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Country Economic Review - Indonesia : I. Recent Economic Developments
A. Growth, Employment, Savings, and Investment1. Aggregate Growth2. Figure 1 shows the pattern for of change in the GDP composition of GDP over the past few years. GDP growth in 2001 grew 3.3 percentin 2001, was slightly below earlier expectations as in response to slowing exports and business spending slowed. The firm recovery from the difficult two2-year recession is quite apparent, as is the importance of the household sector in determining the overall economic performance. The Indonesia's large domestic market provides a broad platform for moderate sustainable growth. Preliminary estimates for GDP in the first quarter of 2002 show a 2.5 percent% increase over the the comparable period in 2001.  3. Household and government consumption, up 5.9 percent% and 8.2 percent%, respectively, were the major factors accounting for in GDP growth in 2001. Strong spending by households and gGovernment has continued in the first quarter of 2002. While Hhousehold consumption has been strong, however, it is unlikely to continue growing much faster than overall income. While it was not unusual for household consumption to grow faster than national income in the boom years before the prior to the East Asian Ffinancial Ccrisis, it seems unlikely, given the degree of political and institutional change, that households will would continue to spend faster than income growth. Households are indeed wealthier, but however, political stability is one key to household (and business) spending prospects. and was boosted by Here tthe relatively peaceful transition in mid-2001 to a new Ppresidency was important. It is possible too that sSpending in 2001 was stimulated, especially for durable goods such as motorcycles, could also have been stimulated because inflation rates increased unexpectedly. 4. The large public sector expenditure was unexpected even through late 2001. The spending may have been partly due to the need to smooth the decentralization process initiated at the beginning of the year. In this tThe Ccentral Government sends 25 percent% of its domestic income and a large part of its natural resource revenue to local governments to support a commensurate transfer of responsibility and approximately 2.5 million staff. In 2001, the first year of decentralization, the Government made considerable efforts were made to ensure that no disruption to that essential services were not disruptedoccurred. In early 2002 some degree of front-loading, of spending early in the year, may have occurred to rebuild flood-damaged structures and facilities. Weaker consumption expansion is anticipated this year considering the severe debt burden and consequent fiscal constraints facing the Central Government. 5. Emerging weakness during 2001 was seen in the GDP figures for exports and imports, -reflecting slackening the emerging weaknesses in demand in international markets. Imports grew 8.1 percent% in 2001 against export growth of only 1.9 percent%. As a result, net exports in 2001-although positive-fell 25.9 percent%. From a national account, GDP-basis exports and imports continued to weaken in the first quarter of 2002 although there is some evidence that the worst is over and that trade levels are stabilizing. In 2000, strength in the external sector was the signaled for the end of the recession; -exports on grew 26.1 percent% in real terms. Conversely, the fall-off in foreign orders depressed business spending in the second- half of 2001. 6. Investment and exports have shown considerable correlation in Indonesia. As Figure 2 shows, after the disruption of the financial disruption of the Ccrisis, investment and exports are again moving quite closely. Stimulated by the export boom in 2000, spending on plant and equipment in the first two quarters of 2001 grew at an average rate of just under 13.3 percent% (on a four-quarter basis). Spending declined thereafter, and the year as a whole showed only a spare 4.0 percent% increase. Spending in the first quarter 2002 was 6.1% below the level in the comparable period in 2001. In addition to following exports, bIn addition to following exports, business spending was also muted in response to recurrent political difficulties. Although the relatively peaceful change in the Ppresidency in July provided for a moment of calm before the terrorist attacks in the United StatesUS in September, the subsequent rise in tension again unnerved businesses. Banking sector weaknesses also discourage investment by business. Finally, investment was also dampened by a longer- term perspective that little progress was being made on essential reforms needed to reduce corruption and strengthen the banking system were making little progress. Investment is one important link between the state of governance and development - a connection discussed in the special topic at the end of the report.  7. Manufacturing output slowed somewhat in 2001, increasing 4.3 percent% during the year against 6.2 percent% in 2000. Utility services (water, gas, electricity, and communications) showed stronger- than- average performance. Banking and finance, however, continued to evidence only slender growth. The first quarter 2002 experience followed closely the pattern for 2001 as a whole. 8. Agriculture continues to reflect pPoor productivity growth and other problems in the rural sector, in 2001 resulted in managing less than 1one percent% growth agriculture sector growthover the past year., which had been poor This continued the poor performance seen since the financial Ccrisis. Figure 3 shows that the last most recent several years' experience stands in stark contrast to that of the decade before prior to the Ffinancial Ccrisis, when agriculture output, particularly paddy, showed a strong upward trend. A lack of inputs such as fertilizer and pesticides, as well as regional security problems are blamed for the disappointing outcomes. The dependence of many rural poor on agriculture and the broader rural economy suggests that addressing these barriers to sustainable development is a priorityshould be brought down.  2. Employment, Wages, and Poverty9. The softening economic growth in 2001 is reflected in preliminary labor market data that show increases in labor market demand unable to fully match increases in the labor force. Although employment continued to edge up in 2001, the 1.1 percent% rise was not sufficient to offset the increase in population and in the labor force participation rate. Gains in employment were reported mainly in the formal sector, accounting for about one- third of the economy, while little growth in jobs was reported in the informal sector (Figure 4). The latter depends especially upon the poorly performing agriculture sector. Open unemployment increased to 8.1 percent% of the labor force from 6.1 percent% in the previous year. By definition, a person is employed even if he or she only works one hour during the reference week. The statistics presented then may well mask changes in hours worked, that affect especially affecting those engaged in the informal sector.  10. Real- wage data supplement this picture. Until end-2001, for two 2 years, real wages showed significant increases in manufacturing- in the formal sector- but stagnation in agriculture and the informal sector. Figure shows the experience since 1996 using data from Biro Pusat Statistik (Central Bureau of Statistics, BPS) Asian Development Bank (ADB) Technical Assistance (TA) 3710-INO: Developing Leading Indicators for Poverty Monitoring. The lack of improvement in failure of real wages in the informal sector and in agriculture to improve is consistent with data on employment data and broader data on recent performance in the agriculture sector. In manufacturing, administered increases in the minimum wage may account for some of the movements in 2001, but higher manufacturing wages were also encouraged by the rise in manufacturing output in 2000 and 2001. Real wages in manufacturing have retraced the ground lost during the financial Ccrisis.  11. Minimum wages have increased considerably in recent months. With decentralization, minimum wages are now set by local governments. In 2001, minimum- wage increases of between 20-30 percent% in real terms were announced., These followinged large increases in 2000 so that real minimum wages in early 2002 are likely higher in major industrial centers than before the financial Ccrisis. There is some evidence that mMinimum- wage regulations have not, apparently, been completely observed in practice BPS Ssurveys, by the Government's ssurveys tatistical agency (BPS) show for instance, show that between 20-30 percent% of surveyed firms paid some workers less than the relevant minimum wage.2 However, recent work suggests that minimum- wage legislation has an increasing impact on overall wage structure and employment in the formal sector.3 The sharp increases in minimum wages, outstripping likely productivity increases, may have contributed to the flattening of employment prospects in the formal sector at the end of -2001 and the stagnation of real wages in the informal sector. 12. Figure 6 shows that the economic recovery in 2000 allowed for a considerable reduction fall in the incidence of poverty. (Data points are as of February of the relevant year. The 2001 estimate is quite preliminary and only provided for total poverty incidence.) The incidence of poverty is very sensitive to changes in the prices of basic foods, which have been quite volatile. However, through in early 2001, growth, the resurgence of employment prospects, and the fall-off in inflation helped lift families above the poverty line. The latest data, representing a preliminary reading for early 2001, suggest that suggest that there were even improvements in rural poverty was reduced, which is -a suggestion difficult to reconcile with other wage and agriculture performance data. The incidence of poverty is particularly sensitive to changes in the prices of basic foods especially rice, which have been quite volatile. Food prices increase in the next reading on the incidence of poverty. The broad features of the incidence and distribution of poverty in 2000 and early 2001 were quite similar to those before the financial Ccrisis. In the second half of 2001 and early 2000, weaker growth and resurgent double-digit inflation has have considerably dampened the prospects for further poverty reduction.  13. The development model widely accepted in Indonesia before the financial Ccrisis was one of export-led growth: investments were expected to develop export-oriented industries that would stimulate broad-based economic growth. Indeed, tThe association between national output, investment, and exports was remarkable during the decade before prior to the financial crisis: the correlation coefficient between any two of these variables was over 98 percent%. The link between investment and GDP was thought particularly important and the incremental capital output ratio (ICOR) thought a useful guide to judge whether investment streams were sufficient to support projected growth rates. The association between exports and investment appears to be returning (para. 6). ICORs, however, are conceptually difficult measures.4 In practice they are. also quite volatile in periods of economic shocks or during turning points in the business cycle. 14. From the standpoint of investment and savings, the current share of GDP allocated to private investment is low by recent historical standards (Figure 7). A recent report by the Coordinating Board for Investment (BKPM) suggests a possible further fall-off in private investment. In January-February the first two months of 2002, 149 foreign investment projects valued at $489.3 million were approved by the Bboard, a sharp decline from the 189 projects valued at $2.3 billion approved in January-February the first two months of 2001. A similar decline was noted in domestic investment projects. There is, however, not a close link between BKPM approvals and actual investment, however, are not closely linked, and the data reflect plans rather than spending or even hard commitments. The BKPM reports are may be regarded rather as an indicator of business sentiment.  15. The current level of investment does surpass represent above 20 percent% of GDP. The issue is not so much the level of investment, but rather the impact of investment on the economy. In tThe long--term the concern is whether the investment will provide for increases in capacity to produce. There is aAnecdotal evidence suggests that much investment is simply maintaining existing capacity because of uncertainties concerning future business prospects. In this respect tThe impact of investment will depend very much on the Government's efforts and on issues that affect long-term business confidence, as discussed in below (Section II). 16. In addition to the longer-term concern with respect to capacity addition, there is the question of the short-term impact of investment on employment is also a concern. In 2001, business spending on plant, equipment, and inventories fell 0.7 percent%. Income growth was thus retarded by weak business sentiment. Investment has an important impact on the job creation, of employment opportunities and slack investment spending by businesses may have been a factor in slowing employment in manufacturing at the end of -2001 and in the continued stagnating employment stagnation in the informal economy. 17. Although measurement uncertainties are great, aggregate savings have likely been larger than aggregate investment, implying a domestic capacity to finance higher levels of business spending; -investment is limited by business sentiment, not availability of savings. The ability to mMobilizinge savings to finance investment will, however, demands continued strengthening of the financial sector. Despite sustained restructuring, the banking system is still unable to resume lending activity at a level supportive of higher economic growth rates for the economy. ____________________ 2BPS, 1 March 2002, available: http://www.bps.go.id/releases/eng-upah-2001-01mar02.pdf.
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