THE PROSPECT OF INDONESIA’S ECONOMY 2015 AND 2016

Business Luncheon Indonesia Netherlands Association (INA)

By Anthony Budiawan

Jakarta, Financial Cub 8 September 2015

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INDONESIA’S CURRENT ECONOMIC CONDITION

Is it already at the bottom?

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Indonesia’s economic growth declining

GDP growth continues to decline: • Last two quarters below 5% However, the government estimates the economy in 2016 will grow 5.5% Why is the government so optimistic? • Will consumption increase? • Will investment increase? • Will exports increase? Can government spending improve the economy?

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Indonesia’s economic growth declining

GDP growth 2014: 5.02% Projection 2015: 4 times revised • 5.8% (APBN) • 5.7% (APBN-P) • 5.4% (May 2015) • 5.0% - 5.2% (July 2015) 4.5% growth (2015) is considered good

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GDP growth 2015 Description Q1 2015 Q2 2015 Household Consumption 2.65% 2.56% Government spending 0.14% 0.18% Investment 1.40% 1.14% Inventory change and discrepancy statistics 0.14% -0.81% Growth from Domestic 4.33% 3.07% Export -0.13% -0.03% Import -0.51% -1.63% Net Export (export - import) 0.39% 1.60% GDP growth 4.72% 4.67%

GDP growth from domestic Q1 2015: 4.33% Q2 2015: 3.07% GDP growth from international trade • Q1 2015: 0.39% • Q2 2015: 1.60%

• Export 2015 decrease • Import 2015 decrease faster than export • (Export – import) contribute significantly to the GDP growth • Indonesia’s growth largely depends on imports performance • If imports increase, the economic growth will be depressed Page | 5

Rupiah continues to depreciate

2 Aug 2011 USD 1 = Rp 8,460

- 66.28%

25 Aug 2015 USD 1 = Rp 14,067

• What would be the value of Rupiah: Rp 15,000? Rp 16,000? • What are the consequences of further decline in Rupiah to the economy? Page | 6

Rupiah continues to depreciate

Why Rupiah depreciate since 2011?

Why Rupiah appreciate between 2009 – 2011?

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Rupiah and monetary policy of the FED

2015: Rupiah still depressed, uncertainty if the FED rate increase

• QE = Quantitative Easing: monetary policy used by the FED to stimulate US economy • QE: creates new money to buy financial assets such as treasury notes and mortgagebacked securities • Impact of QE: Net money inflow to EM economies, EM currencies up, inflationary: commodity prices up Page | 8

Rupiah and monetary policy of the FED

Average rate

Average Rate Change

2008 9,692

Exchange rate (Rupiah to USD) 2009 2010 2011 2012 2013 2014 1H2015 10,408 9,087 8,776 9,384 10,459 11,869 12,968 -7.38% 12.69% 3.42% -6.93% -11.45% -13.48% -9.26%

Rupiah rebound in 2009, but in average still below the 2008 average rate

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Impact of QE on commodity prices

Palm oil average price (USD per metric ton) 2008 2009 2010 2011 2012 2013 Average price 862.92 644.07 859.94 1,083.79 942.08 760.33 Change -25.36% 33.52% 26.03% -13.08% -19.29%

2014 1H2015 743.71 613.87 -2.19% -17.46%

Palm oil price in 2009 rebound, but in average still below 2008 price Page | 10

Impact of QE on commodity prices

Coal average price (USD per metric ton) 2008 2009 2010 2011 2012 2013 2014 1H2015 Average price 136.18 76.98 106.04 130.12 103.25 90.60 75.14 64.41 Change -43.48% 37.75% 22.72% -20.65% -12.25% -17.07% -14.29%

Coal price in 2009 rebound, but in average still below 2008 price Page | 11

Impact of QE on commodity prices

Rubber average price (USD per pound) Rubber 2008 2009 2010 2011 2012 2013 2014 1H2015 Average price 118.56 87.17 165.72 218.51 153.19 126.76 88.75 79.91 Change -26.48% 90.12% 31.86% -29.89% -17.25% -29.98% -9.97%

Rubber price in 2009 rebound, but in average still below 2008 price Page | 12

Trade Balance and Current Account

Trade balance deficit since 2012 • 2012: deficit USD 1.67 billion • 2013: deficit USD 4.06 billion • 2014: deficit USD 1.89 billion

• Current Account until 2011: Surplus • Current Account since Q4 2011: Deficit

Surplus Non Oil & Gas < deficit Oil & Gas • Fall of commodity prices

2015: surplus USD 5.74 billion (7 months) • Exports decrease, Imports decrease faster • Declining oil price: reduce the deficit in Oil & Gas sector

Reduction in the deficit 2014 is attributed to the free fall of crude oil price in 2H 2014

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Fundamental of Indonesia’s economy

The government tend to say that Indonesia’s economic fundamentals are strong enough I would challenge that opinion: • on what basis is Indonesia’s economic fundamentals regarded as strong Indonesia’s current economic condition is fundamentally weak: • Current account deficit is chronic and therefore difficult to fight because it is structurally dependent on commodity prices, including oil price • Balance of payment is dependent on the financial and capital accounts: capital inflow to Indonesia is mostly short-term in nature i.e. hot money • Indonesia’s industry structure is fundamentally weak: dependent on commodities, import of intermediary goods as well as capital goods, industrial goods less competitive than the neighboring countries Page | 14

Dependent on commodity • Indonesia’s economy is increasingly dependent on commodities as a result of commodity boom in mid 2000s  (1) FATS, OILS AND WAXES  (2) MINERAL FUELS AND OILS  (3) RUBBER AND RUBBER ARTICLES HS

Description

2007 15 FATS, OILS AND WAXES 10,227 27 MINERAL FUELS AND OILS 7,123 40 RUBBER AND RUBBER ARTICLES 6,249 TOTAL 3 COMMODITIES 23,598 SHARE OF EXPORT (%) 25.6%

2008 15,624 10,656 7,637 33,918 31.4%

EXPORT (Million USD) 2009 2010 2011 2012 12,220 16,312 21,655 21,300 13,934 18,726 27,444 26,408 4,913 9,373 14,352 10,475 31,066 44,411 63,452 58,183 31.9% 34.2% 39.2% 38.0%

2013 19,225 24,780 9,394 53,399 35.6%

2014 21,060 21,058 7,100 49,217 33.7%

• Three groups of commodity contribute 39.2% of the total export in 2011 • Further fall of commodity prices will hurt exports and the economy

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Depreciation of Rupiah: good or bad?

Average Rate Change

2008 9,692

Exchange rate (Rupiah to USD) 2009 2010 2011 2012 2013 2014 1H2015 10,408 9,087 8,776 9,384 10,459 11,869 12,968 -7.38% 12.69% 3.42% -6.93% -11.45% -13.48% -9.26%

Palm oil average price (USD per metric ton) 2008 2009 2010 2011 2012 2013 Average price 862.92 644.07 859.94 1,083.79 942.08 760.33 Change -25.36% 33.52% 26.03% -13.08% -19.29%

2014 1H2015 743.71 613.87 -2.19% -17.46%

Coal average price (USD per metric ton) 2008 2009 2010 2011 2012 2013 2014 1H2015 Average price 136.18 76.98 106.04 130.12 103.25 90.60 75.14 64.41 Change -43.48% 37.75% 22.72% -20.65% -12.25% -17.07% -14.29% Rubber average price (USD per pound) Rubber 2008 2009 2010 2011 2012 2013 2014 1H2015 Average price 118.56 87.17 165.72 218.51 153.19 126.76 88.75 79.91 Change -26.48% 90.12% 31.86% -29.89% -17.25% -29.98% -9.97%

• Rupiah Depreciate: more Rupiah for exporters, the revenue in Rupiah does not drop as much as the drop of the revenue in dollar, it helps them stay in business • The fall of commodity prices (partly) compensated by the fall of Rupiah • Weak Rupiah helps reduce imports, restore trade balance

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Indonesia’s monetary policy • Rupiah depreciates 22% from June 5, 2013 (Rp 9,856) to Dec 6, 2013 (Rp 12,020) • Bank Indonesia’s policy response: increase BI rate from 5.75% to 7.5% (in 5 months) Can the increase of BI rate prevent Rupiah from the depreciation? • Rupiah is still depressed in 2014 • Depressed Rupiah is good for exporters, good for the economy, • Depressed Rupiah will reduce import and restore the deficit of trade balance

Can the increase of BI rate fight the inflation? • The 2013 inflation is a non-monetary inflation (i.e. cost push inflation), most likely cannot be solved with high interest rate • High interest rate will hurt the economy, will reduce private consumption and investments • Other countries reduce the interest rate to stimulate the economy Page | 17

Government spending

Indonesia GDP (Rp trillion) 1H 2014 Description Consumption 2,927 Government spending 395 Investment 1,638 Inventory change and discrepancy statistics 187 GDP from domestic consumption 5,148 Export Goods and Services Import Goods and Services

Net Export (Export - Import) GDP

1,243 1,278

1H 2015 Change 3,159 7.92% 434 9.88% 1,817 10.90% 165 -12.03% 5,575 16.66% 1,220 1,199

(35) 5,113

-1.83% -6.16%

21 5,596

9.44%

Government spending 1H 2015 is 9.88% higher than 1H 2014 It is an illusion to expect government spending increases economic growth this year Page | 18

Factors influenced Indonesia’s economy • Global economic condition, particularly China, will determine the global demand for Indonesian goods: weakening China’s economy will depress exports • The development of commodity prices will influence exports: a further fall of the prices will hurt exports and will hurt Indonesia’s economy • Indonesia’s monetary policy: the current level of BI rate is too high to stimulate the economy, particularly private consumption, as well as the investment • Government spending does not play a significant role in Indonesia’s economic development: • The most important thing is the total government spending, not the substitution between the expenditures • The budget deficit is set to a maximum of 3% of GDP, the current level of budget deficit is approaching the maximum Page | 19

Factors influenced Indonesia’s economy

• The FED monetary policy has a major influence on the development of commodity prices and the exchange rate: • increase in the FED rate could result in the net capital outflow from EM economies, including Indonesia, and the depreciation of Rupiah

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OUTLOOK 2015 - 2016

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Outlook (1) Sooner (2015) or later (2016) the FED will increase the FED rate: • Rupiah will further depreciate: Rp 15,000 per USD is not surprising, Rp 16,000 per USD is not impossible • Commodity prices will still depressed, especially if China’s economic growth decrease, which most likely will happen Global economy is still weak, China’s economic growth continues to decline • Global demand for Indonesian product decrease, export decrease

• In response to the increase of the FED rate, I expect Bank Indonesia will increase, or hold, the BI rate: domestic economy will weaken, private consumption and investment will decrease AEC, ASEAN Economic Community, is in effective in 2016 • If Indonesia cannot compete with the neighboring countries, import will increase, economy will decrease Page | 22

Outlook (2)

If further fall of Rupiah and further decline in export resulted in bankruptcies then Indonesia’s economy will certainly go into recession Considering the above factors, I expect Indonesia’s economic growth: • 2015: 4.5% • 2016: less than 4.5%

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THANK YOU

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