ASEAN ISSUE 2020-06-25
Effect of COVID-19 on the Indonesia’s Economy and Future Prospects
Indonesia, with a population of about 270 million and annual GDP of US$1.1 trillion, is the largest economy among ASEAN (35.7% of total ASEAN GDP) Member States (AMS). The country has also been recording a high growth rate of more than 5% for the last 5 years.
While Indonesia and Korea have made significant progress in economic cooperation and exchanges over the years, there is still much to be desired in view of the potential of the partnership. In 2019, Indonesia was fourth largest trading partner of Korea among AMS (after Vietnam, Malaysia and Singapore) with a bilateral trade volume of US$16.47 billion (US$7.65 billion in exports and US$8.82 billion in imports). In terms of FDI, Indonesia was Korea’s third largest FDI destination with US$960 million (after Vietnam (US$4.47 billion) and Singapore (US$3.03 billion)).
Nevertheless, prospects are bright. Korea and Indonesia have been working to expand bilateral economic cooperation and last year, on the occasion of the ASEAN-ROK Commemorative Summit, the two sides concluded the Comprehensive Economic Partnership Agreement (CEPA). CEPA will allow free access to the Indonesian market for 93 percent of Korean made products including iron and steel, chemical products and auto parts etc. This is an increase from the 80% free access under the existing ASEAN-ROK FTA.
There are also expectations for increased cooperation in infrastructure development. The Indonesian government plans to resume major large-scale infrastructure projects, including the construction of the new capital city as soon as the coronavirus situation improves. Indonesia has been benchmarking Korea’s Sejong City as one of its references for the project, and cooperation in this relocation project is also one of the major international cooperation projects of the Presidential Committee for Balanced National Development in Korea.
Against this backdrop, this week’s ASEAN Issue will take a look at the current economic situation of Indonesia focusing on the economic impact of COVID-19 as well as the future prospects.
■ Outlook of Indonesia’s Economy
Like many other ASEAN countries, the outlook for Indonesia’s economy this year is not very encouraging. In mid-May, as the coronavirus continued its spread in the region, the Indonesian government revised its GDP growth forecast down to 2.3% and estimated that in the worst-case scenario, it could further drop down to 0.4%. Indeed, the current forecasts may continue to decline for the time being in view of the fact that Indonesia’s social distancing measures following its first confirmed case began to take place in March which is relatively later than other countries.
After the first case, the virus spread quickly and by June 20, there were over 45,000 confirmed cases reported from all 34 provinces. The continuing spread of COVID-19 and the government’s declaration of the large-scale social restrictions (PSBB), primarily to contain the virus, are both having a negative impact on the growth prospects of Indonesia’s economy.
Revisions to Indonesia’s economic forecasts are also being made among international financial organizations and research institutes. The Asian Development Bank (ADB) and the International Monetary Fund (IMF) each revised their growth forecasts for Indonesia to 2.5% and 0.5% respectively in April. In its World Economic Outlook report released on June 8th, the World Bank saw Indonesia making 0% growth this year. This was a huge downward revision from its initial estimates and were based on factors such as falling prices of raw materials which are Indonesia’s major export items, sharp decrease in household consumption expenditures and the likelihood of prolonged social distancing measures due to the pandemic.
Fitch Solutions, a U.S. credit rating firm, after repeatedly revising its forecasts for Indonesia-from 4.7% (March 30) to 2.8% (April 20)-finally ended up estimating a negative growth of -1.3% (May 6) which is, by far, the lowest estimate for Indonesia until now. Focus Economics, a global economic analysis and outlook organization, also expected Indonesia's GDP growth rate at 4.5% in March, but re-adjusted the number to 0.3% on May 26 as the COVID-19 began to take its toll.
■ 1st Quarter Growth Rate : 2.97% -- Lowest since 2001
On May 5, the Indonesian Bureau of Statistics (BPS) reported that Indonesia's GDP growth rate in the first quarter shrunk to 2.97% which was a sharp drop from the previous year (the growth rate of the Q1 2019 was 5.07% and Q4 2020 was 4.97%). This was the lowest number since the first quarter of 2001 and the reasons for the freefall were attributed to the significant reduction in household spending (5.01% > 2.84%) and investment (5.03% > 1.7%), which account for more than 50% of the GDP, as well as to the decrease in government spending (5.22% > 3.74%). In case of trade, exports increased by 0.24% but imports fell by -2.19%.
The Ministry of Finance of Indonesia saw a further decrease in growth rates in the second quarter all the way down to 0.4%. After hitting bottom in the second quarter, the Ministry expected the economy to recover in the third quarter (1.2%) and then make positive growth of 3.1% in the fourth quarter. This prediction, however, is based on the assumption that COVID-19 will reach its peak between May and June, and following a flattening of the curve, economic activities will resume in the third quarter. In other words, the forecasts may change again depending on how the pandemic progresses.
■ Impact on Major Industries
According to a statement in April by the Ministry of Finance of Indonesia, the sectors most affected by COVID-19 in the first quarter were hotels and restaurants (-6.6%), mining (-6.5%), manufacturing (-5.6%), and transportation (-5.4%).
Manufacturing, which makes up 19% of Indonesia’s GDP as of 2019, is facing unprecedented challenges due to temporary production suspensions and severe contractions in consumption. In particular, sales in automobiles, a strategic industrial sector that accounts for 1.8% of Indonesia’s GDP, fell sharply due to the sudden drop in consumption and factory shutdowns of major automakers such as Toyota and Honda.
The Indonesian Automobile Industry Association (GAIKINDO) expected that the sales of automobiles to be around 0.6 million units which is almost half of last year’s sales (1.1 million units). The Association also predicted decline in export of cars from 350,000-400,000 units to 175,000 units this year. As a matter of fact, while retail sales of new cars fell by 15% recording 76,800 units in March, wholesale sales of new cars (cars sold by manufacturers to dealers), which is a leading indicator of consumer trends, fell by a whopping 90.6% with only 7,871 units sold in April. It is a clear downturn in domestic sales and consumer sentiment.
According to IHS Markit, Indonesia’s Purchasing Managers' Index (PMI), a measure of manufacturing and service activities, has fallen from 45.3 in March to 27.5 in April, which is the worst deterioration since 2011 (PMI index 50 or less = contraction of manufacturing activity). IHS Markit analyzed that the drop was due to large reductions in purchases from companies whose factories have shut down and sales dampened. Also, the rise in prices of food, textiles, basic metals, chemicals and paper products resulting from the fall in value of the rupiah (fell by 17.6% against the dollar in Q1 which is the largest plunge among Asian currencies) also was seen to have negatively affected the PMI. Meanwhile, the Ministry of Manpower and the Workers Social Security Agency stated that more than 2.8 million people have lost their jobs as of April, and expected an additional 2.9-5.2 million could lose their jobs due to the coronavirus.
Growth rates in tertiary industries including the service sector also show a clear downward trend. In tourism industry, which accounts for about 10% of Indonesia's GDP, the effect is particularly noticeable. According to the numbers released by the Indonesian Bureau of Statistics (BPS) in April, the number of foreign tourists visiting Indonesia in Q1 2020 was 2.6 million, a 31% decrease from the previous year’s 3.8 million. Specifically, the number of tourists in March fell by 64% compared to the same period in the previous year which seems to be due to the sharp reduction in the number of Chinese tourists who accounted for 13% of foreign tourists coming to Indonesia. According to the Ministry of Tourism, revenue from tourism will likely decrease by US$10 billion this year, finishing at about half of last year's revenue of US$20 billion.
Naturally, service sectors such as hotels and restaurants whose profits are directly linked to the number of incoming tourists are affected by this trend. The Indonesian Hotel & Restaurant Association (PHRI) reported that the overall occupancy rate fell to 30-40% in January, way below the average rate of 50-60% during this period. And in March, following the report of the first confirmed case in Indonesia, the rate further dropped all the way down to 20%.
■ Government Unveils the Largest Economic Stimulus Package
Following the declaration of emergency by the Indonesian National Board for Disaster Management (BNPB) on January 28, the Indonesian government has been rolling out stimulus measures to minimize the economic impact and damage caused by the COVID-19.
On February 25, the government announced its first stimulus package worth US$ 675 million. The stimulus includes financial support for tourism, airline, and real estate industries in the form of subsidies, tax cuts, and allowances.
1. Incentives for the tourism and airline industries
- incentives for tourism marketing and promotions
- tax waiver for hoteliers and restaurants in the 10 promoted tourism destinations for the next 6 months
2. Funding for low-income household
- Affordable Food Program (Sembako Murah) to boost local consumption for 15 million low-income households to purchase food products at discounted prices
On March 13, the government issued the second round of stimulus measures as the pandemic began to spread across the country. This second package, totaling 120 trillion IDR (US$ 8billion) was much more comprehensive and aimed to minimize the damage in the manufacturing sector and facilitate trade.
1. Fiscal Incentives
- Income tax reduced by 30% in 19 selected industries (chemicals and chemical products, automobiles, pharmaceuticals, machinery, textiles, etc.)
- Refund/relaxation of value-added-tax (VAT) in 19 selected manufacturing industries mentioned above for the next 6 months.
- Deferral of import tax payments in 19 selected manufacturing industries mentioned above for the next 6 months.
- Exemption of income tax on manufacturing workers whose annual income below 200 million IDR (US$13,000).
2. Non-fiscal Incentives
- Simplification of import procedures for steel and food products in accordance with the relaxation of ‘Restriction and Prohibition’ (Lartas) measures
- Expedition of issuing import-export licenses for 735 companies with sound credit
- Establishment of the National Logistics Ecosystem (electronic system that enables both import and export sectors to collaborate and share logistic information).
- Increase in loans up to 10 billion IDR (US$655,000) for SMEs that can prove good credit history and repayment capabilities
The third round of economic stimulus worth 405.1 trillion IDR (US$ 24.6 billion) was announced on March 31. An additional 150 trillion IDR was allocated for the economic recovery plan; 75 trillion IDR for healthcare; 110 trillion IDR for social protection; and 70.1 trillion IDR for tax benefits and credit guarantees for businesses.
1. Economy Recovery Program
- Credit restructuring and financing for SMEs
- Credit relaxation for loans below 10 billion IDR for business purposes (both loans provided by banks and non-bank financial industry)
- Reduction of interest rates and extension of repayment by 1 year
2. Social Protection
- Provide food support for households in the Family Hope Program and the Staple Food Program
- Subsidies for 5.6 million unemployed, informal workers and self-employed businessmen
- Free electricity supply for 24 million users
- Support for low-cost housing supply (up to 175,000 houses)
3. Healthcare Sector
- Prioritization of purchase of medical equipment such as test kits and ventilators
- Incentives for medical workers (doctors and nurses)
- Subsidy of the Social Security Agency (BPJS Kesehatan) premium
4. Tax Incentives and Credit for Businesses
- Reduction of corporate income tax 25% to 22%
- Tax exemption for manufacturing workers with annual income below 200 million IDR for 6 months
- Extension of debt payment period by six months for micro loan credit for businesses affected by COVID-19
- Deferral of import tax payments for six months in 19 manufacturing sectors
As the pandemic continued to spread without any signs of flattening of the curve, the Indonesian government announced on May 19, its plans to expand government spending to 641 trillion IDR (US$ 43 billion) which would increase the country’s budget deficit from 5.07% to 6.27% of GDP (Presidential Regulation No. 54/2020). The revised package includes stronger social security network, tax incentives, funding for state-owned companies, interest rate subsidies for SMEs, and loan repayment support worth 34.15 trillion IDR for 60 million people unable to pay their debts. Reflecting these changes, social protection budget will be increased to 172.1 trillion (from 110 trillion IDR), and tax support to 123 trillion IDR (from 70.1 trillion IDR).
The latest economic stimulus package unveiled on June 3 is worth approximately 677.2 trillion IDR (US$47.6 billion). The budget will be allocated to improve the medical system (87.55 trillion IDR), strengthen social security network (203.9 trillion IDR) and provide financial support to prevent bankruptcies of domestic SMEs and assist those who have lost their jobs (123,46 trillion IDR).As stimulus measures continue to expand, Indonesia’s budget deficit is expected to reach 6.34% of GDP. Considering that Indonesia has been maintaining a budget deficit of 3% of GDP since 2003 after recovering from the Asian financial crisis, this indeed is an exceptional measure. However, the government has set a limit to this relaxation saying that the revised budget deficit policy will only apply for the fiscal years 2020-2022 and by 2023, the country will return to keeping its budget deficit below 3% of GDP.
■ Prospects and Implications
Josua Pardede, an economist at the Permata Bank, said that due to continued restrictions in movement, growth prospects for the 2nd quarter will likely be further reduced than the 1st quarter. He estimated that if economic activity does not return to normal by the third quarter, Indonesia’s economic growth will drop down to the level of 0~1%, similar to the worst-case scenario (0.4%) presented by the government. Because a growth of 0% implies the loss of jobs of an addition 5~8 million people in the course of the next few months, Pardede argued that the government needs to reallocate the budget and focus restoring the purchasing power of households which will in turn support the recovery of businesses.
In March, after the outbreak of COVID-19 in Indonesia, the rupiah was hit hard, dropping more than 14% against the dollar, as many foreign investors pulled money out of the country. The Central Bank took US$ 9.4 billion from its foreign reserves to stabilize the financial market which triggered concerns by some of a replay of the financial crisis of the 90s.
The government alleviated such concerns and replenished its forex reserves to US$130.5 billion by May (from US$121 billion in March) by issuing US dollar-denominated government bonds. The Central Bank emphasized that the current level of foreign exchange reserves is not only sufficient to withstand external shocks, but also to maintain the stability of the domestic market and financial system. As a matter of fact, the reserves can well-support imports and payment for the government's short-term debts for the next 8 months.
Asian Development Bank economist Yurendra Basnett said that although Indonesia issued government bonds to fill the budget deficit, Indonesia's debt to GDP ratio is well below 40%. Accordingly, ADB recently approved a US$1.5 billion loan to support Indonesia’s COVID-19 response measures.
So, while it is undeniable that COVID-19 has dealt a heavy blow to the Indonesia’s economy, experts say that the recent situation is fundamentally different from the Asian Financial Crisis of the 90s which was a result of a liquidity crises caused by an abrupt outflow of investment. According to the experts, unlike in the past, foreign exchange reserves are abundant, the banking system is sound, and political leadership is strong.
On May 13, President Joko Widodo emphasized that the people need to adapt to the "New Normal" brought by COVID-19 and try to simultaneously uphold their health and economic productivity. As the government’s stimulus measures and health policies take effect to revitalize consumer demand and the temporarily disrupted supply chains are recovered, we can expect to see a return of Indonesia’s economy back to its previous growth trajectory.
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