip that of tradables. Consumer price
inflation rose in the September quarter to the top of the central bank’s target
range, and seems likely to increase further. The stock market boom continued in
the year to September, notwithstanding a brief correction in August. Bank Indonesia’s exchange rate and monetary policies have created an arbitrage opportunity that appears to be contributing significantly to private capital inflow. The
2008 budget maintains a modest deficit, but contains seemingly unrealistic plans
for large increases in certain categories of spending and in tax revenue. Moreover,
the projected world oil price is so low as to call into question the transparency of
fiscal policy.
There is concern that Indonesia’s recent growth has depended too heavily on
commodity prices, but real export growth was in fact substantial in the first half
of 2007. Moreover, although Indonesia’s share of non-fuel exports as a whole in
the world market has been eroded somewhat in recent years, this masks large
variations in shares across major markets and product categories. Its market share
rose conspicuously for key primary products in some markets, while it has been
losing market share in a number of labour-intensive manufactures, adding weight
to concern about the impact of labour market policies on employment growth.
Employment in fact grew strongly in the year to February 2007, pushing unemployment down a little, and contributing to a reduction in poverty incidence.
However, employment growth has been conspicuously slow in manufacturing—particularly in labour-intensive industries. Meanwhile, newly announced
closures of certain industries to particular kinds of investors have done little to
improve the business environment.
ISSN 0007-4918 print/ISSN 1472-7234 online/07/030295-28
DOI: 10.1080/00074910701727571
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POLITICAL DEVELOPMENTS
In recent months it has been common for Southeast Asian scholars and media
commentators to look back over the decade since the Asian economic crisis began
in Thailand and spread to Indonesia, Malaysia, South Korea and other countries.
Although Indonesia’s economic growth rate continued to recover in the year to
June 2007, it was still slower than in the several years before the crisis. Much of
the related discussion concerns how to accelerate growth further. Some observers
suggest that slower growth during the post-crisis period is related to less effective
economic policy making (McLeod 2005), and indeed the government’s capacity
to dictate policy has been heavily constrained by a more powerful national parliament (DPR) and more powerful local governments (Perdana and Friawan 2007).
Private interest groups have also become more diverse and vocal, often engaging
in rent-seeking activity at the local as well as the national level.
In addition, President Susilo Bambang Yudhoyono (SBY) has a relatively weak
power base and, from the outset, had to forge a multi-party coalition of diverse
interests to stay in power. His government has introduced four major policy
packages over the last two years in the hope of boosting growth, and perhaps
also of galvanising political support for his policy agenda. The newest package
appeared in June 2007 (box 1), but the proliferation of supposedly major policy
packages—which have so far brought little substantive change to the business
environment—has led to a growing belief that the government and its bureaucracy are much better at talking about reform than at implementing it.
Opposition from the DPR and interest groups has made the government hesitant to pursue important policy reforms, and some feel the president has failed
to exploit fully the strong support he received from voters in 2004. A notable
example of this hesitancy is the omission from the new policy package of further measures to increase competition in Indonesia’s formal labour market.1 Most
economists believe such competition is too constrained by high minimum wages
(which price relatively low-productivity workers out of the market) and by onerous regulations on severance pay and other working conditions (which protect
existing employees from new competitors).
Although the dispersion of power sometimes frustrates efforts to improve economic policies, and failure to make policy improvements probably contributes to
economic hardship for many households and firms, Indonesia continues to consolidate its important post-Soeharto political and institutional achievements. In
the decade since the crisis, there have been four changes of national government
and two national elections, as well as several hundred local elections. In almost
all cases, this has brought about non-violent changes of leadership. The peace
agreement in Aceh appears to be holding, while sectarian tensions in Ambon and
other parts of Maluku have remained dormant in recent months. The police have
recently thwarted further terrorist attacks by Jemaah Islamiyah (JI) and arrested
two of its top leaders (JP, 16/6/2007); two years have passed since the last major
attack. Success against JI has resulted from policies emphasising good intelligence
and international cooperation.
1 See Manning and Roesad (2007) for details of labour market reforms proposed in 2006,
and Narjoko and Jotzo (2007) for a summary of the political gridlock that caused their
abandonment, at least for the present.
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BOX 1 THE NEW ECONOMIC POLICY PACKAGE
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The government launched yet another economic policy package (Presidential
Instruction 6/2007) in June 2007, with the aim of accelerating policy improvements in four areas: the investment climate; the financial sector; infrastructure;
and micro, small and medium enterprises (MSMEs). This package integrates
and continues the three economic packages previously issued by the SBY
administration, but measures to promote the MSME sector are included as
a major field for the first time. The package aims to ‘empower’ MSMEs by
providing better access to financial resources; promoting development of
entrepreneurship and human resources; improving market access; and implementing other regulatory reforms that will help such firms.
The urge to encourage MSMEs is understandable, given that they collectively generate substantial employment and that employment growth has
generally been slow. However, it is both counter-productive and unnecessary to favour particular kinds of firms over others. MSMEs are naturally
competitive in many sectors where economies of scale are unimportant; in
such sectors, they need no special assistance. On the other hand, to restrict
the participation of larger firms in sectors where economies of scale are
significant—which is a notable effect of the new negative list of activities
closed to certain categories of investors, discussed below—is to encourage inefficiency. Policies aimed at improving the entrepreneurial skills and
access to finance of small firms have long had a degree of political appeal in
Indonesia that far exceeds their effectiveness.
A notable difference between this and previous packages is clearer specification of expected outcomes, and more transparent ways of evaluating
them. The three earlier packages had common problems with implementation (Basri and Patunru 2006), and the new approach is intended to address
this and related concerns: the tables summarising the policies, programs and
actions contained in the package include an additional column specifying the
expected outcome for each action (Government of Indonesia 2007). Actual
outcomes will then be examined by an independent external team that is to
monitor progress on package goals for the Coordinating Ministry for Economic Affairs; the new format will allow this team to perform objective evaluations by surveying businesses on specific points.
This change of approach partly signals the government’s recognition that
effective monitoring of policy implementation is important for the package’s credibility. It also probably reflects the growing view that the government must do better at persuading the public and the legislature to support
such packages. However, despite the new procedures for evaluating outcomes, there is no indication that the government will face consequences
other than loss of face should it fail to meet its stated objectives. This creates
scepticism about whether the new package will have any more impact than
its predecessors. The underlying problem is the lack of strong incentives
for the bureaucracy to implement policy reforms that are often in conflict
with its own interests. It is not clear that this new approach does anything
to change those incentives.
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There is still much debate on the role of religion (McGibbon 2006; Salim 2007),
illustrated by recent exchanges between fringe groups arguing for establishment
of a caliphate based on Islamic (syariah) law and mainstream observers who contend that Indonesia should continue to emphasise pluralism—acceptance of, and
mutual respect for, its numerous religions and cultures (JP, 21/8/2007). Notwithstanding this debate, the more moderate groups that celebrate Indonesia’s diversity have continued to prevail in the last decade, and the government has begun to
adopt the profile of a leading supporter of democratic values and human rights in
Southeast Asia. Its support was critical to the July 2007 agreement to establish an
ASEAN Charter (expected to be adopted formally in November), which purports
to transform ASEAN into a rules-based organisation promoting democracy, human
rights, regional security, regional economic cooperation and related principles.
MACROECONOMIC TRENDS AND POLICIES
Economic growth
The year-on-year quarterly economic growth rate continued the acceleration evident since the third quarter (Q3) of 2006, reaching 6.3% in Q2 of 2007 (table 1)—the
highest rate since Q4 of 2004. In its draft budget for 2008 the government assumes
that growth will continue to accelerate in the second half to reach 6.3% for 2007
as a whole, and then increase further to 6.8% in 2008 (Ministry of Finance 2007b).
However, both of these forecasts, especially the optimistic 2008 forecast, are higher
than those by private research organisations and the central bank (Bank Indonesia,
BI).2 Although the growth rate has been increasing, it is still below pre-crisis rates
(7.5–8.2% in 1994–96), and the government is often criticised for not being able to
achieve more on this front. Accelerating economic growth remains a high priority
primarily because it is the most effective way of raising living standards for the
large number of Indonesians living on very low incomes.
Private consumption is by far the largest expenditure component of real GDP,
accounting for just under three-fifths of the total in recent years. Although this
component’s growth rebounded from 3.0% or less in the first three quarters of 2006
to 4.7% in the first two quarters of 2007, it has lagged behind that of other expenditure categories, and its contribution to overall growth has therefore been relatively
small. A more detailed analysis than that shown in table 1 indicates that increased
growth in expenditure on food was particularly conspicuous, rising from 1.6–1.8%
in the first two quarters of 2006 to 3.8–3.9% in the same period in 2007, while growth
of non-food expenditures also rose, from 4.1–4.2% to 5.4%. Meanwhile, the growth
of government consumption was quite slow in the last half of 2006, although it
accelerated in the first half of 2007, reaching 3.8% in the second quarter.
In contrast, fixed investment, the second largest component of domestic
demand, has grown more rapidly than GDP since Q4 of 2006, though it decelerated from 8.2% in that quarter to 6.9% in Q2 of 2007. Over three-quarters of investment is in construction activity, and this component has been growing far more
rapidly than GDP over the last six quarters—though it, too, slowed noticeably in
2 In August 2007, the average forecasts by 14 private think-tanks summarised in Consensus Economics (2007) were 6.1% for 2007 and only 6.2% for 2008. BI’s forecasts are reported
as 6.2% for 2007 and 6.5% for 2008.
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TABLE 1 Components of GDP Growth
(2000 prices; % p.a. year on year)
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
Gross domestic product
Non-oil & gas GDP
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By expenditure
Household consumption
Government consumption
Investment, of which:
Construction
Non-construction
Exports
Merchandise
Imports
Merchandise
Net exports
By sector
Tradables
Agriculture, livestock, forestry & fisheries
Mining & quarrying
Manufacturing
Manufacturing, excluding oil & gas
Non-tradables
Electricity, gas & water supply
Construction
Trade, hotels & restaurants
Transport
Communications
Financial, rental & business services
Other services
5.0
5.7
5.0
5.4
5.9
6.6
6.1
6.6
6.0
6.5
6.3
6.9
2.9
11.5
1.1
7.4
–15.3
11.6
11.7
2.8
0.1
54.7
3.0
28.8
1.1
8.7
–17.1
11.3
11.2
7.5
5.0
31.0
3.0
1.7
1.3
9.3
–17.6
8.2
9.6
10.1
9.9
0.1
3.8
2.2
8.2
10.4
1.5
6.1
6.3
9.7
12.2
–4.6
4.7
3.7
7.7
9.4
2.1
8.9
10.0
8.4
11.8
10.6
4.7
3.8
6.9
7.8
4.0
9.8
9.3
7.2
9.3
20.6
3.9
6.4
2.7
2.9
4.0
6.2
5.1
7.4
4.4
3.9
24.2
5.7
5.8
3.1
1.5
4.0
3.7
4.3
7.0
4.5
8.7
5.5
7.3
22.7
5.3
6.1
4.1
2.2
1.6
5.9
6.9
7.8
5.8
9.3
7.5
6.7
24.0
4.7
6.8
3.9
1.8
0.7
5.9
5.8
8.4
8.1
10.4
7.0
8.6
26.5
6.8
6.0
3.7
–1.1
6.5
5.3
5.8
8.4
8.5
9.4
8.1
–0.2
27.2
7.9
6.8
4.3
2.4
3.4
5.5
6.0
8.4
10.5
7.8
8.3
0.3
27.7
7.7
7.1
Source: CEIC Asia Database.
the first half of 2007. Other investment (mainly in machinery and transport equipment) has been much less buoyant, contracting sharply in the first three quarters
of 2006 and growing relatively slowly thereafter, before recovering to a moderate
rate of 4.0% in Q2 of 2007. These observations amplify concerns that the share of
investment in GDP, particularly investment in machinery and transport equipment, remains too low to support high growth rates such as those achieved before
the crisis.3 On the other hand, the slowdown in construction activity in the first
3 For example, the share of fixed investment in real GDP was 25–27% in 1994–96. Construction’s large share of investment in Indonesia is in marked contrast with some other Asian
economies: recent shares in Thailand were only a little over one-third (CEIC Asia Database).
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half of 2007 has helped alleviate concern that an economy-wide speculative bubble may be developing (see below).
After contracting in the last half of 2006, net exports resumed a robust expansion in the first half of 2007 (table 1). The 2006 contraction was not the result
of low export growth, but of strong growth in imports, which continued into
the first half of 2007. However, there is a substantial discrepancy between the
national accounts and wholesale price indices. The former suggest relatively
low export price inflation, with the merchandise export deflator rising by only
0.8% in 2006 and by 2.8% in the first half of 2007 compared with the first half of
2006. The latter indicate more rapid increases in export prices in these periods
(5.8% and 5.0%, respectively). Correspondingly, the national accounts estimates
show that real export growth (9.6% in both 2006 and the first half of 2007) was
more rapid than is suggested by alternative estimates constructed from merchandise trade data, exchange rates and export price indices (5.0% and 8.3%,
respectively).4 Although these discrepancies are rather large for 2006, both estimates suggest that export quantities grew much faster than export prices in
the first half of 2007, and almost as fast (wholesale price estimates) or faster
(national accounts estimates) in 2006. Thus, despite concern that recent export
growth has resulted primarily from trends toward higher commodity prices, the
data indicate that quantity increases have also been robust.
On the production side, growth of the tradables sectors (comprising, roughly
speaking, agriculture, livestock, forestry and fisheries; mining and quarrying; and
manufacturing) has been consistently much slower than that of non-tradables (all
other sectors) during the six quarters shown in table 1. Growth rates for both
groups of sectors have increased a little over this period, but non-tradables have
grown roughly twice as fast throughout. Agriculture registered negative growth
in the first quarter of 2007 owing to unfavourable climatic conditions, while the
brief burst of relatively high growth in mining and quarrying in Q1 dissipated
in Q2. Manufacturing growth has fallen back below the rate of GDP growth as a
whole. More detailed analysis of the national accounts data shows that in the first
half of 2007 the fastest growing manufacturing industries were paper and printing (11%); food, beverages and tobacco (8.2%); machinery (7.2%); and chemicals
(7.0%). Production of cars also started recovering in March 2007, and total production in the first seven months of the year was 53% higher than in the same period
of 2006—yet still one-third below the level recorded in the first seven months
of 2005 (Gaikindo;5 CEIC Asia Database). Within the non-tradables sectors, communications continued to stand out, with the already very high rate of growth
increasing even further over the last three quarters to reach almost 28% p.a. By
contrast, growth in the transport sector fell abruptly from healthy levels to around
zero in the first half of 2007.
4 The alternative estimate is the growth rate of real exports, calculated as the dollar value
of merchandise exports converted into rupiah at period average exchange rates, and deflated by the wholesale price index for exports.
5 Gaikindo (Association of Indonesian Automotive Industries), , data downloaded from ‘Statistics’, August 2007.
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FIGURE 1 Inflation and Money Supply Growth
(% p.a.)
40
Rice price
30
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20
Currency in circulation
10
CPI inflation
0
Aug–06
Oct–06
Dec–06
Feb–07
Apr–07
Jun–07
Aug–07
Sources: CEIC Asia Database; Bank Indonesia, Laporan Mingguan [Weekly Report], various issues.
Trends in prices and money supply
The downward trend in consumer price inflation established from April to
June 2007, when the rate fell from 6.3% to 5.8% p.a., was subsequently reversed
(figure 1). By September the rate had risen modestly, to 7.0%, which is at the top
of BI’s inflation target range for 2007 (5–7%), and above the 6.5% rate assumed
in the revised budget for 2007. Shortages of rice and other foodstuffs (often
weather-related: JP, 18/9/2007) have kept inflation high in this large category,
which accounts for about 25% of the basket of goods and services used to
calculate the consumer price index (CPI). The slowing of rice price inflation from
the extraordinarily high levels recorded in 2006 is due partly to increases in rice
imports (JP, 16/6/2007) into this highly regulated market. Price rises for cooking
oil and related products have resulted from buoyant international demand for
crude palm oil. In an effort to insulate poor households from the effects of rising
world prices, the government announced its intention to scrap the 10% value
added tax (VAT) for this commodity, having already imposed a tax on palm oil
exports in August (Reuters, 18/9/2007).6
Two alternative measures of inflation, the wholesale price index (WPI) and the
implicit GDP deflator, are shown for a longer time period in figure 2, and compared with CPI inflation. At least for the period under consideration there is a
close correlation between inflation rates as indicated by the GDP deflator and the
WPI. The CPI is less closely correlated with both of these measures, but appears
6 Tinkering with export taxes and the VAT in this piecemeal manner is distortionary. Removing the VAT seems as likely to benefit producers as consumers, and the announcement
appears to be motivated by populist sentiment.
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FIGURE 2 Measures of Inflation
(% p.a.)
25
GDP deflator
20
WPI
CPI
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15
10
5
0
Mar–01
Mar–02
Mar–03
Mar–04
Mar–05
Mar–06
Mar–07
WPI = wholesale price index.
Source: CEIC Asia Database.
to follow them with a (somewhat variable) lag.7 Of particular interest is that inflation as indicated by both the GDP deflator and the WPI had jumped to doubledigit levels by the middle of 2007; this suggests that CPI inflation is also likely to
continue accelerating in the near future. The GDP deflator and WPI data underscore the fact that inflation has been relatively high in agriculture, which is linked
to the fairly rapid rise of food prices observed in the CPI data .
Another reason why CPI inflation seems likely to increase before long is that
the money supply—specifically, currency in circulation, the major component
of base money—has been growing at an average rate of almost 18% p.a. since
November 2006 (figure 1). This is significantly higher than is compatible in the
long run with inflation within the target range of 5–7% combined with real
growth of about 6%. The loose stance of monetary policy is likely to have contributed to the significant depreciation of the rupiah from late May through the
end of August, during which period the rupiah’s dollar value declined by almost
8%. Inflationary pressure was expected to rise in September and beyond, mainly
because of increased demand for food during and after Ramadhan, which started
in mid-September. Given these perceptions of increasing inflationary pressures,
BI decided to slow the pace at which it had been lowering its benchmark interest
rate, the BI rate, and kept it at 8.25% in August and September; despite this, the
annual growth rate of base money increased to over 20% in August (figure 1).
7 The differences arise, of course, because of the different coverage of goods and services
contained in these three indices. For example, the WPI gives higher weights to the prices of
raw materials and intermediate goods, and none at all to services, while the GDP deflator
takes into account capital (as distinct from consumer) goods, as well as goods and services
sold to foreigners.
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FIGURE 3 Jakarta Stock Exchange
2,500
120
100
2,000
80
1,500
60
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1,000
Composite index
(lhs)
40
500
0
Mar–03
Total turnover
(Rp trillion) (rhs)
Sep–03 Mar–04
Sep–04
Mar–05
Sep–05
Mar–06
Sep–06
Mar–07
20
0
Sep–07
Source: CEIC Asia Database.
Financial markets
From early 2003 the Jakarta Stock Exchange (JSX) experienced a very strong bull
run, which continued well into the first three quarters of 2007 (figure 3). The
JSX composite index increased by no less than 54% in the 12 months through
September, despite a sharp 7% decline during August, after turmoil in the US
and European markets related to emerging problems with sub-prime mortgage
lending in the US. Mining and property were among the most buoyant sectors during the 12 months to September, gaining 166% and 190%, respectively.8
The average value of monthly turnover doubled from less than Rp 43 trillion in
April 2006 through March 2007 to Rp 96 trillion between May and August 2007.
Foreign portfolio investment has contributed very strongly to recent stock price
increases: net purchases by foreign investors rose to Rp 22.4 trillion (around $2.5
billion) in the six months through August, a 220% increase over the six months
through February.
The bull run partly reflects perceived improvements in Indonesia’s economic
prospects, but such a rapid increase in stock prices inevitably creates some concern
that an asset bubble may be developing—and that a significant downward correction may follow—though it is very difficult to know when or if that will happen.
Uncertainty associated with the sub-prime loans problem in the US increases this
possibility, because it may encourage foreign fund managers to withdraw funds if
they need to boost their liquidity, or if they feel that Indonesian financial institutions are themselves exposed to excessive risk. Large fluctuations in stock prices do
not necessarily cause concern, but the 1997 crisis illustrated how a large sell-off of
8 Bapepam-LK (Capital Market and Financial Institutions Supervisory Agency), , accessed September 2007.
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assets can have severe consequences in economies such as Indonesia’s. Balance of
payments indicators discussed below suggest Indonesia is now more vulnerable to
such a withdrawal than in recent years. On the other hand, even if there is a bubble
in the stock market, there is little indication of a similarly worrisome bubble in the
real sector, because growth is moderate and the ratio of fixed investment to GDP
is not large. Spending on construction has been quite high, but the growth rate
declined to a reasonable level in the first half of 2007, as noted above.
Reactions of monetary authorities can have a crucial impact when there are
large falls in asset prices. Recent moves by certain central banks to increase system liquidity—notably the US Federal Reserve and the Bank of England—reflect
the view that such actions can help insulate economies from the effects of price
swings in financial markets. On the other hand, many commentators worry about
the moral hazard effect of investors coming to believe that the authorities will
step in to prevent losses even when investments have been imprudent. Such considerations may be academic, however, because the scope that BI has to fine-tune
liquidity conditions in response to nervousness in the capital market is limited,
for at least two important reasons. First, if foreign portfolio investors are preoccupied with conditions in their home markets or other larger markets, rather
than with the Indonesian market, BI may have little influence over their decisions.
Second, the possible benefits of increasing liquidity are constrained by relatively
high inflation and associated fears of rupiah depreciation. There is also concern
about contributing to any bubble that may exist or be emerging. For all of these
reasons, BI’s recent decision to slow the pace at which it had been lowering its
intervention interest rate appears well grounded.
Since the financial turmoil during and following the crisis of the late 1990s,
most East Asian developing economies have been trying to develop bond
markets as an alternative means of deepening financial markets and reducing
vulnerability to large swings in stock prices. However, Indonesia’s ratio of outstanding bonds to GDP was only 15% at the end of June 2007.9 Among the East
Asian countries listed, only Vietnam had a lower ratio (11%), and the ratio of
the third lowest economy (the Philippines, at 36%) was much higher than that
of Indonesia. Thus, Indonesia lags far behind many other East Asian economies
in bond market development. Moreover, government bonds dominate the bond
market in Indonesia, accounting for 85% of the outstanding total. The corporate bond market is correspondingly small, though it started growing faster in
the first half of 2007. According to the Surabaya Stock Exchange, where many
bonds are listed, the total value of outstanding corporate bonds increased by
24% from Rp 62 trillion in December 2006 to Rp 81 trillion in July 2007.10 Most of
the companies issuing new bonds in 2007 were finance companies. Government
bond markets have also been attractive to foreign investors recently. The share
of outstanding tradable bonds11 held by foreign banks and financial institutions
9 Asian Development Bank (ADB), Asian Bonds Online, , accessed September 2007.
10 Surabaya Stock Exchange, , accessed September 2007.
11 On the distinction between tradable and non-tradable bonds, see McLeod (2000): 28–9.
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rose from 1.6% in 2003 to 13% in 2006, before a more rapid increase to 18% in
June 2007 (BI 2007b).12
In some respects, conditions in the financial markets in mid-2007 were similar
to those just before the 1990s economic and financial crisis (McLeod 1997: 7). BI
has been an active buyer in the foreign exchange market, presumably acting on
the belief that it needs to support exporters by preventing appreciation of the currency—or even by causing it to depreciate.13 To this end, it purchased some $21 billion worth of foreign exchange in the period September 2005 through August 2007,
and there are frequent self-congratulatory reports from BI in the media about the
latest increase in Indonesia’s international reserves. But such purchases have an
expansionary monetary impact that needs to be sterilised if they are not to result in
accelerating inflation. Thus, during the same period, BI’s outstanding stock of certificates of deposit (SBIs) (valued at contemporaneous exchange rates) increased
by roughly the same amount. Continuation of these policies is bound to create a
significant problem for the central bank itself, because the interest earnings on its
international reserves are significantly less than the interest it has to pay out on its
certificates. US government securities are yielding a little over 4% p.a., while the
interest rate on SBIs is over 8%. The cost to BI of the 4% negative spread on this
additional $21 billion of reserves financed by the issue of SBIs is of the order of
$840 million annually. In qualitatively identical circumstances in 1997, the central
bank abruptly ceased issuing SBIs to finance its purchases of foreign exchange.
Before much longer, presumably, it will again come to the same conclusion: that
its combined exchange rate and interest rate policies are creating an extraordinarily attractive international arbitrage opportunity for private sector investors at its
own expense—hence the dramatic rise in stock prices, and the recent eagerness to
invest in Indonesian bonds and central bank certificates. Allowing the rupiah to
appreciate somewhat would put an end to this, permitting a greater proportion of
Indonesia’s productive resources to be reallocated to the production of goods and
services to satisfy domestic demand rather than that of foreigners.
The budget and fiscal policy
The government’s draft budget for 2008 was presented by the president as part of
his independence day speech to the DPR in August (table 2). While the expected
growth rate of 6.8% appears somewhat optimistic, inflation of 6.0% is certainly
achievable. However, it may not be compatible with the assumed decline of the
average SBI rate to 7.5% p.a.—and the hoped-for reduction in this rate to 8% p.a.
in 2007 now seems most unlikely to be achieved. The assumption of an exchange
rate of Rp 9,100/$ remains unchanged from the 2007 revised budget, while the
government is counting on a significant increase (around 9%) in oil production as
12 The average yield of all government bonds declined from 9.4% in December 2006 to
7.6% in July 2007, before increasing to 8.2% in August (Surabaya Stock Exchange, , accessed September 2007). This will remove some of
the pressure on the government budget, in which a large portion of revenue has been allocated to interest payments on government debt, 40% of which consists of bonds with
variable interest rates (Lindblad and Thee 2007).
13 In contrast, the law on the central bank states clearly that its objective is simply to safeguard the value of the currency.
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new oil fields come on stream. The deficit remains small, and is expected to rise
slightly from 1.6% of GDP in the revised 2007 budget to 1.7% in 2008.
The draft budget retains an implausibly low oil price estimate of only $60
per barrel. By mid-October actual world oil prices were far higher—close to
$90 per barrel. The only obvious reason why the budget would include such
a low estimate is to hide the magnitude of fuel subsidies that will be paid out
in 2008 if the price stays somewhere near recent levels (on the assumption that
domestic prices will not be adjusted). Wasteful and inequitable subsidies to fuel
consumption accounted for roughly half of budgeted subsidy expenditures in
2007 and 2008 (Ministry of Finance 2007b), but the $60 per barrel forecast allows
the government to show both fuel and total subsidies as declining significantly in
2008. This creates questions about the transparency of fiscal policy.
The maintenance of small budget deficits demonstrates the government’s
determination to reduce the size of its debt relative to GDP over time. It is interesting, however, to look more closely at the details of the financing of these deficits,
since quite large changes in the composition of government debt are occurring.
In particular, at a time when private sector investors are arbitraging the large difference between domestic and foreign interest rates (albeit sometimes exposing
themselves to the risk of depreciation), the government is moving in the opposite
direction. In 2008, it plans to borrow some Rp 92 trillion in the domestic market (about $10 billion, net, after repayment of principal on existing debt), well in
excess of the amount of the deficit. This is a 47% increase over the amount in the
revised budget for 2007, and is to occur at the same time as the government is
running down its stock of foreign debt (indicated by the excess of amortisation
over foreign gross drawing) by Rp 17 trillion (about $1.8 billion). To some extent
it has no choice about when to repay foreign borrowings undertaken in the past,
but it always has the option of borrowing in world markets rather than domestically to cover these cash outflows. Rolling over $1.8 billion of foreign debt at, say,
6%, rather than replacing it with the same quantity of domestic debt at, say, 9%,
would result in a budgetary saving of some $54 million.14 Beyond this, the issuing of additional bonds in overseas markets rather than domestically would add
significantly to this potential saving in interest costs.
Perhaps the most notable features of the draft 2008 budget are the projected
large increases in capital spending (49%), social assistance (42%) and personnel
outlays (30%), together with large increases in non-oil and gas income tax and
VAT collections (24% and 23%, respectively), and a significant decline in government expenditure on goods and services (16%). Increases in capital spending are focused on economic infrastructure, especially transport infrastructure.
It is often plausibly asserted that infrastructure deficiencies have contributed to
a decline in Indonesia’s competitiveness (JP, 15/8/2007), and the government
hopes that increased spending on infrastructure will ease related problems and
create more employment, thereby helping to alleviate poverty. Increased social
assistance includes expenditure on improving public health care, funding rural
development programs, and providing subsidies to the poor for rice, cooking oil
14 These interest rates approximate the yields on 7-year Indonesian government bonds
denominated in dollars and rupiah, respectively, at the end of September 2007 (ADB, Asian
Bonds Online, ).
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TABLE 2 Revised Budget 2007 and Draft Budget 2008
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2007
2008
Growth 2008 Draft:
Revision
Draft
(%)
Share of
(Rp trillion) (Rp trillion)
GDP
(%)
REVENUE AND GRANTS
Taxes
Income tax, non-oil & gas
Income tax, oil & gas
Value added tax
Import duties
Excise duties & other taxes
Non-tax revenues
Oil & gas revenues
Other non-tax revenues
Grants
684.5
489.9
212.5
37.5
152.1
14.4
73.5
191.9
105.4
86.4
2.7
761.4
583.7
264.3
41.0
186.6
14.9
76.8
175.6
112.3
63.3
2.1
11.2
19.1
24.4
9.3
22.7
3.6
4.6
–8.5
6.5
–26.7
–24.0
17.7
13.6
6.1
1.0
4.3
0.3
1.8
4.1
2.6
1.5
0.0
EXPENDITURE
Central government
Personnel
Goods & services
Capital expenditure
Domestic interest payments
External interest payments
Subsidies
Social assistance
Grants & other expenditures
Transfers to regional governments
746.4
493.9
99.9
62.5
68.3
61.4
24.9
105.2
47.5
24.2
252.5
836.4
564.6
129.5
52.4
101.5
62.8
28.7
92.6
67.4
29.6
271.8
12.1
14.3
29.6
–16.2
48.6
2.3
15.5
–11.9
41.8
22.5
7.6
19.4
13.1
3.0
1.2
2.4
1.5
0.7
2.2
1.6
0.7
6.3
DEFICIT
–62.0
–75.0
21.1
1.7
FINANCING
Government bonds
Domestic banks
Foreign gross drawing
Less amortisation
Privatisation, asset recovery, other
62.0
62.3
10.6
42.4
–55.1
1.7
75.0
91.7
0.3
43.0
–59.7
–0.2
21.1
47.1
–97.2
1.3
8.4
–112.1
1.7
2.1
0.0
1.0
–1.4
0.0
ASSUMPTIONS
Real GDP growth rate (%)
Inflation (% p.a.)
Average exchange rate (Rp/$)
SBI average (% p.a.)
Crude oil prices ($/barrel)
Oil production (million barrels per day)
6.3
6.5
9,100
8.0
60
950
6.8
6.0
9,100
7.5
60
1,034
Memo item: nominal GDP (Rp trillion)
3,804
4,307
Sources: Ministry of Finance (2007b); BI (2007a).
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and other basic commodities (JP, 24/7/2007). Personnel expenditure increases are
closely related to efforts by finance minister Sri Mulyani Indrawati to enhance the
welfare of public servants and improve the quality of the bureaucracy (Tempo,
21–27/8/2007: 42–9). Efforts to improve government efficiency are also reflected
in the predicted fall in expenditure on goods and services.
The government has generally found it difficult to meet its spending targets
in recent years, however. In 2007, for example, less than 25% of planned capital
expenditure had been realised in the first seven months (JP, 18/8/2007). Delays
in infrastructure spending result from difficulties over land acquisition—notwithstanding the introduction of a new presidential regulation to deal with precisely
that problem (McLeod 2005: 146–7); inability to coordinate the activities of central
and local governments; and complicated arrangements for private–public cooperation on infrastructure development schemes. Such problems are likely to be
amplified in 2008, with these expenditures planned to accelerate so rapidly. It
is also possible that the government’s continuing anti-corruption campaign will
make officials more risk-averse and reluctant to implement spending programs.
Taking these considerations into account, together with the long lead times
involved even in well-managed infrastructure projects, it is hard to see that the
government will be able to increase its capital expenditures to the extent proposed in such a short time. It is equally difficult to imagine that the proposed cut
in spending on goods and services (over 22% in real terms in an economy growing at 6–7%) will be achieved.
The government projects overall tax revenue to grow by 19% in 2008 (table 2).
Increased tax collection efforts have resulted in a very gradual increase in the ratio
of tax to GDP, from 12% in 2002 to a projected 14% in 2008, and the finance ministry is accelerating efforts to improve tax collection further (Tempo, 21–27/8/2007:
42–49). The authorities still have difficulty meeting tax revenue targets, however.
Tax revenue collected through mid-June 2007 was only 37% of the annual total in
the revised budget for 2007 (Ministry of Finance 2007a: II-16). The government
attributes this to administrative problems with data on previous tax collection
and the lack of standard operating procedures. Others emphasise low tax compliance stemming from a public view that the government’s tax collection procedures and related policies are unfair (JP, 14/8/2007).
In June 2007, after long debate, the parliament passed an amendment to the
2000 general taxation arrangements and procedures law. This was drafted partly in
response to perceptions that Indonesia’s tax laws confer too much power on often
corrupt taxation officials and adversely affect the investment climate. Later in 2007
the DPR is also expected to pass related revisions to the 2000 income tax law and the
2000 VAT and luxury sales tax law (JP, 30/3/2007). All of these changes were proposed by the government in late 2005, and became the subject of vigorous debate
in the DPR, much of it focusing on the procedures for filing objections to tax assessments. In its original bill, the government proposed that taxpayers who wanted to
file a formal objection to their tax assessment would have to make an initial payment, agreed on with the tax office in advance. If the objection was then rejected,
the taxpayer would have to pay a fine amounting to 100% of the agreed amount.
Taxpayers could appeal the tax office’s decision to a tax tribunal, but the fine would
increase to 200% in the event of a failed appeal. This proposal was rejected, and
the amendment that was passed requires no advance payment in the case of for-
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309
mal objections, while fines have been reduced to 50% and 100%, respectively, of
the assessed amount of tax. This amendment was intended to protect taxpayers
who had paid tax correctly but could not afford the cost of filing an objection. The
amendment to the taxation law also has provisions for punishing tax officials found
to have treated taxpayers unjustly, and establishes a grace period of one month
(instead of a few days) to furnish information requested by tax officials.
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The external sector
One of the largest changes in the economy over the last decade has occurred in the
external sector, where moderate current account deficits in the mid-1990s turned
to large surpluses in most subsequent years. The surplus fell close to zero in 2005
(table 3), but increased subsequently to almost 3% of GDP in 2006 and the first half
TABLE 3 Balance of Payments and External Debt
($ million, except as noted)
FLOWS DURING PERIOD
Current account balance
% of GDP
Merchandise exports, f.o.b.a
Merchandise imports, f.o.b.a
Services, net
Income, net
Current transfers, net
Financial account balance
Direct investment abroad
Direct investment in Indonesia
Portfolio investment, assets
Portfolio investment, liabilities
Other investment, assets
Other investment, liabilities
Capital account balance
Net errors & omissions
Financing
Changes in reserves
Use of IMF credits & loans
END OF PERIOD STOCKS
Direct investment in Indonesiab
Portfolio investment, liabilitiesb
External debt
% of GDP (last four quarters)
2004
2005
2006
Jan–Jun 2007
1,563
0.61
70,766
–50,615
–8,810
–10,918
1,139
277
0.10
86,995
–69,463
–9,122
–12,926
4,793
9,936
2.73
103,514
–73,867
–10,106
–14,466
4,863
5,601
2.69
56,146
–39,824
–5,694
–7,715
2,687
1,851
–3,408
1,896
353
4,056
985
–2,030
12
–3,065
8,337
–1,080
5,270
–8,646
–804
2,211
–2,703
5,580
–1,932
6,059
–2,588
–2,204
4,223
–1,746
2,421
–1,233
8,759
–1,649
–2,330
0
333
350
170
–3,105
–179
2,011
–1,943
–309
674
–983
–445
663
–1,106
–14,510
–6,902
–7,609
–8,052
–8,052
0
18,575
14,260
137,024
53
26,911
19,530
130,652
46
32,467
25,588
128,736
35
34,888
34,347
132,719
33
a f.o.b. = free on board.
b Direct and portfolio investment stocks are cumulative flows from 1981 forward.
Source: CEIC Asia Database.
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of 2007. The level of external debt has stabilised at about $130 billion since 2005,
and with steady output growth and inflation, and a reasonably stable exchange
rate, the ratio of debt to GDP has fallen steadily, from 53% in 2004 to just 33% in
mid-2007. One item of particular interest in the financial account of the balance
of payments is inward portfolio investment, which was nearly 45% higher for the
first half of 2007 than for the whole of 2006—and had increased by 15% between
2005 and 2006. This capital inflow has not been allowed to add to resource availability in Indonesia, however, as it has been almost exactly matched by increases
in central bank lending to foreign governments: total inward portfolio investment
for the 18 months to mid-2007 was $14.8 billion, while the increase in BI’s international reserves was $15.0 billion. Recent increases in both inward portfolio and
direct investment have been taken as a sign of renewed confidence among foreign
investors, nevertheless.
Indonesia still exports substantial quantities of oil and natural gas, and the share
of these exports increased slightly to over one-fourth in 2006, but fell back somewhat in the first half of 2007, reflecting fluctuations in oil and gas prices (table 4).
Exports of crude materials (mainly mineral ores, crude rubber and cooking oil) also
benefited from high world prices, which rose markedly in 2006 and the first half
of 2007. By the first half of 2007, the share of this group reached 15% of the total,
about double the 2001 level. In contrast, growth in exports of machinery, which
had been rapid up to 2001, has slowed, and the share of this group fell back to 14%
in 2006 and the first half of 2007. The stagnation of other manufactured exports,
including exports of many labour-intensive products, is of particular concern. The
picture is not entirely bleak, but the fall in the share of other manufactures to only
28–29% in 2006 and the first half of 2007 from as much as 36% in 2001 is important
to understand, and will be examined in more detail below.
A large portion of Indonesia’s imports (about one-quarter in 2006) are not classified by commodity category, and the majority of these are imports through the
export processing zones (EPZs) in Batam and elsewhere.15 Most are probably
machinery and other manufactures used as intermediate inputs. Known imports
of machinery accounted for about one-fifth of all imports in 2006, down from
about one-quarter in 2001 and even higher levels before the crisis, when high
fixed investment generated hig
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
SURVEY OF RECENT DEVELOPMENTS
Sadayuki Takii & Eric D. Ramstetter
To cite this article: Sadayuki Takii & Eric D. Ramstetter (2007) SURVEY OF RECENT
DEVELOPMENTS, Bulletin of Indonesian Economic Studies, 43:3, 295-322, DOI:
10.1080/00074910701727571
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Date: 18 January 2016, At: 20:06
Bulletin of Indonesian Economic Studies, Vol. 43, No. 3, 2007: 295–322
SURVEY OF RECENT DEVELOPMENTS
Sadayuki Takii and Eric D. Ramstetter
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International Centre for the Study of East Asian Development, Kitakyushu
SUMMARY
Notwithstanding improvements in Indonesia’s political and institutional infrastructure, growth remains slower than in pre-crisis years, and there is much discussion about reinvigorating the economy. To this end, the government introduced
its fourth major policy package in June 2007, risking scepticism about its underlying resolve to implement reforms that conflict with the interests of influential
bureaucrats. The abandonment of previous attempts at labour market reform was
perhaps the most conspicuous element of the new package.
Economic growth continued to accelerate, reaching 6.3% in the second quarter.
Most first-half growth was driven by net exports and investment, even though
construction activity slowed noticeably in this period. On the production side,
output of non-tradables continues to outstrip that of tradables. Consumer price
inflation rose in the September quarter to the top of the central bank’s target
range, and seems likely to increase further. The stock market boom continued in
the year to September, notwithstanding a brief correction in August. Bank Indonesia’s exchange rate and monetary policies have created an arbitrage opportunity that appears to be contributing significantly to private capital inflow. The
2008 budget maintains a modest deficit, but contains seemingly unrealistic plans
for large increases in certain categories of spending and in tax revenue. Moreover,
the projected world oil price is so low as to call into question the transparency of
fiscal policy.
There is concern that Indonesia’s recent growth has depended too heavily on
commodity prices, but real export growth was in fact substantial in the first half
of 2007. Moreover, although Indonesia’s share of non-fuel exports as a whole in
the world market has been eroded somewhat in recent years, this masks large
variations in shares across major markets and product categories. Its market share
rose conspicuously for key primary products in some markets, while it has been
losing market share in a number of labour-intensive manufactures, adding weight
to concern about the impact of labour market policies on employment growth.
Employment in fact grew strongly in the year to February 2007, pushing unemployment down a little, and contributing to a reduction in poverty incidence.
However, employment growth has been conspicuously slow in manufacturing—particularly in labour-intensive industries. Meanwhile, newly announced
closures of certain industries to particular kinds of investors have done little to
improve the business environment.
ISSN 0007-4918 print/ISSN 1472-7234 online/07/030295-28
DOI: 10.1080/00074910701727571
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POLITICAL DEVELOPMENTS
In recent months it has been common for Southeast Asian scholars and media
commentators to look back over the decade since the Asian economic crisis began
in Thailand and spread to Indonesia, Malaysia, South Korea and other countries.
Although Indonesia’s economic growth rate continued to recover in the year to
June 2007, it was still slower than in the several years before the crisis. Much of
the related discussion concerns how to accelerate growth further. Some observers
suggest that slower growth during the post-crisis period is related to less effective
economic policy making (McLeod 2005), and indeed the government’s capacity
to dictate policy has been heavily constrained by a more powerful national parliament (DPR) and more powerful local governments (Perdana and Friawan 2007).
Private interest groups have also become more diverse and vocal, often engaging
in rent-seeking activity at the local as well as the national level.
In addition, President Susilo Bambang Yudhoyono (SBY) has a relatively weak
power base and, from the outset, had to forge a multi-party coalition of diverse
interests to stay in power. His government has introduced four major policy
packages over the last two years in the hope of boosting growth, and perhaps
also of galvanising political support for his policy agenda. The newest package
appeared in June 2007 (box 1), but the proliferation of supposedly major policy
packages—which have so far brought little substantive change to the business
environment—has led to a growing belief that the government and its bureaucracy are much better at talking about reform than at implementing it.
Opposition from the DPR and interest groups has made the government hesitant to pursue important policy reforms, and some feel the president has failed
to exploit fully the strong support he received from voters in 2004. A notable
example of this hesitancy is the omission from the new policy package of further measures to increase competition in Indonesia’s formal labour market.1 Most
economists believe such competition is too constrained by high minimum wages
(which price relatively low-productivity workers out of the market) and by onerous regulations on severance pay and other working conditions (which protect
existing employees from new competitors).
Although the dispersion of power sometimes frustrates efforts to improve economic policies, and failure to make policy improvements probably contributes to
economic hardship for many households and firms, Indonesia continues to consolidate its important post-Soeharto political and institutional achievements. In
the decade since the crisis, there have been four changes of national government
and two national elections, as well as several hundred local elections. In almost
all cases, this has brought about non-violent changes of leadership. The peace
agreement in Aceh appears to be holding, while sectarian tensions in Ambon and
other parts of Maluku have remained dormant in recent months. The police have
recently thwarted further terrorist attacks by Jemaah Islamiyah (JI) and arrested
two of its top leaders (JP, 16/6/2007); two years have passed since the last major
attack. Success against JI has resulted from policies emphasising good intelligence
and international cooperation.
1 See Manning and Roesad (2007) for details of labour market reforms proposed in 2006,
and Narjoko and Jotzo (2007) for a summary of the political gridlock that caused their
abandonment, at least for the present.
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BOX 1 THE NEW ECONOMIC POLICY PACKAGE
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The government launched yet another economic policy package (Presidential
Instruction 6/2007) in June 2007, with the aim of accelerating policy improvements in four areas: the investment climate; the financial sector; infrastructure;
and micro, small and medium enterprises (MSMEs). This package integrates
and continues the three economic packages previously issued by the SBY
administration, but measures to promote the MSME sector are included as
a major field for the first time. The package aims to ‘empower’ MSMEs by
providing better access to financial resources; promoting development of
entrepreneurship and human resources; improving market access; and implementing other regulatory reforms that will help such firms.
The urge to encourage MSMEs is understandable, given that they collectively generate substantial employment and that employment growth has
generally been slow. However, it is both counter-productive and unnecessary to favour particular kinds of firms over others. MSMEs are naturally
competitive in many sectors where economies of scale are unimportant; in
such sectors, they need no special assistance. On the other hand, to restrict
the participation of larger firms in sectors where economies of scale are
significant—which is a notable effect of the new negative list of activities
closed to certain categories of investors, discussed below—is to encourage inefficiency. Policies aimed at improving the entrepreneurial skills and
access to finance of small firms have long had a degree of political appeal in
Indonesia that far exceeds their effectiveness.
A notable difference between this and previous packages is clearer specification of expected outcomes, and more transparent ways of evaluating
them. The three earlier packages had common problems with implementation (Basri and Patunru 2006), and the new approach is intended to address
this and related concerns: the tables summarising the policies, programs and
actions contained in the package include an additional column specifying the
expected outcome for each action (Government of Indonesia 2007). Actual
outcomes will then be examined by an independent external team that is to
monitor progress on package goals for the Coordinating Ministry for Economic Affairs; the new format will allow this team to perform objective evaluations by surveying businesses on specific points.
This change of approach partly signals the government’s recognition that
effective monitoring of policy implementation is important for the package’s credibility. It also probably reflects the growing view that the government must do better at persuading the public and the legislature to support
such packages. However, despite the new procedures for evaluating outcomes, there is no indication that the government will face consequences
other than loss of face should it fail to meet its stated objectives. This creates
scepticism about whether the new package will have any more impact than
its predecessors. The underlying problem is the lack of strong incentives
for the bureaucracy to implement policy reforms that are often in conflict
with its own interests. It is not clear that this new approach does anything
to change those incentives.
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There is still much debate on the role of religion (McGibbon 2006; Salim 2007),
illustrated by recent exchanges between fringe groups arguing for establishment
of a caliphate based on Islamic (syariah) law and mainstream observers who contend that Indonesia should continue to emphasise pluralism—acceptance of, and
mutual respect for, its numerous religions and cultures (JP, 21/8/2007). Notwithstanding this debate, the more moderate groups that celebrate Indonesia’s diversity have continued to prevail in the last decade, and the government has begun to
adopt the profile of a leading supporter of democratic values and human rights in
Southeast Asia. Its support was critical to the July 2007 agreement to establish an
ASEAN Charter (expected to be adopted formally in November), which purports
to transform ASEAN into a rules-based organisation promoting democracy, human
rights, regional security, regional economic cooperation and related principles.
MACROECONOMIC TRENDS AND POLICIES
Economic growth
The year-on-year quarterly economic growth rate continued the acceleration evident since the third quarter (Q3) of 2006, reaching 6.3% in Q2 of 2007 (table 1)—the
highest rate since Q4 of 2004. In its draft budget for 2008 the government assumes
that growth will continue to accelerate in the second half to reach 6.3% for 2007
as a whole, and then increase further to 6.8% in 2008 (Ministry of Finance 2007b).
However, both of these forecasts, especially the optimistic 2008 forecast, are higher
than those by private research organisations and the central bank (Bank Indonesia,
BI).2 Although the growth rate has been increasing, it is still below pre-crisis rates
(7.5–8.2% in 1994–96), and the government is often criticised for not being able to
achieve more on this front. Accelerating economic growth remains a high priority
primarily because it is the most effective way of raising living standards for the
large number of Indonesians living on very low incomes.
Private consumption is by far the largest expenditure component of real GDP,
accounting for just under three-fifths of the total in recent years. Although this
component’s growth rebounded from 3.0% or less in the first three quarters of 2006
to 4.7% in the first two quarters of 2007, it has lagged behind that of other expenditure categories, and its contribution to overall growth has therefore been relatively
small. A more detailed analysis than that shown in table 1 indicates that increased
growth in expenditure on food was particularly conspicuous, rising from 1.6–1.8%
in the first two quarters of 2006 to 3.8–3.9% in the same period in 2007, while growth
of non-food expenditures also rose, from 4.1–4.2% to 5.4%. Meanwhile, the growth
of government consumption was quite slow in the last half of 2006, although it
accelerated in the first half of 2007, reaching 3.8% in the second quarter.
In contrast, fixed investment, the second largest component of domestic
demand, has grown more rapidly than GDP since Q4 of 2006, though it decelerated from 8.2% in that quarter to 6.9% in Q2 of 2007. Over three-quarters of investment is in construction activity, and this component has been growing far more
rapidly than GDP over the last six quarters—though it, too, slowed noticeably in
2 In August 2007, the average forecasts by 14 private think-tanks summarised in Consensus Economics (2007) were 6.1% for 2007 and only 6.2% for 2008. BI’s forecasts are reported
as 6.2% for 2007 and 6.5% for 2008.
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TABLE 1 Components of GDP Growth
(2000 prices; % p.a. year on year)
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
Gross domestic product
Non-oil & gas GDP
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By expenditure
Household consumption
Government consumption
Investment, of which:
Construction
Non-construction
Exports
Merchandise
Imports
Merchandise
Net exports
By sector
Tradables
Agriculture, livestock, forestry & fisheries
Mining & quarrying
Manufacturing
Manufacturing, excluding oil & gas
Non-tradables
Electricity, gas & water supply
Construction
Trade, hotels & restaurants
Transport
Communications
Financial, rental & business services
Other services
5.0
5.7
5.0
5.4
5.9
6.6
6.1
6.6
6.0
6.5
6.3
6.9
2.9
11.5
1.1
7.4
–15.3
11.6
11.7
2.8
0.1
54.7
3.0
28.8
1.1
8.7
–17.1
11.3
11.2
7.5
5.0
31.0
3.0
1.7
1.3
9.3
–17.6
8.2
9.6
10.1
9.9
0.1
3.8
2.2
8.2
10.4
1.5
6.1
6.3
9.7
12.2
–4.6
4.7
3.7
7.7
9.4
2.1
8.9
10.0
8.4
11.8
10.6
4.7
3.8
6.9
7.8
4.0
9.8
9.3
7.2
9.3
20.6
3.9
6.4
2.7
2.9
4.0
6.2
5.1
7.4
4.4
3.9
24.2
5.7
5.8
3.1
1.5
4.0
3.7
4.3
7.0
4.5
8.7
5.5
7.3
22.7
5.3
6.1
4.1
2.2
1.6
5.9
6.9
7.8
5.8
9.3
7.5
6.7
24.0
4.7
6.8
3.9
1.8
0.7
5.9
5.8
8.4
8.1
10.4
7.0
8.6
26.5
6.8
6.0
3.7
–1.1
6.5
5.3
5.8
8.4
8.5
9.4
8.1
–0.2
27.2
7.9
6.8
4.3
2.4
3.4
5.5
6.0
8.4
10.5
7.8
8.3
0.3
27.7
7.7
7.1
Source: CEIC Asia Database.
the first half of 2007. Other investment (mainly in machinery and transport equipment) has been much less buoyant, contracting sharply in the first three quarters
of 2006 and growing relatively slowly thereafter, before recovering to a moderate
rate of 4.0% in Q2 of 2007. These observations amplify concerns that the share of
investment in GDP, particularly investment in machinery and transport equipment, remains too low to support high growth rates such as those achieved before
the crisis.3 On the other hand, the slowdown in construction activity in the first
3 For example, the share of fixed investment in real GDP was 25–27% in 1994–96. Construction’s large share of investment in Indonesia is in marked contrast with some other Asian
economies: recent shares in Thailand were only a little over one-third (CEIC Asia Database).
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half of 2007 has helped alleviate concern that an economy-wide speculative bubble may be developing (see below).
After contracting in the last half of 2006, net exports resumed a robust expansion in the first half of 2007 (table 1). The 2006 contraction was not the result
of low export growth, but of strong growth in imports, which continued into
the first half of 2007. However, there is a substantial discrepancy between the
national accounts and wholesale price indices. The former suggest relatively
low export price inflation, with the merchandise export deflator rising by only
0.8% in 2006 and by 2.8% in the first half of 2007 compared with the first half of
2006. The latter indicate more rapid increases in export prices in these periods
(5.8% and 5.0%, respectively). Correspondingly, the national accounts estimates
show that real export growth (9.6% in both 2006 and the first half of 2007) was
more rapid than is suggested by alternative estimates constructed from merchandise trade data, exchange rates and export price indices (5.0% and 8.3%,
respectively).4 Although these discrepancies are rather large for 2006, both estimates suggest that export quantities grew much faster than export prices in
the first half of 2007, and almost as fast (wholesale price estimates) or faster
(national accounts estimates) in 2006. Thus, despite concern that recent export
growth has resulted primarily from trends toward higher commodity prices, the
data indicate that quantity increases have also been robust.
On the production side, growth of the tradables sectors (comprising, roughly
speaking, agriculture, livestock, forestry and fisheries; mining and quarrying; and
manufacturing) has been consistently much slower than that of non-tradables (all
other sectors) during the six quarters shown in table 1. Growth rates for both
groups of sectors have increased a little over this period, but non-tradables have
grown roughly twice as fast throughout. Agriculture registered negative growth
in the first quarter of 2007 owing to unfavourable climatic conditions, while the
brief burst of relatively high growth in mining and quarrying in Q1 dissipated
in Q2. Manufacturing growth has fallen back below the rate of GDP growth as a
whole. More detailed analysis of the national accounts data shows that in the first
half of 2007 the fastest growing manufacturing industries were paper and printing (11%); food, beverages and tobacco (8.2%); machinery (7.2%); and chemicals
(7.0%). Production of cars also started recovering in March 2007, and total production in the first seven months of the year was 53% higher than in the same period
of 2006—yet still one-third below the level recorded in the first seven months
of 2005 (Gaikindo;5 CEIC Asia Database). Within the non-tradables sectors, communications continued to stand out, with the already very high rate of growth
increasing even further over the last three quarters to reach almost 28% p.a. By
contrast, growth in the transport sector fell abruptly from healthy levels to around
zero in the first half of 2007.
4 The alternative estimate is the growth rate of real exports, calculated as the dollar value
of merchandise exports converted into rupiah at period average exchange rates, and deflated by the wholesale price index for exports.
5 Gaikindo (Association of Indonesian Automotive Industries), , data downloaded from ‘Statistics’, August 2007.
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FIGURE 1 Inflation and Money Supply Growth
(% p.a.)
40
Rice price
30
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20
Currency in circulation
10
CPI inflation
0
Aug–06
Oct–06
Dec–06
Feb–07
Apr–07
Jun–07
Aug–07
Sources: CEIC Asia Database; Bank Indonesia, Laporan Mingguan [Weekly Report], various issues.
Trends in prices and money supply
The downward trend in consumer price inflation established from April to
June 2007, when the rate fell from 6.3% to 5.8% p.a., was subsequently reversed
(figure 1). By September the rate had risen modestly, to 7.0%, which is at the top
of BI’s inflation target range for 2007 (5–7%), and above the 6.5% rate assumed
in the revised budget for 2007. Shortages of rice and other foodstuffs (often
weather-related: JP, 18/9/2007) have kept inflation high in this large category,
which accounts for about 25% of the basket of goods and services used to
calculate the consumer price index (CPI). The slowing of rice price inflation from
the extraordinarily high levels recorded in 2006 is due partly to increases in rice
imports (JP, 16/6/2007) into this highly regulated market. Price rises for cooking
oil and related products have resulted from buoyant international demand for
crude palm oil. In an effort to insulate poor households from the effects of rising
world prices, the government announced its intention to scrap the 10% value
added tax (VAT) for this commodity, having already imposed a tax on palm oil
exports in August (Reuters, 18/9/2007).6
Two alternative measures of inflation, the wholesale price index (WPI) and the
implicit GDP deflator, are shown for a longer time period in figure 2, and compared with CPI inflation. At least for the period under consideration there is a
close correlation between inflation rates as indicated by the GDP deflator and the
WPI. The CPI is less closely correlated with both of these measures, but appears
6 Tinkering with export taxes and the VAT in this piecemeal manner is distortionary. Removing the VAT seems as likely to benefit producers as consumers, and the announcement
appears to be motivated by populist sentiment.
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FIGURE 2 Measures of Inflation
(% p.a.)
25
GDP deflator
20
WPI
CPI
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15
10
5
0
Mar–01
Mar–02
Mar–03
Mar–04
Mar–05
Mar–06
Mar–07
WPI = wholesale price index.
Source: CEIC Asia Database.
to follow them with a (somewhat variable) lag.7 Of particular interest is that inflation as indicated by both the GDP deflator and the WPI had jumped to doubledigit levels by the middle of 2007; this suggests that CPI inflation is also likely to
continue accelerating in the near future. The GDP deflator and WPI data underscore the fact that inflation has been relatively high in agriculture, which is linked
to the fairly rapid rise of food prices observed in the CPI data .
Another reason why CPI inflation seems likely to increase before long is that
the money supply—specifically, currency in circulation, the major component
of base money—has been growing at an average rate of almost 18% p.a. since
November 2006 (figure 1). This is significantly higher than is compatible in the
long run with inflation within the target range of 5–7% combined with real
growth of about 6%. The loose stance of monetary policy is likely to have contributed to the significant depreciation of the rupiah from late May through the
end of August, during which period the rupiah’s dollar value declined by almost
8%. Inflationary pressure was expected to rise in September and beyond, mainly
because of increased demand for food during and after Ramadhan, which started
in mid-September. Given these perceptions of increasing inflationary pressures,
BI decided to slow the pace at which it had been lowering its benchmark interest
rate, the BI rate, and kept it at 8.25% in August and September; despite this, the
annual growth rate of base money increased to over 20% in August (figure 1).
7 The differences arise, of course, because of the different coverage of goods and services
contained in these three indices. For example, the WPI gives higher weights to the prices of
raw materials and intermediate goods, and none at all to services, while the GDP deflator
takes into account capital (as distinct from consumer) goods, as well as goods and services
sold to foreigners.
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FIGURE 3 Jakarta Stock Exchange
2,500
120
100
2,000
80
1,500
60
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1,000
Composite index
(lhs)
40
500
0
Mar–03
Total turnover
(Rp trillion) (rhs)
Sep–03 Mar–04
Sep–04
Mar–05
Sep–05
Mar–06
Sep–06
Mar–07
20
0
Sep–07
Source: CEIC Asia Database.
Financial markets
From early 2003 the Jakarta Stock Exchange (JSX) experienced a very strong bull
run, which continued well into the first three quarters of 2007 (figure 3). The
JSX composite index increased by no less than 54% in the 12 months through
September, despite a sharp 7% decline during August, after turmoil in the US
and European markets related to emerging problems with sub-prime mortgage
lending in the US. Mining and property were among the most buoyant sectors during the 12 months to September, gaining 166% and 190%, respectively.8
The average value of monthly turnover doubled from less than Rp 43 trillion in
April 2006 through March 2007 to Rp 96 trillion between May and August 2007.
Foreign portfolio investment has contributed very strongly to recent stock price
increases: net purchases by foreign investors rose to Rp 22.4 trillion (around $2.5
billion) in the six months through August, a 220% increase over the six months
through February.
The bull run partly reflects perceived improvements in Indonesia’s economic
prospects, but such a rapid increase in stock prices inevitably creates some concern
that an asset bubble may be developing—and that a significant downward correction may follow—though it is very difficult to know when or if that will happen.
Uncertainty associated with the sub-prime loans problem in the US increases this
possibility, because it may encourage foreign fund managers to withdraw funds if
they need to boost their liquidity, or if they feel that Indonesian financial institutions are themselves exposed to excessive risk. Large fluctuations in stock prices do
not necessarily cause concern, but the 1997 crisis illustrated how a large sell-off of
8 Bapepam-LK (Capital Market and Financial Institutions Supervisory Agency), , accessed September 2007.
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assets can have severe consequences in economies such as Indonesia’s. Balance of
payments indicators discussed below suggest Indonesia is now more vulnerable to
such a withdrawal than in recent years. On the other hand, even if there is a bubble
in the stock market, there is little indication of a similarly worrisome bubble in the
real sector, because growth is moderate and the ratio of fixed investment to GDP
is not large. Spending on construction has been quite high, but the growth rate
declined to a reasonable level in the first half of 2007, as noted above.
Reactions of monetary authorities can have a crucial impact when there are
large falls in asset prices. Recent moves by certain central banks to increase system liquidity—notably the US Federal Reserve and the Bank of England—reflect
the view that such actions can help insulate economies from the effects of price
swings in financial markets. On the other hand, many commentators worry about
the moral hazard effect of investors coming to believe that the authorities will
step in to prevent losses even when investments have been imprudent. Such considerations may be academic, however, because the scope that BI has to fine-tune
liquidity conditions in response to nervousness in the capital market is limited,
for at least two important reasons. First, if foreign portfolio investors are preoccupied with conditions in their home markets or other larger markets, rather
than with the Indonesian market, BI may have little influence over their decisions.
Second, the possible benefits of increasing liquidity are constrained by relatively
high inflation and associated fears of rupiah depreciation. There is also concern
about contributing to any bubble that may exist or be emerging. For all of these
reasons, BI’s recent decision to slow the pace at which it had been lowering its
intervention interest rate appears well grounded.
Since the financial turmoil during and following the crisis of the late 1990s,
most East Asian developing economies have been trying to develop bond
markets as an alternative means of deepening financial markets and reducing
vulnerability to large swings in stock prices. However, Indonesia’s ratio of outstanding bonds to GDP was only 15% at the end of June 2007.9 Among the East
Asian countries listed, only Vietnam had a lower ratio (11%), and the ratio of
the third lowest economy (the Philippines, at 36%) was much higher than that
of Indonesia. Thus, Indonesia lags far behind many other East Asian economies
in bond market development. Moreover, government bonds dominate the bond
market in Indonesia, accounting for 85% of the outstanding total. The corporate bond market is correspondingly small, though it started growing faster in
the first half of 2007. According to the Surabaya Stock Exchange, where many
bonds are listed, the total value of outstanding corporate bonds increased by
24% from Rp 62 trillion in December 2006 to Rp 81 trillion in July 2007.10 Most of
the companies issuing new bonds in 2007 were finance companies. Government
bond markets have also been attractive to foreign investors recently. The share
of outstanding tradable bonds11 held by foreign banks and financial institutions
9 Asian Development Bank (ADB), Asian Bonds Online, , accessed September 2007.
10 Surabaya Stock Exchange, , accessed September 2007.
11 On the distinction between tradable and non-tradable bonds, see McLeod (2000): 28–9.
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rose from 1.6% in 2003 to 13% in 2006, before a more rapid increase to 18% in
June 2007 (BI 2007b).12
In some respects, conditions in the financial markets in mid-2007 were similar
to those just before the 1990s economic and financial crisis (McLeod 1997: 7). BI
has been an active buyer in the foreign exchange market, presumably acting on
the belief that it needs to support exporters by preventing appreciation of the currency—or even by causing it to depreciate.13 To this end, it purchased some $21 billion worth of foreign exchange in the period September 2005 through August 2007,
and there are frequent self-congratulatory reports from BI in the media about the
latest increase in Indonesia’s international reserves. But such purchases have an
expansionary monetary impact that needs to be sterilised if they are not to result in
accelerating inflation. Thus, during the same period, BI’s outstanding stock of certificates of deposit (SBIs) (valued at contemporaneous exchange rates) increased
by roughly the same amount. Continuation of these policies is bound to create a
significant problem for the central bank itself, because the interest earnings on its
international reserves are significantly less than the interest it has to pay out on its
certificates. US government securities are yielding a little over 4% p.a., while the
interest rate on SBIs is over 8%. The cost to BI of the 4% negative spread on this
additional $21 billion of reserves financed by the issue of SBIs is of the order of
$840 million annually. In qualitatively identical circumstances in 1997, the central
bank abruptly ceased issuing SBIs to finance its purchases of foreign exchange.
Before much longer, presumably, it will again come to the same conclusion: that
its combined exchange rate and interest rate policies are creating an extraordinarily attractive international arbitrage opportunity for private sector investors at its
own expense—hence the dramatic rise in stock prices, and the recent eagerness to
invest in Indonesian bonds and central bank certificates. Allowing the rupiah to
appreciate somewhat would put an end to this, permitting a greater proportion of
Indonesia’s productive resources to be reallocated to the production of goods and
services to satisfy domestic demand rather than that of foreigners.
The budget and fiscal policy
The government’s draft budget for 2008 was presented by the president as part of
his independence day speech to the DPR in August (table 2). While the expected
growth rate of 6.8% appears somewhat optimistic, inflation of 6.0% is certainly
achievable. However, it may not be compatible with the assumed decline of the
average SBI rate to 7.5% p.a.—and the hoped-for reduction in this rate to 8% p.a.
in 2007 now seems most unlikely to be achieved. The assumption of an exchange
rate of Rp 9,100/$ remains unchanged from the 2007 revised budget, while the
government is counting on a significant increase (around 9%) in oil production as
12 The average yield of all government bonds declined from 9.4% in December 2006 to
7.6% in July 2007, before increasing to 8.2% in August (Surabaya Stock Exchange, , accessed September 2007). This will remove some of
the pressure on the government budget, in which a large portion of revenue has been allocated to interest payments on government debt, 40% of which consists of bonds with
variable interest rates (Lindblad and Thee 2007).
13 In contrast, the law on the central bank states clearly that its objective is simply to safeguard the value of the currency.
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new oil fields come on stream. The deficit remains small, and is expected to rise
slightly from 1.6% of GDP in the revised 2007 budget to 1.7% in 2008.
The draft budget retains an implausibly low oil price estimate of only $60
per barrel. By mid-October actual world oil prices were far higher—close to
$90 per barrel. The only obvious reason why the budget would include such
a low estimate is to hide the magnitude of fuel subsidies that will be paid out
in 2008 if the price stays somewhere near recent levels (on the assumption that
domestic prices will not be adjusted). Wasteful and inequitable subsidies to fuel
consumption accounted for roughly half of budgeted subsidy expenditures in
2007 and 2008 (Ministry of Finance 2007b), but the $60 per barrel forecast allows
the government to show both fuel and total subsidies as declining significantly in
2008. This creates questions about the transparency of fiscal policy.
The maintenance of small budget deficits demonstrates the government’s
determination to reduce the size of its debt relative to GDP over time. It is interesting, however, to look more closely at the details of the financing of these deficits,
since quite large changes in the composition of government debt are occurring.
In particular, at a time when private sector investors are arbitraging the large difference between domestic and foreign interest rates (albeit sometimes exposing
themselves to the risk of depreciation), the government is moving in the opposite
direction. In 2008, it plans to borrow some Rp 92 trillion in the domestic market (about $10 billion, net, after repayment of principal on existing debt), well in
excess of the amount of the deficit. This is a 47% increase over the amount in the
revised budget for 2007, and is to occur at the same time as the government is
running down its stock of foreign debt (indicated by the excess of amortisation
over foreign gross drawing) by Rp 17 trillion (about $1.8 billion). To some extent
it has no choice about when to repay foreign borrowings undertaken in the past,
but it always has the option of borrowing in world markets rather than domestically to cover these cash outflows. Rolling over $1.8 billion of foreign debt at, say,
6%, rather than replacing it with the same quantity of domestic debt at, say, 9%,
would result in a budgetary saving of some $54 million.14 Beyond this, the issuing of additional bonds in overseas markets rather than domestically would add
significantly to this potential saving in interest costs.
Perhaps the most notable features of the draft 2008 budget are the projected
large increases in capital spending (49%), social assistance (42%) and personnel
outlays (30%), together with large increases in non-oil and gas income tax and
VAT collections (24% and 23%, respectively), and a significant decline in government expenditure on goods and services (16%). Increases in capital spending are focused on economic infrastructure, especially transport infrastructure.
It is often plausibly asserted that infrastructure deficiencies have contributed to
a decline in Indonesia’s competitiveness (JP, 15/8/2007), and the government
hopes that increased spending on infrastructure will ease related problems and
create more employment, thereby helping to alleviate poverty. Increased social
assistance includes expenditure on improving public health care, funding rural
development programs, and providing subsidies to the poor for rice, cooking oil
14 These interest rates approximate the yields on 7-year Indonesian government bonds
denominated in dollars and rupiah, respectively, at the end of September 2007 (ADB, Asian
Bonds Online, ).
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TABLE 2 Revised Budget 2007 and Draft Budget 2008
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2007
2008
Growth 2008 Draft:
Revision
Draft
(%)
Share of
(Rp trillion) (Rp trillion)
GDP
(%)
REVENUE AND GRANTS
Taxes
Income tax, non-oil & gas
Income tax, oil & gas
Value added tax
Import duties
Excise duties & other taxes
Non-tax revenues
Oil & gas revenues
Other non-tax revenues
Grants
684.5
489.9
212.5
37.5
152.1
14.4
73.5
191.9
105.4
86.4
2.7
761.4
583.7
264.3
41.0
186.6
14.9
76.8
175.6
112.3
63.3
2.1
11.2
19.1
24.4
9.3
22.7
3.6
4.6
–8.5
6.5
–26.7
–24.0
17.7
13.6
6.1
1.0
4.3
0.3
1.8
4.1
2.6
1.5
0.0
EXPENDITURE
Central government
Personnel
Goods & services
Capital expenditure
Domestic interest payments
External interest payments
Subsidies
Social assistance
Grants & other expenditures
Transfers to regional governments
746.4
493.9
99.9
62.5
68.3
61.4
24.9
105.2
47.5
24.2
252.5
836.4
564.6
129.5
52.4
101.5
62.8
28.7
92.6
67.4
29.6
271.8
12.1
14.3
29.6
–16.2
48.6
2.3
15.5
–11.9
41.8
22.5
7.6
19.4
13.1
3.0
1.2
2.4
1.5
0.7
2.2
1.6
0.7
6.3
DEFICIT
–62.0
–75.0
21.1
1.7
FINANCING
Government bonds
Domestic banks
Foreign gross drawing
Less amortisation
Privatisation, asset recovery, other
62.0
62.3
10.6
42.4
–55.1
1.7
75.0
91.7
0.3
43.0
–59.7
–0.2
21.1
47.1
–97.2
1.3
8.4
–112.1
1.7
2.1
0.0
1.0
–1.4
0.0
ASSUMPTIONS
Real GDP growth rate (%)
Inflation (% p.a.)
Average exchange rate (Rp/$)
SBI average (% p.a.)
Crude oil prices ($/barrel)
Oil production (million barrels per day)
6.3
6.5
9,100
8.0
60
950
6.8
6.0
9,100
7.5
60
1,034
Memo item: nominal GDP (Rp trillion)
3,804
4,307
Sources: Ministry of Finance (2007b); BI (2007a).
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and other basic commodities (JP, 24/7/2007). Personnel expenditure increases are
closely related to efforts by finance minister Sri Mulyani Indrawati to enhance the
welfare of public servants and improve the quality of the bureaucracy (Tempo,
21–27/8/2007: 42–9). Efforts to improve government efficiency are also reflected
in the predicted fall in expenditure on goods and services.
The government has generally found it difficult to meet its spending targets
in recent years, however. In 2007, for example, less than 25% of planned capital
expenditure had been realised in the first seven months (JP, 18/8/2007). Delays
in infrastructure spending result from difficulties over land acquisition—notwithstanding the introduction of a new presidential regulation to deal with precisely
that problem (McLeod 2005: 146–7); inability to coordinate the activities of central
and local governments; and complicated arrangements for private–public cooperation on infrastructure development schemes. Such problems are likely to be
amplified in 2008, with these expenditures planned to accelerate so rapidly. It
is also possible that the government’s continuing anti-corruption campaign will
make officials more risk-averse and reluctant to implement spending programs.
Taking these considerations into account, together with the long lead times
involved even in well-managed infrastructure projects, it is hard to see that the
government will be able to increase its capital expenditures to the extent proposed in such a short time. It is equally difficult to imagine that the proposed cut
in spending on goods and services (over 22% in real terms in an economy growing at 6–7%) will be achieved.
The government projects overall tax revenue to grow by 19% in 2008 (table 2).
Increased tax collection efforts have resulted in a very gradual increase in the ratio
of tax to GDP, from 12% in 2002 to a projected 14% in 2008, and the finance ministry is accelerating efforts to improve tax collection further (Tempo, 21–27/8/2007:
42–49). The authorities still have difficulty meeting tax revenue targets, however.
Tax revenue collected through mid-June 2007 was only 37% of the annual total in
the revised budget for 2007 (Ministry of Finance 2007a: II-16). The government
attributes this to administrative problems with data on previous tax collection
and the lack of standard operating procedures. Others emphasise low tax compliance stemming from a public view that the government’s tax collection procedures and related policies are unfair (JP, 14/8/2007).
In June 2007, after long debate, the parliament passed an amendment to the
2000 general taxation arrangements and procedures law. This was drafted partly in
response to perceptions that Indonesia’s tax laws confer too much power on often
corrupt taxation officials and adversely affect the investment climate. Later in 2007
the DPR is also expected to pass related revisions to the 2000 income tax law and the
2000 VAT and luxury sales tax law (JP, 30/3/2007). All of these changes were proposed by the government in late 2005, and became the subject of vigorous debate
in the DPR, much of it focusing on the procedures for filing objections to tax assessments. In its original bill, the government proposed that taxpayers who wanted to
file a formal objection to their tax assessment would have to make an initial payment, agreed on with the tax office in advance. If the objection was then rejected,
the taxpayer would have to pay a fine amounting to 100% of the agreed amount.
Taxpayers could appeal the tax office’s decision to a tax tribunal, but the fine would
increase to 200% in the event of a failed appeal. This proposal was rejected, and
the amendment that was passed requires no advance payment in the case of for-
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Survey of recent developments
309
mal objections, while fines have been reduced to 50% and 100%, respectively, of
the assessed amount of tax. This amendment was intended to protect taxpayers
who had paid tax correctly but could not afford the cost of filing an objection. The
amendment to the taxation law also has provisions for punishing tax officials found
to have treated taxpayers unjustly, and establishes a grace period of one month
(instead of a few days) to furnish information requested by tax officials.
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The external sector
One of the largest changes in the economy over the last decade has occurred in the
external sector, where moderate current account deficits in the mid-1990s turned
to large surpluses in most subsequent years. The surplus fell close to zero in 2005
(table 3), but increased subsequently to almost 3% of GDP in 2006 and the first half
TABLE 3 Balance of Payments and External Debt
($ million, except as noted)
FLOWS DURING PERIOD
Current account balance
% of GDP
Merchandise exports, f.o.b.a
Merchandise imports, f.o.b.a
Services, net
Income, net
Current transfers, net
Financial account balance
Direct investment abroad
Direct investment in Indonesia
Portfolio investment, assets
Portfolio investment, liabilities
Other investment, assets
Other investment, liabilities
Capital account balance
Net errors & omissions
Financing
Changes in reserves
Use of IMF credits & loans
END OF PERIOD STOCKS
Direct investment in Indonesiab
Portfolio investment, liabilitiesb
External debt
% of GDP (last four quarters)
2004
2005
2006
Jan–Jun 2007
1,563
0.61
70,766
–50,615
–8,810
–10,918
1,139
277
0.10
86,995
–69,463
–9,122
–12,926
4,793
9,936
2.73
103,514
–73,867
–10,106
–14,466
4,863
5,601
2.69
56,146
–39,824
–5,694
–7,715
2,687
1,851
–3,408
1,896
353
4,056
985
–2,030
12
–3,065
8,337
–1,080
5,270
–8,646
–804
2,211
–2,703
5,580
–1,932
6,059
–2,588
–2,204
4,223
–1,746
2,421
–1,233
8,759
–1,649
–2,330
0
333
350
170
–3,105
–179
2,011
–1,943
–309
674
–983
–445
663
–1,106
–14,510
–6,902
–7,609
–8,052
–8,052
0
18,575
14,260
137,024
53
26,911
19,530
130,652
46
32,467
25,588
128,736
35
34,888
34,347
132,719
33
a f.o.b. = free on board.
b Direct and portfolio investment stocks are cumulative flows from 1981 forward.
Source: CEIC Asia Database.
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Sadayuki Takii and Eric D. Ramstetter
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of 2007. The level of external debt has stabilised at about $130 billion since 2005,
and with steady output growth and inflation, and a reasonably stable exchange
rate, the ratio of debt to GDP has fallen steadily, from 53% in 2004 to just 33% in
mid-2007. One item of particular interest in the financial account of the balance
of payments is inward portfolio investment, which was nearly 45% higher for the
first half of 2007 than for the whole of 2006—and had increased by 15% between
2005 and 2006. This capital inflow has not been allowed to add to resource availability in Indonesia, however, as it has been almost exactly matched by increases
in central bank lending to foreign governments: total inward portfolio investment
for the 18 months to mid-2007 was $14.8 billion, while the increase in BI’s international reserves was $15.0 billion. Recent increases in both inward portfolio and
direct investment have been taken as a sign of renewed confidence among foreign
investors, nevertheless.
Indonesia still exports substantial quantities of oil and natural gas, and the share
of these exports increased slightly to over one-fourth in 2006, but fell back somewhat in the first half of 2007, reflecting fluctuations in oil and gas prices (table 4).
Exports of crude materials (mainly mineral ores, crude rubber and cooking oil) also
benefited from high world prices, which rose markedly in 2006 and the first half
of 2007. By the first half of 2007, the share of this group reached 15% of the total,
about double the 2001 level. In contrast, growth in exports of machinery, which
had been rapid up to 2001, has slowed, and the share of this group fell back to 14%
in 2006 and the first half of 2007. The stagnation of other manufactured exports,
including exports of many labour-intensive products, is of particular concern. The
picture is not entirely bleak, but the fall in the share of other manufactures to only
28–29% in 2006 and the first half of 2007 from as much as 36% in 2001 is important
to understand, and will be examined in more detail below.
A large portion of Indonesia’s imports (about one-quarter in 2006) are not classified by commodity category, and the majority of these are imports through the
export processing zones (EPZs) in Batam and elsewhere.15 Most are probably
machinery and other manufactures used as intermediate inputs. Known imports
of machinery accounted for about one-fifth of all imports in 2006, down from
about one-quarter in 2001 and even higher levels before the crisis, when high
fixed investment generated hig