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Economic Research BureauDirectorate of Economic Research and Monetary Policy
2008-2012Indonesian Economic Outlook
ASEAN Economic Integration and the National Economic Outlook
January 2008
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January 2008
Economic Research BureauEconomic Research BureauEconomic Research BureauEconomic Research BureauEconomic Research BureauDirectorate of Economic Research and Monetary PolicyDirectorate of Economic Research and Monetary PolicyDirectorate of Economic Research and Monetary PolicyDirectorate of Economic Research and Monetary PolicyDirectorate of Economic Research and Monetary Policy
Indonesian Economic Outlook
ASEAN Economic Integration andthe National Economic Outlook
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Daftar Pustaka
ii Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Editors-in-Chief:Editors-in-Chief:Editors-in-Chief:Editors-in-Chief:Editors-in-Chief:
Made Sukada
Editorial Team:Editorial Team:Editorial Team:Editorial Team:Editorial Team:
Wijoyo Santoso
Endy Dwi Tjahjono
Harmanta
Hidayah Dhini Ari
Ferry Kurniawan
Haris Munandar
Oki Hermansyah
Myrnawati Savitri
The editorial team would like to thank the following members of the Focus Group Discussionsfor their participation, information and suggestions: Ministry of Finance, Ministry of Trade, Na-tional Development Planning Agency (BAPPENAS), Institute of Economic and Social Research ofthe University of Indonesia (LPEM-UI), Bogor Agricultural Institute (IPB), Indonesian Instituteof Sciences (LIPI), the Centre for Strategic and International Studies (CSIS), Indonesian Cham-ber of Commerce and Industry (KADIN), Indonesian Association of Automotive Manufacturers(GAIKINDO) and the Indonesian Textile Industries Association (API).This assessment is the result of analysis and research by the economic research team at theDirectorate of Economic Research and Monetary Policy (DKM). The assessment represents solelythe opinions of the team and does not necessary present or reflect the official opinions of BankIndonesia.
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Daftar Pustaka
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition iii
TABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTSTABLE OF CONTENTS
LIST OF TABLESLIST OF TABLESLIST OF TABLESLIST OF TABLESLIST OF TABLES ......................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... vvvvv
LIST OF GRAPHSLIST OF GRAPHSLIST OF GRAPHSLIST OF GRAPHSLIST OF GRAPHS ......................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... viiviiviiviivii
LIST OF DIAGRAMSLIST OF DIAGRAMSLIST OF DIAGRAMSLIST OF DIAGRAMSLIST OF DIAGRAMS ............................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... viiiviiiviiiviiiviii
CHAPTER 1 - GENERAL REVIEWCHAPTER 1 - GENERAL REVIEWCHAPTER 1 - GENERAL REVIEWCHAPTER 1 - GENERAL REVIEWCHAPTER 1 - GENERAL REVIEW ..................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... 11111
1.1 The World and Indonesian Economy ........................................................................ 1
1.2 Indonesian Economic Outlook, 2008-2012 .............................................................. 4
1.3 Implications for Macroeconomic and Sectoral Policy ................................................. 5
CHAPTER 2 - UPDATE OF THE WORLD AND INDONESIAN ECONOMYCHAPTER 2 - UPDATE OF THE WORLD AND INDONESIAN ECONOMYCHAPTER 2 - UPDATE OF THE WORLD AND INDONESIAN ECONOMYCHAPTER 2 - UPDATE OF THE WORLD AND INDONESIAN ECONOMYCHAPTER 2 - UPDATE OF THE WORLD AND INDONESIAN ECONOMY ................................................................................................................................................................................................... 77777
2.1 Overview of the World Economy .............................................................................. 7
2.2 Overview of the Indonesian Economy ...................................................................... 10
2.2.1 Indonesian Economic Indicators ..................................................................... 10
2.2.2 Sectoral Developments in the National Economy ............................................ 14
2.2.3 Real Sector and Macroeconomic Policy .......................................................... 17
CHAPTER 3 - GEARING FOR THE ASEAN ECONOMIC COMMUNITY (AEC) 2015:CHAPTER 3 - GEARING FOR THE ASEAN ECONOMIC COMMUNITY (AEC) 2015:CHAPTER 3 - GEARING FOR THE ASEAN ECONOMIC COMMUNITY (AEC) 2015:CHAPTER 3 - GEARING FOR THE ASEAN ECONOMIC COMMUNITY (AEC) 2015:CHAPTER 3 - GEARING FOR THE ASEAN ECONOMIC COMMUNITY (AEC) 2015:
IMPLICATIONS FOR THE INDONESIAN ECONOMYIMPLICATIONS FOR THE INDONESIAN ECONOMYIMPLICATIONS FOR THE INDONESIAN ECONOMYIMPLICATIONS FOR THE INDONESIAN ECONOMYIMPLICATIONS FOR THE INDONESIAN ECONOMY .............................................................................................................................................................................................................................................................................................................................................................. 1919191919
3.1 Background to Establishment of the ASEAN Economic Community .......................... 20
3.2 Dynamics of the ASEAN Economy ............................................................................ 22
3.3 Conceptual Review of Economic Integration Theory ................................................. 25
3.4 AEC and Implications for Welfare ............................................................................. 28
3.4.1 Impact on Trade in Goods .............................................................................. 28
3.4.2 Impact on Investment, Growth and Poverty ................................................... 29
3.4.3 Impact on Labour Conditions ......................................................................... 30
3.5 AEC and Post-Integration Distribution of Output ...................................................... 32
3.6 AEC 2015 and the Monetary Authority Role ............................................................ 34
3.7 Policy Implications .................................................................................................... 35
3.7.1 Improvements to the Investment Climate and Institution Building .................. 35
3.7.2 Preparation at the Sectoral Level .................................................................... 36
CHAPTER 4 MEDIUM-TERM ECONOMIC OUTLOOKCHAPTER 4 MEDIUM-TERM ECONOMIC OUTLOOKCHAPTER 4 MEDIUM-TERM ECONOMIC OUTLOOKCHAPTER 4 MEDIUM-TERM ECONOMIC OUTLOOKCHAPTER 4 MEDIUM-TERM ECONOMIC OUTLOOK ............................................................................................................................................................................................................................................................................................................................................... 4141414141
4.1 Assumptions for the Global Economy, 2008-2012 .................................................... 41
a. World Economic Growth ...................................................................................... 41
b. World Commodity Prices ...................................................................................... 42
c. International Interest Rates ................................................................................... 43
d. Global FDI Inflows ................................................................................................ 43
4.2 Assumptions for the Indonesian Economy, 2008-2012 ............................................. 44
a. Government Financial Condition .......................................................................... 44
b. Domestic Interest Rates ........................................................................................ 44
c. FDI Inflows ........................................................................................................... 44
Table of Contents
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iv Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Table of Contents
4.3 Projection for the Indonesian Economy, 2008-2012 ................................................. 45
4.4 Policy Implications .................................................................................................... 47
4.4.1 Macroeconomic Policy (Monetary and Fiscal) .................................................. 47
4.4.2 Microeconomic (Structural) Policies ................................................................ 47
CHAPTER 5 - TOPICAL ISSUESCHAPTER 5 - TOPICAL ISSUESCHAPTER 5 - TOPICAL ISSUESCHAPTER 5 - TOPICAL ISSUESCHAPTER 5 - TOPICAL ISSUES ............................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... 4949494949
5.1 Mobility of Production Factors, Distribution and Regional Economic Integration ....... 49
5.1.1 Background and Motivation ........................................................................... 50
5.1.2 Economic Modelling ...................................................................................... 52
5.1.3 Policy Implications .......................................................................................... 53
5.1.4 Epilogue ........................................................................................................ 54
5.2 Regional Economic Integration, Investment and the Role of Monetary Authority ...... 54
5.2.1 Background and Motivation ........................................................................... 55
5.2.2 Data and Analysis Method ............................................................................. 55
5.2.3 Short Run Analysis ......................................................................................... 57
5.2.4 Long Run Analysis .......................................................................................... 57
5.2.5 Conclusions ................................................................................................... 58
5.3 Impact of Proximity on Provincial Commodity Exports: Gravity Model Approach ....... 58
5.3.1 Overview of Exports by Indonesias Provinces ................................................. 60
5.3.2 Model and Estimates ..................................................................................... 60
5.3.3 Estimate Results ............................................................................................. 61
5.3.4 Conclusions ................................................................................................... 62
5.4 Human Capital Formation, Income Inequalities and Economic Integration:
A Meta-Analysis ....................................................................................................... 62
5.4.1 Background and Motivation ........................................................................... 62
5.4.2 Education, Openness and Income Inequalities ................................................ 62
5.4.3 Overlapping Generation Economic Model, Heterogeneity and Economic
Integration ..................................................................................................... 64
5.4.4 Role of Human Capital in Conditions of Equilibrium ....................................... 65
BIBLIOGRAPHYBIBLIOGRAPHYBIBLIOGRAPHYBIBLIOGRAPHYBIBLIOGRAPHY ......................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................................... 6666666666
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Indonesian Economic Outlook 2008 - 2012, January 2008 Edition v
LIST OF TABLESLIST OF TABLESLIST OF TABLESLIST OF TABLESLIST OF TABLES
Table 1.1 Projections .............................................................................................................. 5
Table 2.1 World Commodity Consumption ............................................................................ 8
Table 2.2 Global FDI Inflows, 1997-2006 ............................................................................... 9
Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006 ........................................ 10
Table 2.4 WEF Competitiveness Ratings ................................................................................. 11
Table 2.5 Competitiveness Ratings by IMD ............................................................................. 12
Table 2.6 Ranking of Competitiveness Components ............................................................... 12
Table 2.7 Findings of Survey on Doing Business ..................................................................... 13
Table 2.8 Progress, Implementation of Presidential Instruction No. 6 of 2007 ......................... 17
Table 3.1 Economic Indicators for ASEAN* ............................................................................ 23
Table 3.2 Labour Productivity in ASEAN ................................................................................. 23
Table 3.3 Intraregional Exports from Exporting Countries as Share of Total Exporting Country
Trade ...................................................................................................................... 24
Table 3.4 Total Exports from Exporting Countries to Export Destinations as Share of Total
Exporting Country Trade ......................................................................................... 24
Table 3.5 Export Commodities from Exporting Countries to Export Destinations as Share of
Total Exporting Country Trade ................................................................................. 24
Table 3.6 Intra-Industry Trade (IIT) Index for ASEAN-5 by Sector over 5 Years .......................... 25
Table 3.7 Intra-Industry Trade (IIT) Index for Indonesia by Sector over 5 Years ......................... 25
Table 3.8 Migrant Workers in ASEAN, 2006 (thousands) ........................................................ 31
Table 3.9 FDI Outcomes and Employment .............................................................................. 32
Table 3.10 Basic Indicators for ASEAN ...................................................................................... 33
Table 3.11 Human Development Indicators for ASEAN ............................................................. 33
Table 3.12 Competitiveness Components, Selected ASEAN Members ...................................... 33
Table 3.13 Condition of ASEAN Infrastructure ......................................................................... 34
Table 4.1 Projection of Global FDI Inflows, 2008-2011 ........................................................... 44
Table 4.2 Basic Domestic Assumptions ................................................................................... 45
Table 4.3 Projections .............................................................................................................. 47
Table 5.1 Investment Growth and Macroeconomic Performance in Thailand .......................... 56
Table 5.2 Investment Growth and Macroeconomic Performance in Indonesia ........................ 56
Table 5.3 Investment Growth and Macroeconomic Performance in Cambodia ....................... 56
Table 5.4 Investment Growth and Macroeconomic Performance in Singapore ........................ 56
List of Tables
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vi Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
List of Tables
Table 5.5 Investment Growth and Macroeconomic Performance in Malaysia .......................... 56
Table 5.6 Investment Growth and Macroeconomic Performance in the Philippines ................. 56
Table 5.7 Investment Growth and Macroeconomic Performance in Vietnam .......................... 56
Table 5.8 Inward FDI and Macroeconomic Performance - 2006 Reference Year ...................... 57
Table 5.9 Inward FDI and Macroeconomic Performance 2002-2006 Reference Period ......... 57
Table 5.10 Contribution by Province to Non-Fuel Exports and Imports ...................................... 58
Table 5.11 Major Export Commodities and Exporting Regions .................................................. 59
Table 5.12 Gravity Model Estimates ......................................................................................... 61
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Indonesian Economic Outlook 2008 - 2012, January 2008 Edition vii
LIST OF GRAPHS
Graph 2.1 Contributions to World Growth .............................................................................. 7
Graph 2.2 Contributions to World Growth .............................................................................. 7
Graph 2.3 Oil Prices, Demand and Production Capacity ........................................................... 8
Graph 2.4 Non-Fuel Primary Commodity Prices ....................................................................... 8
Graph 2.5 World Commodity Supply ....................................................................................... 9
Graph 2.6 Global FDI Inflows and Mergers & Acquisitions ....................................................... 9
Graph 2.7 GDP Growth 1989-2007 ........................................................................................ 10
Graph 2.8 Inflation 1989 2007 ............................................................................................. 11
Graph 2.9 The Most Problematic Factors for Doing Business .................................................... 12
Graph 2.10 Time Required for Business Licensing (days) ............................................................ 13
Graph 2.11 Most Attractive Venues for FDI (number of responses) ............................................ 13
Graph 2.12 Risk Indices ............................................................................................................. 14
Graph 2.13 Criteria for Determination of FDI Venues (Percentage of Responses) ........................ 14
Graph 2.14 Sectoral Share of GDP ............................................................................................ 15
Graph 2.15 Sectoral Investment ................................................................................................ 15
Graph 2.16 Sectoral Dynamics of Capital Stock ......................................................................... 15
Graph 2.17 Sectoral Growth of Capital Stock ............................................................................ 15
Graph 2.18 BI Rate and Inflation ............................................................................................... 18
Graph 4.1 World Economic Growth and Volume of World Trade ............................................. 42
Graph 4.2 World Oil Price History and Projections .................................................................... 42
Graph 4.3 World Commodity Prices, 1906-2006 ..................................................................... 43
Graph 4.4 Trend in Fiscal policy ............................................................................................... 44
List of Graphs
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Daftar Pustaka
viii Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
LIST OF DIAGRAMS
Diagram 4.1 Structural Reforms, Aggregate Supply and Performance of the Indonesian Economy 45
List of Diagrams
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Daftar Pustaka
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition ix
F O R E W O R DDEPUTY GOVERNOR OF BANK INDONESIA FOR MONETARY POLICY
FOR PUBLICATION
OF THE INDONESIAN ECONOMIC OUTLOOK, JANUARY 2008 EDITION
The Directorate of Economic Research and Monetary Policy has completed an in-depth study on
the medium-term outlook for the Indonesian economy (2008-2012). The findings of this study have
been carefully organised for presentation in this January 2008 edition of the Indonesian Economic Outlook.
My congratulations for this achievement.
The Indonesian Economic Outlook is a regular semi-annual publication by Bank Indonesia forming
a vital component of a wide range of analyses by many units at Bank Indonesia. The description of the
constellation of the economy, the main study themes, projections and topical issues all serve as a strategic
window on the future condition of the Indonesian economy.
The main topic chosen for this edition is: ASEAN Economic Integration and the National Economic
Outlook. As the monetary authority in this republic, Bank Indonesia has the statutory obligation of
working consistently for low, stable inflation. This low, stable inflation will bring improvement to the
investment climate, which in turn will stimulate greater investment and bring significant expansion in
the stock of capital. This book describes how prudent monetary policy is proven to be a pro-investment
policy, particularly in gearing for the ASEAN Economic Community (AEC) in 2015.
However, investment is hampered by various issues that unfortunately still beset this nation. It is
essential that policy makers, including Bank Indonesia, make use of the dynamics of the global and
domestic economy in the creative design and earnest implementation of a range of policies for
improvement of the investment climate. In the medium-term, the most relevant and effective policy for
the Indonesian economy is a structural policy for strengthening aggregate supply.
The effects of structural flaws will undeniably have a negative impact on inflation and
macroeconomic stability, and therefore the design and implementation of structural policies is not
only the domain of the Government, but also represents a concern of Bank Indonesia. Significant
strengthening in aggregate supply is not only intended to create opportunities and build capacity
among the poor, but is also a prerequisite for high economic growth without sacrificing price stability.
To build the productivity and efficiency of the economy, determined, unswerving effort is necessary to
incorporate FDI-led investment growth, improvement in the quality of our nations human capital and
broader, more intensive transfer of technology into the spirit of each and every policy at the national,
regional and sectoral level.
Foreword
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Daftar Pustaka
x Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Finally, on behalf of the Board of Governors of Bank Indonesia, I would like to express my sincere
appreciation to the Editorial Team. May the Almighty God always bestow His Blessing on our work and
lighten our steps on the journey to a better future.
DEPUTY GOVERNOR OF BANK INDONESIADEPUTY GOVERNOR OF BANK INDONESIADEPUTY GOVERNOR OF BANK INDONESIADEPUTY GOVERNOR OF BANK INDONESIADEPUTY GOVERNOR OF BANK INDONESIA
Hartadi A. SarwonoHartadi A. SarwonoHartadi A. SarwonoHartadi A. SarwonoHartadi A. Sarwono
Foreword
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Outlook Ekonomi Indonesia 2008 - 2012, Edisi Januari 2008 xi
PREFACE
Let us offer our praise and thanksgiving to the Almighty God, by Whose pleasure the book on the
Indonesian Economic Outlook 2008-2012, edition IV January 2008, has successfully reached completion.
In departure from past publications of the Outlook, this edition examines opportunities and challenges
as Indonesia gears for the ASEAN Economic Community (AEC) in 2015 and the relevant implications for
the Indonesian economy. The issue of economic integration has been given special focus in view of the
agreement reached by Indonesia and nine other ASEAN members in November 2007 on the blue print
for establishment of the ASEAN Economic Community in 2015. This represents a joint commitment to
building a stable, prosperous and highly competitive region with balanced economic growth and reduction
in poverty and socio-economic disparities. There is a growing need for assessment of Indonesias economic
fundamentals and the economic integration of ASEAN to support medium to long-term analyses and
projections on the direction of the economy over the coming five years. For this reason, the Indonesian
Economic Outlook has been developed as a regular product of the Economic Research Office of the
Directorate of Economic Research and Monetary Policy at Bank Indonesia.
The economic projections in this Edition IV of the Indonesian Economic Outlook are intended for
use as internal reference for the units at Bank Indonesia in their medium-term analyses and projections,
including assessments and formulation of Destination Statements in the Strategic Forum (FORSTRA) held
each year, and as a source of information for Bank Indonesia stakeholders. Information and data in these
projections is updated on an ongoing basis. The publication of the Indonesian Economic Outlook is the
culmination of a sincere desire to help place the Indonesian economy on a better course for the benefit
of all who call this country their home.
Jakarta, January 2008
Directorate of Economic Research and Monetary Policy
MADE SUKADAMADE SUKADAMADE SUKADAMADE SUKADAMADE SUKADA
Director
Preface
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Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
1
In the last five years, the world economy has
been marked by a high growth above the historical
average (more than 4%), steadily expanding global
FDI inflows and soaring prices for oil and non-oil
commodities, all leading to added world
inflationary pressure. During the same period, the
Indonesian economy has also seen accelerated
growth, albeit at a moderate level, a low
investment-to-GDP ratio in comparison to the pre-
crisis period despite rising net FDI inflows, and
average inflation slightly above that of the pre-crisis
years triggered mainly by the fuel price hikes in
2005.
In 2008-2012, growth in the world economy
and volume of world trade is predicted to remain
strong, while oil and gas and non-oil commodity
prices will hold above their historical averages. In
the domestic economy, macroeconomic stability
is forecasted to continue with Indonesias fiscal
condition within safe limits accompanied by
steadily rising inflows of FDI. Based on these
assumptions for the world and domestic economic
conditions, the Indonesian economy is predicted
to see further improvement in 2008-2012, with
more vigorous, higher quality economic growth
and falling inflation. This economic outlook is
based on optimism for policy synergy between
Government and Bank Indonesia in maintaining
macroeconomic stabil ity and steady
improvements in the investment climate,
infrastructure, employment and business certainty
through real sector policies. Indonesias
macroeconomic stability and vast market potential
represent two major attractions for international
investors, and for this reason, FDI is predicted to
Chapter 1: General Review
keep pouring into Indonesia and support strong
investment growth. With investment on the rise,
the economy is expected to chart higher, better
quality growth alongside reduced inflation. A
further benefit will be improvement in real public
purchasing power, which augurs for continued
high growth in consumption. At the same time,
conducive external conditions reflected in the
sustained high volume of world trade is predicted
to strengthen the performance of Indonesias
exports. Growing exports and flourishing
investment activity will be followed by a surge of
imports of goods and services that in turn will
diminish the current account surplus. However,
mounting global FDI inflows will provide a safety
valve for the downward pressure on the balance
of payments, thus maintaining relative exchange
rate stability.
For Indonesia to achieve 7.4%-8.0%
economic growth in 2012, stable macroeconomic
conditions will require support from robust
sectoral policies, such as improvement in the
investment climate (including construction of
infrastructure), greater competitiveness and
productivity, and improvements in the quality of
human resources. These conditions are key to
overcoming supply-side l imitations and
stimulating global FDI inflows in support of high,
better quality economic growth.
1.1 The World and Indonesian Economy
The dynamics of the Indonesian economy areThe dynamics of the Indonesian economy areThe dynamics of the Indonesian economy areThe dynamics of the Indonesian economy areThe dynamics of the Indonesian economy are
very closely interlinked with the global and regionalvery closely interlinked with the global and regionalvery closely interlinked with the global and regionalvery closely interlinked with the global and regionalvery closely interlinked with the global and regional
economy and influenced by progress improvementseconomy and influenced by progress improvementseconomy and influenced by progress improvementseconomy and influenced by progress improvementseconomy and influenced by progress improvements
in the investment climate, infrastructure,in the investment climate, infrastructure,in the investment climate, infrastructure,in the investment climate, infrastructure,in the investment climate, infrastructure,
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2 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
productivity, competitiveness and domestic supplyproductivity, competitiveness and domestic supplyproductivity, competitiveness and domestic supplyproductivity, competitiveness and domestic supplyproductivity, competitiveness and domestic supply
constraints. constraints. constraints. constraints. constraints. The world economy has maintained
above 4% growth during the past five years,
surpassing the historical average.1 Key to this
performance is the brisk pace of economic growth
in developing countries (led by China and India)
and Europe. This vigorous growth in the world
economy has been accompanied by surging
volume of world trade volume beyond the long-
term trend.2 Consistent with these developments,
global inflows of foreign direct investment (FDI)
flows have seen rapid expansion. However, this
impressive performance is daunted by burgeoning
world prices for oil and non-oil commodities. The
combination of soaring commodity prices amid
continued strong world economic growth has
fuelled world inflationary pressures.
Central banks have responded in varyingCentral banks have responded in varyingCentral banks have responded in varyingCentral banks have responded in varyingCentral banks have responded in varying
ways to mounting world inflationary pressure asways to mounting world inflationary pressure asways to mounting world inflationary pressure asways to mounting world inflationary pressure asways to mounting world inflationary pressure as
commodity prices remain stubbornly high.commodity prices remain stubbornly high.commodity prices remain stubbornly high.commodity prices remain stubbornly high.commodity prices remain stubbornly high. This is
explained by the move by some central banks to
consider financial market stability and the outlook
for their domestic economies, in addition to
inflationary pressures. The United States Federal
Reserve has given high priority to recovery from
the financial market crisis and stimulus for the
domestic economy, as demonstrated by aggressive
cuts in the Fed Funds Rate to 3.00% in January
2008. On the other hand, the European Central
Bank (ECB) and Bank of Japan (BOJ) appear to give
greater priority to control of domestic inflationary
pressures and have therefore kept interest rates
on hold.
On the domestic front, while Indonesia is ableOn the domestic front, while Indonesia is ableOn the domestic front, while Indonesia is ableOn the domestic front, while Indonesia is ableOn the domestic front, while Indonesia is able
to maintain macroeconomic stability, higher, betterto maintain macroeconomic stability, higher, betterto maintain macroeconomic stability, higher, betterto maintain macroeconomic stability, higher, betterto maintain macroeconomic stability, higher, better
quality growth continues to be hampered by thequality growth continues to be hampered by thequality growth continues to be hampered by thequality growth continues to be hampered by thequality growth continues to be hampered by the
array of structural problems such as the investmentarray of structural problems such as the investmentarray of structural problems such as the investmentarray of structural problems such as the investmentarray of structural problems such as the investment
climate, infrastructure, productivity andclimate, infrastructure, productivity andclimate, infrastructure, productivity andclimate, infrastructure, productivity andclimate, infrastructure, productivity and
competitiveness (supply side). competitiveness (supply side). competitiveness (supply side). competitiveness (supply side). competitiveness (supply side). Part of this is
explained by the post-crisis structure of the
Indonesian economy, supported more by
consumption and exports while investment has had
a much less significant role. The lack of recovery in
investment is demonstrated by the diminishing
share of investment to GDP, particularly in key
sectors of the Indonesian economy such as
manufacturing, agriculture and mining. In all of
this, inflation behaved differently before and after
the crisis with considerably increased volatility in
the post-crisis period. This condition of lower post-
crisis economic growth alongside slightly higher
inflation is an indication of supply-side constraints
impacting aggregate supply,3 rendering the
Indonesian economy more sensitive to price
pressures.
In spite of the problems described above,In spite of the problems described above,In spite of the problems described above,In spite of the problems described above,In spite of the problems described above,
international investors generally see promise ininternational investors generally see promise ininternational investors generally see promise ininternational investors generally see promise ininternational investors generally see promise in
the business outlook and Indonesia is stillthe business outlook and Indonesia is stillthe business outlook and Indonesia is stillthe business outlook and Indonesia is stillthe business outlook and Indonesia is still
regarded an attractive venue for FDI.regarded an attractive venue for FDI.regarded an attractive venue for FDI.regarded an attractive venue for FDI.regarded an attractive venue for FDI. In an
UNCTAD survey in 2007, Indonesia ranked
among the top 15 most attractive countries for
FDI. In addition, Indonesias rating on FDI
performance and potential has seen steady
improvement.4 This is consistent with the
progressive improvement in perceptions of risks
in Indonesia over the years, as show in the
International Country Risk Guide (ICRG).
1 In 1970-2006, world economic growth averaged 3.7%.
2 Average growth in volume of world trade during the 1970-
2006 period came to 6.1%.
3 BIs analysis using the SVAR Blanchard-Quah approach
indicates a steeper post-crisis supply curve compared to the
pre-crisis period. For further analysis, see Nugroho (2007):
Review of the Pre and Post-Crisis Aggregate Supply Curve,
Indonesian Economic Outlook, July 2007 edition.
4 World Investment Report 2007.
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Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
3
Furthermore, Indonesia is seen as having a large
potential market and healthy business climate.
In the constellation of the Indonesian andIn the constellation of the Indonesian andIn the constellation of the Indonesian andIn the constellation of the Indonesian andIn the constellation of the Indonesian and
world economy over the past five years, externalworld economy over the past five years, externalworld economy over the past five years, externalworld economy over the past five years, externalworld economy over the past five years, external
factors have contributed in increasingly significantfactors have contributed in increasingly significantfactors have contributed in increasingly significantfactors have contributed in increasingly significantfactors have contributed in increasingly significant
ways to economic developments in Indonesia.ways to economic developments in Indonesia.ways to economic developments in Indonesia.ways to economic developments in Indonesia.ways to economic developments in Indonesia. This
is related to Indonesias growing openness to both
the world economy and the region. A noteworthy
development of significance at the regional level is
the plan to move forward the establishment of the
ASEAN Economic Community (AEC) from 2020 to
2015 with the objective of creating a stable,
prosperous and highly competitive zone with
balanced economic growth and reduction of
poverty and socioeconomic disparities. This is
because economic integration promises greater
prosperity for participating nations through
increased market access and incentives for higher
levels of efficiency and economic competitiveness,
including opportunities for more extensive
absorption of labour.
As a region in its own right, ASEAN offersAs a region in its own right, ASEAN offersAs a region in its own right, ASEAN offersAs a region in its own right, ASEAN offersAs a region in its own right, ASEAN offers
vast economic potential. vast economic potential. vast economic potential. vast economic potential. vast economic potential. In analysis of intra-
ASEAN trade, the Intra-Industry Trade (IIT) index
calculations point to linkages among the various
ASEAN industries that offer strong support for the
ASEAN economic integration process. Using
gravity model applied for five ASEAN nations over
the 1989-2006 period found that the AFTA
agreement is one factor spurring intra-ASEAN
trade.5 In all of this, liberalisation of trade, services
and investment and mobility of labour will affect
labour conditions. For Indonesia, the opportunity
for labour migration is potentially advantageous
in view of the relatively high rate of
unemployment in Indonesia compared to other
ASEAN nations.6 However, the FDI trend in
Indonesia over the past five years indicates a shift
in FDI industry orientation from the secondary to
the tertiary sector. Concerning absorption of
labour, this shift in orientation calls for close
monitoring given that the secondary sector
(manufacturing) has traditionally been the largest
provider of employment.
To optimise the benefits of economicTo optimise the benefits of economicTo optimise the benefits of economicTo optimise the benefits of economicTo optimise the benefits of economic
integration, each country is demanded to expandintegration, each country is demanded to expandintegration, each country is demanded to expandintegration, each country is demanded to expandintegration, each country is demanded to expand
production capacity.production capacity.production capacity.production capacity.production capacity. In this regard, the central bank
has a significant role through monetary policy in
promoting higher levels of investment in order to
accumulate physical capital. Empirical evidence
from data from Thailand, Indonesia, Cambodia,
Singapore, Malaysia, the Philippines and Thailand
(ASEAN-7) for the 1992-2006 period points to a
strong relationship between inflation and
investment in those countries.7 A positive
correlation was also identified between
macroeconomic stability and investment growth.
Both findings indicate that a country with low
inflation and stable macroeconomic conditions will
tend to attract high levels of investment. Central
bank policy aimed at achieving and maintaining
low inflation and stable macroeconomic conditions
can be fittingly described as pro-investment
monetary policy.
5 More complete information on the study findings is
presented in the Box titled Impact of AFTA on ASEAN-5
Export Performance: A Gravity Model Approach in
Chapter 3.
6 According to statistical data taken in 2006, Indonesia and
Myanmar are the two largest labour exporting nations,
accounting for 23% and 27% of total migrant workers in
ASEAN.
7 More complete study findings are presented in Chapter V,
Topical Issue 2 under the title, Regional Economic
Integration, Investment and the Monetary Authority Role.
-
4 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
1.2 Indonesian Economic Outlook, 2008-2012
The overall forecast is for further improvementThe overall forecast is for further improvementThe overall forecast is for further improvementThe overall forecast is for further improvementThe overall forecast is for further improvement
in the Indonesian economy in the coming five yearsin the Indonesian economy in the coming five yearsin the Indonesian economy in the coming five yearsin the Indonesian economy in the coming five yearsin the Indonesian economy in the coming five years
with growth in the range of 7.4%-8.0%. Thiswith growth in the range of 7.4%-8.0%. Thiswith growth in the range of 7.4%-8.0%. Thiswith growth in the range of 7.4%-8.0%. Thiswith growth in the range of 7.4%-8.0%. This
projection assumes that world economic growth andprojection assumes that world economic growth andprojection assumes that world economic growth andprojection assumes that world economic growth andprojection assumes that world economic growth and
volume of world trade remain strong alongsidevolume of world trade remain strong alongsidevolume of world trade remain strong alongsidevolume of world trade remain strong alongsidevolume of world trade remain strong alongside
sustained high prices for oil and natural gas andsustained high prices for oil and natural gas andsustained high prices for oil and natural gas andsustained high prices for oil and natural gas andsustained high prices for oil and natural gas and
non-oil commodities, relative stability in world andnon-oil commodities, relative stability in world andnon-oil commodities, relative stability in world andnon-oil commodities, relative stability in world andnon-oil commodities, relative stability in world and
Indonesian monetary policy, robust fiscal conditionsIndonesian monetary policy, robust fiscal conditionsIndonesian monetary policy, robust fiscal conditionsIndonesian monetary policy, robust fiscal conditionsIndonesian monetary policy, robust fiscal conditions
in Indonesia and rising inflows of FDI in Indonesia.in Indonesia and rising inflows of FDI in Indonesia.in Indonesia and rising inflows of FDI in Indonesia.in Indonesia and rising inflows of FDI in Indonesia.in Indonesia and rising inflows of FDI in Indonesia.
The major sources of this growth will be significant
inflows of FDI stimulated by improvements in the
investment climate with FDI reaching 1.5% of GDP
in 2012, bringing the share of investment to about
30% of GDP that year. In addition, intraregional
trade in the ASEAN and Asia-Pacific is predicted to
become a significant source of economic growth in
the medium-term. On the domestic front, disciplined
monetary policy aimed at safeguarding
macroeconomic stability and a continued fiscal
stimulus will have a vital role in bolstering Indonesias
medium-term economic prospects. The above
economic growth forecast is clearly contingent on
robust structural policies such as improvement in
the investment climate, empowerment of MSMEs,
financial sector reform and improvement in
infrastructure.
These conducive external and domesticThese conducive external and domesticThese conducive external and domesticThese conducive external and domesticThese conducive external and domestic
conditions are expected to generate higherconditions are expected to generate higherconditions are expected to generate higherconditions are expected to generate higherconditions are expected to generate higher
economic growth accompanied by subduedeconomic growth accompanied by subduedeconomic growth accompanied by subduedeconomic growth accompanied by subduedeconomic growth accompanied by subdued
inflation.inflation.inflation.inflation.inflation. Macroeconomic stability in combination
with vast market potential represents a vital draw
card for international investors to keep investing in
Indonesia.8 Steadily expanding inflows of FDI will
be followed by buoyant investment growth, set to
climb from about 9.3% in 2008 to 13.0%-15.0%
in 2012. The brisk investment growth will build
greater economic capacity (read: improvements in
production and distribution) on the supply side,
paving the way for improvement in economic
growth from 6.2% in 2008 to 7.4%-8.0% in 2012
alongside reduced inflation. Low inflation
accompanied by the planned increases in minimum
wage levels will strengthen public purchasing power,
with private consumption predicted to maintain
vigorous growth reaching 5.6%-6.0% in 2012.
With external conditions still conducive,With external conditions still conducive,With external conditions still conducive,With external conditions still conducive,With external conditions still conducive,
Indonesias exports are predicted to improve furtherIndonesias exports are predicted to improve furtherIndonesias exports are predicted to improve furtherIndonesias exports are predicted to improve furtherIndonesias exports are predicted to improve further
alongside mounting global FDI inflows to Indonesia.alongside mounting global FDI inflows to Indonesia.alongside mounting global FDI inflows to Indonesia.alongside mounting global FDI inflows to Indonesia.alongside mounting global FDI inflows to Indonesia.
This will keep the balance of payments in strongThis will keep the balance of payments in strongThis will keep the balance of payments in strongThis will keep the balance of payments in strongThis will keep the balance of payments in strong
shape with a stable trend in the exchange rate.shape with a stable trend in the exchange rate.shape with a stable trend in the exchange rate.shape with a stable trend in the exchange rate.shape with a stable trend in the exchange rate.
The various structural improvements launched by
the Government, dealing with areas such as
infrastructure, licensing, customs and taxation, will
provide significant support for Indonesias export
competitiveness. In addition, the high volume of
FDI will be accompanied by technological
advancements benefiting productivity and
efficiency. However, export growth and flourishing
investment activity will be followed by increased
imports of goods and services, which in turn will
diminish the current account surplus. However,
mounting global FDI inflows will provide a safety
valve for the pressure bearing down on the balance
of payments. The relatively secure condition of the
balance of payments, supported by improving
economic fundamentals, is forecasted to keep the
exchange rate stable.9
8 UNCTAD survey findings state that market size and growth
alongside the quality of the business environment are the
major determining factors in decisions on venues for FDI.
9 This is borne out in survey findings published by UNCTAD
and the Economist Intelligence Unit (EIU) at The Economist,
stating that FDI inflows in Indonesia will remain positive,
particularly because of the size of the domestic market and
considerable potential for expansion seen as adequately
compensating for risks.
-
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
5
Higher economic growth, subdued inflation,Higher economic growth, subdued inflation,Higher economic growth, subdued inflation,Higher economic growth, subdued inflation,Higher economic growth, subdued inflation,
a stable exchange rate trend and supply-sidea stable exchange rate trend and supply-sidea stable exchange rate trend and supply-sidea stable exchange rate trend and supply-sidea stable exchange rate trend and supply-side
improvements are predicted to contribute to higherimprovements are predicted to contribute to higherimprovements are predicted to contribute to higherimprovements are predicted to contribute to higherimprovements are predicted to contribute to higher
levels of public prosperity.levels of public prosperity.levels of public prosperity.levels of public prosperity.levels of public prosperity. Robust economic growth
driven by expanding production capacity will
generate employment for the growing workforce,
with unemployment projected to ease to 7.5%-
8.5% in 2012. The increased employment of the
workforce accompanied by falling inflation will also
reduce poverty levels. These medium-term
improvements in the economic outlook will in turn
boost prosperity levels with per capita income
expected to climb from USD 1,980 in 2008 to USD
2,950-3,000 in 2012.
1.3 Implications for Macroeconomic and Sectoral
Policy
The envisaged 7.4%-8.0% economic growth
calls for strong support from macro and sectoral
policies as follows:
a. Monetary policy must maintain a prudent
stance, guiding public expectations of
inflation towards the inflation target while
carefully taking account of the dynamics of
the world and domestic economy.
b. Continuation of the fiscal stimulus for the
economy at the central and regional level over
the next five years without sacrificing long-
term fiscal sustainability. The fiscal stimulus
must be targeted at improving infrastructure,
promoting industry capable of generating high
levels of employment, maintaining public
purchasing power, alleviating poverty and
improving income distribution. A steady
reduction is predicted in the fiscal deficit to
1.4% of GDP at end-2012.
c. Given the importance of physical investment
and human resources to long-term economic
growth, creation of a conducive climate for
investment, infrastructure development,
improved competitiveness and improvement
in human capital will be crucial to building
quality, sustainable economic growth and
readiness for the launching of AEC in 2015.
Concerning this, Presidential Instruction
(Inpres) No. 6 of 2007 concerning Policy for
Accelerated Development of the Real Sector
and Empowerment of Micro, Small and
Medium Enterprises (MSMEs), which covers:
1) Improvements in the Investment Climate,
2) Financial Sector Reform, 3) Accelerated
Construction of Infrastructure and 4)
Empowerment of MSMEs, needs to be fast-
tracked for optimum implementation.
Projections 2007 2008 2009 2010 2011 2012
Table 1.1 ProjectionsTable 1.1 ProjectionsTable 1.1 ProjectionsTable 1.1 ProjectionsTable 1.1 Projections
Component Growth (%)Gross Domestic ProductGross Domestic ProductGross Domestic ProductGross Domestic ProductGross Domestic Product 6.3 6.2 6.2-6.8 6.8-7.4 7.2-7.8 7.4-8.0 - Private Consumption 5.0 5.4 5.6-5.9 5.6-6.0 5.6-6.0 5.6-6.0 - Government Consumption 3.9 3.8 4.0-5.0 7.0-9.0 8.0-10.0 8.0-10.0 - Investment 9.2 9.3 10.5-10.8 11.0-13.0 12.0-13.0 13.0-15.0 - Export on Goods and Services 8.0 7.9 8.1-9.1 10.5-11.5 11.5-12.5 12.5-13.5 - Import on Goods and Services 8.9 9.4 10.4-10.7 12.5-13.5 13.5-14.5 14.5-15.5OthersOthersOthersOthersOthers Income per Capita (USD) 1.947.1 1980 2145-2180 2375-2410 2650-2685 2950-3000 Unemployment (%) 9.1 9.0 9.0-10.0 8.5-9.5 8.0-9.0 7.5-8.5 Inflation taget (%)* 6.01% 5.01% 4.51% 4.01%
*) Pursuant to Decree of the Minister of Finance No. 1 of 2008.
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6 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
Chapter 1: General Review
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Chapter 2: Update of the World and Indonesian Economy
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition 7
The long-term outlook for the world
economy remains positive, despite the turbulent
dynamics of recent months. Reinforcing this is high
world economic growth accompanied by
expanding volume of world trade and growing
international capital flows. Nevertheless, these
positive developments are clouded by persistently
high levels of world commodity prices (fuel and
non-fuel) and the ongoing turmoil on world
financial markets. Domestically, the Indonesian
economy has shown steady progress even though
daunted by weak supply-side response, low
investment role and still inadequate quality of
economic growth reflected in high rates of
unemployment and poverty.
2.1 Overview of the World Economy
In the last five years, world economic growthIn the last five years, world economic growthIn the last five years, world economic growthIn the last five years, world economic growthIn the last five years, world economic growth
has forged ahead at more than 4% per annum,has forged ahead at more than 4% per annum,has forged ahead at more than 4% per annum,has forged ahead at more than 4% per annum,has forged ahead at more than 4% per annum,
surpassing the historical average (3.7% for 1970-surpassing the historical average (3.7% for 1970-surpassing the historical average (3.7% for 1970-surpassing the historical average (3.7% for 1970-surpassing the historical average (3.7% for 1970-
2006).2006).2006).2006).2006). This impressive performance has been driven
by buoyant growth in developing countries and
Europe (unprecedented levels in the last five years).
Rapid economic growth in developing economies,
led by China, India and Russia, has filled the gap
created by the US economic slowdown in the wake
of financial market woes triggered by the subprime
mortgage crisis. For the first time, China and India
have become engines of world growth, as shown
in Graphs 2.1 and 2.2.1 These impressive
developments in the world economy have also
been accompanied by steady expansion in world
Chapter 2: Update of the World and Indonesian Economy
trade, with volume growing at an average of 9.2%
in the past three years, ahead of the long-term
trend.2
Graph 2.2 Contributions to World GrowthGraph 2.2 Contributions to World GrowthGraph 2.2 Contributions to World GrowthGraph 2.2 Contributions to World GrowthGraph 2.2 Contributions to World Growth
Graph 2.1 Contributions to World GrowthGraph 2.1 Contributions to World GrowthGraph 2.1 Contributions to World GrowthGraph 2.1 Contributions to World GrowthGraph 2.1 Contributions to World Growth
However, these impressive developments areimpressive developments areimpressive developments areimpressive developments areimpressive developments are
overshadowed by spiralling oil pricesovershadowed by spiralling oil pricesovershadowed by spiralling oil pricesovershadowed by spiralling oil pricesovershadowed by spiralling oil prices.
Fundamentally, the surging prices are the result of
pressing world demand amid tight supply (see
Graph 2.3). Soaring world oil consumption,
especially in emerging markets like China
2 In 1970-2006, growth in volume of world trade averaged
6.1%.
Source: IMF: Survey Magazine-IMF Research
35
30
25
20
15
10
5
0China India United
StatesEuro area Russia Japan Brazil
2006
2007
(Based on PPP weights, percent of world growth)
Contributions to Real GDP Growth
Source: IMF: Survey Magazine-IMF Research
35
20
15
10
5
0UnitedStates
Euro area China Japan India UnitedKingdom
Russia
2006
2007
(Based on PPP weights, percent of world growth)
Contributions to Real GDP Growth
1 In 2006, contributions of growth from China (11.5%), India
(9%) and Russia (8%) accounted for half of world economic
growth.
-
Chapter 2: Update of the World and Indonesian Economy
8 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
accounting for more than one third of growth in
world oil consumption, has not been matched by
adequate supply. In fact, since 2003, spare
production capacity among world oil producers
tend to decline. This has led to an upward spiral in
oil prices beginning in 2003, with prices reaching
a record high of USD100 per barrel in early January
2008. Furthermore, non-fundamental factors, such
as geopolitical conditions in oil-producing
countries, climatic factors and expectations also
influence movement in oil prices.
Graph 2.3 Oil Prices, Demand andGraph 2.3 Oil Prices, Demand andGraph 2.3 Oil Prices, Demand andGraph 2.3 Oil Prices, Demand andGraph 2.3 Oil Prices, Demand andProduction CapacityProduction CapacityProduction CapacityProduction CapacityProduction Capacity
Source: Energy International Agency (EIA)
Oil Demand - Million Barrel per Day (left)
Oil Price WTI - $ per Barrel (left)Spare Capacity - Million Barrel per Day (right)
100
80
60
40
20
02000 2001 2002 2003 2004 2005 2006 2007
77 77 78 8082 84 85 86
6
5
4
3
2
1
0
3.1 4.1
5.6
1.9
1.3 1.01.5
2.1
6769
57
43
332829
34
Non-oil and gas primary commodities haveNon-oil and gas primary commodities haveNon-oil and gas primary commodities haveNon-oil and gas primary commodities haveNon-oil and gas primary commodities have
also shown a steady upward trend.also shown a steady upward trend.also shown a steady upward trend.also shown a steady upward trend.also shown a steady upward trend. Before 2000,
these commodity prices were relatively stable (see
Graph 2.4). However, after 2003, primary
commodity prices mounted significantly, with price
escalation reaching as much as 28% in 2006. Prices
have spiralled mainly in response to high world
demand amid tight supply. Table 2.1 below shows
the size of Chinas contribution to consumption of
some non-fuel commodities, such as aluminium
and copper. Supply has tightened because of low
levels of investment in basic metal production and
lack of new discoveries of reserves. Since 2004,
metal inventories have remained below their
historical average (see Graph 2.5). Soaring prices
for metal commodities have also been followed
by mounting food prices. This has resulted not only
from supply constraints, due to harvest failures for
example, but has also been spurred by growing
demand for foodstuffs in biofuel production. The
combination of spiralling commodity prices and
robust world economic growth has fuelled world
inflationary pressures. In the second half of 2007,
inflation surged ahead in industrialised nations and
developing nations alike.
Graph 2.4 Non-Fuel Primary Commodity PricesGraph 2.4 Non-Fuel Primary Commodity PricesGraph 2.4 Non-Fuel Primary Commodity PricesGraph 2.4 Non-Fuel Primary Commodity PricesGraph 2.4 Non-Fuel Primary Commodity Prices
Source: IMF Database
Non Fuel Primary Commodity Growth Non-Fuel Primary Commodity Price Index - RHS
%30
25
20
15
10
5
0
-5
-10
-15
-201981 19831985 1987 1989 1991 19931995 1997 19992001 2003 2005 2007
%160
140
120
100
80
60
40
20
0
Table 2.1 World Commodity ConsumptionTable 2.1 World Commodity ConsumptionTable 2.1 World Commodity ConsumptionTable 2.1 World Commodity ConsumptionTable 2.1 World Commodity Consumption(% Growth)(% Growth)(% Growth)(% Growth)(% Growth)
Source: Bank of England, Inflation Report November 2007
United UnitedWorld States China World States China
Oil 1.7 0.3 0.6 1.4 0.1 0.5Alumunium 5.2 -0.4 2.8 6.6 0.2 5.5MetalsMetalsMetalsMetalsMetalsCopper 3.4 -0.9 2.5 2.7 -0.8 3.1Zinc 4.4 -0.5 3.3 2.4 -0.4 2.4Agriculture food (c)
Wheat 0.5 -0.1 -0.2 1.2 -0.1 -0.1Maize 2.5 1.0 0.5 3.5 1.4 0.8Soya beans 4.4 0.0 1.9 5.0 0.9 1.6Memo:Memo:Memo:Memo:Memo:Share of wprld GDP (percent) (d) - 20.8 12.3 - 19.6 15.1
Projections2008-2012
2000 - 04 2005 - 07 (a)
Contribution of (b) Contribution of (b)
-
Chapter 2: Update of the World and Indonesian Economy
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition 9
In keeping with the impressive performanceIn keeping with the impressive performanceIn keeping with the impressive performanceIn keeping with the impressive performanceIn keeping with the impressive performance
in the world economy over the past 4 years, globalin the world economy over the past 4 years, globalin the world economy over the past 4 years, globalin the world economy over the past 4 years, globalin the world economy over the past 4 years, global
inflows of foreign direct investment (FDI) haveinflows of foreign direct investment (FDI) haveinflows of foreign direct investment (FDI) haveinflows of foreign direct investment (FDI) haveinflows of foreign direct investment (FDI) have
seen rapid expansion.seen rapid expansion.seen rapid expansion.seen rapid expansion.seen rapid expansion. Following a period of
substantial negative growth, global FDI charted
significant gains in 2004-2006. The negative
growth in 2001-2003 resulted mainly from
slowing world economic growth and the end of
the previous boom in mergers and acquisitions
(M&A). However, with the improving condition
of the world economy, FDI inflows climbed sharply
with growth in 2004, 2005 and 2006 at 26.6%,
33.1% and 37.4%. In 2006, FDI inflows almost
touched the previous high in 2000 at about USD
1.3 billion (as shown in Table 2.2 below). In 2007,
FDI inflows remained strong although not as high
as in the 2004-2006 period.
Graph 2.5 World Commodity SupplyGraph 2.5 World Commodity SupplyGraph 2.5 World Commodity SupplyGraph 2.5 World Commodity SupplyGraph 2.5 World Commodity Supply
Source: BoE, Energy Infromation Agency, London Metal Exchange, The Economist, ThompsonData Stream and US Department of Agriculture
Wheat. maize andsoya beans (b)
1997 1999 2001 2003 2005 2007
(number of standard deviations)
Oil (d)
Metals ( c )
2.0
1.5
1.0
0.5+
0.0
0.5
1.0
1.5
2.0
The sharp rise in global FDI is explained inThe sharp rise in global FDI is explained inThe sharp rise in global FDI is explained inThe sharp rise in global FDI is explained inThe sharp rise in global FDI is explained in
part by higher corporate profits worldwide, whichpart by higher corporate profits worldwide, whichpart by higher corporate profits worldwide, whichpart by higher corporate profits worldwide, whichpart by higher corporate profits worldwide, which
have driven up share prices and fuelled a wave ofhave driven up share prices and fuelled a wave ofhave driven up share prices and fuelled a wave ofhave driven up share prices and fuelled a wave ofhave driven up share prices and fuelled a wave of
cross-border mergers and acquisitions.cross-border mergers and acquisitions.cross-border mergers and acquisitions.cross-border mergers and acquisitions.cross-border mergers and acquisitions. The close
link between global FDI inflows and cross-border
M&A is depicted in Graph 2.6 below. This rise in
corporate earnings has caused reinvested earnings
to be an important component in FDI inflows,
accounting for 30% of global FDI inflows in 2006.
In developing nations, this ratio can reach as much
as 50% of total FDI inflows. Government policy in
FDI destination countries has played a role in the
upward trend in global FDI inflows. In 2006, a total
of 147 policies were launched to make FDI host
nations more attractive and conducive venues for
investment. Significant examples include corporate
tax cuts in Brazil and India.
Source: National Statistics, Economist Intelligence Unit, IMF, UNCTAD
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Word totalWord totalWord totalWord totalWord total 491,8491,8491,8491,8491,8 712,9712,9712,9712,9712,9 1.113,81.113,81.113,81.113,81.113,8 1.408,31.408,31.408,31.408,31.408,3 851,1851,1851,1851,1851,1 618,1618,1618,1618,1618,1 563,4563,4563,4563,4563,4 730,2730,2730,2730,2730,2 971,7971,7971,7971,7971,7 1.335,11.335,11.335,11.335,11.335,1
Developed countriesDeveloped countriesDeveloped countriesDeveloped countriesDeveloped countries 279,0279,0279,0279,0279,0 493,8493,8493,8493,8493,8 853,0853,0853,0853,0853,0 1.125,01.125,01.125,01.125,01.125,0 563,4563,4563,4563,4563,4 421,1421,1421,1421,1421,1 354,6354,6354,6354,6354,6 379,5379,5379,5379,5379,5 546,8546,8546,8546,8546,8 824,4824,4824,4824,4824,4
% of world total 56,7 69,3 76,6 79,9 66,2 68,1 62,9 52,0 56,3 61,7
Emerging markets 212,8 219,1 260,9 283,3 287,8 197,0 208,9 350,7 424,9 510,7
% of world total 43,3 20,7 23,4 20,1 33,8 31,9 37,1 48,0 43,7 38,8
Table 2.2 Global FDI Inflows, 1997-2006Table 2.2 Global FDI Inflows, 1997-2006Table 2.2 Global FDI Inflows, 1997-2006Table 2.2 Global FDI Inflows, 1997-2006Table 2.2 Global FDI Inflows, 1997-2006(USD billions)(USD billions)(USD billions)(USD billions)(USD billions)
Graph 2.6 Global FDI Inflows and Mergers &Graph 2.6 Global FDI Inflows and Mergers &Graph 2.6 Global FDI Inflows and Mergers &Graph 2.6 Global FDI Inflows and Mergers &Graph 2.6 Global FDI Inflows and Mergers &AcquisitionsAcquisitionsAcquisitionsAcquisitionsAcquisitions
Source: National Statistics, Economist Intelligence Unit, IMF, UNCTAD
1,600
1,400
1,200
1,000
800
600
400
200
0
(US$ bn)
1992 93 94 95 96 97 98 99 2000 01 02 03 04 05
FDI inflowsM & As
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Chapter 2: Update of the World and Indonesian Economy
10 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
2.2 Overview of the Indonesian Economy
From long-term perspective, the constellation
of world economic developments, marked by
sustained high economic growth and volume of
world trade, substantial global FDI inflows and
unabated high commodity prices, will continue to
influence the dynamics of the Indonesian economy.
2.2.1 Indonesian Economic Indicators
Domestic economic indicators showDomestic economic indicators showDomestic economic indicators showDomestic economic indicators showDomestic economic indicators show
improvement, although still overshadowed by aimprovement, although still overshadowed by aimprovement, although still overshadowed by aimprovement, although still overshadowed by aimprovement, although still overshadowed by a
range of structural problems that could preventrange of structural problems that could preventrange of structural problems that could preventrange of structural problems that could preventrange of structural problems that could prevent
Indonesia from achieving faster economic growth.Indonesia from achieving faster economic growth.Indonesia from achieving faster economic growth.Indonesia from achieving faster economic growth.Indonesia from achieving faster economic growth.
Macroeconomic stability, a prerequisite for
sustainable economic growth, can be maintained
through collaboration by the Government and the
monetary authority in their various policies.
However, in the drive for faster, higher quality
economic growth, Indonesia remains beset by a
range of structural problems.
Since 2002, Indonesias economic growthSince 2002, Indonesias economic growthSince 2002, Indonesias economic growthSince 2002, Indonesias economic growthSince 2002, Indonesias economic growth
has gathered momentum, albeit slowly, withhas gathered momentum, albeit slowly, withhas gathered momentum, albeit slowly, withhas gathered momentum, albeit slowly, withhas gathered momentum, albeit slowly, with
growth still below the pre-crisis levelgrowth still below the pre-crisis levelgrowth still below the pre-crisis levelgrowth still below the pre-crisis levelgrowth still below the pre-crisis level (see Graph
2.7).3 Economic growth in the post-crisis period
has averaged about 5% per annum, well short of
that in the pre-crisis period indicate a weakening
Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006Table 2.3 Policy Changes in FDI Destination Countries, 1992-2006
Source: UNCTAD, World Investment Report 2007
Item 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Number of Countries that
Introduced Changes 43 56 49 63 66 76 60 65 70 71 72 82 103 93 93
Number of Regulatory Change 77 100 110 112 114 150 145 139 150 207 246 242 270 205 184
More Favorable to FDI 77 99 108 106 98 134 136 130 147 193 234 218 234 164 147
Less Favorable to FDI 0 1 2 6 16 16 9 9 3 14 12 24 36 41 37
3 The analysis is based on the following periodisation: 1989-
1996 for pre-crisis; 2000-2007 for the post-crisis period.
in aggregate demand.4 This has been accompanied
by structural change in the economy, with
investment, once representing 30% of GDP,
hovering at only about 20% of GDP in the post-
crisis period. Private consumption has experienced
the reverse, increasing from the pre-crisis share at
less than 60% of GDP to a consistent post-crisis
level at more than 60% of GDP.
Graph 2.7 GDP Growth 1989-2007Graph 2.7 GDP Growth 1989-2007Graph 2.7 GDP Growth 1989-2007Graph 2.7 GDP Growth 1989-2007Graph 2.7 GDP Growth 1989-2007
Source: CEIC
Economic Growth Average 1989-1996 Average 2000-2007
-5
-3
-1
1
3
5
7
9
2007*)200520032001199919971995199319911989
Average 1989 - 1996 7.3%
Average 2000 - 2007 5.0%
Inflation has behaved with differentInflation has behaved with differentInflation has behaved with differentInflation has behaved with differentInflation has behaved with different
characteristics in the pre-crisis and post-crisischaracteristics in the pre-crisis and post-crisischaracteristics in the pre-crisis and post-crisischaracteristics in the pre-crisis and post-crisischaracteristics in the pre-crisis and post-crisis
periods. While the inflation rate in the two periodsperiods. While the inflation rate in the two periodsperiods. While the inflation rate in the two periodsperiods. While the inflation rate in the two periodsperiods. While the inflation rate in the two periods
only slightly different, its volatility has soared inonly slightly different, its volatility has soared inonly slightly different, its volatility has soared inonly slightly different, its volatility has soared inonly slightly different, its volatility has soared in
4 According to research by BI, the long-term trend in
Indonesias economic growth during the 1981-2007 period
came to 4.9%. This long-term trend is a constant in the
GDP equation derived from macroeconomic models.
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Chapter 2: Update of the World and Indonesian Economy
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition 11
the post-crisis periodthe post-crisis periodthe post-crisis periodthe post-crisis periodthe post-crisis period (see Graph 2.8). Post-crisis
economic growth is below that of the previous
period, but despite this, the average post-crisis
inflation is slightly higher than it was in the pre-
crisis period. Theoretically, this occurs only when
aggregate demand softens alongside a
commensurate slowing in aggregate supply. This
interaction in supply and demand is indicative of
supply constraints.5 Accordingly, resolution of
various structural issues, which will bring
improvement to the investment climate and the
supply side, in conjunction with stimulation of
demand will be key to creating sustainable, quality
growth.
Graph 2.8 Inflation 1989 2007Graph 2.8 Inflation 1989 2007Graph 2.8 Inflation 1989 2007Graph 2.8 Inflation 1989 2007Graph 2.8 Inflation 1989 2007
Average 1989-1996 = 8.2% Average 2000-2007 = 8.7%
%
-5
0
5
10
15
20
2007200520032001199919971995199319911989
Source : CEIC
Various indicators and survey findings pointVarious indicators and survey findings pointVarious indicators and survey findings pointVarious indicators and survey findings pointVarious indicators and survey findings point
to the continued slow pace of improvement into the continued slow pace of improvement into the continued slow pace of improvement into the continued slow pace of improvement into the continued slow pace of improvement in
economic conditions in Indonesia. economic conditions in Indonesia. economic conditions in Indonesia. economic conditions in Indonesia. economic conditions in Indonesia. According to the
Global Competitiveness Report 2007-2008,
Indonesias economic competitiveness is still ranked
in the 54th position out of 131 countries, following
the significant improvement achieved in 2006
5 Using the Blanchard-Quah SVAR, a research by Bank
Indonesia indicates a steeper post-crisis supply curve
compared to the pre-crisis period. For further analysis, see
Nugroho (2007): Review of the Pre and Post-Crisis
Aggregate Supply Curve, in Indonesian Economic Outlook,
July 2007 edition.
compared to 2005 (see Table 2.4).6 A similar
situation was identified in the International Institute
for Management Development (IMD) survey
published in the World Competitiveness Yearbook
for 2007, which states that Indonesias economic
competitiveness has not improved (Table 2.5). In
2007, Indonesias competitiveness slipped from
52nd spot in 2006 to 54 out of 55 countries.7
Indonesias position was only one notch above
Venezuela and right below that of below
Argentina, Poland and Croatia. When compared
with other ASEAN countries, such as Singapore,
Malaysia, Thailand and the Philippines, Indonesia
lags far behind.
6 Publication by the World Economic Forum (WEF), based on
survey findings.
7 The IMD criteria in evaluating a countrys competitiveness
include indicators such as economic performance,
government efficiency, business legitimacy, business
efficiency and infrastructure.
Source: World Economic Forum, Global Competitiveness Report 2006 & 2007
NegaraPeringkat
2005 2006 2007
Indonesia 69 54 54Singapore 5 8 7Malaysia 25 19 21Thailand 33 28 28Phillippines 73 75 71Vietnam 74 64 68Kamboja 111 106 110Timor-Leste 113 120 127
Table 2.4 WEF Competitiveness RatingsTable 2.4 WEF Competitiveness RatingsTable 2.4 WEF Competitiveness RatingsTable 2.4 WEF Competitiveness RatingsTable 2.4 WEF Competitiveness Ratings
The poor condition of IndonesiasThe poor condition of IndonesiasThe poor condition of IndonesiasThe poor condition of IndonesiasThe poor condition of Indonesias
infrastructure, institutions and basic education hasinfrastructure, institutions and basic education hasinfrastructure, institutions and basic education hasinfrastructure, institutions and basic education hasinfrastructure, institutions and basic education has
contributed to the lack of improvement incontributed to the lack of improvement incontributed to the lack of improvement incontributed to the lack of improvement incontributed to the lack of improvement in
economic competitiveness.economic competitiveness.economic competitiveness.economic competitiveness.economic competitiveness. The 2007 WEF (World
Economic Forum) survey also states that the most
important factor hampering business in Indonesia
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Chapter 2: Update of the World and Indonesian Economy
12 Indonesian Economic Outlook 2008 - 2012, January 2008 Edition
is poor infrastructure, followed by inefficient
government bureaucracy, as shown in Table 2.6 and
Graph 2.9. The quality of Indonesias institutions is
also rated low based on the Transparency
International survey on perceptions of corruption,
in which Indonesia is rated 134th on the list of
corrupt countries worldwide (out of 163 countries).
Meanwhile, a World Bank survey has identifiedMeanwhile, a World Bank survey has identifiedMeanwhile, a World Bank survey has identifiedMeanwhile, a World Bank survey has identifiedMeanwhile, a World Bank survey has identified
a number of barriers to commencing business ina number of barriers to commencing business ina number of barriers to commencing business ina number of barriers to commencing business ina number of barriers to commencing business in
Indonesia, which include the number of proceduresIndonesia, which include the number of proceduresIndonesia, which include the number of proceduresIndonesia, which include the number of proceduresIndonesia, which include the number of procedures
to be completed and the costs involved in businessto be completed and the costs involved in businessto be completed and the costs involved in businessto be completed and the costs involved in businessto be completed and the costs involved in business
startupstartupstartupstartupstartup. In general, Indonesias ranking by ease of
starting business ventures improved from 133 in
2006 to 123 in 2007 (see Table 2.7). However,
Indonesias ranking also suffers badly when
compared to other ASEAN countries. Indonesias
position in the 123rd spot is ahead only of countries
like Lesotho, Algeria and Egypt. The most important
barrier to doing business in Indonesia is the process
for starting a business venture, which normally
requires 105 days. This is far longer than the time
Negara 2007 2006 2005 2004 2003
USA 1 1 1 1 1Singapore 2 3 3 2 4Hongkong 3 2 2 6 40China 15 18 31 24 29Taiwan 18 17 11 12 17Malaysia 23 22 28 16 21India 27 27 39 34 50Korea 29 32 29 35 37Thailand 33 29 27 29 30Philippines 45 42 49 52 49Brazil 49 44 51 53 52South Africa 50 44 46 49 47Argentina 51 47 58 59 58Poland 52 58 57 57 55Croatia 53 59 - - -IndonesiaIndonesiaIndonesiaIndonesiaIndonesia 5454545454 5252525252 5959595959 5858585858 5757575757Venezuela 55 53 60 60 59
TotalTotalTotalTotalTotal 5555555555 5555555555 6060606060 6060606060 5959595959
Table 2.5 Table 2.5 Table 2.5 Table 2.5 Table 2.5 Competitiveness Ratings by IMDCompetitiveness Ratings by IMDCompetitiveness Ratings by IMDCompetitiveness Ratings by IMDCompetitiveness Ratings by IMD
Source: International Institute for Management Development (IMD)
Indonesia 2006 2007
Indonesia 69 54Overall indexOverall indexOverall indexOverall indexOverall index 5454545454 5454545454Basic requirementsBasic requirementsBasic requirementsBasic requirementsBasic requirements 7575757575 8282828282Institutions 60 63Infrastructures 78 91Macroeconomic stability 73 89Health & primary education 93 78Efficiency enhancersEfficiency enhancersEfficiency enhancersEfficiency enhancersEfficiency enhancers 4444444444 3737373737Higher education and training 70 65Goods market & efficiency 33 23Labor market efficiency 51 31Financial market sophistication 58 50Technological readiness 75 75Market size 15 15Innovation & sophistication factorsInnovation & sophistication factorsInnovation & sophistication factorsInnovation & sophistication factorsInnovation & sophistication factors 4141414141 3434343434Business sophistication 41 33Innovation 39 41
Table 2.6 Ranking of CompetitivenessTable 2.6 Ranking of CompetitivenessTable 2.6 Ranking of CompetitivenessTable 2.6 Ranking of CompetitivenessTable 2.6 Ranking of CompetitivenessComponentsComponentsComponentsComponentsComponents
Source: World Economic Forum, Global Competitiveness Report 2006 & 2007
required in neighbouring countries in ASEAN, such
as Singapore (5 days), Malaysia (24 days), Thailand
(33 days), Vietnam (50 days) and even the Philippines
(58 days) (see Graph 2.10). In this category, Indonesia
holds 168th position out of 178 countries.
Even so, Indonesia is still regarded as anIndonesia is still regarded as anIndonesia is still regarded as anIndonesia is still regarded as anIndonesia is still regarded as an
attractive location for FDI. attractive location for FDI. attractive location for FDI. attractive location for FDI. attractive location for FDI. In a 2007 survey by
UNCTAD, Indonesia ranked among the 15 most
attractive countries for FDI (see Graph 2.11).8
Graph 2.9 The Most Problematic Factors forGraph 2.9 The Most Problematic Factors forGraph 2.9 The Most Problematic Factors forGraph 2.9 The Most Problematic Factors forGraph 2.9 The Most Problematic Factors forDoing BusinessDoing BusinessDoing BusinessDoing BusinessDoing Business
Inadequate supply of infrastructure 20.50Inefficient government bureaucracy 16.10
Access to financing 10.80Policy instability 10.70
Restrictive labour regulations 8. 50Tax regulations 8.00
Inadequately educated workforce 5.60Inflation 5.50
Corruption 4.20Foreign currency regulations 3.70
Government instability/coups 2.20Tax rates 2.00
poor work ethic in national labour force 1.80Crime and theft 0.50
5 10 15 20 250Source: World Economic Forum. Global Competitiveness Report 2007
8 UNCTAD, World Investment Prospects Survey 2007-2009.
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Chapter 2: Update of the World and Indonesian Economy
Indonesian Economic Outlook 2008 - 2012, January 2008 Edition 13
Another UNCTAD publication states that Indonesia
has achieved steady improvement in rating for FDI
performance and potential.9 This demonstrates
that while Indonesia is still beset with structural
Rank Time Rank Time Rank Time Rank Rank Time Cost(days) (days) (days) (days) (% debt)
IndonesiaIndonesiaIndonesiaIndonesiaIndonesia 2006 133 163 97 117 224 123 42 49 142 570 122,7IndonesiaIndonesiaIndonesiaIndonesiaIndonesia 2007 123 168 105 99 196 121 42 51 141 570 122,7Malaysia 2006 21 74 30 102 285 65 144 4 62 600 27,5Malaysia 2007 24 74 24 105 285 67 144 4 63 600 27,5Thailand 2006 17 27 33 11 156 19 2 32 26 479 14,3Thailand 2007 15 36 33 12 156 20 2 33 26 479 14,3Philippines 2006 130 135 58 75 177 81 33 141 113 842 26Philippines 2007 133 144 58 77 177 86 33 141 113 842 26Singapore 2006 1 11 6 5 102 13 9 2 5 120 17,8Singapore 2007 1 9 5 5 102 13 9 2 4 120 17,8India 2006 132 93 35 133 224 108 62 32 177 1,420 39,6India 2007 120 111 33 134 224 112 62 33 177 1,420 39,6Honduras 2006 126 143 44 98 184 89 36 147 126 480 30,4Honduras 2007 121 135 21 72 125 78 24 147 124 480 30,4Brazil 2006 113 120 152 95 316 109 47 62 112 616 16,5Brazil 2007 122 122 152 107 411 110 45 64 106 616 16,5Lesotho 2006 119 120 73 146 601 129 101 141 99 695 16,6Lesotho 2007 124 126 73 146 601 132 101 141 99 695 16,6Algeria 2006 125 119 24 104 240 153 51 62 120 630 17,4Algeria 2007 125 131 24 108 240 156 51 64 117 630 17,4Egypt 2006 152 126 19 165 249 147 193 105 146 1,010 25,3Egypt 2007 126 55 9 163 249 101 193 83 145 1,010 25,3China 2006 92 128 35 175 349 28 29 81 20 406 8,