Chasing the Possibility 7% percent GDP growth sustainability
Demographic dividend is one of the key drivers for Indonesia’s well known structural growth story.The basic thesis is that with Indonesia’s population enters productive age; income per capita should be on the uptrend, supporting consumption growth of the nation. Of course, demographic dividend is not everlasting with Indonesia estimated to start losing its demographic dividend in 2025 onwards.
A decade ago, 2025 felt like a long time and most of us have a sense of calmness within as we told ourselves that this country had 20 years to get the balancing act right between consumption and capacity. Unfortunately, we wake up today realizing that 2025 is less than 10 years away while our quest for capacity building remains at best modest and certainly still lags the targeted level. Adding more concern is the fact that while Indonesia’s GDP per capita has been on the rise in IDR term, depreciation in the country’s currency has resulted in its GDP per capita in USD term to be declining in the past 4 years. While we hope trend of GDP per capita in USD term to reverse starting 2016, the fact remains, tons of homework remains before Indonesia can safely embark into an era of achieving its full potential.
For a long time, Indonesia has been hoping to reach the possibility 7% GDP growth. Is 7% merely an unreachable target? Not really. India and China have proven that such level of growth is indeed achievable, though cautions remain important to avoid creating a bubble. But at least we know, 7% very doable and achievable indeed. Now the remaining question is what is the recipe for Indonesia to achieve this long coveted 7% growth.
First, stable politics is paramount. When it comes to emerging country, there is literally no further discussion is required unless politics is stable. We are not talking about having a full majority control, nor complete parliament domination. As 2009-2014 shows, parliamentary dominance mean nothing if built on top of shaky ground. While political noise is unavoidable in democratic country, in order for government to be able to effectively manage a country’s economy, political stability is a must.We only need to see past examples of emerging countries disturbed by political instability and even most recently, current example of the like of Brazil.
Second, balancing consumption with capacity. Consumption growth is largely given for Indonesia on the back of demographic dividend and emergence of middle class. Of course, currency stability is needed in order to maintain purchasing power. Despite regulatory requirement for all domestic transactions to be done in IDR, Indonesia still rely on imports. Thus, depreciation in IDR simply implies erosion of purchasing power. It is not to say that Indonesia needs to have stronger IDR either. Stronger IDR translate to higher imports and lower exports which will hurt trade balance. The key here is stability of IDR.
Stability of IDR however, is something that may be easier said than done. The main challenge is here hot money flow. We know that our economy has fall victim to hot money flow too many times. With global low interest rate, massive monetary easing, Indonesia should be aware of the risk of hot money inflow in near future. If we are not prepared, such inflow will swing IDR to much stronger position but only to see the currency collapsed again like so often happened in the past when outflow takes place later. Unfortunately, outflow will take place later. It is just a matter of when. The world will not keep a negative or near zero interest rates forever. One day, central banks across the world will hike rates and when they do, funds will be withdrawn, once again. Assuming relatively stable IDR, Indonesia is likely to see pick up in consumption as GDP per capita increases, and has indeed been showing such trend to date. However, increase in consumption reduces capacity. To put it simply, without growing capacity, increase in consumption will translate to higher need for imports and upward pressure in inflation. Failure to balance capacity growth with consumption growth was experienced by India between 2007 and 2012. Given strong consumption and lacking capacity growth via investment, India suffered from a surge in 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 business to invest. However, the timing may be ripe now as the nation can leverage of global technological improvements. We are not suggesting a massively advanced technology here. However, we are more referring to more basic business implications. For example, current developments of E-Commerce allow companies to reduce their marketing expenses. Even to take it a notch further, rapid growth of social media allows public to participate in monitoring government. In recent times, we have even seen public servant engaging in illegal activities such as corruption, caught red handed, that will published in media subsequently after being expose in social media, almost instantaneously. Such occurrence may play a role in reducing illegal activities, which in turn, lower the hidden costs of Indonesian economy that has long been a main challenge for businesses.
Fourth, liquidity and funding. In order to build capacity, Indonesia needs funding. To rely solely on foreign funding may further increase Indonesia’s vulnerability to global shocks. However, domestic banking system has relatively limited excess liquidity. Despite having one of the lowest loans to GDP ratio globally, Indonesia’s banking system continues to face challenges in liquidity, as the country also has one of the lowest deposits to GDP globally.
There are two main cause of such occurrence. First, is the relatively modest national saving rate. But the second issue is even more paramount, that is leakages to off shore entities. To put it simply, to build capacity, we need loan. In order to lend, banks need funding. But, Indonesian banks compete with off-shore banks when it comes to funding. This is where the much anticipated tax amnesty may have a significant role to play. Tax amnesty is hoped to be the turning point and even allowing for Indonesian to repatriate at least part of their off-shore saving back to domestic economy. In addition, tax amnesty is also expected to increase the country’s tax ratio. This is highly required as improvement in tax ratio enhances government’s budget revenues, allowing government to invest in public infrastructure, a required component to entice businesses to invest and expand capacity. In simple example, if we need businesses to set up new factories, we need to ensure sufficient infrastructure such as ports and roads. In order to have sufficient addition of ports and roads capacity, government needs to invest and in order to invest, government needs tax revenues.
However, despite the obvious benefits of tax amnesty, there remains issue to be considered. For example, Indonesia’s financial industry may need to expand USD based product options. This is required in order to avoid repatriated fund to be converted into IDR which may result in unnecessary strengthening of IDR. While significant amount is likely to be reported in tax amnesty, we are not expecting hundreds of billions of dollar to be repatriated back into Indonesia instantaneously.
Fifth, human capital quality. We often think of capacity as being brick and mortar factories and roads and ports and stuffs. Unfortunately, we often forget about human capital. With funding and sufficient economic benefits and demand, road, ports, factories and the likes, can be built. But after these capacities are put in place, we need someone to run it. For example, factories need labor to produce. Unfortunately, Indonesia’s human capital quality remains at best, modest. As an economy progress through, the required human capital quality increases. There is only one possible solution to enhance Indonesia’s relatively lagging human capital quality. That is, education.
The main problem with relying on formal education to enhance human capital quality is the long period required. Unfortunately, time is something Indonesia is starting to run out of. With demographic dividend starting to be eroded in 2025, the country has less than 9 years to meet its requirements. One potential solution is vocational study. However, this is a segment of education that we have yet to see government and private alike, to put much attention on.
Continuously enhancing human capital quality is also necessary even as Indonesia presumably managed to meet all the requirements above and its economy progress on. Enhancement of human capital quality is required in order to prevent Indonesia to fall into middle income trap. Middle income trap is a situation where a nation’s labor is too expensive for it to engage in labor intensive business, but the quality of its labor is not sufficient to progress through to more sophisticated business. That is, the nation is trapped being middle income with inability to move further up to higher income category.
In conclusion, it may sound like there are plenty of works to be done. That is true. However, at the same time, Indonesia indeed has almost all the necessary ingredients and it is just a matter of putting in the works to make it happen. After all, nothing is free in this world. With the current ever evolving world, the only thing that is constant is change.
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