INDONESIA ECONOMIC OUTLOOK 2011- December 2010

INDONESIAN COMMERCIAL NEWSLETTER

December 2010

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INDONESIA'S ECONOMIC OUTLOOK, 2011

Backgrounds

By the end of 2010, there were mixed perceptions about the world economic recovery. Some expressed optimism and other are less optimistic or even pessimistic. Optimism came after major economies ended a period of contraction and the world trade is brisker and the financial conditions of the crisis-hit countries have improved.

At the same time some expressed pessimism that strong demand as a result of economic revival would trigger price hikes that could disrupt stability. The main fear is shortage in food supplies with production falling as a result of extreme weather condition which hit almost all regions in the world.

Food price hikes and shortage in supplies would trigger inflation causing potential social crisis. A number of countries in Europe and Asia have suffered financial crisis. Food crisis has led to the downfall of dictatorial administration under strong man in Tunisia inspiring massive protests in other countries in that region.

Food crisis is still a local problem but with natural disasters in production centers like Australia, where big floods have destroyed food crops, the crisis could spread to wider regions.

So far Indonesia is still safe from crisis but fears already affected market stability. The prices of food products like rice and chili shot up. The prices of chili doubled toward the end of 2010.

However, more observes expressed optimism that the world economic condition including Indonesian economic condition would improve in 2011. In 2010, the trend was favorable in general led by China and other major emerging economies in Asia like India. One by one industrial countries managed to lift themselves from the crisis like the United States and a number of European countries.

The United States, the exporter of crisis in 2008 reported a 2.7% growth in 2010 after a contraction of 2.6% in 2009. Japan which also suffered a contraction of 5.2% in 2009 posted a growth of 3.1% in 2010.

Indonesia, which was one among a few countries recording a fairly strong growth in 2009, reported better performance in 2010 with brisker international trade and manufacturing sector, which was badly hit by the malaise in 2009. In 2010, the country's exports rose to a peak of US$ 157.7 billion or an increase of 35.4% from 2009. The recovery of export market from the deep slump in 2009 gave greater boost to the country's economic growth notably the real sector.

An impressive growth was recorded by the automotive sector both two and four wheeled motor vehicle industries. In 2010, car sales shot up to a new peak of 764,000 units and sales of motor vehicles surged to an all time record of 7.5 million units. Similarly strong growth was recorded in the electronic goods market although imports began to flood the domestic market. Local producers still recorded an increase in sales.

With the improved condition of the world economy, the country's economy grew faster than previously expected in 2010. However, Indonesia had not gone through 2010 without challenge. Political instability triggered by food shortage and skyrocketing prices of commodities in some countries in the world had also affected the country resulting in a surge in inflation toward the end of 2010.

Indonesia was lucky with the rupiah gaining strength as a result of strong inflows of foreign capital. Foreign capital is flowing into emerging markets in Asia including Indonesia as investors are looking for more profitable market. In 2010, the country's inflation was quite high but with the strong rupiah, the country could maintain good growth as imports are relatively cheaper in rupiah term.

One of the major factors that have continued to come in the way boosting economic growth is inadequate infrastructure. The problem could not be sorted out in short term. Poor condition of highways, insufficient sea transport facilities and shortage in power supply are big hurdles in the development of the investment sector, expected to be one of the main drivers of growth in 2011.

Growth will likely be lopsided among the sectors. High growth is expected to be recorded in certain some sector like automotive sector but sluggish growth might continue in other sectors.

However, almost all analysts agree that his country's economy would grow faster in 2011. Despite the inflation threat and soaring food prices, the country gain from the primary commodity prices such as those of crude palm oil, rubber, cocoa, and coal which contribute considerably to the country's export earning.

The government and Bank Indonesia are optimistic that the country's economic growth is higher in 2011. The central bank predicted the growth at 6%-6.5% and the government sets the economic growth target at 6.4%. The World Bank has also given a high growth prediction at 6.2% for the country's economy in 2011. The optimism in 2011 is based on the improvement of the macro economic indicators notably with the growing exports.

The OECD's forecast for the country's economic growth is 6.3% and the International Monetary Fund (IMF) predicted the country's economy would expand 6.2% in 211 and 6.5% in 2012.

Overview of Indonesia's economy in 2010

Indonesia is one of a few countries that managed to chalk up a fairly high economic growth in 2009, when many advanced economies suffered a contraction; Indonesia recorded an economic growth of 4.5% only lower than the economic growth rates of China and India. In 2010, the country recorded a stronger growth of 6.1%.

The big domestic market and prudential policy adopted by the government and the country's banking industry saved the country from the devastating impact of the global financial crisis.

Increase in domestic demand and the purchasing power of the people in 2010 pushed up inflation but remained within control. Inflation was estimated to exceed 6.9% in 2010 up from 2.78% in 2009. The low inflation in 2009 was largely due to weak demand amid the global slump.

In 2009, when the financial crisis went out of control in the world, the country's exports dropped sharply by 15% to US$116 billion from US$138 billion in 2008. However, toward the end of 2009, the export market was brisker and began to grow. In the first six months of 2010, the country's exports already reached US$ 72.52 billion or an increase of 44.8% from the same period in the previous year. In the whole of 2010, the export value hit a new record of US$ 150 billion.

Similarly imports increased even higher than exports. In the first half of 2010, the country's imports were valued at US$ 62.89 billion or an increase of 52% from 2009.

The increase in imports indicated the revival of the country's ailing manufactured sector as the imports were dominated by industrial basic materials. The increase in imports was also driven by growing imports of consumer goods. The implementation of the Asean China Free Trade Agreement (FTA) also contributed to the rise in imports.

The international confidence in Indonesia's economy is reflected in the strong inflows of foreign capital to the country. In addition, the Jakarta composite index has increased steadily and was rated among the best performing stock exchanges in the world in 2010. The JCI in 2010 rose from 2,534 pints in 2009 to 3,501 pints in October 2010.

Meanwhile, the rupiah value was relatively stable in 2010. At the height of the crisis, the rupiah sank to as low as 12,000 per US dollar, but it did not take long time to recover. The rupiah regained strength and is stable at the level of less than 9,000, a level considered safe for both consumers and exporters.

The strong inflows of foreign capital also contributed to the increase in the country's foreign exchange reserves now exceeding the level of US$ 100 billion or an all time peak, up from around US$ 92.8 billion by November, 2010 and US$ 66.1 billion by the end of 2009.

A number of international rating agencies have raised the country's sovereign debts to one notch below the investment grade. The government is optimistic the agencies will give the country the investment grade this year.

Transport and communications sector continue to lead in growth

Indonesia's GDP grew 6.1% yoy in the same quarter in 2010. Positive growth was recorded in almost all sectors lead by the transport and communications sector that grew 13.5% with the lowest growth of 2.5% recorded in the agricultural sector. Meanwhile, the hotel, restaurant and trade sectors, which was badly hit in 2009 has begun to recover. In 2009, this sector grew only 1.1% but in 2010, the sector grew strongly by 8.7%.

Indonesia already lifted itself of the impact of the devastating global financial crisis, with almost all sector growing.

Exports filly recover in 2010. After deep slump in 2009, the country's exports strongly recovered in 2010 with exports hitting new record. In 2010, exports were valued at US$ 157.7 billion or an increase of more than 35% with exports of commodities other than oil and gas making up US$ 129.7 billion or an increase of 33%.

The largest export destination was Japan to which exports in December 2010 were valued at US$ 1.72 billion, followed by China to which exports were worth US$ 1.70 billion and the United States US$ 1.30 billion. The three countries accounted for 34.9% of the total exports with the European Union (27 countries) accounting for US$1.93 billion in the same month.

Exports of manufactured goods rose 33.47% in 2010 year-on-year, exports of agriculture products rose 14.9% and exports of mining and other products surged by 35.4%.

Increase was also recorded in imports in 2010 up to US$ 135.6 billion from US$ 96.8 billion in the previous year.

Imports of commodities other than oil and gas were valued at US$ 108.24 billion in 2010 or an increase of 39.04% from US$ 77.85 billion in 2009. Imports of oil and gas were valued at US$27.36 billion in 2010 or an increase of 44.16% from US$18.98 billion in 2009.

The largest supplier in 2010 was China from which imports were valued at US$ 19.69 billion or 18.19% of the country's total imports , followed by Japan from which imports were valued at US$16.91 billion (15.62%) and Singapore US$ 10.05 billion (9.29%). Imports from Asean countries accounted for 22.03%, from the EU 9.02%.

Inflation in 2010 higher than target

In 2009, Indonesian economy was relatively stable with inflation at 2.78% or the lowest in the past 10 years. In entering the year 2010, however, inflation began to scale up to reach 6.96% or higher than the target of 5% - 6% set by Bank Indonesia for the whole year. The increase in inflation was inherent in growing economic activities.

Toward the end of 2010, there was growing concern again with a surge in inflation triggered by soaring prices of food commodities including rice and chili. Shortage in food supplies in the world followed extreme climate in the world including in the country.

However, the inflation in 2010 was still manageable as at the same time the rupiah gained strength against the US dollar that imports were cheaper in rupiah term. Toward the end of 2010, the rupiah continued to gain with the inflowing foreign capital.

Economic challenges in 2011

The recovery of the global economy brings about greater optimism that the country's economy would grow faster. However, there are a number of challenges that need to be seriously addressed the government. The challenges are both external and internal as follows:

External challenges

" The global economic recovery is still vulnerable as the recovery has been sustained by generous incentives.

" Soaring energy and primary commodity as well as food prices are potential threat to the market stability pushing up the prices of consumer goods and export commodities. Food price hikes have triggered political unrest in the Middle East and the political instability could easily spread to neighboring countries.

" Capital inflows could end with disruption of stability in the event of sudden reversal.

Internal challenges

" Inadequate infrastructure may remain a stumbling block as no significant progress made to cope with the problem with long delay in the implementation of projects. Completion of the first phase of the electricity fast tract program has been long delayed. Similarly a number of toll road projects have been idles for years either because of financial problem and difficulty in land clearing.

" The lending rates remain high compared with in neighboring countries resulting in large un-disbursed loans.

" Red tape and corruption remain rampant causing high cost of economy.

World's economic outlook 2011

Toward the end of 2010, analysts were split on the world economic prospects for 2011. Earlier almost all agreed that the year 2011 will see a better economic condition with the encouraging trend in developed economies. However, toward the end of 2010, the optimism was dampened with financial turmoil in a number of European countries such as Greece.

The World Bank predicted the global economy would expand by 3.3% in 2011 slower than 3.9% in 2010. The World Bank's estimate for growth of developing economies is 6% in 2011 slower than 7% on the average in 2010, but still higher than a 2.4% growth forecast for advanced economies in 2011 .

The World Bank expressed concern especially with the soaring prices of commodities including food and fuels as a result of relaxation in the monetary policies adopted by advanced nations and the strong demand in developing economies.

A revised report of the World Economic Outlook, of the IMF said the global economy may grow 4.4% in 2011 or higher than its projection in October, 2010. In 2012, the global economy is predicted to grow by 4.5%

The IMF also revised its earlier prediction of the growth of advanced economies to 2.5% from its estimate of 2.2% in October, 2010.

Prospects of Indonesia's economy, 2011

In general, Indonesia has fared better than many other countries and has greater chance of growing faster in 2011.

A number of factors sustaining the growth of the country's economy in 2011 include:

" Prudent management of the state finance by maintaining low deficit in balance of payments and safe macro economic policy.

" Healthy and profitable banking system. After the monetary crisis in 1998, Bank Indonesia has continued to adopt tight control of the country's banking system and prudent banking principle. The country's banking industry, therefore, was more prepared to face the 2008's financial crash.

" Natural resources still available in abundance. The country gains from the soaring prices of primary commodities reducing the impact of the high cost the country pays for the soaring oil prices.

" The huge domestic market and growing purchasing power of the people served as the driving motor for the country's economy protecting the country from the devastating impact of the global economic woes.

" The per capita GDP which reached US$ 3,000 in 2010 provided a great strength to drive the economy. Based on experience of other countries when the GDP per capita has reached US$ 3,000, the economy would grow faster because of growing domestic demand.

According to the World Bank, Indonesia could accelerate its economic growth in the next two years from 6.1% in 2010 to 6.4% in 2011 and 6.7% in 2012, driven by growing investment and exports in addition to growing domestic consumption.

The economic growth in the next two years will be marked with smaller current account surplus because of increase in imports of capital goods. The soaring prices of primary commodity will have contradictory effects - contributing to economic growth and causing greater inflationary pressure.

In the years after 2012, especially toward the end of 2014, a team of the World Bank predicted Indonesia's economy would expand by 7%, but special efforts are needed to boost investment and productivity.

Meanwhile, Bank Indonesia predicted that the country's economy would grow 6%-6.5% in 2011 and 6.1%-6.6% in 2012 with household consumption, investment and exports as the main drivers.

The board of governor of Bank Indonesia predicted the country's inflation would be around 5%-6% in 2011 and 4.5%-5.5% in 2012. The central bank, however, warned of the risk of the tendency of an increase in demand being faster than offer, increase in commodity prices in international market and disturbance in production and distribution system of essential goods.

Bank Indonesia, therefore, will continue to address the inflationary risks and will take into account of the strong inflows of foreign capital and the high domestic excess liquidity in adopting its policy. Bank Indonesia is taking a number of steps to mitigate negative impact of the foreign capital inflows and strengthen the resilience of the banking system such as with its regulation on minimum reserve requirement (GWM) for foreign exchange and giro account in rupiah of foreign investors in domestic banks.

The government also predicted faster economic growth in 2011. In the beginning the government's growth target was set at 6,3%, but later it was more optimistic revising up the target to 6.4% , much higher than 5.8% growth target set in the 2010 state budget.

With the recovery of export markets and high prices of primary commodities, the country's exports are expected to continue to climb. Based on his trend in 2010, the country's exports could grow by as high as 30% in 2011. Similarly imports would grow faster dominated by industrial basic materials and capital; goods that would contribute to pushing up exports. More investors are expected to seek to do business in the country attracted by the better prospects ahead of the country.

Meanwhile, the purchasing power of the people is also expected to grow. With a GDP per capita already exceeding US$ 3,000 demand would increase in the domestic market contributing to the revival of the country's sluggish manufacturing sector. The manufacturing sector is expected to find a good momentum for growth as already recoded in the automotive and electronic industries.

With lending rates relatively low and stable and strong rupiah, the domestic market would grow faster that the country's GDP would expand by a stronger pace in 2011. Therefore, the country's economy could grow 6.5%-7% especially if problem caused by inadequate infrastructure and increase in lending rate could be sorted out.

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