INDONESIAN ECONOMY - CAUTIOUSLY OPTIMISTIC DESPITE

UNCLAS SECTION 01 OF 02 JAKARTA 000469 SIPDIS SIPDIS SENSITIVE DEPT FOR EAP/MTS AND EB/IFD/OMA TREASURY FOR IA-SETH SEARLS SINGAPORE FOR SUSAN BAKER COMMERCE FOR 4430-JEAN KELLY DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN DEPARTMENT PASS EXIM BANK E.O. 12598: N/A TAGS: EFIN EINV ECON PGOV ID SUBJECT: INDONESIAN ECONOMY - CAUTIOUSLY OPTIMISTIC DESPITE POTENTIAL GLOBAL PRESSURES ¶1. (SBU) Summary: Local economists remain cautiously optimistic about Indonesian economic forecasts for 2008 despite global and local pressures. Indonesia's 2008 economic growth will be 6.0-6.3%, down from the originally forecasted 6.8%, according to economists. The U.S. economic slowdown combined with protracted high oil, mining commodity and agriculture prices have led to these growth rate revisions. Due to high commodity prices, the Government of Indonesia (GOI) will spend a higher percentage - possibly up to 50% - of its 2008 budget on food and fuel subsidies. The poor are disproportionately affected by increased transportation and food costs, a potential political liability for the 2009 elections. End SSummary. Global Economic Downturn Anticipated -------------- ¶2. (U) Four top Indonesian economists discussed the global economic outlook and debated the implications for the Indonesian economy during an event in Jakarta sponsored by a prominent political risk consulting firm on February 29. Panelists included: Fauzi Ichsan of Standard Chartered, Sebastian Paredes of Bank Danamon, Nicholas Cashmore of CLSA, and Anton Gunawan of Citi. They predicted that skyrocketing demand from emerging markets and slow supply-side adjustments would keep oil, commodity and food prices high. Financial market instability would continue until investors understand the true level of losses in the U.S. sub-prime mortgage market. Limited Near-Term Impact on Indonesia -------------- ¶3. (U) The panelists expect the global downturn to slow growth in Indonesia to roughly 6.0-6.3%, significantly lower than the government's initial 2008 forecast of 6.8%, but on par with Indonesia's 2007 GDP growth rate. The economists based their forecasts on the view that internal demand, which constitutes more than 60% of Indonesian GDP, will continue to accelerate and that Indonesia has a well-diversified export base, by product and destination. The panelists were more cautious about the outlook for foreign capital flows into Indonesia, given the increased aversion to risk among global investors. However, none expected a sudden reversal of current levels of portfolio inflows. ¶4. (U) Quality of near-term economic growth in Indonesia remains questionable, according to Citi's Gunawan. The global slowdown disproportionately affects the labor-intensive manufacturing sector, clouding the job growth outlook. He noted that the decline in unemployment last year - from 10.3% to 9.1% - in the formal sector masks significant underemployment and unemployment in the large informal sector. He also observed that while real wages are increasing in some sectors, notably financial services, real and even nominal wages have fallen for many manufacturing workers. Global Prices Reduce Policy Flexibility -------------- ¶5. (SBU) The level and pace of inflation and its impact on monetary and fiscal policies could create economic instability in Indonesia, according to the experts. Continuing high globll commodity and food prices would force the centa l bank - Bank Indonesia (BI) - to maintain currnnt interest rate levels, potentially slowing credit growth, according to a majority of the panelists One panelist also noted that in recent discussoons, BI officials stated that the central bank pa ns to use its substantial foreign exchange reservss to maintain the value of the Rupiah in an effort to control imported inflation. While Indonesiah(as roughly $56 billion in foreign exchange resevves, BI cannot continue this policy indefinitely iQ downward pressure on the currency remains signiiicant. ¶6. (SBU) On the fiscal side, panelists noted that high and rising oil and food prices havei(ncreased the cost of the government's subsidy rggime. The panelists warned that the Indonesian goe rnment could spend as much as 50% of its 2008 bddget on subsidies, particularly fuel subsidies, if oil remains near $100 per barrel. Since increasd transportation and food costs disproportionately affect the poor, the current administration is ul(ikely to cut the subsidy programs in advance oftthe 2009 election. Panelists also JAKARTA 00000469 002 OF 002 noted that the increased spending on subsidies and cash transfers leading up to the election would crowd out much needed infrastructure investment. Further, as the 2009 election season heats up, the executive and legislative branch's appetite for reform will diminish. Policy Inertia Prevents Agriculture Boom -------------- ¶7. (SBU) Nicholas Cashmore stated that Indonesia is well positioned to take advantage of global economic trends. Higher commodity prices could increase agricultural sector growth, leading to higher growth in rural communities. Cashmore conceded that the slow approval processes for hybrid seeds, land use policies that prohibit efficient use of farmland, and poor irrigation systems in Indonesia are hampering the sector's ability to take advantage of current price levels. However, he argued that the private sector now has a strong incentive to push for policy changes and make the investments in rural infrastructure needed to increase farm yields in Indonesia. He also noted that the gap between wages in Indonesia and China has continued to narrow, increasing foreign direct investment interest throughout the country. HUME