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NEWS UPDATES Asean Affairs   03 January 2011

Inflation may dull Indonesian outlook

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Indonesia enjoyed a great year in 2010 as rising consumer demand, strong commodity prices and low interest rates combined to create a virtuous cycle.Nearly every sector experienced growth, including manufacturing, which had struggled to join the economic upswing in the past few years. The only sector that continues to struggle is oil and gas, where investors are wary after complaints of unclear regulations.

Years of fiscal discipline and demographic dividends are paying off for Indonesia. Its foreign reserves stand at close to $94.7 billion, and its banking and corporate sectors are healthy. Strong economic growth has put more money into consumers’ hands, with per-capita income expected to hit $3,000 in the near future.

International ratings agencies such as Standard & Poor’s and Moody’s Investors Service have indicated the country is close to receiving an investment grade rating. Once that happens, it can expect more foreign fund inflows and, more importantly, longer-term capital.

The government’s belated push to improve infrastructure will likely continue in 2011 and support economic growth. Better infrastructure will provide a massive multiplier effect for the economy, creating new jobs and improving cost efficiency.

Given the buoyant mood in the country, the government is confident the economy will expand by 6.4 percent in 2011, up from 6 percent this year. President Susilo Bambang Yudhoyono on Tuesday said, “With that economic growth target, we expect the welfare of the people will improve, marked by a declining poverty rate to 11.5 percent and the unemployment rate to decline to 7 percent from 7.4 percent this year.”

“It’s hard to ignore Indonesia,” said Fauzi Ichsan, Indonesia economist at Standard Chartered Bank. “Given that 70 percent of the economy is based on domestic consumption with net exports contributing 10 percent, better infrastructure would be a huge boost to the economy.”

Despite the rosy outlook, though, economists and policy makers are still cautious as 2011 could see an inflation spike.

Commodity prices are on the rise, with oil now back to more than $90 a barrel and prices of commodities such as corn, crude palm oil, wheat and sugar all up significantly.

According to Harry Su, senior vice president and head of Research at Bahana Securities, GDP growth could be less than the 6.4 percent targeted by the government in 2011 because of higher inflation.

“We believe that inflation could erode purchasing power if it breaks 7 percent,” he said.

Bank Indonesia has not yet acted on the possibility of higher inflation, holding the benchmark interest rate at 6.5 percent.

“The BI governor is pro-growth, but the risk is that the central bank could be behind the curve so it could be difficult to reign in inflation,” Su said. “That is the single biggest risk I see for the economy in 2011.”

Bank Indonesia flagged the risk of higher inflation when its deputy governor said in early December that global commodity prices would rise sharply in 2011.

“We will not hesitate to raise rates if the core inflation exceeds 5 percent,” Hartadi said.

Core inflation, which measures consumer prices while excluding volatile items such as food, rose 4.31 percent year-on-year in November. Headline inflation reached 6.33 percent year-on-year that month.

Unlike its counterparts in countries such as Malaysia, Thailand and the Philippines, which tightened their monetary policies, Bank Indonesia has been reluctant to raise rates on concerns that investors seeking higher returns in emerging economies would flood the country’s markets, triggering inflation and economic volatility.

Like many emerging economies, Indonesia was able to escape a recession in 2009 because of its strong domestic economy and robust banking system.

Foreign direct investment in Indonesia could surpass $14 billion, a significant increase over 2009, when realized investment amounted to $10.5 billion. Total foreign investment, including portfolio investment, could exceed $22 billion.

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