Indonesia, which has been trying to jack up its tepid economic growth rate, likely achieved slightly faster expansion in the third quarter than in the previous three months. (GA Photo/Mohamad Defrizal)

Indonesia One of the Strongest Emerging Markets: Templeton

AUGUST 07, 2016

Jakarta. Last week, the Indonesian economy surprised observers and policymakers alike with its strongest growth in the last ten quarters.

But for Michael Hasenstab, the chief investment officer at global fund manager Franklin Templeton Investments, that may be just a small vindication for a long-held belief.

Amid rising uncertainties haunting a fragile recovery of the global economy, Hassenstab has always viewed Indonesia among the few economies that still offer robust growth, thanks to the country's prudent fiscal policy, favorable demographics, healthy level of foreign exchange reserves and continuing structural reforms.

Templeton's proprietary Local Markets Resilience Index, which assess investment risks and opportunities in emerging markets, puts the largest economy in Southeast Asia ahead of Thailand, Malaysia and China.

"Over the last several years, prudent fiscal and monetary policies have entrenched macroeconomic stability in Indonesia," Hasenstab said in a commentary sent to the Jakarta Globe.

The country last year shed off most subsidies in fuel, reducing volatility in fiscal and monetary deficits and putting the country in "a strong position" to respond to deterioration in external environment of the last few years, which stemmed from weak commodity prices and a deceleration in China’s economy, Hasenstab said.

The Indonesian government has been maintaining a prudent fiscal deficit management in the past few years, in line with an imposed legal deficit cap of 3 percent of the gross domestic product (GDP). This year, with large shortfall in tax revenue imminent, newly elected Finance Minister Sri Mulyani Indrawati laid out a series of budget cuts as one of her first actions in office to maintain the deficit at below 2.5 percent of the GDP.

Hasenstab said Bank Indonesia, the country's central bank, can now make a more credible monetary policy, after the main culprits in its missing its own inflation target were eliminated.

Inflation has been tame this year, cooling further in July to 3.2 percent from 3.4 percent a month earlier and falling within the central bank's target of between 3 percent to 5 percent. That allowed Bank Indonesia to cut benchmark interest rate by 1 percentage point so far this year to 6.5 percent in order to rejuvenate growth.

Favorable demographics

Indonesia's GDP expanded at a faster-than-expected 5.2 percent in April to June from the same period a year earlier, thanks to higher commodity prices and stronger consumption.

And for Hasenstab, its long term prospect was just as bright.

"Macroeconomic stability and supportive monetary policy have allowed GDP growth to remain robust. Looking forward, Indonesia’s demographics provide a solid underpinning for current and future domestic demand," he said.

Hasenstab noted only about 5 percent of Indonesia's population are 65 or older — a veritable advantage when coupled with a steady increase in the rate of urbanization and a decline in unemployment rate, from 10 percent in the mid-2000s to a current level of 5.5 percent.

In the second quarter, exports made up less than 20 percent of Indonesia's GDP, while more than 83 percent of the quarter growth came from private consumption and capital formation.

"The strength of domestic demand is a fundamental strength of the Indonesian economy, in our view," Hasenstab said.

External strength

At current stance, Indonesia is largely shielded from external shock, Hasenstab said.

"Indonesia runs a small current account deficit that is not fully financed by net foreign direct investment flows, leading to a narrow balance of payments deficit of 1 percent of GDP," he said.

Still, Bank Indonesia sat on a $111.4 billion foreign exchange reserve by the end of last month, the highest level since May last year, and capable of covering more than twice the level of short-term debt.

"Indonesia's public debt is not vulnerable to foreign exchange mismatches," Hasenstab said.

Structural reforms

The country can still benefit from improvement, tough.

"To further strengthen the country’s prospects for sustainable robust growth, the government should raise the very low revenue ratio in order to fund an increase in capital expenditure, notably on infrastructure," Hasenstab said.

Indonesia's current 15 percent tax-to- GDP ratio is very low compared to OECD members' average of 34 percent. The government introduced the tax amnesty program last month, which beside boosting tax revenue this year, will also expand the country's tax base in coming years.

In addition, the country also needs to further improve its business environment and transparency.

The World Bank's Ease of Doing Business survey last year placed Indonesia at 109 out of 189 countries, moving up 11 places from a year earlier, thanks to a new policy to make it easier for companies to register their businesses and pay tax.

"On an international scale, Indonesia does not rank very highly, and further progress will be needed in the years ahead," Hasenstab said.