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The Long Road to Recovery 

NEWS | 6 October 2020
The Covid-19 pandemic and associated containment measures triggered the deepest global recession in eight decades which will require a long recovery while many countries including Indonesia continues the battle to survive. NOW!JAKARTA

Overview: The Indonesia Economic Prospects (IEP) is a bi-annual World Bank report that aims to provide an impartial and up-to-date assessment of recent global and domestic macroeconomic developments, outlook and risks, as well as specific development challenges for the Indonesian economy. In doing so, the IEP informs public policy debate, not only for the government but also for the private sector, civil society organizations, and other domestic and international stakeholders. 

The IEP has two main objectives. First, it highlights key developments in the Indonesian economy over recent months, and places these in a longer-term context. Based on these developments, and on policy changes over the period, the IEP regularly updates the outlook for Indonesia’s economy. The ongoing Covid-19 pandemic highlights the continued need for sound macroeconomic monitoring to help the economy weather the impact of the crisis. 

Second, the report provides an in-depth examination of selected economic and policy issues, and an analysis of the country’s medium-term development challenges. It is intended for a wide audience, including policy makers, business leaders, financial market participants, and the community of analysts and professionals engaged in Indonesia’s evolving economy. The IEP is a product of the World Bank’s Jakarta office and receives guidance from an editorial board chaired by Satu Kahkonen, Country Director for Indonesia and Timor-Leste. 

Executive Summary: The Covid-19 pandemic and associated containment measures triggered the deepest global recession in eight decades. As many countries implemented lockdowns and travel restrictions, global demand for goods and services plummeted along with tourism flows and commodity prices; supply chains were disrupted; and financial market volatility spiked. The Government of Indonesia also implemented mobility restrictions from mid-March and then a partial lockdown from April to June, preventing many firms and shops from operating, and discouraging many consumers from shopping.

Hit by severe external and domestic shocks, economic activity tumbled. Real GDP growth slumped from 5.0 percent yoy in Q4 2019 to 3.0 percent in Q1 2020, the lowest quarterly growth since 2001. Private consumption slowed as mobility restrictions and personal avoidance behavior curbed household consumption. Investment growth also declined with heightened uncertainty and lower commodity prices. There was broad-based slowdown across sectors. Manufacturing, construction and low value-added service sectors including transport, storage, hotels and restaurants, sectors that employ a larger number of workers, all saw a near halving in their sectorial growth rates from Q4 2019. 

In contrast, growth of modern, knowledge-intensive services sectors, including digital, financial, education and health services accelerated. The slowdown in domestic demand and the unexpected growth in some manufactured exports helped narrow the current account deficit (CAD) to 2.5 percent of GDP in Q1 2020 from 2.7 percent of GDP in Q4 2019. The goods trade surplus soared, as some diversion of manufacturing production from China and higher palm oil prices earlier in the year propped up export values, while imports contracted due to lower consumption and, investment and falling oil prices. 

With the sudden stop in global travel and transport, both services exports and imports plunged. Amid global financial volatility, sharp and sudden portfolio outflows, larger than those during the Global Financial Crisis and the Asian Financial Crisis, brought the financial account to its first quarterly deficit since 2011. As a result, government bond yields surged by 57 basis points and the Rupiah depreciated by 17.7 percent in Q1. Despite the smaller CAD, the larger financial account deficit led to an overall Balance of Payments deficit and international reserves fell to USD 121.0 billion at the end of March. Following massive easing by global central banks, external liquidity conditions improved significantly in the second quarter, which led the Rupiah to appreciate and bond yields to fall. This global easing, together with the relatively benign inflation rate, allowed Bank Indonesia (BI) to cut the policy rate by a cumulative 50 bps in Q1.

To mitigate the economic impacts of Covid-19, the Government has announced a package of IDR 695.2 trillion, with an overall estimated impact on the budget of 4.3 percent of GDP, including new spending of 3.0 percent of GDP. Together with lower revenues, the fiscal deficit is expected to widen to 6.3 percent of GDP. The package includes larger allocations to the health sector, significant increases in social assistance, large tax incentives for corporates, bailouts of SOEs, credit programs for SMEs and equity injections for banks that restructure SME loans, and additional spending by local governments and line ministries.

The impact of Covid-19 on livelihoods has been severe, with workers in heavily affected sectors such as transport and construction reporting large declines in income. Without measures to mitigate the shock, the pandemic would lead poverty to increase by 2.0 percentage points. The substantial increase in social assistance spending as part of the Government’s mitigation package is therefore critical: if appropriately targeted and fully disbursed with minimal leakage, the package would significantly mitigate the impact of the pandemic on poverty. 

Private consumption is expected to slow sharply and investment to contract. Government consumption growth will accelerate but cannot fully offset the weakness in other components of domestic demand. Export and import volumes are projected to slump on adverse external conditions, with imports projected to shrink more rapidly on sharply weaker domestic demand. Net exports are therefore expected to make a positive contribution to overall headline growth. Predicated on a gradual but steady reopening of the economies in Indonesia and abroad, the baseline growth outlook foresees a recovery spanning the next two years, with private consumption recovering first, followed by private investment. 

Finally, a sound financial system is a foundation of a sustainable recovery, and ensuring adequate liquidity and oversight is a priority. With millions of jobs destroyed during the crisis, and the possible acceleration of trends in labor demand that favor the skilled, the unemployed need to be supported in their job search and upskilling to meet employer needs. Moreover, rectifying newly identified gaps in Indonesia’s social protection coverage, building on Covid-driven expansions in the system, and expediting the delivery of appropriately funded universal health care for all, will help build, employ, and protect Indonesia’s human capital.

At the same time, Covid-driven cuts to public capital spending and postponements of infrastructure projects need to be reversed to avoid putting at risk the Government’s growth-enabling infrastructure agenda. Efforts to catalyze private sector participation in infrastructure are paramount, but additional spending will also be necessary. Given these expenditure needs, as well as the imperative of flattening the debt curve, temporary fiscal measures need to be gradually unwound, and revenues increased.

The economic downturn’s heavy fiscal burden has put public debt on an elevated trajectory entailing higher debt servicing costs that, if not reversed through revenue enhancing reforms, will eventually crowd out priority spending or risk Indonesia’s hard-earned investment grade credit rating.

Source: World Bank