‘Widening deficit, capital flight to hurt Indonesia in short term’

A widening current account deficit and capital flight from emerging markets (EMs) could destabilise the Indonesian economy in the short-term, despite its long–term growth potential, QNB has said in a report. “Indonesia has enormous long–term growth potential. The large and rapidly growing population has favourable demographics and is increasingly wealthy. Indonesia has a rich endowment of natural resources and a vibrant and dynamic private sector that underpins the growth outlook,” QNB said. Indonesia has already risen to become the 16th largest economy in the world with GDP of $878bn in 2012 and was the fourth fastest growing economy among the G20 in 2008-12. With these strong fundamentals, emerging Indonesia has the potential to grow at near double digit rates. However, according to QNB Group, there are risks to the economic outlook going forward and growth is likely to be below potential in the 5%-6% range. In the short run, the widening current account deficit and capital flight from EMs could destabilise the economy. In the medium term, underinvestment in infrastructure threatens to cage Indonesia’s “tiger” economy in crippling supply bottlenecks.Indonesia’s long–term growth potential mainly lies in its favourable demographics. It is the fourth most populous nation in the world (244mn people). The population is young and growing quickly, with a rapid expansion of a consuming middle class. GDP per capita has more than doubled in twelve years to $4,977 in 2012 on a purchasing power parity basis. The scale of opportunity is breathtaking: there were 35mn new mobile subscribers in 2012 alone. In addition, there will be 90mn new middle class consumers by 2030, according to a recent report from the consulting firm McKinsey. In addition, Indonesia is well endowed with a wealth of natural resources. it is the largest coal exporter in the world; was formerly the largest exporter of LNG until Qatar took over the top spot; has vast areas of fertile land producing high value crops such as palm oil and rubber; and has a large mining sector that extracts a broad range of metals from tin to gold as well as various basic materials. With these fundamentals, Indonesia should be able to achieve growth close to the double digit rates reached by China in recent years. Notwithstanding this strong potential, the Indonesian economy has recently run into a rough patch. The current account deficit has widened, reaching 4.4% of GDP in Q2 2013 as lower commodity prices and a drop in exports of natural resources reduced export receipts. At the same time, strong domestic demand continued to push up the import bill. Investor confidence was further shaken by the announcement on last May 18 of the Federal Reserve’s intention to taper its quantitative easing (QE) programme. This led to capital outflows from EMs, including Indonesia, as dollar liquidity tightened globally. The combination of a widening current account deficit and capital flight led to a sharp depreciation in the value of the rupiah and a stock market correction of 23.9% from its peak in May to end–August 2013. As a result, real growth in investment slowed from 9.8% in 2012 to 4.7% in Q2 2013 (year on year). According to QNB Group, weaker investment and exports will lead to a slowdown in overall real GDP growth from 6.2% in 2012 to 5.5% in 2013 and 5.1% in 2014. The short-term risk remains that growth could be even slower if the global economic recovery fails to materialise or if there is serious fallout from QE tapering. Slow global growth and weaker external demand could lead to lower commodity prices and a wider current account deficit.