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A year of crisis and setback for Indonesia’s economy

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A vendor wearing a protective face mask waits for customers amid the COVID-19 outbreak in Jakarta, Indonesia, 22 December 2020 (Photo: Reuters/Ajeng Dinar Ulfiana).

In Brief

President Joko ‘Jokowi’ Widodo confidently announced his plan for ‘Indonesia Emas 2045’ (Golden Generation 2045) after winning the 2019 presidential election, setting a target for Indonesia to become one of the world’s top five economies. But the COVID-19 pandemic has significantly disrupted the country’s growth trajectory — and possibly its long-term development path toward that goal.

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Indonesia has the highest number of COVID-19 infections among ASEAN countries. As of late December, more than 700,000 people have been infected and more than 21,000 people have died from the disease there. These figures likely underestimate the gravity of the situation because of limited testing capacity compared to other countries.

Restrictions on civic activities and enforced social distancing — known in Indonesia as Pembatasan Social Berskala Besar (PSBB) — has taken a massive economic toll. Indonesia’s GDP growth was negative in two consecutive quarters: by 5.3 per cent in the second quarter of 2020 and by 3.5 per cent in the third quarter. Almost 40,000 formal sector firms had to lay off or retrench their employees during PSBB. The number of unemployed in August 2020 increased by 2.7 million people, bringing the unemployment rate to 7.1 per cent — the highest level since 2011.

Beyond the rising unemployment rate, the pandemic has sent many people into poverty. In March, around 1.63 million Indonesians fell into poverty, raising the poverty rate to 9.8 per cent or 26.4 million people, up from 9.2 per cent in September 2019.

Finance Minister Sri Mulyani projected that GDP for 2020 will contract by 1.7–2.2 per cent before rebounding and rising by 4.5–5.5 per cent in 2021. This projection is optimistic and assumes that Indonesia can control COVID-19 into 2021 as vaccines are distributed. But the possibility of new COVID-19 waves hitting Indonesia and necessitating another round of PSBB remains a real threat. With COVID-19 still around, both consumers and investors will not regain full confidence to start spending and investing. Economic recovery will depend on the effectiveness of the government’s response to the pandemic.

Indonesia must also watch its macroeconomy cautiously. While the 1997 Asian Financial Crisis forced the country to implement prudent macroeconomic policy by reducing the debt-to-GDP ratio, the COVID-19 crisis has forced the public sector to do ‘whatever it takes’ to rescue the economy.

To finance various stimulus and social protection programs, the government has boosted its spending by 18.6 per cent from 2019. For 2020, it has budgeted Rp 695.2 trillion (US$47 billion) worth of economic stimulus aiming to strengthen the health care system and provide social safety net programs. The 2021 draft budget also allocates Rp 356 trillion (US$24 billion) to further support the country’s economic recovery from the pandemic.

Given that tax collection efforts are expected to be significantly reduced, the government will rely on issuing new debt to fill its financing needs. The challenge is that there are insufficient takers for Indonesian government bonds. As a result, the government and Bank Indonesia (BI) agreed to launch its ‘burden-sharing’ program. This allows BI to buy government bonds by acting as a standby buyer in the primary market. While it may solve the short-term funding gap, the immediate market reaction was negative. There is a risk that this program could be prolonged beyond its 2020 deadline and will affect BI’s independence from the Ministry of Finance.

One clear outcome from the COVID-19 crisis is that Indonesia’s debt level will reach a new record high. Central government debt-to-GDP rose from 30 per cent in 2019 to 38 per cent in 2020, and is projected to reach 41 per cent in 2021. In 2021, the government will spend Rp 373.2 trillion (US$26.5 billion) on debt interest repayment. This is more than 10 per cent of the government’s budget and will squeeze the country’s already limited fiscal capacity. While an increase in debt is unavoidable, how fast Indonesia can recover from the 2020 recession to its pre-COVID-19 growth will determine its ability to repay its debt.

The government made a bold political decision to pass its Omnibus Bill on Job Creation in October. For this to be effective, the government needs to deliver specific operational frameworks to attract investment and build market confidence. These will be big challenges given the weak institutional capacity for enforcing laws and regulations amid Indonesia’s decentralised political system.

The main policy challenges going forward are to control the pandemic, distribute vaccines and ensure a smooth transition to a new normal with stricter health protocols. The recent cabinet reshuffle indicates Jokowi’s unhappiness with his administration’s capacity and also his strategy to address challenges. While this is a positive sign, heavy political interests will continue overriding policy implementation. To boost economic recovery, the government needs to rebuild public confidence in the public health situation and the government’s capacity to address it.

Siwage Dharma Negara is Senior Fellow, Coordinator of the Indonesia Studies Programme and Coordinator of the APEC Study Centre at ISEAS-Yusof Ishak Institute.

This article is part of an EAF special feature series on 2020 in review and the year ahead.

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