December 2015 Reforming amid uncertainty INDONESIA ECONOMIC QUARTERLY Reforming amid uncertainty December 2015 Preface The Indonesia Economic Quarterly (IEQ) has two main aims. First, it reports on the key developments over the past three months in Indonesia’s economy, and places these in a longer- term and global context. Based on these developments, and on policy changes over the period, the IEQ regularly updates the outlook for Indonesia’s economy and social welfare. Second, the IEQ provides a more in-depth examination of selected economic and policy issues, and analysis of Indonesia’s medium-term development challenges. It is intended for a wide audience, including policymakers, business leaders, financial market participants, and the community of analysts and professionals engaged in Indonesia’s evolving economy. The IEQ is a product of the World Bank’s Jakarta office and receives editorial and strategic guidance from an editorial board chaired by Rodrigo Chaves, Country Director for Indonesia. The report is compiled by the Macroeconomics and Fiscal Management Global Practice team, under the guidance of Shubham Chaudhuri, Practice Manager, Ndiame Diop, Lead Economist and Hans Anand Beck, Senior Economist. Led by Elitza Mileva, Country Economist, and with responsibility for Part A, editing and production, the core project team comprises Arsianti, Magda Adriani, Masyita Crystallin, Fitria Fitrani, Ahya Ihsan, Yue Man Lee and Violeta Vulovic with additional editing by Edgar Janz, Matt Wai-Poi and Sinead Maguire. Administrative support is provided by Titi Ananto. Dissemination is organized by Indra Irnawan, Jerry Kurniawan, Gb Surya Ningnagara and Nugroho Sunjoyo, under the guidance of Dini Djalal. This edition of the IEQ also includes contributions from Mattia Makovec (Part A.7, Labor), Magda Adriani, Mubariq Ahmad, Ann Jeannette Glauber, Iwan Gunawan, Elitza Mileva, Sarah Moyer (Part B.1, Forest fires), Samuel Clark, Ihsan Haerudin, Jennifer Noveck, Kevin A. Tomlinson, Kathleen A. Whimp (Part B.2, the Village Law), Agnesia Adhissa, Evarist Baimu, Massimiliano Cali, Brasukra Sudjana (Part C.1, Trans-Pacific Partnership). Key data and inputs (Part B.1, Forest fires) were received from Massimiliano Cali, Letizia Ferlito, Pandu Harimurti, Muhammad Farman Izhar, Anita Ellen Kendrick, Ruby Mangunsong, Rosfita Roesli, George Henry Stirrett Wood, Rinsan Tobing. Special thanks to Fauziah Alhasanah, Augustan, Nugraheni Setyaningrum (BPPT) and Ridho Benardo Becken, Paulina Laurentia Diana, Gita Febriyanti, Rina Octavia, Owen Podger, Dian Puspita (Yayasan Pengurangan Resiko Bencana, PRB). The report also benefited from discussion with and in-depth comments from Ernest Berthe and Triyanto Fitriyardi (IFC), Sudhir Shetty, Nikola L. Spatafora, Maria Monica Wihardja and John Burch (Australia-Indonesia Government Partnership Fund). This report is a product of the staff of the International Bank for Reconstruction and Development/the World Bank, supported by funding from the Australian government under the Support for Enhanced Macroeconomic and Fiscal Policy Analysis (SEMEFPA) program. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent, or the Australian government. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. The photograph on the cover and Executive Summary is taken by and copyright of Pusdatinmas, BNPB (Disaster Agency), 2015 and the remaining photographs are taken by Arsianti, Curt Carnemark and Josh Estey and copyright of the World Bank. All rights reserved. For more World Bank analysis of Indonesia’s economy: For information about the World Bank and its activities in Indonesia, please visit www.worldbank.org/id. To receive the IEQ and related publications by email, please email madriani@worldbank.org. For questions and comments, please email emileva@worldbank.org. Table of contents EXECUTIVE SUMMARY: REFORMING AMID UNCERTAINTY ................................... I  A. ECONOMIC AND FISCAL UPDATE ............................................................................... 1  1.  Unfavorable external conditions persist, despite improvement in market sentiment ................... 1  2.  Moderate third-quarter GDP growth was supported by public spending ..................................... 2  3.  Inflation has moderated due to base effects but El Niño-related risks remain ............................. 5  4.  Capital flows declined further, in line with the emerging market trend ........................................ 6  5.  Financial conditions remain tight, driven partly by lower foreign inflows .................................... 8  6.  Higher budget execution rates supported growth in the third quarter ........................................10  7.  Job creation has weakened and become even more reliant on low-productivity sectors..............14  8.  The improvement in investment hinges on the government’s reform effort ................................15  B. SOME RECENT DEVELOPMENTS IN INDONESIA’S ECONOMY ........................ 18  1.  Indonesia’s fire crisis: Who benefits and who pays? .....................................................................18   a.  Palm oil production is worth billions: who benefits?....................................................................................... 20  b.  The 2015 fires cost Indonesia an estimated IDR 221 trillion: who pays? ......................................................... 21  c.  The case for peatland moratorium and restoration ......................................................................................... 24  2.  Realizing the potential of the Village Law ................................................................................... 26  a.  Ensuring the Village Law targets the poor and near poor .............................................................................. 27  b.  Streamlining village fund disbursement .......................................................................................................... 29  C. INDONESIA 2016 AND BEYOND: A SELECTIVE LOOK ........................................... 31  1.  The Trans-Pacific Partnership agreement: opportunity or threat for Indonesia? ........................31  a.  The TPP will affect the Indonesian economy ................................................................................................. 32  b.  Joining the TPP will influence Indonesian economic policy-making ............................................................ 34  APPENDIX: A SNAPSHOT OF INDONESIAN ECONOMIC INDICATORS ................ 36  LIST OF FIGURES Figure 1: The outlook for commodity prices has weakened further ......................................... 2  Figure 2: Global financial conditions remain tight for emerging markets ............................... 2  Figure 3: GDP growth stabilized at 4.7 percent yoy in Q3 2015… ............................................ 3  Figure 4: … supported by a significant rise in real public sector capital spending .................. 3  Figure 5: Monthly indicators of investment activity may signal a pickup… ............................ 4  Figure 6: … although business sentiment remains subdued .................................................... 4  Figure 7: CPI inflation eased due to base effects ...................................................................... 5  Figure 8: The financial account balance deteriorated further................................................... 6  Figure 9: Capital inflows to emerging markets are expected to bottom out in Q4 ................... 7  Figure 10: Foreign investors sold off Rupiah-denominated portfolio assets in Q3 2015 ........... 7  Figure 11: Emerging market equities have recorded gains since September ........................... 9  Figure 12: Private external debt growth has tapered with the rise in debt burden ................... 9  Figure 13: The pick-up in credit growth since July has been driven by investment loans ......10  Figure 14: Oil and gas revenues continue to drive the revenue slowdown .............................. 11  Figure 15: Except for energy subsidies, disbursement rates were higher than in previous years .......................................................................................................................... 11  Figure 16: Higher health, infrastructure and social assistance spending is planned for 2016 .12  Figure 17: Moderate growth has resulted in higher unemployment… ....................................14  Figure 18: … with only the construction and trade sectors driving job creation .....................14  Figure 19: Affected provinces have suffered damage and losses due to fire and haze… ........ 22  Figure 20: …which has reduced 2015 GDP growth................................................................. 22  Figure 21: Infrastructure gaps vary greatly across Indonesia.................................................. 27  Figure 22: The 90/10 Dana Desa formula treats village residents inequitably ....................... 28  Figure 23: DD district to village disbursement was slow in 2015 ............................................ 29  Figure 24: TPP countries’ share in Indonesian goods exports is high, albeit slightly declining ................................................................................................................................. 32  Figure 25: TPP markets are even more important for Indonesian manufacturing exports .... 32  Figure 26: US applied tariff rates are generally very low ......................................................... 33  Figure 27: Potential for trade diversion away from Indonesian exports is concentrated in apparel ..................................................................................................................... 33  Figure 28: Indonesia has actively used restrictive trade and investment measures ............... 35  LIST OF APPENDIX FIGURES Appendix Figure 1: Quarterly and annual GDP growth.......................................................... 36  Appendix Figure 2: Contributions to GDP expenditures ....................................................... 36  Appendix Figure 3: Contributions to GDP production........................................................... 36  Appendix Figure 4: Motorcycle and motor vehicle sales ........................................................ 36  Appendix Figure 5: Consumer indicators ............................................................................... 36  Appendix Figure 6: Industrial production indicators ............................................................. 36  Appendix Figure 7: Balance of payments ............................................................................... 37  Appendix Figure 8: Current account components .................................................................. 37  Appendix Figure 9: Exports of goods ..................................................................................... 37  Appendix Figure 10: Imports of goods .................................................................................... 37  Appendix Figure 11: Reserves and capital flows ..................................................................... 37  Appendix Figure 12: Inflation and monetary policy................................................................ 37  Appendix Figure 13: Monthly breakdown of CPI ................................................................... 38  Appendix Figure 14: Inflation comparison across countries................................................... 38  Appendix Figure 15: Domestic and international rice prices .................................................. 38  Appendix Figure 16: Poverty and unemployment rate ............................................................ 38  Appendix Figure 17: Regional equity indices ......................................................................... 38  Appendix Figure 18: Selected currencies against USD ........................................................... 38  Appendix Figure 19: 5-year local currency govt. bond yields.................................................. 39  Appendix Figure 20: Sovereign USD bond EMBIG spread ................................................... 39  Appendix Figure 21: Commercial and rural credit and deposit growth .................................. 39  Appendix Figure 22: Banking sector indicators ...................................................................... 39  Appendix Figure 23: Government debt ................................................................................... 39  Appendix Figure 24: External debt ......................................................................................... 39   LIST OF TABLES Table 1: In the base case, GDP growth is projected at 5.3 percent in 2016 ..............................iii  Table 2: In the base case, GDP growth is projected to pick up to 5.3 percent in 2016 ............. 6  Table 3: A current account deficit of 2.0 percent of GDP is projected for 2015 ........................ 8  Table 4: The Ministry of Finance projects a fiscal deficit of 2.2 percent of GDP in 2016 ........13  Table 5: The government’s reform agenda is broad-based* ....................................................16  Table 6: Hectares burned by province, June – October 2015 ...................................................19  Table 7: Estimated losses and damages from forest fires and haze in June-October 2015 reached IDR 221 trillion ........................................................................................... 23  Table 8: The estimated lost public revenue over one year as a result of a moratorium on peatland development is substantial ....................................................................... 25  Table 9: Estimated construction cost of peatland restoration ................................................ 25  Table 10: A higher fiscal effect of transfers to villages is expected in the medium term ........ 26  Table 11: Districts have been slow to adopt the required regulatory framework .................... 29  LIST OF APPENDIX TABLES Appendix Table 1: Budget outcomes and projections ............................................................ 40  Appendix Table 2: Balance of payments ................................................................................. 40  Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance...................41  Appendix Table 4: Indonesia’s development indicators at a glance....................................... 42  LIST OF BOXES Box 1: An important and wide-ranging reform process was initiated in September ...............16  Box 2: Certification standards could encourage environmentally friendly production practices.........................................................................................................................19  Box 3: Peat fires have significant consequences for climate change .......................................21  Box 4: Other costs – the unknown cumulative impact of fire and haze on flora and fauna ... 24  Box 5: Assessing the equity of Dana Desa allocations by comparing two villages ................ 28  Reforming amid uncertainty Indonesia Economic Quarterly Executive summary: Reforming amid uncertainty In a challenging Although global financial markets have stabilized since October, external conditions international and remain unfavorable. At home, already moderate GDP growth was negatively domestic affected by an economic and environmental crisis which was caused by man-made environment, made fire and haze and cost Indonesia an estimated IDR 221 trillion (1.9 percent of GDP) worse by the fire and in five months. In this difficult environment, the government has demonstrated a haze disaster, the clear intent to implement wide-ranging reforms focused on raising the investment government has rate, revitalizing the domestic industry, and facilitating trade. One indication of this committed to is the significant increase in public capital spending by an estimated 49.8 percent improve growth year on year (yoy) in real terms in the third quarter, reversing the negative trend of 2014 and early 2015. Moreover, the 2016 State Budget calls for further improvement in the composition of spending by shifting resources from energy subsidies to infrastructure, health and targeted social assistance. A second signal is the reform agenda initiated in September through the announcement of seven policy packages of regulatory and structural reforms and fiscal stimulus. However, significant The government’s commitment to accelerate public spending in 2015, despite lower revenue-related risks than projected revenue collection, has expanded the fiscal deficit to 2.5 percent of may limit the ability GDP in October and, based on recent trends, possibly even higher in November. of fiscal policy to However, increasing the deficit to the legal limit of 3 percent for the general boost investment and government is unlikely to provide enough space to reach the expenditure targets set growth in the July revision of the fiscal outlook. Furthermore, reaching the 2016 total revenue target could be challenging, given the revenue shortfall in 2015 and continuing weak macroeconomic conditions and low commodity prices. If revenue collection were to remain weak in 2016, the ongoing strong public infrastructure spending momentum and its growth impulse may be at risk. December 2015 THE WORLD BANK | BANK DUNIA i Reforming amid uncertainty Indonesia Economic Quarterly Investor risk Emerging market assets rebounded in October after the sharp losses recorded in aversion has August and September, when the uncertainty about the Chinese economic moderated but slowdown and the U.S. interest rate outlook was particularly high. Despite a more global economic favorable market sentiment, capital flows to emerging economies have remained activity remains weak and borrowing costs relatively high. In addition to tight financing conditions, subdued Indonesia still faces subdued external demand for its exports in the near term and persistently low commodity prices over the medium run. Recent data point to subdued GDP growth across the globe for a fourth consecutive quarter. Public spending In the third quarter, real GDP grew at 4.7 percent yoy, the same pace as in Q1 and supported growth in Q2 2015. Growth was supported by an increase in public sector spending both on the third quarter, consumption and capital. At the same time, private sector investment is estimated to with private have remained subdued, with some high-frequency (leading) data pointing to a pick- investment still weak up in the fourth quarter, while others, in particular business sentiment indicators, signaling persistent weakness. The aggregate unemployment rate increased to 6.2 percent, from 5.9 percent in August 2014, reversing the declining trend observed in the past decade. Moreover, the sectors that are still creating jobs – construction and trade – are low productivity sectors. Man-made fire and Another factor constraining GDP growth in the third quarter was the fire and haze- haze cost Indonesia related losses in several provinces. Between June and October 2015, more than IDR 221 trillion in 100,000 man-made fires burned 2.6 million hectares of land, an area four and a half just five months, times the size of Bali. The World Bank estimates that the fires cost Indonesia at contributing to least IDR 221 trillion (USD 16.1 billion), equivalent to 1.9 percent of 2015 GDP slower growth and more than twice the reconstruction cost after the Aceh tsunami. Partly due to the El Niño-related drought and to the forest fires, real agricultural output declined at a quarter-on-quarter seasonally adjusted annualized rate (qoq-saar) of 4.9 percent in Q3 2015, the first significant decline in over four years. Kalimantan, where much of the country’s fragile peatlands are located, was the hardest hit, with GDP declining by 1.2 percent qoq-saar in the third quarter (-5.1 percent qoq-saar in East Kalimantan). The government has called for a moratorium on new peatland concessions, a cancellation of existing, non-developed concessions, and peatland restoration. Additional efforts should focus on conserving the remaining peat forests and stopping the drainage of deep peat or high biodiversity areas. Despite a relatively Turning to the external sector, trade continued to weaken in the third quarter, with low current account both exports and imports reaching their lowest levels since 2010. As in previous deficit, external quarters, imports declined more than exports, thus supporting a narrower current pressures remain as account deficit. Although this eased some of Indonesia’s external pressures, net capital flows declining net capital flows resulted in a balance of payments deficit. Even though contracted further… capital flows were resilient in the first half of 2015, owing to government bond inflows, total net capital flows in the first three quarters, at USD 9.6 billion, decreased by almost 70 percent compared with the same period last year. Compared with its level up to October last year, net foreign purchases of Rupiah-denominated sovereign bonds (SUNs) are down by 54.4 percent, while government foreign- currency debt increased by 80 percent. SUNs have lost some of the appeal to foreign investors, as the volatility of the Rupiah rose this year. December 2015 THE WORLD BANK | BANK DUNIA ii Reforming amid uncertainty Indonesia Economic Quarterly … constraining Domestic credit also remains tight, though there are some signs of a pick-up in monetary policy in investment loan growth. Headline inflation declined below 5 percent yoy in the very short term, November, owing in large part to the base effect from last year’s sharp increase in even with inflation retail fuel prices. Nevertheless, monetary policy remains constrained in the very easing short term on account of weaker capital flows and continued exchange rate depreciation pressures. In response to heightened Rupiah volatility since August, Bank Indonesia (BI) unveiled a set of measures to stabilize the currency. The measures range from foreign exchange interventions in the forward market to issuing Bank Indonesia Certificates (SBIs) in foreign currency. In addition, BI renewed its bilateral currency swap agreement with China. The baseline outlook Looking ahead, Table 1: In the base case, GDP growth is projected at 5.3 percent of 4.7 percent GDP the World Bank in 2016 growth in 2015 and forecast for GDP 2014 2015p 2016p 5.3 percent in 2016 (Annual percent growth remains Real GDP change) 5.0 4.7 5.3 remains at 4.7 percent for Consumer price (Annual percent unchanged… 2015 and 5.3 index change) 6.4 6.3 4.6 percent for 2016 Current account (Percent of GDP) -3.1 -2.0 -2.4 (Table 1). balance Although the Budget balance* (Percent of GDP) -2.2 -2.5 -2.2 headline Note: * October realization reported for 2015; Projection of the Ministry of projections are Finance for 2016. Source: BI; BPS; Ministry of Finance; World Bank staff calculations unchanged from the October 2015 IEQ, public consumption and investment are now expected to contribute slightly more to growth both this year and next, while export growth has been revised down once again. The baseline projections reflect the government’s commitment to higher capital allocation in the approved 2016 Budget, which may crowd in private investment and support overall growth. The growth pick-up in our baseline is also based on gradually improving external conditions. … with risks to the The main external risks, unchanged from the October 2015 IEQ, include a stronger outlook continuing than projected slowdown in emerging market economies, including China’s, weaker to weigh on the than expected global trade recovery, lower than projected commodity prices, and downside the possibility of renewed increases in financial market volatility. On the domestic front, as the driver of growth in the short term has shifted to the public sector, a key risk to the outlook is weaker than expected fiscal revenues. The full implementation of the government’s current expenditure plans for 2016 is at risk, if revenue collection is to remain weak. For the remainder of 2015, frontloading of government securities issuance and greater reliance on multilateral financing have helped mitigate financing risks. As of December 2, the government had already secured IDR 510.4 trillion from securities issuance and USD 3.89 billion (around IDR 53 trillion) in foreign official lending. Village transfers Part of the planned increase in public infrastructure spending in the 2016 Budget is have been expected to materialize through higher transfers to local governments, including the substantially Village Fund (Dana Desa, DD) whose resources will more than double next year. increased and, Villages can play an important role in ensuring that basic services respond to village despite early residents’ needs. However, limited village capacity is likely to continue to constrain implementation the use of funds, particularly in remote and less developed areas. There have been challenges, have the considerable disbursement delays this year, suggesting poor preparation by both potential to address districts and villages. In addition, the revised formula for DD distribution allocates rural inequality 90 percent of the funds equally among villages (the remaining 10 percent depend on December 2015 THE WORLD BANK | BANK DUNIA iii Reforming amid uncertainty Indonesia Economic Quarterly demography and geography). As a result, large villages, where most of the poor and near poor live, receive a much lower allocation per person, which is contributing to higher inequality. The TPP impact on Another potential step in Indonesia’s new reform process is the country’s signaling trade may be limited, its intention to join the Trans-Pacific Partnership (TPP) agreement in the near but the diversion of future. Whether membership materializes or not, the agreement is likely to have a investments may be limited impact on trade, because import tariffs in member countries are already low a more important and Indonesia has trade agreements with most of them. However, the effect on issue investment may be more important, as the pact increases access to a sizable share of the global economy and affords higher legal protection for foreign investors than domestic legislation usually does. These factors may induce foreign investment re- allocation away from third countries, including Indonesia, to TPP members. On the other hand, joining the pact is likely to influence policy-making beyond merchandise trade, for example by requiring regulations to ensure equal treatment of foreign and domestic companies. Although the TPP allows implementation flexibility with respect to current laws and regulations, it restricts in some ways the room for future economic policy-making. For instance, TPP members have limited leeway to make laws and regulations more restrictive towards other member countries. This could be particularly important for Indonesia, the most active user of restrictive trade and investment measures in South East Asia. December 2015 THE WORLD BANK | BANK DUNIA iv Reforming amid uncertainty Indonesia Economic Quarterly A. Economic and fiscal update 1. Unfavorable external conditions persist, despite improvement in market sentiment Global growth Third-quarter data point to subdued global economic activity for a fourth disappointed once consecutive quarter. Growth softened in the U.S. and in the Euro Area, while Japan again… entered a technical recession. Among major emerging economies, China’s slowdown continues, Brazil’s challenges have intensified, and Russia’s economy contracted. Only India’s GDP growth, at 7.4 percent yoy, remained solid in the third quarter. … prompting The overall growth slowdown has weighed on global trade and on the demand for downward revisions commodities. The World Bank revised down its commodity price forecast once to commodity price again in October (Figure 1).1 In addition to weaker than previously expected global forecasts growth, high stocks in OECD countries, resilient non-OPEC output, and greater projected Iranian production next year have further lowered projected oil prices. As a net oil importer, low oil prices tend to benefit Indonesia but put pressure on the government’s budget which relies on the oil and gas sector for about 20 percent of its revenues. Global risk aversion Turning to financial developments, emerging market assets rebounded in October has declined, but after the sharp losses recorded in August and September, when the uncertainty borrowing costs about the Chinese economic slowdown and the U.S. interest rate outlook were remain high particularly high. However, some countries, such as Brazil, Turkey and South Africa, have experienced renewed volatility in December. Despite a more favorable market sentiment, capital flows to emerging economies have remained weak and borrowing costs high relative to 2014 and early 2015 (Figure 2). 1 World Bank, Commodity Markets Outlook, October 2015: http://www.worldbank.org/en/research/commodity- markets. December 2015 THE WORLD BANK | BANK DUNIA 1 Reforming amid uncertainty Indonesia Economic Quarterly Indonesia’s In Indonesia, foreign borrowing by the government has shown signs of government has stabilization, while the stock market continues to experience foreign outflows (see taken advantage of Section 5). For the first time since June, net purchases of Rupiah-denominated the recent financial government bonds by foreign investors turned positive in October (USD 391 market stabilization million). As several other emerging countries have done in recent weeks, on December 1 Indonesia raised USD 3.5 billion in an international bond sale (to pre- finance the 2016 budget) ahead of a potential U.S. interest rate hike. Figure 1: The outlook for commodity prices has Figure 2: Global financial conditions remain tight for weakened further emerging markets (index of Indonesia’s six main export commodity prices) (EMBIG spread, basis points) 180 600 Forecast 160 500 140 Global EM 400 120 July 2015 300 100 200 80 Indonesia October 2015 60 100 40 0 2012 2013 2014 2015 2016 2017 2018 Jan-14 Jul-14 Jan-15 Jul-15 Note: The index includes the prices of coal, copper, oil, gas, palm Source: JP Morgan; World Bank staff calculations oil and rubber. Source: World Bank; World Bank staff projections 2. Moderate third-quarter GDP growth was supported by public spending Moderate growth in In the third quarter, real GDP grew at 4.7 percent yoy, the same pace as in Q1 and Q3 2015 confirmed Q2 2015. Growth was underpinned by an increase in public sector spending both expectations that on consumption and on capital. At the same time, private sector investment is stronger policy estimated to have remained subdued, with some high-frequency (leading) data efforts are needed to pointing to a pick-up in the fourth quarter, while others, in particular business support growth in sentiment indicators, signaling persistent weakness. The El Niño-related drought the near term and losses caused by forest fires and haze in several provinces are estimated to have had a material negative impact on GDP (see also Section B.1). Real agricultural output declined by 4.9 percent qoq-saar in Q3 2015, the first significant decline in over four years. Kalimantan was the hardest hit, with GDP declining by 1.2 percent qoq-saar in the third quarter (-5.1 percent qoq-saar in East Kalimantan). Amid heightened uncertainty, and significant downside risks to the outlook, the World Bank maintains its baseline growth forecast at 4.7 percent for 2015 and 5.3 percent for 2016. The projections reflect gradually improving external demand and higher government capital spending. Higher government Private consumption grew by 5.0 percent yoy, up from 4.7 percent in Q2. However, spending drove the this rise was entirely due to the growth in consumption of non-profit institutions pickup in which increased as the effect of high H1 2014 election-related spending dropped out consumption growth of the annual comparison. Household expenditure growth has remained at 5.0 … percent yoy for four consecutive quarters. The public sector’s contribution to GDP December 2015 THE WORLD BANK | BANK DUNIA 2 Reforming amid uncertainty Indonesia Economic Quarterly growth also rose as expenditure disbursement, including on infrastructure development, accelerated. Government consumption grew by 6.6 percent yoy (up from 2.1 percent in Q2), contributing 0.5 percentage points yoy to growth (Figure 3). … and the Fixed investment growth increased to 4.6 percent yoy, from 3.7 percent in Q2, improvement in contributing 1.5 percentage points yoy to growth. The pick-up in investment was investment growth driven by improving construction, machinery and equipment, and vehicle spending. Although Statistics Indonesia (Badan Pusat Statistik, BPS) does not publish a breakdown of public versus private investment, an estimate of real government capital spending (deflated by the implicit total investment deflator2) shows a significant growth acceleration to 49.8 percent yoy in Q3 2015, reversing the negative trend of 2014 and early 2015 (Figure 4). Figure 3: GDP growth stabilized at 4.7 percent yoy in Figure 4: … supported by a significant rise in real Q3 2015… public sector capital spending (contributions to GDP growth yoy, percentage points) (growth yoy, percent) Stat. discrepancy* 60 Net exports Investment 10 Government consumption 40 Private consumption 8 GDP 20 6 4 0 2 -20 0 -40 -2 -4 -60 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Note: * Statistical discrepancy includes changes in inventories. Note: Real government capital spending is deflated using the total Source: BPS; World Bank staff calculations fixed investment deflator from the national accounts. Source: BPS; Ministry of Finance; World Bank staff calculations However, both Net exports continued to contribute positively to growth (1.2 percentage points import and export yoy), albeit by less than in the second quarter (1.6 percentage points). Import volumes remained volumes declined by 6.1 percent yoy, compared with -7.0 percent in Q2. Exports weak decreased by 0.7 percent yoy in real terms, after falling by 0.1 percent in the second quarter. According to data from the Netherlands Bureau for Economic Policy Analysis, export volumes continued to decline across Asia by an average of 4.3 percent yoy in Q3, versus -2.5 percent in Q2, as emerging market import demand continues to weigh on global trade. Monthly investment Investment growth improved in sequential terms from 1.8 percent qoq-saar in Q2 activity indicators to 7.4 percent in Q3. There is some evidence of further improvement in the fourth suggest a pick-up, quarter. The acceleration in government investment spending continued in October, though business with monthly (nominal) capital expenditure reaching IDR 22 trillion, up 11.8 percent relative to September and almost double the October 2014 level. 2 The implicit total investment deflator is calculated as the ratio of total nominal gross fixed capital formation to total real fixed capital formation, both taken from the national accounts. December 2015 THE WORLD BANK | BANK DUNIA 3 Reforming amid uncertainty Indonesia Economic Quarterly sentiment remains Furthermore, commercial cement sales picked up momentum and capital goods subdued imports, a leading indicator for investment, may have bottomed out in Q3 (Figure 5). However, business sentiment indices have not yet reversed their declining trend. Both the current and expected business activity indicators complied by BI continue to decline. The Nikkei/Markit’s purchasing managers index (PMI) for manufacturing, at 46.9 in November, continues to signal weaker activity (Figure 6). Figure 5: Monthly indicators of investment activity Figure 6: … although business sentiment remains may signal a pickup… subdued (four-quarter moving average of growth qoq-saar, percent) (seasonally adjusted indices) Fixed investment, LHS 60 12 Capital imports*, RHS 30 PMI Commercial cement sales*, RHS 25 50 10 20 40 8 15 BI Expected business activity 6 10 30 5 20 4 0 2 10 -5 BI Current business activity 0 -10 0 Mar-12 Mar-13 Mar-14 Mar-15 Jan-14 Jul-14 Jan-15 Jul-15 Note: * Last observation is October 2015. Source: BI; Nikkei/Markit; World Bank staff calculations Source: BPS; World Bank staff calculations In the base case, Looking ahead, the World Bank’s forecast for GDP growth remains at 4.7 percent GDP is projected to for 2015 and 5.3 percent for 2016 (Table 2). Although the headline projections are increase by 4.7 unchanged from the October 2015 IEQ, public consumption and investment are percent in 2015 and now expected to contribute slightly more to growth both this year and next, at the 5.3 percent in 2016… expense of exports. This revision reflects the government’s commitment to higher capital allocation in the approved 2016 Budget (see Section 6), which may crowd in private investment and support overall growth. The growth pick-up in the baseline is also based on gradually improving external conditions. The World Bank expects global growth to increase to 3 percent in 2016, from 2.5 percent estimated for this year.3 However, the balance of risks, both external and domestic, to the baseline scenario is still to the downside (see Section 8). 3 See the East Asia Pacific Economic Update, October 2015: Staying the Course. December 2015 THE WORLD BANK | BANK DUNIA 4 Reforming amid uncertainty Indonesia Economic Quarterly 3. Inflation has moderated due to base effects but El Niño-related risks remain Headline inflation CPI inflation dropped to Figure 7: CPI inflation eased due to base effects declined below 5 4.9 percent yoy in (change yoy, percent; last observation November 2015) percent yoy due November, from 6.2 12 mainly to last year’s percent in October, owing Food high base of in large part to the base 10 comparison effect from the sharp increase in retail fuel prices 8 a year ago (Figure 7). Core inflation, which excludes 6 Headline the more volatile food and energy prices, also eased to 4 4.8 percent yoy in Core November, from 5.0 2 percent in the previous month. After decelerating 0 somewhat in September Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 and October, food price Note: Food prices are a weighted average of the raw and processed inflation rose again in food price components of the CPI. November in month-on- Source: BPS; World Bank staff calculations month terms. Although retail rice prices have increased at a more subdued pace in the past two months, likely on the back of higher stockpiles, the prices of other food commodities, such as meat and vegetables, picked up. The moderate to severe El Niño conditions have adversely affected agricultural output across Indonesia this year, increasing the volatility of food prices.4 Inflation is projected The World Bank expects an annual average CPI inflation rate of 6.3 percent in 2015, to decline, though El declining to an average rate of 4.6 percent in 2016. In the base case, the forecast Niño-related upward accounts for a moderate effect of El Niño on food prices early next year.5 price pressures are According to the Food and Agriculture Organization, planting of the 2016 main expected in early season paddy crop, which accounts for the bulk of annual production, has been 2016 delayed as a consequence of below-average rainfall in large parts of Indonesia.6 Moreover, the dry weather is expected to lower the yields of early-planted crops, particularly in rain-fed areas. As El Niño remains the main risk to the inflation outlook, the government’s response to the supply constraints (e.g. allowing rice imports to replenish stocks) is an important determinant of the near-term trajectory of food prices. 4 See Section B.1 for estimates of the negative impact of fire and haze on agriculture (and other sectors) in June- October 2015. 5 See Part B.1 of the October 2015 IEQ for more details on these estimates. 6 Global Information and Early Warning System (GIEWS) on food and agriculture, November 13, 2015, Indonesia Country Brief: http://www.fao.org/giews/countrybrief/country.jsp?code=IDN. December 2015 THE WORLD BANK | BANK DUNIA 5 Reforming amid uncertainty Indonesia Economic Quarterly Table 2: In the base case, GDP growth is projected to pick up to 5.3 percent in 2016 (percentage change, unless otherwise indicated) Annual YoY in Fourth Quarter Revision to Annual 2014 2015 2016 2014 2015 2016 2015 2016 1. Main economic indicators Total Consumption expenditure 4.8 4.8 4.9 4.3 5.3 3.9 0.4 0.0 Private consumption expenditure 5.3 4.9 5.2 4.7 5.4 4.1 0.2 0.0 Government consumption 2.0 3.6 3.2 2.1 4.1 2.4 1.5 0.0 Gross fixed capital formation 4.1 4.5 5.2 3.7 5.6 4.0 0.8 0.2 Exports of goods and services 1.0 -0.7 2.3 -0.1 1.7 4.0 -0.5 -2.4 Imports of goods and services 2.2 -5.7 1.8 -7.0 1.5 3.7 -2.5 -1.8 Gross Domestic Product 5.0 4.7 5.3 4.7 5.2 4.1 0.0 0.0 2. External indicators Balance of payments (USD bn) 15.3 6.3 16.5 - - - 1.3 -0.8 Current account balance (USD bn) -27.5 -16.9 -22.2 - - - 0.9 2.7 As share of GDP (percent) -3.1 -2.0 -2.4 - - - 0.0 0.2 Trade balance (USD bn) -3.0 6.7 1.9 - - - 0.8 0.7 Capital & financial acc. bal. (USD bn) 45.4 23.2 38.7 - - - 0.4 -3.5 3. Other economic indicators Consumer price index 6.4 6.3 4.6 6.5 4.7 5.0 -0.2 -0.6 GDP Deflator 5.4 4.2 4.5 4.8 4.3 3.8 -0.7 -0.8 Nominal GDP 10.7 9.2 10.1 9.6 9.5 8.1 -0.5 -0.8 4. Economic assumptions Exchange rate (IDR/USD) 11800 13400 13800 - - - 0 -200 Indonesian crude price (USD/bl) 98 51 50 - - - -7 -11 Note: Exports and imports refer to volumes from the national accounts. All figures are based on revised and rebased GDP. Exchange rate and crude oil price assumptions are based on recent averages. Revisions are relative to projections in the October 2015 IEQ. Source: BPS; BI; CEIC; World Bank staff projections 4. Capital flows declined further, in line with the emerging market trend Despite a sizable Although a narrower Figure 8: The financial account balance deteriorated trade surplus, current account deficit further external pressures eased some of Indonesia’s (USD billion) remain as net capital external pressures, Current account Direct investment flows contracted declining net capital flows Portfolio investment Other investment 20 further resulted in a balance of Overall balance Basic balance payments deficit in the 15 third quarter (Figure 8). 10 Even though capital flows were resilient in the first 5 half of 2015, owing to 0 government bond inflows, total net capital flows in -5 the first three quarters -10 decreased by almost 70 percent compared with the -15 same period last year. Sep-12 Sep-13 Sep-14 Sep-15 Although capital flows to Note: Basic balance = direct investment + current account balance. emerging economies are Source: BI; World Bank staff calculations expected to rebound in the first half of 2016, external financing risks remain elevated due to the uncertainty about the timing of the normalization of U.S. monetary policy. December 2015 THE WORLD BANK | BANK DUNIA 6 Reforming amid uncertainty Indonesia Economic Quarterly The broad-based A trade surplus of USD 4.1 billion was recorded in Q3 2015. Both exports and slowdown in trade imports declined, by 17.4 percent yoy and 24.6 percent yoy, respectively, reaching continued in the their lowest levels since 2010. The slowdown in trade was broad-based: both third quarter commodity and manufacturing exports declined, as did energy and non-energy imports. An increase was observed only in copper exports which grew by 47.5 percent yoy due to the temporary export permits issued to PT Newmont Nusa Tenggara and PT Freeport Indonesia, both of which expired at the end of September. Figure 9: Capital inflows to emerging markets are Figure 10: Foreign investors sold off Rupiah- expected to bottom out in Q4 denominated portfolio assets in Q3 2015 (four-quarter moving average, USD billion) (net foreign purchases, USD billion; Indonesia EMBIG spread, basis points) 400 30 Equities Forecast SBI 350 30 Emerging markets 8 SUN 500 Indonesia, RHS 25 Gov. global bonds 300 6 EMBIG spread 400 20 250 4 300 200 15 2 150 200 10 0 100 5 100 50 -2 0 0 -4 0 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Source: The Institute of International Finance; World Bank staff Note: SUN – Rupiah-denominated government bonds; SBI – BI calculations certificates. Source: BI; JP Morgan; World Bank staff calculations After two resilient Net capital inflows this year have been weaker compared with last year, despite quarters, third strong government bond issuance in the first two quarters. Total net capital flows in quarter capital flows the first three quarters of this year were USD 9.6 billion, equivalent to only 27 weakened percent of their year-ago level or 72.5 percent compared with 2013, the year of the significantly… Fed taper tantrum. In the third quarter, net capital flows were USD 1.2 billion, compared with USD 14.7 billion in Q3 2014 and USD 4.6 billion in Q3 2013. This was in line with the global trend of weaker capital flows to emerging markets (Figure 9). The Institute of International Finance projects that the capital flows slowdown to thirty major emerging economies will bottom out at the end of this year,7 which is consistent with the expected growth pick-up for these countries. … as both FDI and In the three quarters of 2015, FDI decreased by 34.2 percent relative to the same portfolio flows were period in 2014. There have been net equity outflows in most months, with a lower compared with cumulative net outflow of USD 1.3 billion so far this year (Figure 10). This last year compares with USD 3.9 billion of net inflows in January – October 2014. In the third quarter, there were USD 1 billion of net foreign sales of SUNs, though foreigners have purchased USD 5.3 billion of SUNs in net terms year to date. However, compared with their level up to October last year, net foreign purchases of SUNs are down by 54.4 percent. At the same time, government foreign-currency debt increased by 80 percent relative to the same period last year. International 7 The Institute of International Finance capital flows database. December 2015 THE WORLD BANK | BANK DUNIA 7 Reforming amid uncertainty Indonesia Economic Quarterly bonds have remained attractive to foreign investors at the expense of local-currency ones, as the volatility of the Rupiah rose this year. The World Bank The projected 2015 current Table 3: A current account deficit of 2.0 percent of forecast for the account deficit remains at 2 GDP is projected for 2015 current account percent of GDP (Table 3). (USD billion unless otherwise indicated) 2014 2015 2016 deficit is 2 percent of Although imports have not yet Overall balance of GDP in 2015 and 2.4 picked up as expected, with payments 15.3 6.3 16.5 in 2016 both raw material (net of fuel) As percent of GDP 1.7 0.7 1.8 and capital goods imports Current account -27.5 -16.9 -22.2 declining – by 9.1 percent and As percent of GDP -3.1 -2.0 -2.4 3.4 percent yoy, respectively, in Goods trade balance 7.0 15.8 12.1 Services trade balance -10.0 -9.1 -10.2 Q3 2015, a smaller decrease in Income -29.7 -29.0 -29.4 imports is expected in the last Transfers 5.2 5.4 5.3 quarter in line with higher Capital and financial 45.4 23.2 38.7 public capital spending (see accounts Section 2). Since the October As percent of GDP 5.1 2.7 4.2 Direct investment 15.9 11.4 13.1 2015 IEQ, the World Bank has Portfolio investment 26.1 10.9 22.9 revised down its commodity Financial derivatives -0.2 0.1 -0.1 price outlook once again.8 Low Other investment 7.8 0.8 2.7 commodity prices and demand Memo: are expected to constrain Basic balance -11.6 -5.5 -9.1 Indonesia’s export revenues As percent of GDP -1.3 -0.6 -1.0 over the medium term. At the Note: Basic balance = current account balance + net direct investment same time, manufacturing Source: BI; World Bank staff calculations exports have continued to decline despite the small depreciation (of 3.8 percent between January and October) of the real exchange rate this year. The current account deficit in 2016 has been revised down to 2.4 percent of GDP, as the projected public infrastructure-related pick-up in imports is smaller than previously expected. 5. Financial conditions remain tight, driven partly by lower foreign inflows Though global Indonesian asset prices have recovered most of the losses incurred during the recent financial volatility global financial turbulence episode. The Rupiah appreciated by 5.6 percent between has subsided since September 30 and December 7. However, net short-term capital outflows in the September, financing third quarter limited the availability of external financing (see Section 4). Higher conditions remain borrowing costs have also reduced the demand for external funding, especially from tight the private sector. At the same time, there are signs of a pick-up in domestic credit growth, in particular investment loans, since June. Indonesian equities The JCI increased by 7.0 percent between September 30 and December 7, after and the Rupiah have declining by 11.1 percent between August 10 and September 30 (Figure 11). Equity recovered most of prices in most emerging economies have recovered from the lows reached during the August — the equity market turbulence triggered by the Renminbi depreciation on August 11.9 September losses… However, some countries, such as Brazil, Turkey and South Africa, have experienced renewed volatility in December. After a significant appreciation of 8.1 percent between October 2 and 9, the Rupiah has stabilized at its early-August level, following the general emerging market trend. 8 World Bank, October 2015 Commodity markets outlook: Understanding El Niño: http://pubdocs.worldbank.org/pubdocs/publicdoc/2015/10/22401445260948491/CMO-October-2015-Full- Report.pdf 9 See also Part A Section 5 in the October 2015 IEQ. December 2015 THE WORLD BANK | BANK DUNIA 8 Reforming amid uncertainty Indonesia Economic Quarterly … and borrowing JP Morgan’s Emerging Market Bond Index - Global (EMBIG) spread for Indonesia costs have also decreased by 49 basis points between September 30 and November 20, after declined from their increasing by 125 basis point between June 30 and September 30. The recent highs corresponding changes in the global EMBIG spread, which measures average emerging market US dollar borrowing costs, were a decline of 67 basis points and a rise of 83 basis points. Similarly, Indonesia’s domestic 10-year government bond yield declined by 105 basis points between September 30 and November 20, after increasing by 145 basis points in the previous quarter. External debt growth The overall increase in external borrowing costs this year (including because of the has declined, as the depreciating Rupiah), coupled with weaker profits and higher foreign exchange service burden has hedging costs,10 have resulted in slower external debt growth. Foreign borrowing increased grew by 2.7 percent yoy in September, down from 6.3 percent in June and an average of 11.4 percent in 2011-2013 (Figure 12). Private external debt growth decelerated to 4.1 percent yoy in September, from 9.6 percent in June. Foreign borrowing by the trade, services, transport and communication, and manufacturing sectors declined by 22.0, 18.6, 16.6 and 4.7 percent yoy in the third quarter. Although the external debt-to-GDP ratio remains moderate, at 34.9 percent in September, Indonesia’s ability to repay debt from export revenues has worsened with the significant contraction in exports this year (by 13 percent yoy in January- September 2015). Figure 11: Emerging market equities have recorded Figure 12: Private external debt growth has tapered gains since September with the rise in debt burden (period change, percent) (growth yoy, percent, LHS; ratio to exports, percent, RHS) Brazil Indonesia Malaysia External debt/exports (RHS) 50 200 8 Turkey South Africa Government and BI 6 Private 170 40 4 140 2 30 110 0 20 80 -2 -4 50 10 -6 20 -8 0 -10 -10 -12 -10 -40 Aug 10-Sep 30 Sep 30- Dec 7 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Source: BI; JP Morgan; World Bank staff calculations Source: BI; World Bank staff calculations BI announced In response to heightened Rupiah volatility in August and September, on September several measures to 30 BI unveiled a set of measures to help stabilize the currency. The measures reduce volatility in include: foreign exchange interventions in the forward market; lengthening the the foreign exchange maturity of the BI deposit facility to three months; easing the reporting market requirements for forward foreign exchange transactions; issuing SBIs in foreign currency; and decreasing the SBI holding requirement from one month to one week. The new measures notwithstanding, BI continues to intervene in the foreign exchange spot market in periods of high volatility. In addition, on November 16 BI 10 The IDR-USD one-year onshore swap rate averaged 12.3 percent in Q3 2015, up from 8.5 percent in the previous quarter. December 2015 THE WORLD BANK | BANK DUNIA 9 Reforming amid uncertainty Indonesia Economic Quarterly renewed its bilateral currency swap agreement with China and raised the maximum amount to RMB 130 billion (USD 20 billion), from RMB 100 billion previously. BI also has bilateral swap agreements with Japan for USD 23 billion and with South Korea for KRW 10.7 trillion. Investment credit Credit growth recorded a Figure 13: The pick-up in credit growth since July growth picked up in slight pick-up from 9.6 has been driven by investment loans June percent yoy in July to 10.1 (growth yoy, percent) percent in October, mainly 20 because of an increase in 18 investment credit growth 16 (Figure 13). Investment 14 credit growth rose from 10.1 12 percent in June to 12.7 in 10 October. In line with the decline in deposit rates since 8 August 2014, deposit growth 6 Credit Investment loans eased to 9.0 percent yoy in 4 Working capital Deposits October, from 13.8 percent 2 in July. Bank performance 0 has been relatively stable, Jan-15 Apr-15 Jul-15 Oct-15 with non-performing loans Source: BI; World Bank staff calculations at 2.7 percent in September and net interest margins at 5.3 percent between July and September. 6. Higher budget execution rates supported growth in the third quarter By October, the Fiscal policy in 2015 features a strong tension between lower than projected revenue realized deficit collection and the desire to accelerate public spending disbursement to support reached 2.5 percent growth. As a result, by October the realized fiscal deficit reached 2.5 percent of of GDP, as fiscal GDP, exceeding the Ministry of Finance’s full-year target (revised in July) of 2.2 policy prioritized percent (Table 4).11 If recent trends continue into November and December, the growth fiscal deficit is likely to be higher than 2.5 percent by the end of the year. The large revenue shortfall is likely to constrain the implementation of the 2016 Budget, due to a “base” effect, and poses a risk of another revenue shortfall next year (see below). The broad-based Overall revenue collection in the first ten months of 2015 declined by 9.7 percent weakening in relative to the same period in 2014, reflecting low oil and gas prices and a weak revenues continued macroeconomic environment (Figure 14). By the end of October, total revenue in October 2015 outturns reached IDR 1,099.7 trillion, which is equivalent to 66.7 percent of the Ministry of Finance’s revenue outlook set in July 2015. This revenue realization compares with an average of 76 percent in the last five years. Cumulative tax revenue declined by 1.2 percent yoy, significantly below the targeted increase of 19 percent in the latest revenue outlook. Oil and gas revenues, both tax and non-tax, continue to be a major driver of the 2015 revenue slowdown. In January – October, oil and gas revenues contributed -10.7 percentage points yoy to the overall nominal revenue decrease, mostly owing to lower international oil and gas prices. VAT collection also continued to decline in line with the moderation in nominal growth of private consumption (8.0 percent yoy in Q1-Q3 2015versus an average of 11.8 First Semester 2015 Government State Budget Implementation Report (Laporan Pemerintah Tentang, Pelaksanaan 11 Anggaran Pendapatan dan Belanja Negara, Semester Pertama Tahun Anggaran 2015). December 2015 THE WORLD BANK | BANK DUNIA 10 Reforming amid uncertainty Indonesia Economic Quarterly percent yoy in the corresponding periods in 2012-2014) and the decrease in imports in the first three quarters of 2015. Figure 14: Oil and gas revenues continue to drive the Figure 15: Except for energy subsidies, disbursement revenue slowdown rates were higher than in previous years (contributions of selected revenue categories to nominal revenue growth (IDR trillion, LHS; percent yoy, RHS) yoy, percent) Income taxes O&G Income taxes N-O&G Jan-Oct 2013 Jan-Oct 2014 VAT/LGST Excises Jan-Oct 2015 2015 growth (yoy, RHS) Import duties Export tax 600 60 NTR O&G NTR N-O&G Total revenues 500 50 20.0 400 40 300 30 10.0 200 20 100 10 0.0 0 0 -10.0 -20.0 Jan-Oct 2013 Jan-Oct 2014 Jan-Oct 2015 Note: O&G stands for “oil and gas”, N-O&G – “non-oil and Note: Energy subsidies declined by 68 percent yoy (not shown on gas”; LGST – “luxury goods sales tax”; NTR – “non-tax chart). revenues”. Source: Ministry of Finance; World Bank staff calculations Source: Ministry of Finance; World Bank staff calculations Public spending After a slow start in the first half of the year, expenditure disbursement accelerated accelerated across and reached IDR 1,384 trillion in October – 72.4 percent of the full-year allocation expenditure in the revised 2015 outlook. All expenditure items, except energy subsidies, categories in H2 experienced a strong 20 percent yoy nominal growth (Figure 15). In particular, the 2015… disbursement of capital expenditure increased by 39 percent yoy, though it remained low relative to the ambitious target in the revised 2015 Budget. … though project According to data from the Budget Realization Evaluation and Monitoring Team,12 implementation public spending disbursement varied across line ministries. For example, spending varied across by the Ministry of Public Works and Housing reached 48.5 percent of the target, ministries and while the Ministry of Transport only 28.4 percent, and the Ministry of Energy and between the central Mineral Resource 28.6 percent. In addition, transfers to sub-national governments, and sub-national including the Village Fund, accounted for 83 percent of the full-year allocation, up governments by 14.7 percent yoy. However, actual spending by local governments remains a challenge.13 The recently The 2016 Budget, which was approved by Parliament on October 30, contains approved 2016 further improvements in the composition of spending, including further reduction Budget foresees in energy subsidies and higher spending on health, infrastructure and social further assistance. However, reaching the 2016 total revenue target could be challenging, improvements in the given the revenue shortfall in 2015 and continuing weak macroeconomic conditions composition of and low commodity prices. The government projects a fiscal deficit of 2.2 percent spending… of GDP (IDR 273.4 trillion) next year. 12http://monev.lkpp.go.id/tepraPerubahan/summary?instansi=K18&tahun=2015 13According to media reports citing the Ministry of Home Affairs, by September 22 provincial governments spent on average only 50 percent of their budgets (19 percent in the case of DKI Jakarta): http://m.republika.co.id/berita/nasional/umum/15/10/03/nvm246354-penyerapan-apbd-pemprov-dki-jakarta- terendah-dari-34-provinsi-seindonesia. December 2015 THE WORLD BANK | BANK DUNIA 11 Reforming amid uncertainty Indonesia Economic Quarterly … though the The revenue target for 2016 is set at IDR 1,822 trillion (14.3 percent of GDP). The optimistic revenue rise in revenues is expected to come entirely from higher tax receipts, up 13.1 target will require percent relative to the latest 2015 revenue outlook, while non-tax revenues are significant tax projected to contract by 2.0 percent. The 2016 Budget includes several tax measures collection which, if implemented effectively, are expected to help mobilize additional tax improvements revenues in 2016. Apart from a planned adjustment in excise tariffs, all of the proposed measures refer to improvements in tax administration by increasing the capacity for revenue collection of the Directorate General of Tax and the Directorate General of Customs and Excises through improvements in IT, audit procedure, and law enforcement. Further reduction in Total public expenditure, Figure 16: Higher health, infrastructure and social energy subsidies in at IDR 2,096 trillion (16.6 assistance spending is planned for 2016 2016 will allow for percent of GDP), is set to (IDR trillion ) more spending on rise by 9.7 percent relative Fuel subsidy Infrastructure development to the revised 2015 300 Social assistance Health priorities… outlook. The main reason for the increase is the 250 significant rise in transfers to local governments, 200 including the Village Fund (see also Part B.2), by 15.9 150 percent yoy. Energy 100 subsidies are expected to decline by 27 percent 50 compared with the allocation in the revised 0 2015 outlook, providing 2012 2013 2014 2015* 2016** further fiscal space for Note: See footnote 3 in main text. spending on infrastructure, Source: Ministry of Finance; World Bank staff calculations health, and targeted social assistance (Figure 16).14 The government plans to further improve the targeting of electricity subsidies, in particular for households with 450VA – 900VA power supply, by using the unified database which is managed by the National Team for the Acceleration of Poverty Reduction (TNP2K) and which compiles social economic information for 96 million individuals (around 40 percent of Indonesia’s population).15 … such as According to the 2016 Budget, the allocation for infrastructure development will infrastructure, health rise by 7.2 percent from the level in the revised 2015 Budget. Most of the increase is and targeted social expected to materialize through higher transfers to local governments (mainly assistance through the Special Allocation Find (Dana Alokasi Khusus, DAK) and the Village Fund (Dana Desa)) and capital injections into state-owned enterprises,16 which will 14 Infrastructure and health spending refers to the definition outlined in the draft 2016 Budget Financial Note. Infrastructure spending includes expenditures of the ministries of Public Works and Housing, Transport, Energy and Mineral Resources, and Agriculture; transfers to sub-national governments through DAK (see next paragraph) and the Village Fund; as well as capital injections into state-owned enterprises. Health spending includes expenditures by the Ministry of Health and the Medicine Control Agency, and transfers to local governments through DAK. Social assistance follows the World Bank definition and excludes the health insurance subsidy for the poor (PBI), which is included in health spending, and the temporary programs to compensate for subsidized fuel price increases. 15 Global Subsidy Initiative, Indonesia Energy Subsidy Briefing November 2015: https://www.iisd.org/gsi/news/indonesia-news-briefing-november-2015. 16 Parliament has made the planned capital injection of IDR 40.2 trillion conditional on discussions to revise the 2016 Budget, which are likely to happen in Q1 2016. December 2015 THE WORLD BANK | BANK DUNIA 12 Reforming amid uncertainty Indonesia Economic Quarterly offset the 15-percent decline in central line ministry budgets. To support the implementation of the national health insurance program (Jaminan Kesehatan Nasional, JKN) and to achieve universal access to healthcare by 2019, the government plans to expand the coverage of subsidized health insurance (Penerima Bantuan Iuran, PBI) from 88.2 million people in 2015 to 92.4 million people in 2016. The budget allocation for this will rise from IDR 20.3 trillion in the revised 2015 Budget to IDR 25.5 trillion next year. The government has also allocated more funds for other health spending (central and estimated sub-national spending), reaching the minimum 5 percent of total expenditure threshold mandated by Law 36/2009 concerning Health (compared with 3.7 percent in the revised 2015 Budget). In addition, the government plans to double the number of conditional cash transfer (Program Keluarga Harapan, PKH) beneficiaries from 3 million households in 2015 to 6 million in 2016 and the budget allocation from IDR 6.1 trillion to IDR 13.8 trillion. Table 4: The Ministry of Finance projects a fiscal deficit of 2.2 percent of GDP in 2016 (IDR trillion, unless otherwise indicated) 2015 2015 2015 2016 Ministry of January – October Revised Budget Finance revised Budget Budget realization outlook A. Revenues 1,762 1,650 1,100 1,822 1. Tax revenues 1,489 1,367 894 1,547 Income tax 679 678 441 757 Oil and gas 50 52 43 41 Non-oil and gas 630 596 397 716 VAT/LGST 577 498 308 572 International trade taxes 49 40 28 40 Import duties 37 35 25 37 Export taxes 12 5 3 3 2. Non-tax revenues* 269 279 205 274 B. Expenditures* 1,984 1,910 1,384 2,096 I. Central government 1,320 1,246 830 1,326 Personnel 293 N/A 234 N/A Material 239 N/A 132 N/A Capital 276 N/A 99 N/A Interest payments 156 157 133 185 Subsidies 212 214 151 183 Energy subsidies 138 140 105 102 Fuel 65 66 59 64 Electricity 73 75 45 38 Non-energy subsidies 74 74 47 81 Grants 5 N/A 1 4 Social 104 N/A 76 0 Other expenditures 36 N/A 4 0 II. Transfers to regions 665 664 554 770 C. Primary balance -67 -103 -151 -89 D. Overall balance -223 -260 -284 -273 as percent of GDP -1.9 -2.2 -2.5 -2.2 Key economic assumptions Real GDP growth (percent) 5.7 5.2 5.3 CPI (yoy, percent) 5.0 4.2 4.7 Exchange rate (IDR/USD) 12,500 13,100 13,900 Crude-oil price (USD/barrel) 60 59 50 Oil production ('000 barrels/ day) 825 825 830 Note: * Unpublished Ministry of Finance data. Source: Ministry of Finance December 2015 THE WORLD BANK | BANK DUNIA 13 Reforming amid uncertainty Indonesia Economic Quarterly 7. Job creation has weakened and become even more reliant on low- productivity sectors The growth Indonesia’s recent labor market performance has been adversely affected by the moderation has economic slowdown and weaker external conditions which followed the end of the resulted in higher commodities boom. Job creation in the past year has been modest, with less than unemployment in 200,000 new jobs created between August 2014 and August 2015. This compares 2015… with an average of 2.6 million new jobs created yearly between 2006 and 2012, and with an increase in the working-age population by 3.1 million. As a result, the aggregate employment rate declined to 61.7 percent, the lowest it has been since 2008. The aggregate unemployment rate increased to 6.2 percent, from 5.9 percent in August 2014, reversing the declining trend observed in the past decade (Figure 17). Figure 17: Moderate growth has resulted in higher Figure 18: … with only the construction and trade unemployment… sectors driving job creation (share of labor force, percent) (change in the number of employed yoy, millions) 65 12 Average 2006-2012 2013 2014 2015 Agriculture 10 60 Employment Social & personal rate (LHS) services 8 Mining, quarrying 55 +electricity 6 Manufacturing 50 Unemployment rate (RHS) 4 Transport & comm Finance, real estate & 45 business services 2 Wholesale & retail trade 40 - 2001 2003 2005 2007 2009 2011 2013 2015 Construction -1.5 -1 -0.5 0 0.5 1 1.5 Source: BPS; World Bank staff calculations Source: BPS; World Bank staff calculations … with agriculture The sectors that have experienced the largest job losses are agriculture, with over 1.2 and social and million jobs lost, and social and personal services, with 500,000 jobs lost (Figure 18). personal services While the decline in employment in agriculture has been an ongoing trend during losing jobs the last fifteen years, in the last year job losses in this sector were the worst since 2011. Social and personal services, on the contrary, have been one of the sectors with the highest contribution to job creation during the past decade, with 1 million new jobs created each year between 2006 and 2012. Therefore, its recent slowdown can be particularly worrying, as informal and low-skilled workers formerly employed in this sector may have difficulties finding new opportunities under weaker macroeconomic conditions. An additional worrying signal is coming from the manufacturing industry, where employment has been stagnant, likely reflecting lower external and domestic demand. While construction The sectors that still contribute significantly to job creation are construction, which and trade continue to in the past two years has created more than twice as many jobs as during 2006-2012, create jobs… and wholesale and retail trade. Furthermore, advanced services, such as banking, finance, and real estate, although still contributing modestly to overall job creation, have exhibited an encouraging trend. December 2015 THE WORLD BANK | BANK DUNIA 14 Reforming amid uncertainty Indonesia Economic Quarterly … those jobs are Although the rise in unemployment has so far been moderate, the underlying trends low-productivity are a cause for concern. The sectors currently creating jobs may simply be absorbing ones unskilled labor shed by other sectors, such as agriculture, personal services and manufacturing. Moreover, the sectors that are still creating employment – construction and trade – are low-productivity sectors. It is, therefore, unlikely that their expansion, without a revitalization of the manufacturing sector, will lead to the productivity jump that Indonesia still needs to address its structural challenges in the midst of the current economic slowdown. 8. The improvement in investment hinges on the government’s reform effort Risks related to Risks to the World Bank’s economic outlook for Indonesia are tilted to the global growth, trade downside. The main external risks, unchanged from the October 2015 IEQ, include and financial a stronger than projected slowdown in emerging market economies, including markets remain to China’s, weaker than expected global trade recovery, and lower than projected the downside commodity prices. Despite recent stabilization in global financial markets, renewed increases in financial market volatility remain a risk. Higher external borrowing costs may further constrain investment. Moreover, a weaker than expected Rupiah, in addition to higher emerging market interest rate spreads, may raise private sector balance sheet pressures, with negative consequences for investment as well. Public financing On the domestic front, as the driver of growth in the short term has shifted to the risks in 2015 are public sector, a key risk to the outlook is weaker than expected fiscal revenues. limited… Higher budget disbursement rates, coupled with weak revenue collection, have resulted in larger than expected budget deficit and gross financing needs in 2015. According to the Directorate General of Budget Financing and Risk Management, 2015 gross financing needs are IDR 497.2 trillion with a budget deficit of 2.2 percent of GDP. If the 2015 budget deficit reaches the legal limit of 2.7 percent of GDP for the central government,17 gross financing needs will increase by IDR 52 trillion (0.6 percent of GDP). As of December 2, the government has already secured IDR 510.4 trillion from securities issuance and USD 3.89 billion (around IDR 53 trillion) in foreign official lending. Frontloading of government securities issuances and greater reliance on multilateral financing have helped mitigate fiscal risks in 2015. … but expenditure Although financing risks are limited, if revenues were to weaken further in the cuts may be needed, remaining weeks of 2015, expenditures may have to be cut. For example, the if revenues weaken government may need to postpone capital projects or delay payments. This, in turn, further… will limit the public infrastructure spending momentum and may reduce growth. The full implementation of the government’s current expenditure plans for 2016 is also at risk, if revenue collection is to remain weak. … putting the onus On the upside, the recent policy reform packages’ focus on deregulation (see Box 1) on regulatory reform may help lift private sector sentiment and private investment going forward. implementation to Because the policy space for economic stimulus remains constrained, attention has improve investor turned to the structural reform measures announced in September—December this sentiment year. So far, however, a comprehensive assessment of the impact of the packages is not available and private investment growth has remained subdued (see Section 2). Early signs of effective reform implementation may help provide a much needed boost to business confidence. 17 PMK No. 183/PMK 07/2014. See also page 17 of the July 2015 IEQ. December 2015 THE WORLD BANK | BANK DUNIA 15 Reforming amid uncertainty Indonesia Economic Quarterly Box 1: An important and wide-ranging reform process was initiated in September The Government started a significant effort of regulatory reform with seven economic policy packages announced between September 9 and December 4, 2015. Further packages are expected over the coming years. The recently announced reforms go beyond regulatory simplification and fiscal stimulus, and include structural reforms (Table 5). The Government’s intent is fourfold: to increase investments, revitalize domestic industry, facilitate trade and improve logistics, and ease the procurement of raw materials, particularly in such sectors as agriculture, marine affairs and fisheries, and mining products. As usual, implementation will be the crucial test. While some measures could be adopted immediately (e.g. the electricity subsidies), most regulatory reforms require structured and broad-based consultation (including with consumers, users of intermediate inputs or services and producers) to ensure policy consistency and economy-wide benefits and to avoid unintended consequences.1 Table 5: The government’s reform agenda is broad-based* Package Focus Main proposed reforms I Regulatory - Rationalize regulations by eliminating redundancies and inconsistencies (134 new simplification regulations which largely revise existing ones; 16 ministries and agencies responsible for enacting them). II Investment - Simplified procedures to obtain a license to invest in industrial estates; climate - Accelerated procedures to obtain tax incentives; - Development of new bonded logistics parks. III Small enterprises - Subsidized access to fuel, electricity and gas; and cooperatives - Reduced interest rates for micro-loans under the Micro-, Small- and Medium-sized Enterprise Credit (Kredit Usaha Rakyat, KUR) program; - Simplified land licensing. IV Minimum wage - Formula-based minimum wages; determination - Expansion of KUR’s coverage. V Tax relief - Asset revaluation with a lower income tax revaluation tariff;** - Removal of double taxation on real estate, property and infrastructure to encourage the development of real estate fund investment products; - Deregulation in sharia banking. VI Special economic - Tax incentives, licensing and customs processing simplification, etc., to make zones (SEZs) investment in SEZs more attractive; - New regulations to provide legal certainty for private companies that operate drinking water supply systems; - Fully paperless electronic applications for import licenses for drugs, raw materials for drugs and traditional medicines, cosmetics, food, and supplements. VII Access to - Accelerate the process of land title registration to help enable micro- and small-sized collateral through enterprises to use the land as collateral, as well as introduce an electronic land land titles registration system; - Reduce the income tax for enterprises and workers in labor intensive industries in all provinces in Indonesia. Note: * The table highlights the main proposed reforms. More information on the packages can be found on the Coordinating Ministry for Economic Affairs website: http://ekon.go.id/ekliping. ** From 10 percent to 3-6 percent, depending on submission date. Source: Coordinating Ministry for Economic Affairs Most of the proposed reforms are work in progress, with some regulations already enacted, and some in the pipeline. For instance, as of November 4, the Ministry of Trade had revised 15 regulations, which included removing/ simplifying 10 selected import licenses (i.e. forest products, textile and batik textile products, sodium polyphosphate, clove, tire, optical disks, cooling system based goods, ozone destroying materials, horticulture products). The reduced fuel and electricity prices for industry entered into effect immediately, with the gas price reduction to enter into effect on January 1, 2016. The Indonesia Investment Coordinating Board enacted regulation to facilitate a three-hour investment licensing service. Others are work in progress, requiring inter-ministerial coordination and agreement, or are being reviewed by the Ministry of Law and Human Rights to ensure format compliance and conformity with more superior regulations already in effect as part of the so-called ‘harmonization process’. For the reforms to be felt on the ground, local government buy-in and implementation capabilities are critical. National reforms will not have much impact without local adoption and implementation.2 Starting in Surabaya, Jakarta, Bali, Batam, Semarang, and Banjarmasin, the Coordinating Ministry for Economic Affairs recently initiated a consultation process with sub-national governments to communicate about the packages, as well as to collect new ideas. Progress at the local level is likely to happen at different speeds across the archipelago. To accelerate the process, local December 2015 THE WORLD BANK | BANK DUNIA 16 Reforming amid uncertainty Indonesia Economic Quarterly governments could be given incentives to participate in the ongoing reform drive. Reform champions can be identified and supported through a dedicated program. To sustain the reform effort, an institutionalized, empowered and centralized review process for new regulations against government objectives would be needed to manage the ongoing reform implementation and the “flow” of incoming regulations. The experiences of countries that successfully accelerated business climate reforms show the importance of a dedicated reform team with frequent reporting to the highest level of government. In addition, strengthened and broad-based private sector participation can promote transparency and facilitate effective communication of successful reforms. In some countries, such as South Korea, Sweden, Mexico, Hungary and Mongolia, a comprehensive inventory of all licenses has led to concrete reform actions. They introduced a “regulatory guillotine”, which tests the legality, necessity and business friendliness of a given regulatory requirement, with three possible outcomes: abolish, amend or leave as-is. International experience offers different ways in which government agencies can improve the quality of the “flow” of incoming regulations (e.g., relying on regulatory impact assessment), minimize the disruption that comes from unexpected rule-making (e.g., through notice-and-comment processes), and avoid unintended negative impact on the private sector (e.g., via public-private dialogue). Finally, complementary process improvements areimportant. For instance, in the case of easing imports, the implementation of process improvements, such as fully paperless electronic applications, parallel processing, and a risk-based import approval regime, would significantly enhance reform outcomes. Note: 1 For instance, two newly enacted regulations (Ministry of Trade Regulation Nos. 87/2015 and 70/2015) created controversy by making it more difficult for producers to import, and their implementation is currently on hold by virtue of Minister of Trade Regulations; 2 For example, in October 2014, twelve years after passing the law on building, less than half of the regions in the country had passed regulations on building permits; not all regions with regulations had actually implemented them; and only 16 regions had appointed expert teams to appraise applications. Presentation by Ministry of Public Works (MoPW), October 2014: http://www.academia.edu/8832085/Implementasi_Peraturan_Daerah_Mengenai_Bangunan_Gedung; information verified with MoPW officials. December 2015 THE WORLD BANK | BANK DUNIA 17 Reforming amid uncertainty Indonesia Economic Quarterly B. Some recent developments in Indonesia’s economy 1. Indonesia’s fire crisis: Who benefits and who pays? Man-made fire and According to the government, 2.6 million hectares of land burned between June and haze cost Indonesia October 2015,18 an area four and half times the size of Bali. Man-made fires – more IDR 221 trillion in than 100,000 of them19 – were used to prepare land for agriculture and to gain just five months access to land cheaply. The absence of controlled burning measures or sufficient law enforcement meant that the fires grew out of control, fed by drought and exacerbated by the effects of El Niño. This vast economic and environmental crisis is repeated year after year, as a few hundred businesses and a few thousand farmers seek to profit from land and plantation speculation practices, while tens of millions of Indonesians suffer health costs and economic disruptions. In 2015, fires cost Indonesia an estimated IDR 221 trillion (USD 16.1 billion) (see Section b). Regional and global costs would be much higher. The government has pledged to prioritize a response and the president has called for action. Now is the time for Indonesia to address the underlying drivers of man-made fires, enforce laws and revise policies in order to reduce the risk of these economic disasters from recurring. 18 Communicated by Indonesia’s Ministry of Environment and Forestry at the Meeting of Communication Forum for Disaster Data and Information in Jakarta November 10, 2015. 19 Global Fire Emissions Database: http://www.globalfiredata.org/index.html. December 2015 THE WORLD BANK | BANK DUNIA 18 Reforming amid uncertainty Indonesia Economic Quarterly Unlike years past, By October 2015, eight provinces had Table 6: Hectares burned by province, fires in Papua were a burned more than 100,000 hectares each. June – October 2015 big part of the 2015 In line with historical patterns, the Province Thousand Percent fire crisis islands of Sumatra and Kalimantan – hectares 1 S. Sumatra 608 23 where most of the country’s fragile 2 Cen. Kalimantan 429 16 peatlands (lahan gambut) are located – 3 E. Kalimantan 388 15 were the hardest hit. The provinces of 4 S. Kalimantan 292 11 South Sumatra and Central Kalimantan 5 Papua 268 10 represented 23 percent and 16 percent of 6 W. Kalimantan 178 7 the total burned area, respectively. 7 Riau 139 5 8 Jambi 123 5 Unlike past years, however, fires in Other 186 7 Papua were particularly widespread, Total 2,611 100 resulting in 10 percent of the total area Source: Agency for the Assessment and burned nationally. Draining and Application of Technology (Badan Pengkajian dan Penerapan Teknologi, BPPT); Ministry of conversion of peatlands, driven largely Environment and Forestry; World Bank staff by palm oil production, contributes to calculations the intensity of haze from fire. About 33 percent of the total area burned was peatlands, leading to noxious haze that blanketed parts of Indonesia and the region, disrupting transport, trade, and tourism, forcing school closures and negatively affecting health. The 2015 fires also contributed significantly to Indonesia’s substantial greenhouse gas (GHG) emissions (see Box 3). Box 2: Certification standards could encourage environmentally friendly production practices In 2015, the estimated economic cost of fire to Indonesia (IDR 221 trillion) was larger than the estimated value added from Indonesia’s 2014 gross palm oil exports (IDR 115 trillion) and the value added from the country’s entire 2014 palm oil production (IDR 168 trillion).1 While not all fires are set to clear land for oil palm, oil palm – an important and growing sector of the economy – is a large driver of land conversion. Given government support for its continued expansion,2 coupled with the negative externalities of use of fire in some oil palm production, a consideration of the relative costs of both is warranted. Indonesia has a mandatory certification scheme – the Indonesian Sustainable Palm Oil Initiative (ISPO) – governing oil palm production on plantations greater than 25 hectares that promotes sustainably-produced oil palm. In addition, most large companies subscribe to the Roundtable on Sustainable Palm Oil (RSPO) – a voluntary certification scheme globally accepted as the mark of sustainability. In addition, the Indonesia Palm Oil Pledge (IPOP) is a platform where participating companies pledge to produce and trade only deforestation-free oil palm within their supply chains. This means not sourcing palm oil produced on peat or old shrub lands or from areas that were once primary or secondary forests. Traceability is a key element of the IPOP commitment as it mandates that the palm fruit produced or traded is consistent with deforestation-free and sustainable agriculture practices. Given that IPOP members represent 60-65% of Indonesia’s (2013) 33 million tons of annual crude palm oil production, commitment to such standards implies a significant part of Indonesian production should be deforestation-free. However, there are technical challenges to ensuring the IPOP pledge is met. Specifically, government has expressed concern that some producers, namely smallholders, may not be able to comply and have pushed for these producers to be exempted. Monitoring is impeded, in part, by the absence of a transparent, agreed-upon map of sensitive areas that are off-limits to development. Several steps could make certification schemes and pledges more robust, leading to more sustainable production practices. On the policy side, a government regulation for peatland protection, restoration, and management, including a roadmap for transitioning people and production off of sensitive peatland areas, should be formalized and enforced. Technical follow-up is also needed. Specifically, given that some certification standards, including the RSPO, call for the protection of lands with high conservation value and/or high carbon stock, a government-led, publically-consulted inventory– including on peatlands – would provide a single set of data to inform a baseline upon which policy and investment decisions could be made. Additionally, monitoring and implementation of responsible production standards would be strengthened considerably with the finalization of the OneMap initiative, which aims to integrate relevant land-use and boundary data into a single, publically-available database for Indonesia. Such a map could help guide investment decisions by demarcating forest from non-forest lands. Data could also be integrated to include additional December 2015 THE WORLD BANK | BANK DUNIA 19 Reforming amid uncertainty Indonesia Economic Quarterly information on sensitive ecosystems (e.g., peatlands and primary forest), and identify lands that may need further protections. Note: 1 Based on a gross export value of USD 17.5 billion in 2014 and total palm oil production value of IDR 302.5 trillion (USD 25.5 billion) multiplied by the palm oil industry value added share 0.556 of total palm oil output taken from the Indonesian 2008 Input-Output table. The data sources are Food and Agriculture Organization, Indonesian Palm Oil Producers Association, and Indonesian Ministry of Agriculture; 2 The government aims to increase crude palm oil production to 40 million tons by 2020, from around 31 million tons in 2014 (Krisnamurti, B., 2008, “Government strategic policies in sustainable oil palm development,” presentation at the Indonesian Palm Oil Conference and Price Outlook 2009, Bali. Few gain, many lose Fire has long been a tool for agriculture in Indonesia. Informally, it also plays an from repeated fire important role in land acquisition. This means that, while many suffer extensive fire and haze events and haze-related losses, there are a few who make significant gains. This article looks at this winner-loser dynamic, estimating the economic losses and damages associated with fire and haze in 2015 from eight provinces and relating these to profits gained from one area of agriculture – oil palm. a. Palm oil production is worth billions: who benefits? Fire is a cheap way Indonesia’s fire story is not just one of loss and damage; fires contribute to to clear land for significant economic upside for a diverse, if concentrated, group of actors. Fire is an agriculture… integral part of the process of large-scale conversion of the nation’s rich forest assets, particularly peatlands, into agricultural lands for private benefit. The growth in the prevalence of fire correlates with the expansion of lucrative agricultural commodities such as palm oil and acacia for wood fiber. Land conversion by fire is prohibited by Law No. 32/2009 and penalties include fines and prison terms. Yet, the alternative of mechanical clearing with heavy equipment can be many times more expensive.20 …and an effective There are three common uses for fire in Indonesia: (i) land clearing and preparation; tool for land (ii) land acquisition; and (iii) as a mechanism to force inhabitants off the land. As a acquisition tool for acquisition, landholders burn beyond their concession boundaries or those with no formal claim to the land burn land and then claim it. Without effective enforcement there is no control; and, given the profitability of crops such as oil palm, there is a strong incentive to continue the practice. The cashflow Analysis by the Center for International Forestry Research (CIFOR) provides an generated in just example of the role of fire in the lucrative palm oil industry. Looking at 11 sites three years on one outside of concessioned plantations across 4 districts in Riau, CIFOR concluded hectare of low- that using fire for land acquisition and clearing generates a cashflow of at least USD productivity oil palm 3,077 per hectare of oil palm in just three years.21 While the production process is about USD 3,000 involves illegal means for land clearing, the resulting palm oil is processed at the same facilities as legally-produced palm fruit before both types are sold for consumption. If every hectare burned in 2015 were converted to oil palm, the value would be about USD 8 billion, highlighting the scope for high profit in a short period of time. Poor land management and governance allow this ecologically- destructive activity to continue. Peatlands are a target as they are generally uninhabited and relatively free of overlapping claims. 20 Simorangkir, D., 2007, “Fire use: Is it really the cheaper land preparation method for large-scale plantations?”, Mitig Adapt Strat Glob Change, 12: 147—164. 21 Purnomo, H., Shantiko, B., Gunawan, H. 2015, Political economy study of fire and haze, presented at the International Seminar “Toward a sustainable and resilient community: Co-existence of oil palm plantation, biodiversity and peat fire prevention”, August 5, 2015, University of Riau, Pekanbaru, Bogor, Indonesia: Center for International Forestry Research. December 2015 THE WORLD BANK | BANK DUNIA 20 Reforming amid uncertainty Indonesia Economic Quarterly A concentrated few The CIFOR work finds that 85 percent of the cashflow generated goes to local benefit significantly elites – i.e., those in power or able to take financial risk – and to plantation from Indonesia’s developers. Smaller profits accrue to the land claimant (1 percent), land broker (2 pervasive fires percent), tree cutters (3 percent), slashers (3 percent) and burners (1 percent), and the oil palm farmer (5 percent). Without alternative commensurate economic opportunities, it is no surprise oil palm plantation expansion (especially on peat) continues. However, the rapid expansion also incurs negative impacts that carry domestic, as well as regional and global losses, affecting far more people than the relatively few who benefit. Box 3: Peat fires have significant consequences for climate change Calculating the GHG emissions from Indonesia’s fires is difficult and hinges primarily on quantifying the amount and depth of peatlands burned. While all fires produce GHG emissions, the CO2 emissions from fire are usually balanced by regrowth after the fire. However, this is not the case for peat fires because they burn carbon that has been deposited over thousands of years and cannot be replaced. Peatlands have long been a target for land conversion – draining seemingly unproductive swamp land and then clearing it with fire for agriculture. Dry peatland is quick to burn and difficult to extinguish. Most peat is found on Sumatra, Kalimantan, and Papua but there is no agreed map nor a complete baseline of peatland areas. Allowing drainage and burning of peatlands has significant, even global, consequences for climate change, as well as on health and the economy in Indonesia and the region. In addition to contributing significantly to GHG emissions, peat fires also produce haze due to their high content of aerosols. The Global Fire Emissions Database version 4 (GFED4) provides a best, if uncertain, estimate of the GHG emissions impact of the 2015 fires by extending estimates of earlier years based on satellite-derived burned area and fuel consumption with satellite detections of active fires.1 GFED estimates that in 2015 Indonesian fires contributed roughly 1,750 million metric tons of carbon dioxide equivalent (mtCO2e) to global emissions in 2015. By comparison, based on its 2nd National Communication to the United Nations Framework Convention on Climate Change, Indonesia estimates that its annual economy-wide emissions are 1,800 MtCO2e. Indonesia has pledged to reduce emissions by 29 percent (or 41 percent with international financial support) compared with a business-as-usual scenario by 2030 as part of its contribution to keep global temperatures from exceeding 2 degrees Celsius. Fires like those in 2015 will make reaching this target impossible. Note: 1This approach is described in Van der Werf et al. (2010), “Global fire emissions and the contribution of deforestation, savanna, forest, agricultural, and peat fires (1997–2009)” Journal of Atmospheric Chemistry and Physics, and further detailed on the GFED website. b. The 2015 fires cost Indonesia an estimated IDR 221 trillion: who pays? In 2015, fire in The World Bank estimates that the 2015 fires cost Indonesia at least IDR 221 Indonesia cost nearly trillion (USD 16.1 billion), equivalent to 1.9 percent of 2015 GDP. This is more twice that of than twice the reconstruction cost following the Aceh tsunami.22 The analysis reconstruction estimates impacts on agriculture, forestry, trade, tourism, and transportation. The following the 2004 short-term effect of haze exposure on health and school closures are also included. tsunami in Aceh Other costs captured include those to the environment, emergency response, and fire suppression. However, the estimate does not fully capture long-term impacts on health of sustained exposure to haze, nor the loss of all ecosystem services. Furthermore, it does not incorporate regional or global losses. The analysis is based The estimates presented here cover the period June 1 - October 31, 2015 and 2.4 on the UN disaster million of the 2.6 million hectares – or 94 percent – of the burned area in South loss and damage Sumatra, Central Kalimantan, South Kalimantan, West and East Kalimantan, Riau, assessment Jambi, and Papua. The analysis uses a disaster assessment methodology developed methodology and by the UN Economic Commission for Latin America and the Caribbean 22As reported by the World Bank: http://www.worldbank.org/en/news/feature/2012/12/26/indonesia- reconstruction-chapter-ends-eight-years-after-the-tsunami. December 2015 THE WORLD BANK | BANK DUNIA 21 Reforming amid uncertainty Indonesia Economic Quarterly covers almost all (ECLAC).23 Costs are based on an analysis of the types of land burned as reported burned areas by the Government of Indonesia.24 Where available, actual costs are used. Damages reported by the are an estimate of the amount of financing needed for reconstruction and government rehabilitation, while losses represent the reduction in economic activities and income resulting from the disaster. Figure 19: Affected provinces have suffered damage Figure 20: …which has reduced 2015 GDP growth and losses due to fire and haze… (percent) (percent, LHS; IDR trillions, RHS) Total damage and losses Percent of GDP BI May 2015 growth forecast 40 60 10 Disaster adjusted growth forecast 35 50 8 30 6 25 40 4 20 30 2 15 20 10 0 5 10 -2 0 0 -4 Source: BPS; World Bank staff calculations Note: The provincial growth forecasts are from BI Archipelago Report (Laporan Nusantara), August 2015. Source: BI; BPS; World Bank staff calculations Fire and haze are According to the estimates, fire and haze have resulted in damage and loss values estimated to have ranging between IDR 11.9 trillion (USD 866 million) in Jambi to IDR 53.8 trillion caused substantial (USD 3.9 billion) in South Sumatra (Figure 19). As a share of provincial GDP, reductions in GDP Central Kalimantan is estimated to have suffered the most – 34 percent – half of growth in the which came from agriculture, mainly oil palm plantations. Real GDP growth in the affected provinces affected provinces may be lower by between 0.7 and 4.7 percentage points in 2015, all else equal. The impact Agriculture and forestry have sustained estimated losses and damages of IDR 120 assessment for 2015 trillion in 2015 (USD 8.8 billion) (Table 7). Damages to agriculture include those to indicates agriculture infrastructure and equipment, while losses capture the cost of reclaiming burned and forestry losses of lands for planting and the foregone production revenue during this reclaiming IDR 120 trillion… period. As a result, the 2015 fires are estimated to cause additional losses of about IDR 11 trillion per year for the next three in the case of estate crops (e.g., palm oil, rubber, and coconut) and five years for forests. Damages to estate crops affected companies and small-holder farmers. Costs to food crops (IDR 23.7 trillion) translate into lower incomes for farmers and possible impacts on food security. Forestry losses of IDR 54 trillion include the lost value of timber and the cost of reforestation. 23 ECLAC (2014), Handbook for Disaster Assessment: http://caribbean.eclac.org/content/handbook-disaster- assesment. 24 For 33 percent of the land these details are unknown. In these cases the lowest land value is applied. December 2015 THE WORLD BANK | BANK DUNIA 22 Reforming amid uncertainty Indonesia Economic Quarterly Table 7: Estimated losses and damages from forest fires and haze in June-October 2015 reached IDR 221 trillion (IDR billion) South West South Central East Jambi Riau Suma- Kaliman- Kaliman- Kaliman- Kaliman- Papua Total tra tan tan tan tan Agriculture 2,890 2,482 14,190 4,793 7,187 17,051 15,488 2,370 66,452 Estate crops 1,839 1,841 3,575 3,274 2,315 14,765 13,813 1,311 42,734 Food crops 1,052 641 10,615 1,519 4,872 2,286 1,675 1,059 23,718 Environment 3,109 3,139 16,552 5,158 5,317 10,660 7,282 7,188 58,406 Biodiversity loss 233 335 988 312 369 455 449 803 3,943 Carbon emission 2,876 2,805 15,565 4,846 4,947 10,205 6,833 6,386 54,462 Forestry 1,863 4,175 13,348 2,309 9,583 1,260 11,194 10,246 53,977 Manufacturing and mining 396 2,511 1,823 836 1,678 196 943 0 8,382 Trade 2,528 4,008 3,982 1,652 1,913 1,804 1,481 929 18,298 Transportation 280 430 1,106 237 912 1,522 435 185 5,107 Tourism 140 1599 1626 740 523 571 225 50 5,474 Health 495 298 388 165 327 230 167 8 2,079 Education 53 55 123 61 77 72 61 39 540 Firefighting costs 137 155 677 198 325 477 431 299 2,700 Total in IDR million 11,892 18,853 53,814 16,149 27,843 33,842 37,708 21,314 221,415 Note: Losses do not account for the economic benefit to those who set fires. Source: Bogor Agricultural University; BPPT; BPS; CIFOR; media reports; Ministry of Health; regional governments; World Bank staff calculations … and IDR 59 Costs to the environment were substantial (26 percent of the total) and include trillion in losses to biodiversity (applying the government’s biodiversity value per hectare), as biodiversity losses well as losses to ecosystem services. Because the impact on ecosystem services is and loss of carbon especially difficult to quantify, the assessment focuses on a single foregone service – storage carbon storage.25 Lost capacity for carbon storage represents the single biggest cost of the fires, underscoring their global impact. Transport, trade, High levels of haze through most of September and October cost the transportation tourism, sector IDR 5.1 trillion. Most of the losses were borne by seaports as cargo shipping manufacturing, and was interrupted by poor visibility. Transport costs contributed to slower growth in mining also suffered trade services which suffered IDR 18.3 trillion in losses. Tourism lost IDR 5.5 trillion in revenues due to the fires and haze. The costs to manufacturing and mining totaled IDR 8.4 trillion. Additional Haze has also contributed to the death of 19 people and more than 500,000 cases of significant costs to acute respiratory infections.26 Immediate health costs27 totaled IDR 2.1 trillion.28 society include death The long-term costs cannot yet be quantified. Existing research suggests long-term and illness… exposure to air pollutants correlates with increased cardiovascular and chronic respiratory illness. A study on the effects of the 1998 Indonesian haze crisis on fetal, infant and under-three child mortality showed that air pollution led to 15,600 fewer surviving children.29 25 This number is not meant to be an exact accounting of GHG emissions; rather, it serves to give a sense of the potential magnitude of lost ecosystem services. A value of USD5 per ton is applied to an approximation of the average carbon content of the lands impacted by fire. 26 “Indonesia Forest Fires: Widodo to Visit Stricken Regions as Death Toll Mount,” The Guardian, October 28, 2015. 27 Direct health costs include increased incidence of inpatient and outpatient care, medical equipment and health worker overtime pay due to haze-induced illness. Data on utilization and facility visits are from The Center for Health Crisis Management at the Ministry of Health. Unit costs are based on local regulation on Community Health Centre (Puskesmas) user fees, and case base group payment for inpatient cases (INA CBG). 28 In addition, lost wages as a result of missed work due to illness totaled IDR 54 trillion. 29 Jayachandran, S., 2008, “Air Quality and Early-life Mortality: Evidence from Indonesia’s Wildfires,” NBER Working Paper No. 14011. December 2015 THE WORLD BANK | BANK DUNIA 23 Reforming amid uncertainty Indonesia Economic Quarterly … as well as Haze also forced school closures for up to 34 days, resulting in IDR 540 billion in prolonged school costs.30 In some instances, schools closed for weeks at a time, obliging teachers to closures accommodate take-home assignments. Conditions were worst in October, impacting 24,773 schools and 4,692,537 students. Child-care costs and foregone wages increase when parents must care for children normally in school; these costs are not included in the World Bank assessment. Long-term, sustained school closures could contribute to weaker graduation rates if reclaiming lost school days becomes burdensome. Box 4: Other costs – the unknown cumulative impact of fire and haze on flora and fauna The full impact of Indonesia’s systemic fire and haze on flora and fauna is unknown. Fire destroys natural genetic variability, which helps species adapt resistance to parasites and infectious diseases. Burning biomass produces the precursors of ground-level (tropospheric) ozone (O3), which impacts plant growth and photosynthesis and leads to long-term effects on ecosystem structure and function. O3 has been shown to reduce yields of major food crops and to affect the nutritional quality of wheat, rice, and soybean. It can also reduce the capacity of land to act as a carbon sink. The particulate matter in haze has also been shown to reduce local rainfall, which could in turn impact recently planted crops. Sustained exposure to haze could also lead to the “volcano effect”, i.e., a decrease in plant productivity in the short term due to limited sun exposure and a deleterious effect on plant physiology and photosynthesis. In the longer term, it could lead to an overall weakening in the ability of plant species to recover from shocks as a result of cumulative exposure to stress. In extreme cases, haze exposure could affect a species’ ability to survive. Fire and haze also negatively affect pollinators, in turn affecting agricultural production. Chronic exposure to haze creates a sustained environment of stress, the impacts of which – on productivity and evolution – are unknown. The recurring nature of Indonesia’s fire crisis is of particular concern. While species can adapt, adaptations may not always be beneficial or possible. Fire wipes out living soil organisms, requiring years before pioneer species can recolonize. More concerning, however, is that long-term environmental stress will eventually lead to a tipping point, after which ecosystems will be altered irreversibly. How or when ecosystems will change is not known but the impact of this process could extend beyond Indonesia. c. The case for peatland moratorium and restoration A moratorium on On October 23, 2015, President Widodo called for a moratorium on new peatland new peatland concessions and a cancellation of existing concessions that have not been concessions, coupled developed, thereby halting the legal conversion of peatland and peat swamp forests with peatland into agricultural land. He also called for peatland restoration, including re-wetting management and priority areas. This should be accompanied by efforts to conserve remaining peat restoration, is swamp forests and to stop drainage in areas of deep peat or high biodiversity. Fewer necessary… fires on peat will reduce haze, which in turn will reduce the economic and environmental costs. … but short-term The following back-of-the-envelope calculations for the two provinces that will be impacts to revenue most impacted – Riau and Central Kalimantan (which together have 151,471 need to be hectares of peatland) – could help better understand the cost of a moratorium. A considered moratorium includes two primary costs: (i) lost tax and fee revenue to local and national government, and (ii) a reduction in land value for concession holders. The estimated loss in annual revenue to local governments (but not the central government) in Riau and Central Kalimantan would amount to about IDR 2.0 trillion (USD 154 million) and IDR 1.2 trillion (USD 92 million), respectively. To accommodate the lost land value, the moratorium could be accompanied by a concession buy-back, land substitution offer, or a combination of both. At IDR 135 30The World Bank estimates an average daily loss of productivity in the seven provinces covered in this section (excluding East Kalimantan) multiplied by the number of school closures as a result of haze. December 2015 THE WORLD BANK | BANK DUNIA 24 Reforming amid uncertainty Indonesia Economic Quarterly million (USD 10,000) per hectare – a reasonable estimate for well-managed certified oil palm plantations – a one-time land buy-back would cost IDR 131.6 trillion (USD 9.8 billion) in Riau and IDR 72.8 trillion (USD 5.4 billion) in Central Kalimantan. Table 8: The estimated lost public revenue over one year as a result of a moratorium on peatland development is substantial One-time Land tax Personnel Hectares Royalties Total annual Province licensing revenue tax revenue impacted (annual) revenue fees (annual) (annual) (IDR billions) Riau 975,000 390 1,131 284 554 1,969 Central Kalimantan 539,071 216 625 122 405 1,152 Restoration is Indonesia has targeted two Table 9: Estimated construction cost of peatland possible but should million hectares of restoration be targeted degraded peatlands for Peatland to be 460,000 hectares identified as priority (Musi Banyu Asin + Ogan restoration. To be restored Komering Ilir + Pulang Pisau) effective, restoration must Land reconstruction and/or water be planned carefully and Cost per hectare management IDR 13,500,000 per hectare include a long-term Cost to restore IDR 6.2 trillion management plan. Poorly 460,000 hectares implemented, restoration Cost to restore 2 IDR 27 trillion million hectares could have unintended Note: Restoration cost per hectare is assumed to be $1,000, which effects and costs, especially includes the cost for heavy equipment for canal blocking, etc. Source: World Bank staff calculations in areas where local populations depend on these lands for their livelihood. A quick estimate of initial restoration costs for basic canal blocking in two million hectares is IDR 27 trillion. This does not include recurrent costs of long-term management. It also excludes costs to businesses that must adapt to low-drainage practices or transition to activities that are compatible with wet peatlands. Effective restoration will prioritize areas where investment offers the greatest return, such as those where only a small portion of the peat dome has been impacted. Moreover, international experience demonstrates that conservation of intact wetland habitats is less expensive than restoration. In the long term, a The moratorium and restoration pledges are welcome first responses from the comprehensive government and are much cheaper than the costs that accrue from repeated incidence landscapes approach of fire and haze disasters. However, they will not solve Indonesia’s fire crisis as both is needed only target peatlands, which represent only one-third of the fires in 2015. A long-term commitment to sustainable landscapes management is needed. This means taking action to improve governance and management of land and natural resources, including: transparently defining land boundaries and allowable uses that recognize and balance trade-offs among land uses and users; improving tenure and use rights with a focus on local communities and customary practice (adat); completing and enforcing spatial planning, taking into consideration ecosystem services and strengthening land licensing procedures accordingly; and aligning institutions, policies and incentives across sectors and levels of government to promote sustainable landscape management. Completion and dissemination of OneMap is an important step. December 2015 THE WORLD BANK | BANK DUNIA 25 Reforming amid uncertainty Indonesia Economic Quarterly 2. Realizing the potential of the Village Law The Village Law has Enacted in early 2014, Law 6 of 2014 (Village Law) establishes a new institutional the potential to framework for community development in Indonesia’s 74,091 rural villages (desa). address rural The law increases the authority and responsibility of villages, while recognizing inequality in traditional village government arrangements (adat). Rural areas have consistently Indonesia higher rates of poverty (14.7 percent compared to 8.3 percent in urban areas), connectivity is poor, and the quality of basic services is consistently lower than in urban areas. With an average population of 2,500, villages are better connected to citizens compared to rural districts (kabupaten), which govern an average population of almost half a million. While villages are not a substitute for the delivery of effective services from district governments, they can strengthen the demand for basic services and ensure that they respond to village residents’ needs. Indonesia has an established track record of successfully delivering small scale infrastructure at the sub-district level (kecamatan), with strong community involvement, through the National Program for Community Empowerment (Program Nasional Pemberdayaan Masyarakat Mandiri, PNPM Mandiri), which was progressively rolled out to 67,100 villages between 2007 and 2014. The Village Law Under the Village Law, fiscal transfers to villages are substantially increased substantially compared with previous years. At full implementation in 2017, an average-sized increases direct village is expected to receive IDR 1.7 billion a year. Transfers are financed partly transfers to villages from the national budget through an envelope (Village Fund, Dana Desa, DD) equivalent to ten percent of transfers to regions, and partly by districts redirecting 10 percent of their untied revenue sources31 to villages. DD is being increased to the full required level over three years (Table 10), but the district allocation is expected to be financed in full from 2015. Even for 2016, transfers to villages are comparable in size to the conditional capital grants to districts (Dana Alokasi Khusus, DAK), which are budgeted at around IDR 90 trillion for 2016. Table 10: A higher fiscal effect of transfers to villages is expected in the medium term (IDR trillion unless otherwise indicated) Basis for envelope 2014* 2015 2016 2017 2018 2019 National budget (Dana 10 percent of regional transfers, N/A 20.8 47.7 81.2 103.8 111.8 Desa) implemented gradually from 2015 10 percent of fiscal balance funds 12.6 34.2 37.6 42.3 55.9 60.3 net of DAK District budget** 10 percent of district taxes and 4.2 4.1 4.3 4.9 5.7 6.4 levies Total transfers to villages 16.8 59.1 89.5 128.4 165.4 178.5 As share of GDP (percent) 0.5 0.7 0.9 1.1 1.1 Amount for average-sized 0.8 1.2 1.7 2.2 2.4 village (IDR billion) Note: *Before the introduction of the Village Law, villages received transfers from district-level governments only. ** Estimates for 2015- 2019 are based on the legal liability under the Village Law as amounts actually budgeted in 2015 are not yet available. Source: Ministry of Finance compilation of 2014 data from district budgets; revised 2015 Budget; 2016 Budget; 2017-2019 World Bank staff calculations Village transfers can Village transfers can contribute to the reduction of poverty and inequality in at least contribute to poverty three ways: (i) by providing temporary employment in infrastructure projects to reduction in the long absorb surplus agricultural labor during economic downturns and other shocks; (ii) 31Common Allocation Fund (Dana Alokasi Umum, DAU), Revenue Sharing Fund (Dana Bagi Hasil, DBH), and district taxes and fees. December 2015 THE WORLD BANK | BANK DUNIA 26 Reforming amid uncertainty Indonesia Economic Quarterly term and cushion by building and maintaining basic infrastructure in regions that have infrastructure against economic gaps; and (iii) by improving access to quality basic services in parts of the country shocks in the short where infrastructure is less of a priority. Many villages in Indonesia still have large term infrastructure gaps (Figure 21) and can focus initially on filling those. In areas that are better developed, villages should be encouraged to allocate funds to support health and education service delivery in ways that are appropriate for their scale and capacity. Given the size of village transfers, ensuring they are well used is crucial. The following analysis focuses on two aspects of implementation: making sure that transfers address inequality and overcoming district-to-village disbursement delays. Figure 21: Infrastructure gaps vary greatly across Indonesia (share of villages in district with gravel or stone main road, percent) Source: Village Potential Statistics (PODES) 2011, Coordinating Ministry for Social Welfare /National Team for the Acceleration of Poverty Reduction (TNP2K)/PNPM Support Facility, 2014 a. Ensuring the Village Law targets the poor and near poor32 Attempts to treat The formula initially approved for the distribution of Dana Desa was based on villages fairly may population, poverty, land area and geographic difficulty. In April 2015, the formula overshadow was changed to give a weight of only 10 percent to these factors, with the remaining equitable access to 90 percent allocated on the basis of equal village shares (bagi rata). Under the equal services by village share component, each village receives the same amount, regardless of the residents population it serves. The objective of the formula revision appears to be honoring the electoral commitment to provide IDR 1 billion (satu milyar) to each village, and to ensure that populous Java does not benefit unduly from a transfer that is intended to address underdevelopment. However, Indonesian villages vary greatly in size and treating them equally results in a significant variation in their capacity to deliver services. Although the costs of Differences in the cost of service delivery between locations are largely driven by delivering services three factors, the most important of which is population size. For example, early by villages are driven childhood infrastructure and staffing costs rise with the number of children, as a mainly by population separate classroom and teacher are needed for every 40 students. So do the costs of size… learning materials, overhead and other operating expenses (at IDR 700,000 per child). Two other factors drive the variable costs of service delivery: remoteness (because of additional transport costs) and the number of poor people (because they are more likely to rely on public services rather than pay for private services). 32 “Poor and near poor” refers to the bottom 40 percent of the income distribution. December 2015 THE WORLD BANK | BANK DUNIA 27 Reforming amid uncertainty Indonesia Economic Quarterly …large villages The 90/10 formula results Figure 22: The 90/10 Dana Desa formula treats receive a much lower in a large variation in the village residents inequitably Dana Desa DD allocations villages (millions, LHS; IDR thousands, RHS) allocation per receive for each resident. Number of poor and near poor (LHS) Median DD per capita (RHS) person… Grouping villages into 30 1200 deciles based on the per capita amount of DD they 25 1000 receive from the 90 percent 20 800 that is allocated on an equal share basis33 shows that 15 600 large villages have far less per person to spend on 10 400 service delivery than small 5 200 villages (Figure 22).34 The ten percent of largest - 0 villages receive a median 1 2 3 4 5 6 7 8 9 10 per capita DD allocation of Source: Village Potential Statistics (PODES) 2011; National only IDR 36,500, whereas Social Economic Survey (SUSENAS) 2013; World Bank staff calculations the median for the ten percent of smallest villages is IDR 1.1 million per capita. The much lower per capita DD allocation to large villages limits their capacity to deliver services to their residents.35 … resulting in an The inequitable impact of the formula results from the number of poor and near increase in poor who live in large villages. Thirty-four percent of poor and near poor village inequality, because residents, or 27 million people, live in the 10 percent of villages with the lowest per many more poor and capital DD allocation. More than 50 percent of the poor and near poor live in the near poor live in bottom two deciles—the villages receiving per capita allocation that is less than one large villages tenth of the amount distributed to the villages in the highest two deciles. Almost 95 percent of the poor and near poor live in villages that receive less than the national average per capita distribution of the DD (see also Box 5). Box 5: Assessing the equity of Dana Desa allocations by comparing two villages The impact of the 90/10 formula on the capacity of villages to deliver services is illustrated by comparing the resources available to two villages in different parts of Indonesia. Birang village is located in the relatively well-off district of Berau in East Kalimantan. The village of Senaru is in the underdeveloped district of North Lombok in the province of West Nusa Tenggara. Village Birang Senaru Senaru’s Dana Desa allocation in 2015 is just IDR 52,000 per District poverty rate (percent) 4.8 35.9 capita. With a poverty rate of over 35 percent, Senaru has an Population 286 6,350 estimated 2,000 poor residents. In contrast, Birang will receive 2015 DD 90 percent equal IDR 932,000 per person in 2015—almost twenty times as share allocation (IDR million) 266.5 328.0 much—to provide services to a population that includes fewer DD allocation per capita (IDR) 932,000 52,000 than 20 people that are classified as poor. 33 Because information on the geographic difficulty index and poverty are not publicly available at the village level, it is not possible to simulate the exact amount of DD allocations. Therefore, the analysis is based on the 90 percent of DD that is distributed using the equal share component. 34 Districts have some discretion over the formula for distributing the district allocations to villages. Many districts have chosen to apply a weighting of 60 percent or more to equal shares. Given that total transfers to villages are currently dominated by the district allocation, this has a slightly equalizing effect on overall distributions. As the amount of DD increases to the full required level, which will exceed the district allocation, the inequality between villages will increase. 35 Non-fiscal factors contribute to poor service delivery, but the absence of funding is a critical constraint. December 2015 THE WORLD BANK | BANK DUNIA 28 Reforming amid uncertainty Indonesia Economic Quarterly b. Streamlining village fund disbursement DD implementation Dana Desa allocations are Figure 23: DD district to village disbursement was got off to a slow start passed to villages via slow in 2015 this year, due in part district governments in (percent of districts, LHS; percent of villages in sample, RHS) to the 2015 allocation three tranches: 40 percent National-to-District (tranche I) formula revision in April, 40 percent in July District-to-Village (tranche I) and the final 20 percent in 1 1 October. Although district 0.9 0.9 governments are mandated 0.8 0.8 to pass the transfers on to 0.7 0.7 villages within seven days 0.6 0.6 of receiving them, they are 0.5 0.5 also obliged to ensure that 0.4 0.4 villages have the basic 0.3 0.3 requirements in place to be 0.2 0.2 able to spend the funds— 0.1 0.1 including having a plan, a 0 0 budget, and a bank Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec account. When the Note: Sample includes 314 districts covering 55,469 villages. allocation formula was Source: Ministry of Finance; Coordinating Ministry of Human changed well into the 2015 Development and Culture/World Bank Diagnostic Survey, November 2015; World Bank staff calculations fiscal year, both districts and villages were required to revise their budgets in order to disburse and spend DD lawfully. By the end of July all districts had received the first tranche, but it had only been passed on to an estimated 42 percent of villages (Figure 23). More recently disbursements have accelerated and, at the end of November, almost all villages are estimated to have received their first and second tranches. Ensuring disbursement occurs earlier in the year will be critical to improving the quality of spending in the future. Early The Village Law and its Table 11: Districts have been slow to adopt the required implementation implementing regulations regulatory framework challenges also establish a strong role for (in percent) Percent of districts contributed to districts in the Core district decrees required with decrees disbursement delays management of the village Procurement 73 in 2015 transfers. Both districts Village financial management 73 and villages were Village budget preparation 44 unprepared to implement Village development priorities 29 Village authorities (functions) 15 new rules and procedures Note: Sample covers 329 districts. in 2015. Districts have Source: Coordinating Ministry of Human Development and struggled to put in place Culture/World Bank Diagnostic Survey, November 2015; World Bank staff calculations the regulatory framework of core local decrees that recently enacted national laws require of them (Table 11). Villages have not had a chance to learn and understand the new rules and procedures. In addition, delays in the appointment of senior civil servants in Jakarta meant that the roll-out of a nation-wide training program for village officials only began in August 2015, eight months after the new program was introduced. The establishment of a new ministry responsible for village development and community empowerment meant that community facilitators were without contracts for the first six months of the year. December 2015 THE WORLD BANK | BANK DUNIA 29 Reforming amid uncertainty Indonesia Economic Quarterly Improved access to The national government has struggled to effectively monitor disbursements to information will villages because of gaps in existing information systems. This could be addressed in provide the basis for the future by adapting existing district financial reporting systems, as well as the accelerating district chart of accounts, to collect real-time information on district disbursements. disbursements from This could provide the basis for strengthening “carrot and stick” incentives for districts to villages in districts to speed up disbursements. Real-time information would allow the national 2016 government to identify poor performers, which could be used to quickly deploy “rapid appraisal teams” to assist local governments to address bottlenecks. Where district capacity is less of an issue, disbursement data could provide the basis for putting pressure on poorly performing districts. Similarly, by modifying the conditions for the disbursement of the second and third tranches, the Ministry of Finance could use its power of withholding future funds to ensure districts do not only disburse to select villages. A professional As DD allocations increase dramatically in the next few years, village capacity is facilitator network likely to continue to constrain villages’ use of funds, particularly in remote and less will be critical to developed areas. The introduction of new procedures and increased revenues has support villages in exerted pressure on village planning and financial capacity. This could also test the absorbing funds technical capacity of existing community institutions to execute additional community development and empowerment activities. Maintaining a professional network of village facilitators to support village development planning, budgeting, execution, oversight and reporting would help the national government ensure that pressure to spend money, complex procedures, and low capacity do not lead to wasteful spending. Community Indonesia has a unique and valuable legacy of community-driven development that participation will provides a foundation for implementation of the Village Law. It is impossible for help ensure funds districts—and less so for the national government—to oversee the use of funds by are spent well, not all villages. Accountability at this scale will be most effective if villagers themselves just quickly are have more opportunities for participation in planning and implementation, have access to information about what their officials should be and are doing, and are provided with channels to give feedback. Implementation Implementing transfers at this the village level is challenging. Few countries have challenges are to be attempted to push funding from the national level to villages on such a scale. expected and Concerns about the slow pace of disbursement are understandable, but delays are to expectations need to be expected given the scope and scale of the reform. Expectations of how quickly be managed smooth implementation can be achieved need to be managed, and the emphasis should be on using the funds well, not just spending them quickly. The government has shown a willingness to make adjustments as implementation problems emerge, but some caution is needed. Given that the program that is being implemented in more than 70,000 villages, the government should resist the temptation to change procedures too frequently. The regulatory framework will inevitably need revising as problems are identified, but care should be taken to systematically diagnose its weaknesses and allow time for socializing revisions at the village level. Management of the Village Law is shared between three main ministries, and national leadership and improved coordination will be critical to success over the first five years. December 2015 THE WORLD BANK | BANK DUNIA 30 Reforming amid uncertainty Indonesia Economic Quarterly C. Indonesia 2016 and beyond: a selective look 1. The Trans-Pacific Partnership agreement: opportunity or threat for Indonesia? Twelve Pacific Rim In October twelve Pacific Rim economies (Australia, Brunei Darussalam, Canada, countries have Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, United States, and signed a new trade Vietnam) reached an agreement to strike the largest trade pact in two decades, the agreement covering Trans-Pacific Partnership (TPP). When implemented, the TPP will cover some 40 40 percent of the percent of the global economy, over 30 percent of global merchandise trade, and global economy should create a new Pacific economic bloc with reduced barriers to the trade of goods and services.36 Tariffs between members on the vast majority of goods will be eliminated either immediately or after a transition period. The agreement also aims to reduce non-tariff barriers (NTBs) and to restrict members’ ability to impose new NTBs in the future. Like other trade agreements, the TPP contains general provisions which apply to all members and specific provisions which apply to individual countries. The latter are typically in the form of exceptions to the general rules to allow countries to adjust to the agreement and maintain autonomy in areas of particular domestic interest. The agreement is far The 30 chapters of the agreement cover a host of areas well beyond merchandise reaching in scope, trade, such as investments, cross-border services trade, temporary entry of business regulating many persons, government procurement, state-owned enterprises, intellectual property, areas beyond trade competition, e-commerce, labor, the environment and regulatory coherence. Many of these areas have either been left outside the scope of World Trade Organization (WTO) negotiations (“WTO extra” measures) or have been difficult to fully resolve in the broader multilateral trading system (“WTO plus” measures). The aim of the agreement is to further liberalize most of these areas so as to promote foreign investments, trade in services, competition and cooperation between member countries. 36As it allows for membership expansion, the TPP may well cover a larger share of the global economy in the future. December 2015 THE WORLD BANK | BANK DUNIA 31 Reforming amid uncertainty Indonesia Economic Quarterly a. The TPP will affect the Indonesian economy Whether Indonesia Indonesia is not yet a signatory to the TPP. However the country has signaled the joins the TPP or not, intention to join the agreement in the near future. The Trade Minister recently the agreement is declared that Indonesia aims to join within two to three years, an intention likely to have confirmed during the recent trip of President Widodo to the US.37 Whether implications for its Indonesia actually joins or not, the agreement is likely to have implications for its economy economy. Carefully assessing the relative costs and benefits of TPP membership will be important to ensure the country uses it as an opportunity to revitalize its non- commodity tradable sector and spur economic growth. Such an assessment is well beyond the scope of this note, which provides only some reflections that may be a useful framework for analyzing these possible costs and benefits. Figure 24: TPP countries’ share in Indonesian goods Figure 25: TPP markets are even more important for exports is high, albeit slightly declining Indonesian manufacturing exports (share of total exports, percent,LHS; total exports to TPP members, (share of manufacturing exports to TPP in total manufacturing USD billion, RHS) exports and in total merchandise exports, percent) Exports (RHS) Share 60 60 100 90 50 50 80 Share in manufacturing exports 40 70 40 60 30 30 50 40 20 20 30 20 10 Share in total merchandise exports 10 10 0 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2000 2002 2004 2006 2008 2010 2012 2014 Source: UN COMTRADE database; World Bank staff calculations Source: UN COMTRADE database; World Bank staff calculations TPP member As for any Free Trade Agreement (FTA), the most basic effect of the TPP on third countries are countries is the diversion of trade towards members of the new trading bloc and responsible for a away from non-member countries. The extent of trade diversion depends on significant share of various factors, including the importance of the trading bloc for Indonesian exports, Indonesia’s exports, the initial level of trade barriers and the supply response of member and non- particularly in member countries. TPP countries account for a large share of Indonesian exports, manufacturing… although that share has been slightly declining in recent years (Figure 24), partly due to higher commodity exports to China. The TPP bloc is even more important for Indonesian manufacturing exports, although again the TPP share in these exports has been stagnant or declining in recent years (Figure 25). On the other hand, the share of manufacturing exports to TPP members in total merchandise exports has been rising since 2011, highlighting the importance of these markets for Indonesia’s trade rebalancing strategy away from commodities. 37See http://www.thejakartapost.com/news/2015/10/11/ri-could-join-trans-pacific-partnership-within-two- years.html for Minister Lembong’s words, and http://www.theguardian.com/world/2015/oct/27/indonesia-will- join-trans-pacific-partnership-jokowi-tells-obama for President Widodo’s statement. December 2015 THE WORLD BANK | BANK DUNIA 32 Reforming amid uncertainty Indonesia Economic Quarterly …but import tariffs While TPP countries are important export destinations for Indonesia, the extent of in these countries are trade diversion is likely to be limited by the generally low tariff rates currently already low and applied by these countries. Even if the TPP is going to bring these tariffs to zero for Indonesia has trade TPP exporters, the price advantage thus created for those exporters vis-à-vis other agreements with exporters, including Indonesian ones, is going to be generally low. In addition, most of them Indonesia has FTAs in place with various TPP countries, including Japan, Vietnam, Malaysia and Singapore, which ensure preferential market access to those countries. Indonesia would likely have no further market access gains in those countries from signing the TPP. Of the TPP countries which have no FTA with Indonesia, the US is by far the most important export destination. Like most other high income countries, the US has generally very low applied tariff rates (Figure 26). The majority of the applied rates are zero and there are only a handful of sectors in which Indonesia exports to the US with rates above 20 percent. Sectors protected by special non-tariff barriers, such as quotas, rather than by tariff barriers, are not included as the information on the tariff equivalent of such NTBs is not readily available. To the extent that these NTBs are eliminated following the TPP, they could give rise to trade diversion as well. Figure 26: US applied tariff rates are generally very low Figure 27: Potential for trade diversion away from (frequency distribution of US applied tariff rates weighted by US Indonesian exports is concentrated in apparel imports from Indonesia in 2014) (large Indonesian exports to the US in 2014 facing high tariffs and competition from Vietnam and Malaysia) 30 .4 25 .3 U S R a te (% ) Density 20 other footwear .2 sports footwear jacket & coats of fibre 15 .1 blouses shirts trousers jacket & coats of cotton 10 0 0 20 40 60 80 0 200000 400000 600000 US Rate Import from Indonesia (US$1000) Note: Imports are classified at the Harmonized System (HS) six- Note: Imports are classified at the Harmonized System (HS) six- digit level. digit level. To avoid clutter the figure only shows sectors with US Source: UN COMTRADE and TRAINS databases; World Bank imports from Indonesia above USD 10 million. staff calculations Source: UN COMTRADE and TRAINS databases; World Bank staff calculations However, the The diversion of foreign investments towards TPP countries may be another diversion of possible risk of the trade agreement for non-member countries. The TPP increases investments may be commercial access to a sizable share of the global economy for producers located in a more important TPP countries. There is evidence that this is an important factor affecting foreign issue firms’ decision on where to invest.38 In addition, the TPP affords higher legal protection for foreign investors than domestic legislation usually does. While this protection is subject to country-specific exemptions, it is potentially wide in scope, covering areas such as intellectual property rights, expropriation, performance 38Kenyon, T. and Y. Margalit, 2014, “Does joining international treaties attract foreign investment? Experimental firm-level evidence”, mimeo, Columbia University. December 2015 THE WORLD BANK | BANK DUNIA 33 Reforming amid uncertainty Indonesia Economic Quarterly requirements, and access to government procurement. These factors may increase foreign investors’ appetite towards TPP markets, thus inducing foreign investment re-allocation away from third countries, including Indonesia, to TPP members. This could provide further impetus for Indonesia to accelerate the implementation of the ASEAN foreign investment protection agreement. b. Joining the TPP will influence Indonesian economic policy-making TPP membership is Joining the TPP could potentially imply important regulatory changes in several likely to influence areas of the economy for a country like Indonesia. The spirit of the agreement is to policy-making make the member countries’ regulations less discriminatory vis-à-vis the other beyond merchandise members. Beyond the removal of tariff and non-tariff barriers for merchandise trade… trade, a key objective of the agreement is the equal treatment of foreign investors and services providers with domestic competitors. In principle this could translate into regulation that ensures that sectors be fully open to investors from TPP countries; governments not favor domestic companies at the expenses of foreign ones through procurement or – in the case of state-owned enterprises - through non-commercial assistance; foreign investors not be subject to special performance requirements, such as local content in production, minimum level or percent of exports and technological transfer; temporary entry of business persons be facilitated; and competition policy be transparent and non-discriminatory. The TPP affects domestic legislation in other ways as well, including requiring minimum periods of protection for patents and trademarks along with strong enforcement mechanisms; promoting internationally recognized labor rights; and combatting the illegal trade in wild fauna and flora. …afforded by an All of these measures are underpinned by an extra-territorial enforcement extra-territorial mechanism in the form of a Dispute Settlement Institution which allows members dispute settlement to address disputes between themselves over TPP implementation. To maximize mechanism… compliance, the Dispute Settlement chapter allows for the use of trade retaliation (e.g., suspension of benefits), if a Party found not to have complied with its obligations fails to become compliant. While such a mechanism is relatively new for FTAs, it is quite common in bilateral investment treaties (BITs). In fact, foreign investments in Indonesia from countries which are signatories of a BIT with Indonesia can already resort to an international investor–state dispute settlement mechanism if the investor believes that the treaty has been violated.39 … although The extent to which the TPP measures may lead to changes in a country’s existing implementation laws and regulations depends on the will of the member country to liberalize, as well flexibility may limit as on the willingness of the other members to make concessions. In fact, the text of the extent of changes the agreement allows for a considerable amount of flexibility in its implementation. in current laws and The liberalization measures in all of the main chapters do not necessarily apply to regulations existing domestic regulations (“non-conforming measures”) specified by members in their section of the agreement. For example, Indonesia could have the option, subject to the other parties’ agreement, to continue discriminating against foreign investments in any of the sectors restricted in the country’s negative investment list in force at the time of its eventual joining of the TPP. There are hundreds of pages of such exceptions in the countries’ TPP schedules: for example, Malaysia maintaining a limit of 49 percent on foreign ownership of motor vehicle production, or Vietnam requiring foreign firms that win government contracts to use local labor 39In a recent case the British coal mining company Churchill Mining PLC brought Indonesia before the International Centre for Settlement of Investment Disputes. December 2015 THE WORLD BANK | BANK DUNIA 34 Reforming amid uncertainty Indonesia Economic Quarterly and materials. The level of flexibility, however, differs and the chapters on intellectual property, state-owned enterprises and government procurement allow for more limited exceptions. Those are some of the areas in which Indonesia may need to implement more sweeping changes in case of joining. However, to the extent that the decision to join the TPP is predicated on the desire to integrate with a large trading bloc, the utilization of such implementation flexibility may well be only temporary. Finally, the TPP may In addition to its impact on Figure 28: Indonesia has actively used restrictive restrict in some ways the regulatory status quo, trade and investment measures the room for future the TPP text is likely to (number of restrictive measures on trade and investments passed and economic policy- limit in some ways the implemented June 2009-to date, select South East Asian countries) making freedom of future 250 Passed Implemented economic policy-making. The agreement affords 200 countries little flexibility to make laws and regulations 150 more restrictive towards other member countries. As 100 a result, the TPP provides 50 the benefit of more certainty in the direction of 0 future economic policies. This limitation could be particularly important for Indonesia, which is the Source: Global Trade Alert (accessed 13/11/2015); World Bank staff most active user of calculations restrictive trade and investment measures among South East Asian comparators (Figure 28). On the other hand, the cost of this TPP-imposed limitation would be the loss of some economic policy space. December 2015 THE WORLD BANK | BANK DUNIA 35 Reforming amid uncertainty Indonesia Economic Quarterly APPENDIX: A SNAPSHOT OF INDONESIAN ECONOMIC INDICATORS Appendix Figure 1: Quarterly and annual GDP growth Appendix Figure 2: Contributions to GDP expenditures (real GDP growth, percent) (contribution to real GDP growth yoy, percent) Private cons. Gov cons. 4 8 Investment Net exports Stat.discrepancy* GDP 8 Year-on-year (RHS) 3 6 4 2 QoQ seas. adjust 4 (LHS) Average (LHS)* 1 2 0 0 0 -4 Sep-09 Sep-11 Sep-13 Sep-15 Sep-12 Sep-13 Sep-14 Sep-15 Note: *Average QoQ growth, Q3 2009–Q3 2015 Note: * includes changes in stocks Source: BPS; World Bank staff calculations Source: BPS; World Bank staff calculations Appendix Figure 3: Contributions to GDP production Appendix Figure 4: Motorcycle and motor vehicle sales (contribution to real GDP growth yoy, percent) (seasonally-adjusted sales growth yoy, percent) Agriculture Mining and constr. 60 Manufacturing Comm & transport Trade, hotel & rest Other services 8 GDP 40 Motor vehicle sales Cement sales 20 4 0 -20 Motorcycle sales 0 -40 Sep-12 Sep-13 Sep-14 Sep-15 Oct-12 Oct-13 Oct-14 Oct-15 Source: BPS; World Bank staff calculations Source: CEIC; World Bank staff calculations Appendix Figure 5: Consumer indicators Appendix Figure 6: Industrial production indicators (retail sales index 2010=100) (PMI diffusion index and production index growth yoy, percent) 200 60 20 BI Retail sales index 180 BI Consumer Survey Industrial production, RHS Index 160 55 10 140 120 50 0 100 Manufacturing PMI, LHS 80 45 -10 Nov-12 Nov-13 Nov-14 Nov-15 Nov-12 Nov-13 Nov-14 Nov-15 Source: BI Source: BPS; Markit HSBC Purchasing Managers Index December 2015 THE WORLD BANK | BANK DUNIA 36 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Figure 7: Balance of payments Appendix Figure 8: Current account components (USD billion) (USD billion) Capital and financial Current account 10 Errors and omissions Overall BoP inflows 15 Secondary income Goods trade 5 10 0 5 -5 Current account 0 -5 -10 Primary income Services trade -10 -15 Sep-12 Sep-13 Sep-14 Sep-15 Sep-12 Sep-13 Sep-14 Sep-15 Source: BI Source: BI; World Bank staff calculations Appendix Figure 9: Exports of goods Appendix Figure 10: Imports of goods (yoy contribution to total export growth, %) (yoy contribution to total import growth, %) Oil and gas Coal 10 Capital raw materials 15 Mining Palm oil Fuel Consumer goods Rubber Manufacturing Imports Other Total exports 5 10 0 5 0 -5 -5 -10 -10 -15 -15 -20 -20 -25 Sep-13 Sep-14 Sep-15 Sep-13 Sep-14 Sep-15 Source: BI Source: BI Appendix Figure 11: Reserves and capital flows Appendix Figure 12: Inflation and monetary policy (USD billion) (month-on-month and year-on-year growth, percent) 4.0 12 160 5.0 International Reserves (LHS) Headline inflation, YoY (RHS) BI policy rate (RHS) 3.0 8 120 2.5 2.0 Core inflation, 4 80 0.0 1.0 YoY (RHS) 40 -2.5 0 0.0 Non-resident portfolio inflows, (RHS): Headline inflation MoM (LHS) Equities SUN SBI Global bonds 0 -5.0 -1.0 -4 Nov-13 May-14 Nov-14 May-15 Nov-15 Nov-12 Nov-13 Nov-14 Nov-15 Source: BI; CEIC; World Bank staff calculations Source: BPS; World Bank staff calculations December 2015 THE WORLD BANK | BANK DUNIA 37 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Figure 13: Monthly breakdown of CPI Appendix Figure 14: Inflation comparison across (percentage point contributions to monthly growth) countries (year-on-year, November 2015) 4.0 Core Administered India Volatile Headline Indonesia * 3.0 Malaysia China 2.0 Korea Philippines 1.0 Japan USA 0.0 Singapore Thailand * -1.0 Nov-12 Nov-13 Nov-14 Nov-15 -2 -1 0 1 2 3 4 5 6 7 Source: BPS; World Bank staff calculations *November is latest available month, others October Source: National statistical agencies via CEIC; BPS Appendix Figure 15: Domestic and international rice Appendix Figure 16: Poverty and unemployment rate prices ( percent) (percent LHS, wholesale price, in IDR per kg RHS) 120 12,000 25 Domestic rice, IR64-II (RHS) 20 80 8,000 Poverty rate Vietnamese rice 15 5% broken (RHS) 10 40 4,000 Percentage spread (LHS) 5 Unemployment rate 0 0 0 Nov-12 Nov-13 Nov-14 Nov-15 2003 2005 2007 2009 2011 2013 2015 Source: Cipinang wholesale rice market; FAO; World Bank Source: BPS Appendix Figure 17: Regional equity indices Appendix Figure 18: Selected currencies against USD (daily index in local currency, December 7, 2012=100) (monthly index November 2012=100) 250 90 Shanghai-China Turkey 225 112 India 200 134 Indonesia 175 South Africa 150 BSE-india SET-Thailand 156 125 Brazil 178 100 Appreciation SGX-Singapore JCI -Indonesia 75 200 Dec-12 Dec-13 Dec-14 Dec-15 Source: CEIC; World Bank staff calculations Source: CEIC; World Bank staff calculations December 2015 THE WORLD BANK | BANK DUNIA 38 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Figure 19: 5-year local currency govt. bond Appendix Figure 20: Sovereign USD bond EMBIG yields spread (percent) (basis points) 10 475 Indonesia spreads less overall EMBIG 60 Indonesia index spread (RHS) 8 400 0 6 325 -60 Malaysia Thailand 4 250 -120 United States 2 175 -180 Singapore Indonesia EMBIG bond spread (LHS) 0 100 -240 Dec-12 Dec-13 Dec-14 Dec-15 Dec-12 Dec-13 Dec-14 Dec-15 Source: CEIC Source: JP Morgan; World Bank staff calculations Appendix Figure 21: Commercial and rural credit and Appendix Figure 22: Banking sector indicators deposit growth (monthly, percent) (year on year growth, percent) 30 100 10 Loan deposit ratio (LHS) Commercial and rural bank loans 25 80 8 20 60 6 Non-performing 15 Private deposit 40 loans (RHS) Return on assets 4 10 20 2 Capital adequacy ratio (LHS) 5 0 0 Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Sep-10 Dec-11 Mar-13 Jun-14 Sep-15 Source: BI; World Bank staff calculations Source: BI Appendix Figure 23: Government debt Appendix Figure 24: External debt (percent of GDP; USD billion) (percent of GDP; USD billion) 60 Domestic debt, RHS 300 Private external debt, RHS External debt, RHS 60 Public external debt, RHS 300 Total debt to GDP, LHS Total external debt to GDP, LHS 50 250 50 250 40 200 40 200 30 150 30 150 20 100 20 100 10 50 10 50 0 0 0 0 2007 2009 2011 2013 2015 2007 2009 2011 2013 2015 September September Source: MoF; BI; World Bank staff calculations Source: BI; World Bank staff calculations December 2015 THE WORLD BANK | BANK DUNIA 39 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Table 1: Budget outcomes and projections (IDR trillion) 2011 2012 2013 2014 2015 2015 2016 Estimated Revised Actual Actual Actual Actual annual Budget budget realization A. State revenue and grants 1,211 1,338 1,439 1,550 1,762 1,650 1,822 1. Tax revenue 874 981 1,077 1,147 1,489 1,367 1,547 2. Non-tax revenue 331 352 355 399 269 279 274 B. Expenditure 1,295 1,491 1,651 1,777 1,984 1,910 2,096 1. Central government 884 1,011 1,137 1,204 1,320 1,246 1,326 2. Transfers to the regions 411 481 513 574 665 664 770 C. Primary balance 9 -53 -99 -93 -67 -103 -89 D. SURPLUS / DEFICIT -84 -153 -212 -227 -223 -260 -273 (percent of GDP) -1.1 -1.8 -2.2 -2.2 -1.9 -2.2 -2.2 Note: Budget balance as percentage of GDP is using revised and rebased GDP Source: Ministry of Finance Appendix Table 2: Balance of payments (USD billion) 2014 2015 2012 2013 2014 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Balance of payments 0.2 -7.3 15.3 2.1 4.3 6.5 2.4 1.3 -2.9 -4.6 Percent of GDP 0.0 -0.8 1.7 1.0 1.9 2.8 1.1 0.6 -1.3 -1.9 Current account -24.4 -29.1 -27.5 -4.9 -9.6 -7.0 -6.0 -4.2 -4.2 -4.0 Percent of GDP -2.7 -3.2 -3.1 -2.3 -4.3 -3.0 -2.7 -1.8 -1.9 -1.7 Trade balance -1.9 -6.2 -3.0 1.2 -3.2 -0.9 -0.1 1.2 1.5 2.1 Net income & current transfers -22.5 -22.9 -24.5 -6.1 -6.4 -6.1 -5.8 -5.4 -5.7 -6.1 Capital & Financial Account 24.9 22.0 45.4 7.1 13.9 14.7 9.6 6.2 2.2 1.2 Percent of GDP 2.8 2.4 4.9 3.4 6.5 6.8 4.3 2.8 1.0 0.5 Direct investment 13.7 12.2 15.9 3.5 3.8 6.0 5.1 2.9 3.1 2.7 Portfolio investment 9.2 10.9 26.1 8.7 8.0 7.4 2.0 8.5 5.7 -2.2 Other investment 1.9 -0.8 3.5 -4.9 2.1 1.4 5.1 -5.3 -6.5 0.4 Errors & omissions -0.3 -0.2 -2.6 -0.1 0.0 -1.2 -1.3 -0.8 -0.9 -1.7 Foreign reserves* 112.8 99.4 111.6 102.6 107.7 111.2 111.9 111.6 108.0 101.7 Note: * Reserves at end-period Source: BI; BPS December 2015 THE WORLD BANK | BANK DUNIA 40 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Table 3: Indonesia’s historical macroeconomic indicators at a glance 1995 2000 2005 2010 2011 2012 2013 2014 National Accounts (% change)1    Real GDP 8.4 4.9 5.7 6.2 6.2 6.0 5.6 5.0    Real investment 22.6 11.4 10.9 8.5 8.9 9.1 5.3 4.1    Real consumption 21.7 4.6 64.0 4.1 5.1 5.4 5.6 4.8    Private 22.7 3.7 0.9 4.8 5.1 5.5 5.4 5.3    Government 14.7 14.2 6.6 0.3 5.5 4.5 6.9 2.0    Real exports, GNFS 18.0 30.6 16.6 15.3 14.8 1.6 4.2 1.0    Real imports, GNFS 29.6 26.6 17.8 17.3 15.0 8.0 1.9 2.2    Investment (% GDP) 28 20 24 31 31 33 32 33    Nominal GDP (USD billion) 202 165 286 755 893 918 910 889    GDP per capita (USD) 1102 857 1,396 3,178 3,690 3,740 3,659 3,524 Central Government Budget (% GDP)2    Revenue and grants 15.2 20.8 16.8 14.5 15.5 15.5 15.1 14.7    Non-tax revenue 4.8 9.0 5.0 3.9 4.2 4.1 3.7 3.8    Tax revenue 10.3 11.7 11.7 10.5 11.2 11.4 11.3 10.9    Expenditure 13.9 22.4 17.3 15.2 16.5 17.3 17.3 16.9    Consumption 3.9 4.0 2.8 3.6 3.8 3.9 4.1 4.0    Capital 4.6 2.6 1.1 1.2 1.5 1.7 1.9 1.4    Interest 1.4 5.1 2.2 1.3 1.2 1.2 1.2 1.3    Subsidies .. 6.3 4.1 2.8 3.8 4.0 3.7 3.7    Budget balance 1.3 -1.6 -0.6 -0.7 -1.1 -1.8 -2.2 -2.2    Government debt 32.3 97.9 44.3 24.3 22.8 22.6 24.1 23.8    o/w external government debt 32.3 51.4 23.4 11.1 10.2 9.9 11.2 10.2    Total external debt (including private sector) 61.5 87.1 47.1 26.8 25.2 27.5 29.2 33.1 Balance of Payments (% GDP)3    Overall balance of payments .. .. 0.2 4.0 1.3 0.0 -0.8 1.7    Current account balance 3.2 4.8 0.1 0.7 0.2 -2.7 -3.2 -3.1    Exports GNFS 26.2 42.8 35.0 22.0 23.8 23.0 22.4 22.4    Imports GNFS 26.9 33.9 32.0 19.2 21.2 23.2 23.1 22.7    Trade balance -0.8 8.9 2.9 2.8 2.7 -0.2 -0.7 -0.3    Financial account balance .. .. 0.0 3.5 1.5 2.7 2.4 5.1    Net direct investment 2.2 -2.8 1.8 1.5 1.3 1.5 1.3 1.8    Gross official reserves (USD billion) 14.9 29.4 34.7 96.2 110.1 112.8 99.4 111.6 Monetary (% change)3    GDP deflator1 9.9 20.4 14.3 8.3 7.5 3.8 4.7 5.4    Bank Indonesia interest key rate (%) .. .. 9.1 6.5 6.6 5.8 6.5 7.5    Domestic credit (annual average) .. .. 28.7 17.5 24.4 24.2 22.1 15.9    Nominal exchange rate (average, IDR/USD)4 2,249 8,422 9,705 9,090 8,770 9,387 10,461 11,865 Prices (% change)1    Consumer price Index (eop) 9.0 9.4 17.1 7.0 3.8 3.7 8.1 8.4    Consumer price Index (average) 9.4 3.7 10.5 5.1 5.3 4.0 6.4 6.4    Indonesia crude oil price (USD per barrel, eop) 5 17 28 53 79 112 113 107 60 Source: 1 BPS and World Bank staff calculations, using revised and 2010 rebased figures. 2 MoF and World Bank staff calculations (for 1995 is FY 1995/1996, for 2000 covers 9 months), 3 Bank Indonesia, 4 IMF, 5 CEIC. December 2015 THE WORLD BANK | BANK DUNIA 41 Reforming amid uncertainty Indonesia Economic Quarterly Appendix Table 4: Indonesia’s development indicators at a glance 2000 2005 2010 2011 2012 2013 2014 2015 Demographics1 Population (million) 213 227 242 245 248 251 254 .. Population growth rate (%) 1.3 1.2 1.3 1.3 1.3 1.3 1.3 .. Urban population (% of total) 42 46 50 51 51 52 53 .. Dependency ratio (% of working-age population) 55 54 51 51 50 50 49 .. Labor Force2 Labor force, total (million) 98 106 117 117 120 120 122 128 Male 60 68 72 73 75 75 76 78 Female 38 38 45 44 46 45 46 50 Agriculture share of employment (%) 45 44 38 36 35 35 34 33 Industry share of employment (%) 17 19 19 21 22 20 21 21 Services share of employment (%) 37 37 42 43 43 45 45 45 Unemployment, total (% of labor force) 8.1 11.2 7.1 7.4 6.1 6.2 5.9 5.8 Poverty and Income Distribution3 Median household consumption (IDR 000 per month) 104 211 374 421 446 487 548 National poverty line (IDR 000 per month) 73 129 212 234 249 272 303 331 Population below national poverty line (million) 38 35 31 30 29 28 28 29 Poverty (% of population below national poverty line) 19.1 16.0 13.3 12.5 12.0 11.4 11.3 11.2 Urban (% of population below urban poverty line) 14.6 11.7 9.9 9.2 8.8 8.4 8.3 8.3 Rural (% of population below rural poverty line) 22.4 20.0 16.6 15.7 15.1 14.3 14.2 14.2 Male-headed households 15.5 13.3 11.0 10.2 9.5 9.2 11.2 .. Female-headed households 12.6 12.8 9.5 9.7 8.8 8.6 11.9 .. Gini index 0.30 0.35 0.38 0.41 0.41 0.41 0.41 .. Percentage share of consumption: lowest 20% 9.6 8.7 7.9 7.4 7.5 7.4 7.5 .. Percentage share of consumption: highest 20% 38.6 41.4 40.6 46.5 46.7 47.3 46.8 .. Public expenditure on social security & welfare (% of GDP)4 .. 0.4 0.4 0.4 0.4 0.6 0.5 .. Health and Nutrition1 Physicians (per 1,000 people) 0.16 0.13 0.29 .. 0.20 .. .. Under five mortality rate (per 1000 children under 5 years) 52 42 33 32 30 29 28 27 Neonatal mortality rate (per 1000 live births) 22 19 16 16 15 15 14 14 Infant mortality (per 1000 live births) 41 34 27 26 25 24 24 23 Maternal mortality ratio (modeled estimate, per 100,000 live 265 212 165 156 148 140 133 126 births) Measles vaccination (% of children under 2 years) 74 77 78 80 85 84 77 .. Total health expenditure (% of GDP) 2.0 2.8 2.9 2.9 3.0 3.1 .. .. Public health expenditure (% of GDP) 0.7 0.8 1.1 1.1 1.2 1.2 .. .. Education3 Primary net enrollment rate (%) .. 92 92 92 93 92 93 .. Female (% of total net enrollment) .. 48 48 49 49 50 48 .. Secondary net enrollment rate (%) .. 52 61 60 60 61 65 .. Female (% of total net enrollment) .. 50 50 50 49 50 50 .. Tertiary net enrollment rate (%) .. 9 16 14 15 16 18 .. Female (% of total net enrollment) .. 55 53 50 54 54 55 .. Adult literacy rate (%) .. 91 91 91 92 93 93 .. Public spending on education (% of GDP)5 .. 2.7 3.5 3.6 3.8 3.8 3.6 .. Public spending on education (% of spending)5 .. 14.5 20.0 20.2 20.1 20.0 19.9 .. Water and Sanitation1 Access to an improved water source (% of population) 78 81 85 85 86 86 87 87 Urban (% of urban population) 91 92 93 93 94 94 94 94 Rural (% of rural population) 68 71 76 77 77 78 79 80 Access to improved sanitation facilities (% of population) 44 53 57 58 59 60 61 61 Urban (% of urban population) 64 70 70 71 71 72 72 72 Rural (% of rural population) 30 38 44 45 46 47 48 48 Others1 Disaster risk reduction progress score (1-5 scale; 5=best) .. .. .. 3.3 .. .. .. .. Proportion of seats held by women in national parliament (%)6 8 11 18 18 19 19 17 17 Source: 1 World Development Indicators; 2 BPS (Sakernas); 3 BPS (Susenas) and World Bank; 4 MoF, Bappenas and World Bank staff calculation, only includes spending on Raskin, Jamkesmas, BLT, BSM, PKH and actuals; 5 MoF; 6 Inter-Parliamentary Union December 2015 THE WORLD BANK | BANK DUNIA 42 Supported by funding from the Australian Government (Department of Foreign Affairs and Trade, DFAT), under the Support for Enhanced Macroeconomic and Fiscal Policy Analysis (SEMEFPA) program.