Indonesia: a bright spot in an uncertain world

The past two years have been challenging for many investors as elevated levels of inflation and deglobalization trends that emerged as a result of continued geopolitical tensions meant that the hoped-for return to a Goldilocks-like environment was all but impossible. Indonesia’s economy, however, remains one of the few bright spots in an otherwise uncertain world.

Indonesia's growth outlook

Indonesia’s potential growth over the next decade remains strong. Market consensus suggests that the average growth in the country could rise from 3.6% (1993–2019) to ~4.5% in 2030 and 5.2% in 2050.¹ In our view, there are many supportive catalysts that are setting the stage for an upcoming period of strong growth.

Efforts to move up the value chain are attracting record foreign investments

After many years of decline, Indonesia’s manufacturing sector is showing signs of life. The Omnibus Law reforms, while controversial, have gone a long way to address structural challenges. Amid a strong trend of supply chain diversification, Indonesia stands out for its relatively lower wages and favorable demographics—particularly when compared with its neighbors in the region; the country’s ample nickel reserves also play well into the government’s push to become a hub for electric vehicle manufacturing in the region. Foreign direct investment into Indonesia has subsequently risen to a record high, both in U.S. dollar terms and as a share of GDP. 

Realized foreign investment value
Chart showing realized foreign direct investments into Indonesia expressed as a percentage share of the country’s GDP from January 2010 to data available as of February 24, 2022. The chart shows that the share of foreign direct investments has hit its highest level as a share of GDP in the last 12 years.

Source: NSWI, Macrobond, Manulife Investment Management, as of February 24, 2023.

Reform of state-owned momentum is gathering pace

Indonesia’s state-owned enterprises (SOEs) play a disproportionately large role in the country’s economy. The value of SOE assets accounts for over 50% of GDP and sits across a range of strategic industries. The Ministry of State-Owned Enterprises has pursued a broad reform agenda that aims to increase SOE performance and competitiveness through consolidation and improved transparency and quality of governance. Results to date are encouraging: The country’s State-Owned Enterprises Minister Erick Thohir recently announced that the total profit of Indonesia’s SOEs jumped 143% from a year ago to more than 300 trillion rupiah (IDR), led by financial services. Continued reform of Indonesia’s SOEs can help pave the path to more efficient public investment and catalyze private investment. This could help to fill investment gaps in infrastructure, technology, and education, not to mention initiatives to reduce carbon emissions. 

A benign interest-rate outlook

In terms of monetary policy, we believe that Bank Indonesia (BI) is near the peak of its tightening cycle. Despite the surprising acceleration in February headline Consumer Price Index inflation from 5.28% to 5.47% on a year-over-year (YoY) basis,1 BI is unlikely to tighten further—absent renewed supply shocks—for the following reasons:

1 Inflation—The broader downward move toward the central bank’s 2.0% to 4.0% inflation target remains intact. Headline inflation is still well below the 6.0% peak reached in September 2022, and core inflation—a better indicator of underlying price pressures—was slower than expected, decelerating from 3.27% YoY to 3.09% YoY.²

2 Growth rate—Economic growth slowed from 1.81% in Q3 2022 to 0.36% in Q4 2022 on a quarter-over-quarter basis, a development that’s likely to make the central bank think twice before deciding to raise interest rates again.²

3 A stabilizing currency—Concerns about further depreciation of the IDR have faded. Emerging-market central banks are mindful of the financial stability risks associated with sharp currency depreciations. The strong performance of IDR year to date should give BI the breathing room it needs since the central bank may no longer need to raise rates to support the currency and stem capital outflows. 

An upcoming period of strength

Overall, a rising capital stock, a larger share of skilled workers (relative to its peers), and revitalized SOEs have the potential to create positive feedback loops that can boost Indonesia’s total factor productivity and economic dynamism. A relatively benign interest-rate outlook is also likely to enhance the country’s appeal to investors.

 

1 Bloomberg, as of February 24, 2023. Statistics Indonesia, as of March 3, 2023. 

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Sue Trinh

Sue Trinh, 

Former Co-Head, Global Macro Strategy, Multi-Asset Solutions

Manulife Investment Management

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