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'Unlikely to rebound'

Interview: Gabriel DomínguezNovember 5, 2014

Indonesia's economy grew at its slowest pace for five years in the third quarter. The poor performance highlights the scale of the challenge facing the nation's new president Joko Widodo, analyst Gareth Leather tells DW.

Laborers work at the new Nissan plant in Purwakarta, West Java province on May 8, 2014 (Photo: BAY ISMOYO/AFP/Getty Images)
Image: Bay Ismoyo/AFP/Getty Images

Official data published on Wednesday, November 5, showed that Indonesia witnessed yet another quarter of weak growth in the three months to the end of September, with the pace of expansion slowing to 5.0 percent year on year, from 5.1 percent in the second quarter. It was the slowest growth rate for the G20 economy in five years and was well below the 6.5 percent average growth rate achieved from 2011-12.

The data comes as President Joko "Jokowi" Widodo took office last month. For the next five years, the 53-year-old politician will have to deal not only with a hostile parliament - given that most of its members are aligned with the losing candidate - but also with reviving Southeast Asia's largest economy whose growth has started to slow over the past months and whose current account deficit remains high.

In a DW interview, Gareth Leather, Asia economist at the UK-based economic research consultancy Capital Economics, says that while Jokowi offers Indonesia the prospect of a fresh start after years of policy drift, he will have his work cut out. As a result, the analyst doesn't expect growth to rebound anytime in the near future.

Gareth Leather
Leather: 'The most immediate challenge will be reducing Indonesia's vulnerability to Fed tightening'Image: Capital Economics

DW: Jokowi promised market-friendly policies. He also set a more nationalist tone in the campaign trail, favoring an agenda focused on protecting local resources and firms, and thus adding to concerns among foreign investors. What are the causes of the recent slowdown in investment growth?

Gareth Leather: Investment grew by just 4.0 percent in the third quarter, down from 5.0 percent in the second quarter, and an average of around 8.5 percent over the last decade. An uncertain and deteriorating business environment has discouraged both foreign and domestic investment. High interest rates are another factor holding back investment. More recently, the negative turn in the global commodity cycle is also weighing on investment.

President Jokowi recently named professional technocrats to lead the top economic ministries and implement much-needed reforms. How do you view the appointments and how is this likely to help the economy?

At this stage, it is clearly too early to tell whether Jokowi can get Indonesia's economy back on track. However, by appointing a number of technocrats, rather than political placement to key positions, Indonesia could see a general improvement in the quality of policy-making.

Why is it so important to cut fuel subsidies?

By holding down the price of fuel, subsidies reduce the incentive for consumers to use it efficiently. Increased demand for imported fuel in turn hurts Indonesia's external position, which given the large current account deficit is a big worry.

Fuel subsidies also put pressure on public finances. Although the finances of Indonesia's government are relatively healthy, with the fiscal deficit in 2013 coming in at just over two percent of GDP and public debt standing at just 20 percent of the economy, the large subsidy bill crowds out other public spending, such as badly needed improvement to the infrastructure.

Cuts to fuel subsidies also add to inflation. The last time they were cuts, inflation jumped from around five percent year on year to eight percent in just one month. The central bank hiked interest rates not too soon after, causing growth to slow.

How are fuel costs likely to increase as a result?

The government has an option of either cutting them in one go, or by a gradual increase in the administered price of fuel, with the aim of eliminating fuel subsidies within Jokowi's promised timeline. The recent falls in the oil price arguably reduce the urgency for reform. That said, any backsliding would disappoint investors, who have high hopes that Jokowi may be able to turn the economy around.

What are the main challenges facing the economy?

The most immediate challenge will be reducing Indonesia's vulnerability to Fed tightening. Because of its large current account deficit, Indonesia was one of the hardest hit countries during last year's "Taper Tantrum." This leaves BI under pressure to keep monetary policy tight. The other challenge is reviving growth, which in the third quarter grew at its weakest pace in five years.

Joko Jokowi Widodo (ELECTION/JOKOWI-INVESTMENT REUTERS/Darren Whiteside)
Leather: 'It is too early to tell whether Jokowi can get Indonesia's economy back on track'Image: Reuters

Given the recent performance and challenges ahead, what is your outlook for the Indonesian economy in the coming months?

We doubt that growth will slow much further from here, but we don't expect it to rebound either. Commodity prices are likely to remain depressed, which will drag on exports and investment, while monetary policy looks set to remain tight in order to prevent the current account deficit from widening.

Joko Widodo offers Indonesia the prospect of a fresh start after years of policy drift, but he will have his work cut out. However, the constraints of coalition politics, as well as a lack of experience on the national stage, could thwart his efforts. Although a sudden burst of reform in his first few months as president could lead us to upgrade our GDP growth forecasts, for now we are keeping them at 5.0 percent for next year.

Gareth Leather is Asia Economist at Capital Economics, a UK-based economic research consultancy.