Navigating Indonesia’s Economic Growth: Balancing Progress and Sustainability

By: Ronald Sofyan G.S. Sipayung *)

Indonesia’s economy has showcased impressive growth in recent years, with the second quarter of 2023 witnessing a year-on-year (yoy) growth rate of 5,17%, surpassing market expectations. However, to escape the middle-income trap and achieve sustained prosperity, sustaining a growth rate of 6–7% in the impending years is imperative.

Driving Forces behind Economic Growth
Domestic Consumption and Government Spending
Solid domestic consumption and increased government spending have been significant contributors to Indonesia’s economic growth. Despite a deceleration in export-import activities due to volatile commodity prices, domestic consumption remained resolute. The pronounced acceleration in household consumption, witnessing a yoy growth of 5,23% in Q2 2023 against 4,54% in Q1 2023, was instrumental. Factors such as escalated mobility during religious holidays like Idul Fitri and Idul Adha, coupled with school vacations, contributed to this surge. Moreover, the issuance of holiday allowances (THR) and the 13th-month salary for civil servants (PNS) further augmented purchasing power. Sectors like transportation and communication, clothing and footwear, and hotels and restaurants exhibited notable growth within household consumption.

Interestingly, the robust GDP growth can be attributed to disinflationary trends. In the second quarter, the GDP deflator declined faster than the consumer price index (CPI), resulting in relatively strong real growth. Certain sectors, like net exports and household consumption, saw a boost in real terms due to declining prices. Fixed-asset investments and government/non-profit spending also contributed to growth. However, the performance of these sectors in the near-term will depend on global developments. Household consumption remains a key factor, and fiscal transfers and election-related spending are expected to support growth in the short-term.

As a note, GDP deflator is a measure of inflation or deflation in various sectors of the economy, such as manufacturing, wholesale trade, and commodity exports. In the context of Indonesia, a faster decrease in GDP deflator compared to CPI indicates disinflation, which is a general decrease in inflation levels. This disinflation allows for relatively strong economic growth despite weak nominal growth. Changes in GDP deflator can provide insight into how inflation or deflation affects overall economic growth.

The GDP deflator decreased more significantly than the CPI in the second quarter. This holds true since the CPI only reflects inflation at the consumer (retail) level, while the GDP deflator is a broader measure that also takes into account inflation in other activities such as manufacturing, wholesale trade, and commodity exports. In the second quarter, there was a significant drop in commodity prices and inventory dumping from China, which caused a sharper decline in producer prices than the CPI. This explains why the GDP deflator decreased more significantly than the CPI.

Some Challenges
Contractions in Export and Import
Amidst the economic growth, Indonesia faced contractions in both exports and imports during Q2 2023. The export of goods shrank by 2,75% yoy, while imports of goods and services plummeted by 3,08% yoy. This contraction was primarily driven by the decline in the export of mining products by 0,17%. Though exports of services sustained positivity due to increased foreign visitors and foreign exchange inflow, overall export performance was hampered by the normalization of global commodity prices.

The contraction in exports requires meticulous scrutiny due to its potential ramifications for Indonesia’s GDP. This situation is further compounded by the persistently weak global economic conditions, marked by subdued demand for goods that has not yet fully recovered. The United Nations Conference on Trade and Development (UNCTAD) underscored the continuously weak and pessimistic outlook for global trade in the latter half of 2023 during its June session. Additionally, the International Monetary Fund (IMF) projected a global economic growth rate of 3% for 2023 in its July report. These factors collectively emphasize the urgent need for Indonesia to address export challenges and navigate its way toward sustainable prosperity.

Dependency on Commodity Exports and the Role of Diversification
One fundamental aspect that needs to be addressed regarding Indonesia’s exports is its dependency on commodities. Indonesia still heavily relies on commodity exports such as oil, gas, and agricultural products. This dependency renders Indonesia vulnerable to fluctuations in global commodity prices, thereby underscoring the significance of export diversification to mitigate such risks. Export diversification becomes crucial to reduce this dependency and enhance Indonesia’s resilience in the face of external market fluctuations.

The Impact of Currency Appreciation on Export Diversification
Currency appreciation can significantly influence exports by rendering Indonesian products costlier for foreign buyers. This circumstance can result in diminished competitiveness on the global stage, potentially impacting export volumes and revenues. Nonetheless, currency appreciation isn’t the sole determinant shaping Indonesia’s export diversification efforts. Infrastructure, production costs, trade regulations, and market access also wield influence over the country’s capacity to diversify its exports.

Addressing Export Diversification Challenges
To tackle the sluggish pace of export diversification, Indonesia must bolster its product competitiveness on the global arena. This entails elevating product quality, production efficiency, innovation, and nurturing a robust national brand. Furthermore, proactive trade negotiations with key export destinations can enhance market access.

Strategic Considerations for Reindustrialization
The performance of Q2 2023 unveils important structural trends. Firstly, growth has been predominantly driven by the services sector. The transportation and warehousing sector experienced the highest growth at 15,28% (yoy), followed by other service sectors at 11,89%, and the accommodation and food services sector at 9,89%. Secondly, sectors that absorb the workforce, such as agriculture, mining, and manufacturing, have grown below the national growth rate. The agricultural, forestry, and fisheries sector grew by 2,02%, while the manufacturing sector grew by 4,88%. Addressing these challenges necessitates a focus on reindustrialization, as evident from the need to optimize the growth of labor-intensive sectors.

Deindustrialization’s Impact on Indonesia’s Economy
Indonesia’s industrial landscape has witnessed a concerning trend of deindustrialization, evident in the declining proportion of manufacturing industries to the economy since 2002, with the sharpest decrease observed since 2009. This decline has also affected production output and employment, leading to a decrease in the value added by the manufacturing sector. Furthermore, the role of the manufacturing industry in contributing to the Gross Domestic Product (GDP) has been dwindling since 2008. In the last 15 years, Indonesia’s proportion of manufacturing to GDP is among the lowest in ASEAN, with a contribution of 18,3% in 2022, compared to 27,8% in 2008. This decline is more pronounced than countries like Malaysia and Thailand. The causes of deindustrialization include rising production costs, difficulty in sourcing raw materials, insufficient investment in the manufacturing sector, lack of government policy support, and green industrialization issues encompassing energy usage and efficiency.

The Imperative of Reindustrialization for Sustainable Growth
To combat the challenges of deindustrialization and bolster sustainable growth, Indonesia must prioritize comprehensive industrial strategies. This includes reviving and reinvigorating the manufacturing sector through investments, policy support, and fostering a conducive environment for innovation and competitiveness.

Navigating China’s Economic Recovery: A Slow Unfolding
Lastly, an essential aspect to keep a keen eye on is the anticipated gradual pace of China’s economic recovery. As projected by the International Monetary Fund (IMF), China’s economy is expected to achieve a growth rate of 5,2% in 2023. However, a nuanced perspective emerges when delving into recent assessments. Drawing from a survey by Caixin/S&P Global, the Purchasing Managers’ Index (PMI) for China experienced a drop from 50,5 in June 2023 to 49,2 in July 2023. This figure falls below the expectations of several analysts, who had anticipated a value of 50,3.

The multifaceted nature of this situation warrants further exploration. On one hand, the IMF’s growth projection signifies a certain level of economic traction within China. However, the PMI decline, as highlighted by the Caixin/S&P Global survey, points towards underlying challenges. This divergence in data underscores the complexities inherent in forecasting economic trajectories, especially within a dynamic global landscape.

A closer examination of China’s internal dynamics provides valuable insights. The interplay of supply, demand, and export orders forms a delicate ecosystem that can profoundly influence economic momentum. The downward shift in the PMI indicates potential issues within this ecosystem, which might stem from a myriad of factors such as supply chain disruptions, demand-side uncertainties, or changing global trade dynamics.

This scenario carries implications not only for China but also for its global trading partners, including Indonesia. China’s economic performance significantly influences international trade dynamics, as it serves as a major hub for global supply chains. Any shifts in China’s economic trajectory can reverberate across various sectors and markets.

In light of these insights, it becomes evident that comprehending the nuances of China’s economic recovery is pivotal for both policy-makers and businesses alike. Anticipating potential challenges and opportunities arising from China’s economic landscape will enable more informed decisions and strategies. As Indonesia continues to navigate its own economic growth, it must remain attuned to the evolving dynamics in its neighbor’s economy, as these dynamics inevitably shape the broader regional and global economic narrative.

Conclusion
Amidst the impressive economic growth, Indonesia’s journey towards sustained prosperity necessitates tackling the challenges posed by export-import contractions, declining industries, and deindustrialization. By prioritizing export diversification, addressing deindustrialization, and promoting sustainable industrial transformation, Indonesia can strike a harmonious balance between progress and sustainability. Such a balanced approach will empower Indonesia to overcome the middle-income trap and realize its aspiration of becoming a prosperous and resilient nation. Above all, we must reconnect with the grand aspirations of our nation, seeking to break free from the clutches of the middle-income trap. Our journey demands a continuous stream of strategies, policies, and initiatives, ensuring that we, as a nation, don’t grow old before becoming rich. In essence, the road ahead requires unwavering commitment to sustain our momentum toward prosperity, ensuring that the dream of national riches becomes a vibrant reality, not a distant mirage.

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*) Government Officer at Cabinet Secretariat of the Republic of Indonesia