Indonesia is estimated to start losing its demographic dividend from 2025 onward. (ID Photo/Emral Firdiansyah)

Commentary: Chasing the Possibility of 7% GDP Growth, Sustainably


MAY 28, 2016

The demographic dividend is one of the key drivers for Indonesia's well-known structural growth story. The basic thesis is that as Indonesia's population enters a productive age, per-capita income should be on the uptrend and thus support consumption growth in the country. Of course, the demographic dividend is not everlasting and Indonesia is estimated to start losing its demographic dividend from 2025 onward.

A decade ago, the year 2025 would have felt an age away as most of us would consider 20 years sufficient in order to get the balancing act right between consumption and capacity. Unfortunately, we are at the point today where 2025 is already less than 10 years away, while our quest for increased capacity remains at best modest and still lags the targeted level.

Adding more concern is the fact that while Indonesia's gross domestic product per capita has been on the rise in rupiah terms, its US dollar equivalent has been declining for the past four years given the depreciation of the rupiah. While we hope the trend of GDP per capita, in US dollar terms, starts to reverse in 2016, the fact remains that much must be done before Indonesia can fully achieve its potential.

For a long time, Indonesia has been hoping to reach its 7 percent GDP growth target. Is 7 percent simply an unreachable target? Not really. India and China have proven that such a level of growth is indeed possible, though caution should be warranted to avoid inflating a bubble. Below, we outline five key steps for Indonesia if it wants to attain its sought-after growth rate of 7 percent.

First, stable politics are paramount. This does not necessarily mean a majority or full parliamentary control (2009-2014 showed parliamentary dominance means nothing if the foundations are weak). For the government to be able to effectively manage a country's economy, political stability is crucial and one can look towards Brazil as an example of how political instability can have a negative impact on the economy.

Second, balancing consumption with capacity. Consumption growth is the key driver for Indonesia's economy on the back of its demographic dividend and emerging middle class. One of the necessary components of this is a stable rupiah, as a depreciating currency erodes purchasing power. Obviously, achieving this is much easier said than done and the challenge is to effectively manage hot money inflows.

With global interest rates currently at record lows, capital inflows can inflate the currency only for it to collapse when funds are withdrawn. Meanwhile, without growing capacity, the increase in consumption will translate to an increase in imports and higher inflation. India experienced this between 2007-2012 and the result was a surge in its current-account deficit and high inflation.

Third, improving cost efficiency. One of the biggest challenges for Indonesia is its high-cost economy. Without cost efficiency, it reduces the incentive for businesses to invest and now is an ideal time for Indonesian companies to leverage off global technological improvements. This could mean simple changes such as cost controls, such as e-commerce companies taking advantage of current industry trends to trim their marketing expenses.

In other arenas, social media can allow the public to participate in monitoring government, with notable example of corrupt government officials being brought to account after being exposed via social media. These can all play a part in lowering hidden costs for the Indonesia economy and help spur growth for companies

Fourth, liquidity and funding. In order to build capacity, Indonesia needs funding. While the country has one of the lowest loan-to-GDP ratios, implying that leverage remains low, Indonesia also has one of the lowest deposit-to-GDP ratios globally. The country's limited excess banking liquidity is partly due to the fact that Indonesia has suffered from decades of capital leakages to offshore entities.

Indonesia is currently hopeful that the proposed tax amnesty may be the turning point and allow Indonesians to repatriate part of their offshore savings back to the domestic economy. In addition, the proposed tax amnesty is also expected to increase the country's tax ratio, which will be crucial in enhancing the government's budget revenues, allowing investment in much-needed public infrastructure, such as ports and roads.

Despite the obvious benefits of a tax amnesty, Indonesia's financial industry may need to expand US dollar-based product options so that repatriated funds can avoid unnecessary strengthening of the rupiah.

Fifth, developing human capital. We often think of capacity as being brick-and-mortar factories, roads, ports, etc., but we often forget about human capital. After capacity has been added, we need someone to run it. For example, factories need a labor force to produce. Unfortunately, Indonesia's quality of human capital still needs to improve. As economies grow, demand for quality human capital also increases and in this sense, the answer to Indonesia's shortfall is simple; education.

Yet relying on formal education to enhance human capital quality usually requires a longer timeframe. But with the demographic dividend starting to be eroded in 2025, the country has less than nine years to meet its requirements. One potential solution for the country is vocational study.

Enhancement of human-capital quality is also required in order to prevent Indonesia falling prey to the middle-income trap, where a nation's labor is too expensive for it to engage in labor-intensive, lower-end services but the quality of its labor is not yet sufficient to move up the value chain. That is, the nation is stuck in the middle-income phase with limited ability to grow its wealth.

In conclusion, it may sound like there is plenty of work to be done. That is true. However, at the same time, Indonesia has nearly all the necessary ingredients and it is just a matter of putting words into action. After all, nothing is free in this world and the only thing that is constant is change.

Teddy Oetomo is the head of intermediary business at Schroder Investment Management Indonesia