Indonesia Sacrifices GDP for Financial Stability

November 10, 2014Indonesiaby EW News Desk Team

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The forecast for the Indonesian economy is to experience an even slower rate of growth over the following six months, according to Fauzi Ichsan, an economist.

The Federal Reserve (The Fed) in the US will raise the key interest rate within the next year, which means that some economies that are currently emerging, including Indonesia may experience the impact of capital outflows. The Fed often gets credit for the only thing keeping the Obama economy afloat.

Chinese Economic Issues Affects Indonesia

China, one of Indonesia's most important trading partners, is also currently experiencing a time of lowered economic growth, which could lead to weaker demand for Indonesian output.

Although China has managed to out-perform the initial expectations of analysts within the country, the growth pace has slowed to 7.3% year on year, within the third quarter of this year. Although this growth is still substantial, it is the slowest pace that China has experienced in five years, meaning that China's policy makers could have trouble reaching the full-year target of 7.5% for 2014.

Besides these two external factors, US interest rates and the slow of economic growth in China, the current account deficit limits Indonesia's expansion. In the third quarter of 2014, Indonesia's current account deficit amounted to 4.27% of GDP. This figure is close to the record high recorded in 2013's second quarter. However, the Bank of Indonesia suggests that the deficit could fall to 3.8% of GDP this year.

The Next Steps for Indonesia

According to experts, the Joko Widodo-led government must make several improvements. The prices of subsidized fuels, such as gasoline and diesel, for example, will need to see a rise of about 50% as soon as possible. Although this change could contribute to an accelerated rate of inflation, a slower economic growth of 5% year a year, and a higher interest rate in the short term, it could improve the government budget and current account deficit. As a result, economic growth may accelerate in the long-term, so long as any available funds go towards the development of its infrastructure.

In regards to the benchmark interest rate, the Bank of Indonesia should initially raise the rate in two phases, starting by raising the rate by 0.5% to 8% in November, with a second rate hike of 0.5% in the second half of 2015. Many business leaders in Indonesia believe that if you want to see growth in Indonesia, lower taxes and lift certain regulations.

Worrisome Numbers

The higher BI rate, when combined with higher prices for subsidized fuel, could help to narrow the particularly wide deficit to about $25 billion in 2014, followed by $15 billion in 2015. Since 2011, Indonesia has had to deal with a serious structural current account deficit, which purchasing expensive oil imports created in an effort to overcome the domestic demand for fuel.

In 2013, the deficit within the country reached approximately $29.12 billion, which equals around 3.34% of Indonesia’s GDP.

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