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Indonesia's Q3 GDP Results: Investment Shines Through the Rain
By Michael Manetta
After braving an earthquake-induced tsunami and several volcanic eruptions in the past two months, Indonesia now faces heavy rains, which dampened the GDP growth number for Q3. Though adverse weather conditions hampered production at many plantations and mining facilities, the rain failed to keep consumers indoors: Private consumption showed another quarter of strong growth. Yet private investment was the real ray of sunshine, with FDI flowing into sectors catering to the country’s vibrant domestic market. Defying the elements, the economy’s fundamentals remain solid and the outlook bright.
Raining on the Growth Parade
Indonesia’s GDP expanded by an estimated 5.8% y/y in real (non-seasonally adjusted) terms in Q3 2010, far short of Bloomberg’s consensus forecast of 6.35% and just above RGE’s prediction of 5.6%. The low call we made in our September 2010 Outlook update reflected an overly bearish outlook on agricultural output, though our pessimism was warranted: Heavy rainfall limited growth in the agriculture sector to just 1.86% y/y, almost half the 10-year average rate of 3.54% y/y (but above our forecast of 0.8% y/y). For similar reasons, we were also wary of the mining sector's performance, calling for 2.3% y/y growth. Rainfall disrupted output in several key industries, but the impact was more benign than expected, and growth reached 2.75% y/y in Q3.
Other components of GDP on the production side were largely in line with our expectations. Manufacturing and wholesale/retail trade—the economy’s two largest subsectors, together accounting for more than 40% of GDP—both saw strong growth in Q3. Manufacturing expanded at a healthy 4.1% y/y (RGE, 4.3%), while trade and hospitality services grew 8.75% y/y (RGE, 8.9%).
Figure 1: Growth Rates of Key Sectors, 2009-10 (%, y/y)
On the expenditure side, private consumption continued to be the driving force behind final demand, registering 5.15% y/y growth in real terms, a full percentage point above the 10-year average for Q3. This is particularly impressive given the downward trend in real wages for a number of services sectors over the past several months, as inflation has picked up. Nominal wage growth, however, has remained firmly positive. With inflation subsiding slightly in September and October, real wage contraction has moderated, slowing the erosion of purchasing power.
Real gross fixed capital formation in Q3 grew 8.9% y/y, with a staggering 3.9% q/q seasonally adjusted (SA) surge, well above the 10-year average of 1.6% q/q SA. Data from the Investment Coordinating Board (BKPM) show that a pickup in FDI accounted for more than 70% of total private investment growth in Q3, with real estate, transportation, communication and food-related industries the largest beneficiaries of gross FDI. Net exports also contributed to GDP growth as imports slowed faster than exports. Likewise, inventories grew in Q3, albeit at a slower pace than in Q2, contributing 0.07 percentage points (pp) to growth (Q2, 0.13 pp; Q1, 0.59 pp).
Figure 2: Strong Private Consumption Growth and Accelerating Investment Growth Drive Final Demand in Q3 (%, y/y)
Implications: Indonesia Stands Alone
We will present an in-depth look at the growth prospects for Indonesia in our quarterly Outlook published in early December, but the recent data warrant some preliminary commentary. The broad takeaway from Q3 GDP numbers is that Indonesia’s potential growth constraints stem (and will continue to stem) from the supply side rather than the demand side, unlike most other economies in the region, such as Singapore and, to a lesser extent, the Philippines and Malaysia. Private consumption, at close to 60% of GDP, showed resilience in Q3 despite falling real wages and slowing consumer credit growth. Likewise, an improving fiscal position (with a falling debt-to-GDP ratio and a narrowing deficit), a favorable short-term external-debt-to-foreign reserves position and a strong currency have made Indonesia an attractive destination for foreign direct investors. The direction of FDI in Q3 toward domestically oriented sectors such as real estate, communications and food suggests a positive cycle is emerging: Strong domestic consumption is encouraging investment, which in turn has positive feedback effects on consumption via improved labor market conditions and wages.
Figure 3: Falling Real Wages and Stagnant Consumer Credit Growth (October 2009=100)
Meanwhile, numerous supply-side risks remain. Insufficiently developed infrastructure continues to plague a manufacturing sector that depends on timely delivery of intermediate goods for processing and completed merchandise for export or domestic consumption. Domestic producers have expressed frustration over such burdens, with Jakarta’s gridlock the most visible recent example.
The infrastructure problem extends beyond manufacturing. Indonesia’s relatively large agriculture and mining sectors—a combined 22% of GDP—will of course remain vulnerable to erratic weather conditions. Vulnerability in these sectors has economy-wide implications, particularly regarding terms of trade and negative feedback into domestic demand should the country’s large rural population suffer from a disappointing harvest or a correction in commodity prices. Infrastructure problems such as poor drainage and uneven access to power sources exacerbate weather-related problems, or at best fail to mitigate their impact.
While the government has pledged to raise infrastructure spending by US$150 billion in the next five years—beginning with dedicating 10% of the 2011 budget to infrastructure development—central government funding tends to be slow and unreliable, which may delay or disrupt key infrastructure projects. The government has made clear that private investment will have to be a major contributor to the infrastructure drive, a campaign that received a big boost this week when China announced it would invest up to US$6.6 billion (over an undisclosed period of time) in Indonesia’s infrastructure projects. In October, Japan pledged infrastructure investment of US$50 billion over 15 years. Turning these investment plans into reality may be the difference between Indonesia the emerging market and Indonesia the BRIC.