Indonesia economy to grow above 6 percent despite rising oil prices

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Indonesia economy to grow above 6 percent despite rising oil prices

Rate hike of 75 basis points over next three months needed to curb inflationary pressures.

08 March 2011

The Royal Bank of Scotland ("RBS") says rising oil prices may not derail Indonesia's robust economic growth. Looking ahead into 2011, the Bank believes Indonesia will continue to achieve Gross Domestic Product (GDP) growth of 6.6 percent, underpinned by strong domestic demand.

"Indonesia is an important country for RBS in Asia. We believe in the growth prospects of Indonesia and have well-positioned ourselves to help our target clients tap into the local and international capital markets and investment opportunities to achieve their growth ambitions," said Mr. Harry Naysmith, RBS Country Executive to the Bank's top Indonesian clients in Jakarta today at an economic outlook seminar hosted by RBS.

"History has shown the country's resilience in the face of rising oil prices. In 2008 when the Indonesian economy had to grapple with the double whammy of record high oil prices and a currency that was at a twelve year low against the USD, it still managed to record annual GDP growth of 6 percent. In our view, the fact that the economy was on a solid footing heading into the oil price spike helped significantly. This is also the case today," said Ms. Lim Su Sian, RBS Regional Economist, at the RBS seminar, which was also attended by Mr. Anggito Abimanyu, Economist at University of Gadjah Mada and Mr. Purbaya Yudhi Sadewa, Chief Economist at Danareska Research Institute.

Indonesia's GDP growth surprised on the upside in 4Q10, rising to a six year high of 6.9 percent year-on-year (yoy). On a sequential basis, the country's GDP growth reached 2.6 percent quarter-on-quarter (qoq), the fastest pace in a decade and second only to China's performance over the same period.

The upside surprise stemmed from larger than expected contributions from net exports and last minute disbursement of the government budget. While consumption and investment appeared more lackluster, RBS is not concerned. "By industry, the economic expansion was very broad-based, with sequential growth accelerating in six out of nine sectors. Notably, output from the agricultural sector, the country's largest employer, was very strong. At the same time, external demand for Indonesia's commodities continues to boom. Since the collapse of Lehman Brothers in 2008, Indonesia's exports have doubled, a performance matched only by the export powerhouses of Taiwan and Korea," explained Ms Lim.

Policy and FX outlook

Despite a generally bullish outlook for the Indonesian economy, RBS cautions that there are near term risks ahead for the Indonesian Rupiah (IDR). IDR has jumped more than two percent against the USD since 4 February 2011 when Bank Indonesia (BI) responded to rising inflation with an interest rate hike.

However RBS expects the IDR to weaken to 8,900 against the USD by the middle of the year before resuming appreciation in the second half. This is because the Central Bank's commitment to normalising interest rate policy seems to have waned on concerns that rising oil prices will cool growth. Prioritising growth over inflationary risks will have negative repercussions on the IDR.

"Growth will be kept intact partly because fuel subsidies from the government will shield the domestic economy. But higher subsidy spending will widen Indonesia's budget deficit, which the government currently projects to be at 1.8% of GDP. Consequentially, the much needed fiscal reform may be delayed, potentially retarding Indonesia's progress towards an investment grade rating. Meanwhile, because growth remains intact, inflation will continue to rise on demand-pull forces. Together, these factors could put the IDR under pressure," said Ms Lim.

Against a backdrop of robust growth and repeatedly above target inflation, RBS believes an interest rate hike of another 75 basis points over the next three months is needed to fight rising prices and keep up the strength of the IDR.

For more information:

Tan Ping Ping
Public Relations Manager, SEA, RBS +65 6518 8497

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