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.

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 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.

Source and more information: http://www.adb.org/Documents/Books/ADO/2008/Update/Part03-INO.pdf