“The Regional Economic Outlook and Indonesia,” Published in Bisnis Indonesia

Published in Bisnis Indonesia, April 28, 2014

Asia is well positioned to capitalize on the largely favorable global trends and enjoy steady growth in 2014−15. Recent policy actions taken to address vulnerabilities have started to bear fruit. With vigilance and further reforms, the region should remain resilient to global risks and continue to be a dynamic force driving the strengthening global recovery. In the case of Indonesia, its economy is weathering the transition to the new tapering environment well, reaping the benefits from the decisive macroeconomic policy actions taken since mid-2013. The focus on stability and the shift to greater policy flexibility, underpinned by macro-tightening and financial deepening measures, have bolstered confidence and improved market sentiment.

These are the conclusions in our latest Regional Economic Outlook, which are based on the following arguments: First, global activity has been firming up, and this is expected to help Asia’s exports. The growth momentum has gathered steam in the United States and the euro area, thanks to a reduction in fiscal tightening and still accommodative monetary conditions. And while some large emerging market economies have been struggling, overall growth in most emerging markets continues to provide support to the global recovery.

Second, the largest economies in the region are also doing relatively well, despite some challenges. In China, the unveiling of the government’s reform agenda has boosted sentiment, and growth should moderate only slightly to 7.5 percent in 2014. Meanwhile, Abenomics has lifted confidence and inflation in Japan, and growth there should remain above trend at 1.4 percent in 2014. This favorable external environment is benefitting much of the rest of the region, together with healthy labor markets and robust credit growth in many economies. The overall outlook for Asia is one of steady, robust growth of about 5.5 percent in 2014−15. While this is no longer as stellar as a few years ago, it remains enviable by international standards.

Third, external risks have receded in Emerging Asia, including when compared to some emerging economies in other regions. Asia’s emerging markets moved swiftly to address their vulnerabilities following last year’s market turbulence, and now have stronger macroeconomic fundamentals.

So far so good for Asia, but this outlook assumes that risk factors remain dormant. An unexpectedly rapid tightening of global liquidity would affect the region. Domestic vulnerabilities could magnify the impact: as interest rates rise, vulnerabilities stemming from pockets of high corporate leverage and household indebtedness would come to the fore. In addition, economies with weaker fundamentals would be hard hit, similar to what happened a year ago when markets abruptly revised their expectations of future U.S. monetary policy. Asia is also facing various risks originating from within the region. These include a sharper-than-envisaged slowdown and financial sector vulnerabilities in China, a waning impact of Abenomics, and political tensions and uncertainty.

In Asia, a continuation of the recent macroeconomic and structural policy momentum would help keep risks at bay, maintain investor confidence and sustain the region’s growth leadership. Decisive progress on structural reforms is critical. The specific agenda varies across the region: in China, vigorous implementation of the government’s reform blueprint would put growth on a more sustainable path; in Japan, further product and labor market reforms would prevent the return of deflation and low growth; and in many emerging, frontier and developing economies, as well as in Pacific Island countries and small states, lifting regulatory impediments, boosting infrastructure and continuing to promote trade and financial integration are appropriate.

Focusing on our near-term outlook for Indonesia, growth is projected at 5.4 percent in 2014. The main reason for the moderate expected slowdown compared to 2013 is the likely impact of tighter financial conditions on investment growth. At the same time, private consumption growth should remain supportive, boosted by election-related spending. In this context, the current account deficit is projected to narrow to 3.0 percent of GDP in 2014 from 3.3 percent of GDP last year, although the adjustment would likely be larger absent the partial ban on mineral ore exports. With inflation expectations well anchored, the headline rate is expected to decline to 5.5 percent by December 2014—that is, return to the upper bound of Bank Indonesia’s target band.

For Indonesia, macroeconomic and financial policies are expected to continue to be geared toward reducing macro-imbalances and safeguarding financial stability. Here, maintenance of the current monetary policy stance should slow the pace of credit growth, anchor inflation expectations, and contain external pressures, supported by continued bond yield and exchange rate flexibility. The fiscal policy stance will need to support this effort in ensuring that budget performance this year and next further buttress external adjustment and contain vulnerability to funding reversals. At the same time, policies need to carve out adequate space for social protection and infrastructure spending. Thus far in 2014, supportive inflows from abroad and careful management of financing needs have helped minimize pressures.

Looking ahead, structural reforms remain essential to strengthening competitiveness, bolstering investor sentiment and improving jobs and growth prospects. They become all the more important for Indonesia as tailwinds abate from buoyant commodity prices, strong emerging market demand, and extraordinarily accommodative global financial conditions. Under these circumstances, a growth strategy could usefully focus on three objectives: export diversification, financial deepening, and employment generation. The first will require a more concerted push to address infrastructure and logistics bottlenecks and to ensure that the trade and investment climate is outward oriented, with a view to expanding the export base and moving manufacturing up the global value-added ladder. The second centers on strengthening intermediation capacity in the financial sector and broadening the investor base. The third needs to be supported by further education reform and adequate labor market flexibility to ensure that Indonesia has a globally competitive labor force and fully exploits its demographic dividend. Not an easy set of challenges, but not insurmountable either, with recent macro-policy measures a testament to the resolve of policy makers in ensuring Indonesia’s economy remains a dynamic force.

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