Indonesia is composed of seventeen thousand islands that stretch over
five thousand miles along the equator. The Malay peninsula and
Indochina are situated to the north-west, and the continent of Australia
lies due south. Northward lie the Philippines and Micronesia .
The world's largest archipelago, Indonesia 's constellation of
islands straddles the divide between the Asian and Australian
continental plates. As a result, the islands offer a stunning variety of
topographies and ecologies Mist-shrouded volcanoes and mountains,
unexplored rain forests, thousands of miles of beaches, and endless
offshore reefs support a dazzling abundance of wildlife, making
Indonesia an ideal destination for adventure and eco-travel.
The great majority of the country's constituent islands are of
negligible size, but it does hold--wholly or in part--several islands
that are enormous. These include Sumatra, Kalimantan (formerly Borneo,
and shared with Malaysia ),Sulawesi, and Java. The Indonesian state of
Irian Jaya occupies the western half of New Guinea , which is the
world's second largest island (behind Greenland ). The most populous of
the Indonesian islands by far is Java, home to the sprawling capital
city of Jakarta. Other notable islands include the exotic, popular
resort island of Bali, Lombok , Catholic Flores, and Komodo, home of
dragons.
There are two discernible seasons in Indonesia : the dry season,
which extends from June to October, and the rainy season, which lasts
from November to March. Both are hot. The coastal regions, however, are
often cool, and in the mountains the air is often chilly.
History and Culture
As early as the seventh century, powerful Buddhist and Hindu
empires challenged each other for supremacy in Indonesia : the Buddhist
Srivijaya were centered in Sumatra , while the Hindu Mataram located
their capital on Java. The rich architectural and cultural legacy that
remains from that time forms the basis for Indonesia 's national
identity. In the thirteenth century, the Hindu Majapahit of Java faced a
strong challenge from Muslim forces, which spread south from the Malay
peninsula . Slowly losing ground, the Hindus retreated to Bali , where
they remain today. The rest of the islands became Muslim, and various
sultanates were established.
The sixteenth century marked the arrival of the Portuguese, the
first Europeans in Indonesia . Although the Portuguese broke the Islamic
hold on Indonesia, they were eventually displaced in turn by the Dutch,
who named the area the Dutch East Indies. Although a revolt led by
Javanese Prince Diponegoro in 1825 briefly threatened Holland 's empire,
Dutch rule continued until W.W.II and invasion by the Japanese. The
Indonesian revolutionary nationalist movement, led by Sukarno, welcomed
the Japanese as a potential force of liberation, and at the war's end
the movement embarked upon a bloody war of independence against the
restored Dutch rule. Although the war dragged on for four long years,
from 1945-1949, the independence movement was ultimately victorious.
Turmoil characterized the first decade of Indonesian independence,
until in 1957 Sukarno unified power in his own person. An attempted
coup against Sukarno in 1965 brought renewed turmoil; however, the army
led by General Suharto restored order and initiated a purge of
communists. Eventually Suharto eased Sukarno out of the presidency and
assumed office himself. Suharto's rule ushered in a period of stability
and economic development.
Indonesia 's varied past has produced a remarkable array of
vibrant cultures,making it one of the world's most diverse and
fascinating travel destinations. Today, Indonesia is the fifth most
populous nation on Earth, with over 180 million citizens comprising over
300 ethnicities. Most Indonesians are of Malay or Polynesian descent,
though the country's history has produced minority populations from
India , China , Arabia, and Persia , as well as from European colonial
powers such as Portugal , Holland , Spain , and England .
Although primarily a Muslim nation, Indonesia is marked by wide
religious tolerance. Hinduism thrives on Bali, and Christianity has a
significant presence on Flores, Timor , and several other islands.
Indonesians speak numerous languages and dialects, but the common
language is Bahasa Indonesia. English and Dutch are also widely spoken.
Economic Performance
Economic growth remains robust, driven by private consumption and
fixed capital investment. However, inflation has climbed to double-digit
levels, prompting the monetary authorities to raise interest rates
several times. Government subsidies on food, fuel, fertilizer, and
electricity are squeezing the budget, leading to reduced spending for
social services and capital works. GDP growth is forecast at 6.2% for
both this year and next, little changed from April’s forecasts.
Inflation forecasts are revised up.
Updated assessment
GDP expanded by 6.0–6.5% for seven consecutive quarters through
June 2008, and the 6.4% outcome for the first half of 2008 remained in
this band. The main contributors to first-half growth were private
consumption (Figure 3.5.1) and fixed investment.
Private consumption growth picked up from 4.7% in the first half
of 2007 to 5.5% in first half of 2008, despite rising food prices.
Consumers were insulated from higher global fuel prices until May, when
domestic fuel subsidies were cut. Encouragingly, the growth rate for
fixed investment doubled to 14.1% in the first half from the prior-year
period (Figure 3.5.2).
Although more than two thirds of this investment was in buildings,
spurred by strong demand for offices and apartments, investment in
machinery and equipment needed to build productive capacity also grew
rapidly. Net exports made a relatively small contribution to GDP growth.
From the production side, growth of the services sector
accelerated to 9.4% in the first half of 2008, contributing 4 percentage
points of total GDP growth. Growth picked up in transport,
communications, and financial services but slowed in wholesale and
retail trading, hotels, and restaurants. In contrast, the growth rate of
industry decelerated to 3.7% and its contribution to total growth was
just 1.6 percentage points.
Its contribution to total growth was just 1.6 percentage points.
Within the industry group, manufacturing growth slowed for a third
consecutive 6-month period, to 4.1%. The poor performance is largely
attributed to rising wages, inflexible labor laws, and low investment in
manufacturing. Construction expanded by about 8.0%, consistent with its
performance over recent years. Mining production contracted slightly,
despite high global prices for oil, natural gas, coal, and metals. This
largely reflects a lack of investment in oil extraction in recent years.
Crude oil production fell to 899,000 barrels a day in 2007 from 1.4
million barrels in 2000 as existing fields moved toward depletion. Oil
output this year has edged up to 927,000 barrels a day, but still not
enough to make the country a net petroleum exporter, a status it lost in
2003.
Agricultural production rose by 5.3% in the first half of 2008,
well above the rate of the year-earlier period, largely a result of
rains in the dry season and an expansion of production from rubber and
palm oil plantations attributable to higher global commodity prices. The
rains and an increase in the area planted to rice are expected to lift
rice production by 6% to 35 million metric tons in 2008. If this is
achieved, net rice imports are unlikely this year. Agriculture’s share
of the economy is relatively small, so its rebound added just 0.8
percentage points to GDP growth. The increase in production and higher
prices received for agricultural products supported growth in rural
incomes and consumption.
Many of Indonesia’s energy and commodity exports benefited from
higher global prices in the first half, pushing up the value of total
exports by about 28% to $71.7 billion. A diversification of export
destinations toward expanding markets in Asia also helped. The value of
agricultural exports surged by about a half and the value of
manufactured exports rose by about a quarter.
Imports rose at an even faster pace than exports, by 47% to $58.8
billion, a result of higher prices for imported commodities and oil
products, as well as continuing expansion of domestic demand.
Consequently, the trade surplus fell by about 20% to $12.9 billion
in the first half from a year earlier. The current account surplus
dropped to $851 million, from $4.9 billion in the first half of 2007.
(It was in deficit in the second quarter, the first deficit in nearly 3
years—Figure 3.5.3.) The overall balance-of-payments surplus fell to
$2.4 billion from $8.0 billion a year earlier. International reserves
rose by 16.7% to $59.5 billion over the 12 months to June 2008,
providing 4.5 months of cover for imports and official debt repayments.
Inflation increased faster than expected. Rising prices for food
(which makes up 37% of the consumer price index) were a major driver of
inflation, with the solid overall domestic demand underpinning price
pressures. Average inflation during the first 6 months of 2008 was 8.9%,
and in July inflation accelerated to a 22-month high of 11.9% (Figure
3.5.4).
The Government raised administered fuel prices by nearly 29% in
May, which propelled inflation in subsequent months. Producer price
inflation shot up to 25.5% in April 2008, an 8-year high, and businesses
are expected to pass through higher costs to consumers in the months
ahead (operators of public transportation, for example, have yet to pass
on all their higher fuel costs). The weights of the consumer price
index were adjusted in June, reflecting changes in consumption patterns,
to increase the weight of transportation and reduce the weighting for
unprocessed food (Figure 3.5.5).
Credit growth remained high, adding to demand-side price
pressures. Growth in consumption credit accelerated to 32% in June 2008,
partly on account of strong sales of motorcycles and cars. Investment
and working capital credit showed similar growth (Figure 3.5.6). Broad
money growth (M2) slowed to 17% in June 2008 from 19% in December 2007,
contained by Bank Indonesia’s draining of excess liquidity from the
banking system.
After inflation had remained well above Bank Indonesia’s 4–6%
target band for several months, the central bank raised its policy
interest rate in May, and followed with monthly hikes that lifted the
rate by 125 basis points to 9.25% through September (still below the
inflation rate—Figure 3.5.7). The rupiah appreciated by 2.7% against the
US dollar from the start of 2008 to end-August.
Given the range of subsidies provided by the Government for food,
fuel, fertilizer, and electricity, the high international oil and food
prices put considerable pressure on the budget in the first half of 2008
(Box 3.5.1).
The cost of all subsidies this year is projected to nearly double
to the equivalent of 7.0% of GDP, from 3.8% in 2007 (Figure 3.5.8). The
May hike in retail fuel prices trimmed growth in fuel subsidies.
However, total subsidies this year will absorb about 30% of state
expenditure (central government spending and transfers to the regions),
based on a revised budget assumption that domestic crude oil will
average $127 a barrel.
As a result, other spending, including social development and
capital works, has been reduced from original budget targets. Planned
expenditure on education, for example, has been cut by 9.5% from the
original budget and health spending by 7.4%. Capital spending is lowered
by 17% from the original budget. The Government aims to limit the
budget deficit to 1.8% of GDP (widening from 1.2% last year).
It will finance the deficit through loans from multilateral and
bilateral development agencies and bond issues. Domestic and
international bond issuance in the first half totaled $8.4 billion, 64%
of the full-year target. The spread on Indonesian sovereign bonds has
increased sharply, reflecting risk aversion in global markets and
concerns over domestic inflation and the cost of subsidies (Figure
3.5.9).
Moderate economic growth is generating jobs, but not enough to
significantly take down unemployment and underemployment. The Government
targets unemployment of 5.1% in 2009 (it was 8.5% in February 2008),
which would still be above the 4.7% seen just before the 1997–98 Asian
financial crisis. The rate of underemployment (those working fewer than
35 hours a week) was 27.5% of the labor force in February. Furthermore,
70% of total employment is in the informal sector, where wages and
benefits are generally very low. More than 40% of the population lives
on less than $2 a day, leaving them vulnerable to increases in food and
fuel prices.
Underinvestment in power facilities over many years is, since
July, manifested in controlled power blackouts in metropolitan Jakarta
and other cities. The Government required manufacturers to shift some
work to weekends to spread the demand for electricity. Electricity
tariffs are set by the Government and kept low, one reason for
underinvestment in this industry.
Prospects
The forecasts assume that the central bank will continue to
address inflation pressures, that the rupiah remains in its narrow band
against the US dollar (Figure 3.5.10), and that the Government contains
the growth of subsidies. They further assume that weather conditions
will be normal for the rest of 2008 and during 2009, and that there will
be no natural disasters.
Growth in private consumption eased in the April–June quarter and
is expected to slow to 5.1% in the second half of 2008 alongside high
inflation. The impact of inflation will be offset to some degree by
additional spending during the Ramadan holiday period in September.
Growth in investment is expected to moderate in the second half
because of the weaker global economic and financial environment and the
rise in domestic interest rates. Bank credit continues to expand
robustly, though.
Government capital and social spending should pick up, given that
the decline in global oil prices at the start of the second half will
tend to reduce the cost of fuel subsidies. Growth in export earnings is
expected to ease because of likely weaker external demand and a decline
in some commodity prices.Taking these factors into account, GDP growth
is forecast to decline to 6.0% in the second half. As growth in the
first half was higher than expected at 6.4%, the full-year forecast is
now 6.2% (Figure 3.5.11), slightly above the 6.0% expected in ADO 2008.
Parliamentary elections are scheduled for April 2009 and
presidential elections for 3 months later, pointing to a pickup in
budget disbursements in the first half of next year (the proposed 2009
budget raises spending by 12.3%). This is expected to support
consumption, which will also be underpinned by a forecast easing in
inflation. The weak global outlook and rising domestic interest rates
will tend to damp investment, but capital outlays on public
infrastructure are expected to increase in the second half of 2009 as
the new administration turns its attention to deficiencies in ports,
power generation, and many other areas. As fuel subsidy costs decline
alongside the expected easing in world oil prices next year, budget
resources should be freed for social and development spending. Export
growth is expected to ease because of softening commodity prices and
generally sluggish growth in world trade, while import growth could
remain robust if domestic demand is as firm as expected. The GDP growth
forecast for 2009 is unchanged from ADO 2008 at 6.2%.
The trade surplus this year looks set to decline to $22.0 billion,
from $32.8 billion in 2007. The forecast for the current account
surplus is revised down to 1.1% of GDP, from 1.9% in ADO 2008 and an
actual surplus of 2.4% in 2007. The overall balance of payments is
projected to remain in surplus as a consequence of foreign direct
investment and portfolio inflows. In 2009, the current account surplus
is forecast at 1.7% of GDP, upgraded a little owing to the revised
assumption of moderategrowth in global nonfuel commodity prices.
Inflation is expected to remain high through the rest of 2008 and
into 2009, although it may well peak in September 2008. A good domestic
rice harvest has moderated rice prices, but other food items (especially
imported ones) are pushing up inflation. The May increase in retail
fuel prices will underpin high inflation for some time. Moreover, if the
Government’s assumption of domestic crude oil averaging $127 a barrel
proves to be low, another increase in retail fuel prices might be
required.
Without any further fuel price increases, inflation is seen
averaging 10.2% this year, revised up from 6.8% in ADO 2008 because of
higher than expected inflation in the first half. The tightening in
monetary policy will have an impact on price pressures in 2009, when
inflation is set to ease to 7.5% (revised up by 1 percentage point from
ADO 2008) (Figure 3.5.12).
Risks to the forecasts are largely grounded in the costs of
subsidies. Higher than expected prices of food and oil would require
larger subsidies, which would further erode funds available for other
public spending. If inflation does not decline as projected in 2009,
thereby requiring a longer cycle of monetary policy tightening,
consumption and investment would be weaker than forecast.
