Indonesia’s resilient economy still has room to grow after G20

Author: Siwage Dharma Negara, ISEAS-Yusof Ishak Institute

As 2022 ended the world economy was in no better shape than when it began. While countries were still struggling to bounce back from the economic downturn caused by the COVID-19 pandemic, Russia’s military aggression in Ukraine shook global economic and political stability. China’s economy remains uncertain due to prolonged zero-COVID policies. Climate change also poses increased risks.

Under these conditions, Indonesia hosted the G20 Summit in Bali in mid-November. Amid risk of failure, the summit resulted in a G20 leaders’ communique to pursue multilateral cooperation on global economic challenges.

The G20 success sets an important lesson for Indonesia’s 2023 ASEAN Chairmanship and contributes to strengthening regional economic cooperation and stability.

Indonesia seems quite resilient in facing the ongoing adverse global situation. According to the World Bank’s latest projection, its economy is expected to grow by 5.2 per cent year-on-year (YoY) in 2022. Growth will slow to 4.8 per cent in 2023 amid weaker global demand, tighter global finance, widespread capital outflows and currency pressures triggered by a rapid monetary policy tightening cycle. Indonesia must also confront inflationary pressures driven by higher international energy and food prices.

Investors still see Indonesia’s macroeconomic fundamentals as solid amid geopolitical uncertainties and, most importantly, are attracted to its relatively stable political environment.

Foreign direct investment and domestic direct investment have grown by 35.5 per cent YoY in the second quarter of 2022, according to the Investment Coordinating Board (BKPM). Indonesia also managed to secure an investment commitment of US$8 billion from G20 Summit events.

Indonesia experienced a significant trade surplus in the last two years, thanks to high commodity prices. Data from the Ministry of Trade show Indonesia’s total exports reached US$78.2 billion in the third quarter of 2022, a 27.3 per cent increase from last year. This strong trade performance was supported by non-oil and gas exports, especially coal and crude palm oil, which reached US$73.8 billion with a growth rate of 26.2 per cent.

President Joko ‘Jokowi’ Widodo boasted that the robust trade performance was due to the downstream industry policy whereby Indonesia has tried to gradually reduce its dependency on raw mineral exports and move towards higher value-added manufacturing, such as iron and steel. After banning nickel ore exports, iron and steel exports contributed significantly to the recent trade surplus. Indonesia is now aiming to be a global leader in electric vehicles (EVs) by focusing on lithium battery production. The country is betting on its significant nickel resource, a critical ingredient for lithium batteries.

The EU challenged this nickel ore export ban at the WTO, as it has harmed the EU’s stainless steel industry. In November 2022, the WTO panel ruled in favour of the EU, saying the prohibition of nickel exports and domestic processing requirement for nickel ore is not in line with global trade rules. In response, Indonesia filed an appeal against the ruling in mid-December.

Anticipating the final verdict, Indonesia is preparing future taxes on nickel products and will continue pursuing its local industry capabilities, despite the looming trade retaliation from its trading partners. President Widodo’s announcement of plans to ban bauxite exports, starting in June 2023, indicates a doubling down on the forced downstreaming strategy despite trading partners’ and the WTO’s concern.

The government offers various fiscal incentives to encourage further investment in the EVs industry, including ten years of tax holidays. Still, building its EV industry will take a long time as the market remains relatively small.

One critical market opportunity is in the motorcycle industry, as the country had more than 120 million motorists in 2021. With the rising cost of petrol, it is timely to encourage the shift towards EVs. For this, Indonesia needs to continue investing in EV infrastructure, such as charging stations, to unlock this $48 billion potential market.

Most importantly, its effort to develop EVs needs to be synergised with the national energy transition agenda. The government will need to gradually reduce fuel subsidies, to provide incentives for the EV industry and other green and renewable energy alternatives.

The government plans to pass a renewable energy bill in early 2023 to accelerate the energy transition in Indonesia, including by promoting renewable energy, phasing down coal-fired power plants and improving energy efficiency.

In 2022, Indonesia’s digital economy continued to attract a large number of venture investors. Indonesia has seen the value of its digital industry grow significantly from US$41 billion in 2019 to US$77 billion in 2022, with estimated gross merchandise volume growth of 22 per cent, YoY. This figure is expected to increase to US$130 billion by 2025, mainly driven by e-commerce.

The relatively high smartphone penetration rate and improvements in digital infrastructure facilities have contributed to the promising growth of e-commerce and fintech. In line with the rapid digital economy growth, the government aims to bring more micro-, small- and medium-sized enterprises online. To position itself as a digital hub in Southeast Asia, the government is joining other ASEAN countries, including Malaysia, Singapore and Thailand, to launch a Second Home Visa. This program offers long-term visas of up to 10 years for digital foreign workers and investors.

So far, Indonesia has been able to overcome the COVID-19 pandemic relatively well. Its macroeconomic and political stability has contributed to stable and respectable growth. Yet Indonesia must watch for rising inflation due to the global food and energy crisis. It needs to consistently implement its energy transition agenda by reducing inefficient fuel subsidies, continuing investment in renewable energies and increasing digitalisation efforts.

Siwage Dharma Negara is the Co-Coordinator for the Indonesia Studies Programme and Coordinator for the Singapore APEC Study Centre at the ISEAS-Yusof Ishak Institute.