Caution over Indonesia’s economic slowdown
In addition to the external environment, domestic dynamics will also determine the trajectory of Indonesia’s economic growth in 2023. Next year will be a “political year” as the country gears up for the 2024 elections. This condition will typically prompt businesses to take a wait-and-see stance, by withholding investment until after the election results are announced, as well as the policies of the new administration. Many fear that this will hinder the realization of investment, which is precisely what Indonesia crucially needs at the moment.
On the other hand, the domestic economy is still overshadowed by a high inflation rate, which can potentially stand in the way of household consumption recovery and lead to suboptimal growth. From the producers’ side, costs are expected to increase in line with rising production costs are determined by factors such as prices for raw materials, energy and logistics, as well as workers’ wages and interest rates. The Government is also required by law to bring down fiscal deficit back to a number below 3 percent of GDP.
While Indonesia’s economic growth is expected to continue robustly, there is no guarantee that the economy in 2023 will be better than that of this year, for a number of reasons. For example, economic pressure has begun to build up in Q4-2022, as inflation was higher than the previous quarter, energy and food prices have yet to return to normal, and the Rupiah has continued to weaken. These should serve as warning signs in the bid to maintain growth momentum in 2023.
The relatively high economic growth of 2022, predicted to reach above 5.1 percent, cannot be separated from a low base effect in 2021. In 2023, of course, this factor will no longer be relevant, given that Indonesia’s economic growth will have returned to a pre-pandemic level. Strong growth in the transportation and warehousing sector and accommodation as well as food and beverage services in 2022 are likely difficult to be replicated in 2023. Thus, the Government needs to spur other economic sectors to achieve its economic growth target of 5.3 percent in 2023.
This will not be easy, needless to say. Seriousness and accurate policy director in managing economic uncertainty in the run-up to a general election is key to realizing the target. IMF projects that Indonesia’s economic growth forecast will be down to 5 percent in 2023 compared to 5.3 percent in 2022. Meanwhile, after taking various challenges and economic dynamics into account, the Institute for Development of Economics and Finance (INDEF) estimated that Indonesia’s GDP growth will be only 4.8 percent next year. (TABLE-1)
Risk of Rupiah depreciation
The movement of the Rupiah exchange rate against the US dollar is still heavily influenced by the Fed’s monetary policy and global economic uncertainty. The U.S. central bank’s aggressive move in hiking its benchmark interest rate is likely to continue into mid-2023. This will result in further capital outflows. On the other hand, Indonesia’s economic development, which is expected to grow positively next year, will typically be followed by an increase in imports to meet rising domestic demand. This will deplete the nation’s foreign exchange reserves, which in turn will cause Rupiah to depreciate.
Meanwhile, foreign exchange earnings from exports are expected to decline, in line with a sluggish global economy. A strong US dollar, compounded by uncertainty in global financial markets, will continue to put pressure on exchange rates in various countries, particularly developing ones like Indonesia. (FIGURE-1)
Based on Budget 2023 macroeconomic assumptions, the Rupiah exchange rate is set at Rp14,800 per US dollar. Achieving this target would, of course, requires great effort as it is directly linked to a policy to maintain and boost foreign direct investment (FDI) and exports. INDEF is of the view that economic and political challenges in 2023 will be at the front of foreign investors’ minds. In addition, the commodity windfall era is predicted to be over by the end of 2022, which will lead to declining exports of Indonesia’s key commodities. Thus, INDEF forecast that the Rupiah exchange rate may slide to Rp16,000 per US dollar. This projection indicates the need for extra efforts to defend the Rupiah from further depreciation.
Challenges in reining an inflation
The Government set the 2023 inflation target at 3.6 percent (within a range of 3±1 percent). This target will not be easy to achieve given the volatility of energy and food prices, as well as a likely interest rate hike next year. Even though inflation in October and November showed a downward trend, after the Government increased the price of fuel in September, inflationary pressure will remain high in 2023. To complicate matters, several economic sectors have contracted, due to weak global demand, leading to mass layoffs. This will of course eventually hit purchasing power and household consumption. (FIGURE-2)
Maintaining the stability of the food and energy prices will pose a complex challenge for the Government and the central bank. As of the end of 2022, the prices of food and energy commodities are still high, due to supply chain disruptions caused by the Ukraine war. Inflation in 2023 is expected to be largely cost-push, mainly due to weak domestic currency, which has increased the cost of imported goods. Moreover, industries in Indonesia are still largely dependent on raw material and capital goods imports.
IMF projects that Indonesia’s Consumer Price Index (CPI) may increase by 5.5 percent in 2023, up from 4.5 percent this year, indicating that inflationary pressure in Indonesia may rise in 2023. Meanwhile, INDEF predicted that the country’s inflation rate may be as high as 5.6 percent, a figure higher than the Government’s own target. This calls for adequate anticipatory measures to mitigate the risk of price spikes next year.