Consumption may trump reform concerns in Indonesia

While China gives priority to reducing trade imbalances and allowing growth to slow, Indonesia is doing the opposite.

After 10 years of economic adjustment policies, which led to a dramatic improvement in public debt ratios, fiscal and external accounts, and a healthy banking system, the Indonesian government does now seem to take the nation’s economic stability for granted.

Unconventional monetary policy, similar to the approach of Turkish and Brazilian central banks, and more populist policy choices, are indications that the authorities are primarily looking to maximise economic growth.

The nation has grown at an annual rate of more than 6 per cent for most of the past six years. The general idea among policymakers in Jakarta is that growth can be moved to as much as 7 per cent.

At the end of March, the Indonesian parliament blocked a proposal to hike subsidised fuel prices. Currently, the total subsidy costs are accounting for more than 25 per cent of the government budget.

This very high figure, unparalleled in the emerging world, limits the room for the authorities to invest in infrastructure, education and poverty reduction. The poor state of Indonesia’s infrastructure, after more than a decade of underinvestment, is the main reason why Indonesia’s competitiveness is below average in Asia.

Keeping fuel subsidies in place means that there will be limited room for new public investment projects. It also means that Indonesia’s potential growth rate will struggle to move higher than the current estimate of 6 per cent.

But in spite of the poor economic reform momentum, what growth momentum there is in Indonesia remains solid. Household consumption is strong. Keeping interest rates lower than perhaps justified by inflation rates and keeping fuel and electricity subsidies in place is beneficial for the consumer.

But the main reason why household consumption is strong is the high wage growth and low credit penetration on offer. Indonesian consumption growth is likely to remain strong in the coming years, because there is abundant room for growth. Credit to the private sector as a percentage of economic output is only 30 per cent, the lowest among the major Asian countries.

Fixed investment growth, in spite of the lack of fiscal reform, is also strong. Although still insufficient, infrastructure investment has been increasing in recent years. This is clearly visible in Jakarta, where there has been an increase in road construction during recent months.

Moreover, foreign direct investment has been picking up, as foreign manufacturing companies are increasingly interested in the large consumer market of 250m Indonesians. In the past two years, total foreign direct investment into Indonesia has exceeded $10bn (£6.4bn) on an annual basis. In particular, Japanese and Korean companies have been increasing investments in Indonesia in the past few years.