INDONESIAN ECONOMIC GROWTH ACCELERATES, BENEFITS SLOW TO

UNCLAS SECTION 01 OF 03 JAKARTA 003247

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS AND JWEEKS
SINGAPORE FOR SBAKER
TOKYO FOR MGREWE
COMMERCE FOR 4430/BERLINGUETTE
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR TCURRAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIAN ECONOMIC GROWTH ACCELERATES, BENEFITS SLOW TO
TRICKLE DOWN



1. (SBU) Summary. Indonesia's GDP expanded a stronger than expected
6.5% year-on-year (y-o-y) during the third quarter of 2007 on robust
domestic demand and a higher investment rate. Growth in the
agriculture and service sectors outperformed the expansion of
manufacturing activity. Despite more rapid economic growth, there is
little evidence that the standard of living of the majority of
Indonesians is improving at a meaningful rate. The outlook for job
growth remains weak and the incidence of poverty high. If the
current government's economic policy mix cannot generate jobs,
reduce poverty and improve the standard of living for average
Indonesians, pressure for policy changes with a more immediate
impact are likely to mount. End Summary.

Domestic Consumption Fuels Stronger Growth
--------------


2. (U) Indonesia's GDP expanded at a faster than expected pace
during the third quarter of 2007, jumping 6.5% (y-o-y). Strong
domestic demand and a higher investment rate supported the rapid
growth. Government consumption also rose more quickly than in
previous quarters, increasing 6.5% (y-o-y),in response to
Government of Indonesia's (GOI) effort to expand spending during the
second half of 2007. Up to October, however, 2007 budget
realization still shows Rp 17 trillion ($1.8 billion) surplus, due
to slow implementation of both central and local government
spending. Export growth continued albeit at a slower pace than the
first half of the year and considerably slower than rates in early

2006. Exports of goods and service expanded 7.8% (y-o-y) during the
quarter, while imports rose 8.1 % over the same period. Strong
investment, consumption, and import growth (a large portion of which
is intermediate goods) indicate continued strong growth momentum
through the end of the year.

-------------- --------------
Table 1: Real GDP Growth, 2006-2007, Year-on-Year
-------------- --------------
2006 2007 2007 2007
Q4 Q1 Q2 Q3
-------------- --------------
Private Consumption 3.8 4.5 4.7 5.3

Government Consumption 2.2 4.3 3.8 6.5

Fixed Capital Formation 8.2 7.5 6.9 8.8

Exports of Goods and
Services 6.1 8.9 9.8 7.8

Imports of Goods and
Services 9.7 8.4 7.2 8.1
-------------- --------------
GDP 6.1 6.0 6.3 6.5
-------------- --------------
Source: Central Bureau of Statistics

Agriculture, Services Expand Rapidly
--------------


3. (U) On the production side, the agriculture sector expanded 8.9%,
following less than 1.0% (y-o-y) growth in the sector during the
first half of the year. Analysts attribute the pick up in
agricultural activity to rapid growth in palm oil plantations.
Growth in services continued to dominate other sectors, with growth
in the trade/hotel/restaurant, transportation/communications, and
financial services sectors comprising over 40 percent of total GDP
expansion. Manufacturing growth continued to lag most other
sectors, with manufacturing activity expanding just 4.5% (y-o-y)
during the quarter.


4. (U) Bank lending continued to expand, rising over 22%
year-to-date according to Bank Indonesia (BI) officials. However, a
large share of the growth in lending is concentrated in the
capital-intensive natural resource sector. According to Bank
Indonesia data, credit growth to the mining sector rose 75% during
the January-to-June period. In contrast, lending to labor-intensive

JAKARTA 00003247 002 OF 003


manufacturing firms was much slower, increasingly only 11% over the
same period. The spread between lending and deposit rates is still
high.

-------------- --------------
Table 2: 2007 3Q GDP Growth by Industry (percent)
-------------- --------------
Growth Share
Rate GDP Grow.

Agriculture/Livestock/Forestry
and Fishery 8.9 20.0
Mining and Quarrying 1.8 3.1
Manufacturing 4.5 18.5
Electricity/Gas/Water 11.7 1.5
Construction 7.5 7.7
Trade/Hotel/Restaurant 6.9 18.5
Transport/Communication 12.5 12.3
Financial/Bus. Service 8.0 10.8
Services 5.7 7.7
-------------- --------------
GDP 6.5 100.0
-------------- --------------
Note: Share of GDP Growth (Share GDP Grow.)
Source: Central Bureau of Statistics

Average Standard of Living Slow to Improve
--------------


4. (U) Despite more rapid economic growth, there is little evidence
that the standard of living of the majority of Indonesians is
improving at a meaningful rate. While nemployment has trended
downward this year, the ate of decline lags the rate of economic
expansin. According to the Coordinating Ministry for Ecoomic
Affairs, the open unemployment rate droppedslightly from 11.1% in
February 2006 to 10.6% in ebruary 2007. However, the rate of
unemploymenthas failed to return to its 2003 level of 9.6%, an
remains among the highest in the region. (Note Unemployment
statistics in Indonesia do not accrately reflect a large informal
sector.)


5. (U The outlook for job growth is also weak. Similarto bank
lending, much of the large-scale foreigndirect investment (FDI) innally
generated fu"n*w" jobs. Fo example, BP is investing $6.8 billion
in a liquffied natural gas plant in Papua, but the plant wilQ
generate only 400-500 long-term jobs. In contrast, a recent $1
billion Intel investment in Vietnmm will generate roughly 4,000
jobs. Intel has as"o invested $3.3 billion in Malaysia and $1.5
billion in the Philippines, creating 10,600 jobs and ,(000 jobs,
respectively. Increasingly intense regional competition for FDI
means Indonesia must ipprove its investment climate in both absolute
an relative terms to attract new jobs.

Poverty Reaains High
--------------


6. (U) The incd ence of poverty in Indonesia also remains high. The
portion of the population living under the offccial poverty line
($1.55 a day) dropped to 16.6%f"rom 17.8% from March 2006 to March
2007, reversnng the poverty rate rise that occurred during prevo*us
12 months. Nevertheless, World Bank estimates indicate that over
45% of the population still lives on less than $2 a day, meaning a
huge portion of the population remains extremely vulnerable. In
line with this trend, income inequality in Indonesia has worsened
over the past ten years, suggesting wealthy Indonesian's are gaining
the most from more robust economic growth and macroeconomic
stability. The World Bank's estimate of Indonesia's Gini
Coefficient moved from 31.0 to 37.6 over the period 1999 to 2007.
(Note: The Gini Coefficient ranges from zero, where all households
have the same income, to 100, where one individual earns all the
income of the country). Moreover, the World Bank recently reported
that nominal wage increases in Indonesia have failed to keep pace
with inflation for the past two years.


JAKARTA 00003247 003 OF 003



7. (SBU) Because so many Indonesians live at or near the poverty
line, the high prices of staple products, such as rice and cooking
oil, have a significant negative impact on household incomes.
Although the price of rice has stabilized in recent months, it
remains historically high due to poor harvests and government
restrictions on rice imports. The lack of investment in irrigation
equipment in recent years keeps farmers in many areas dependent on
weather patterns for rice production. Moreover, although the GOI
has loosened restrictions on rice imports, some limitations remain.
The price of cooking oil also has increased in recent years due to
soaring global demand for palm oil. While the government has tried
to manage price increases through export taxes, these policies have
been largely ineffective to date, further straining the limited
resources of poor families.

Poverty Persistence May Prompt Policy Shift
--------------


8. (SBU) Indonesia's macroeconomic outlook remains positive, with
more stable prices, a stable currency, GDP growth expected to range
between 6-7% for the next 12 months, improved investment rates, and
modest job growth. These positive trends are the result of prudent
monetary and fiscal policies of Bank Indonesia and the GOI's strong
economic team. Yet, despite five quarters of GDP growth at or in
excess of 6.0%, the number of people living at or near the poverty
line remains high and standards of living among the majority of
Indonesians have been slow to improve. The pressure of higher
inflation remains due to high oil prices. If the current
government's economic policy mix cannot generate jobs, reduce
poverty and improve the standard of living for average Indonesians,
pressure for policy changes with a more immediate impact are likely
to mount. While significant policy changes in the near term are
unlikely, some analysts have raised concerns that the government
will direct lending or relax supervisory standards in order to spur
credit expansion in labor-intensive industries, potentially
undermining the health of the country's banks.

HUME