Can Indonesia’s economy move from a situation of investment in flux to an investment influx? This is one of the questions posed by the World Bank’s March 2014 edition of the Indonesia Economic Quarterly.
Why is Indonesia’s investment growth in flux? First, there has been a slowdown in fixed investment, due to lower terms of trade and tighter external financing conditions. This has helped narrow Indonesia’s external imbalances.
Second, while foreign direct investment—an important source of investment financing—has remained solid so far, the rapid growth of FDI inflows seen in recent years shows signs of plateauing.
Third, Indonesia remains reliant on external financing from portfolio investment inflows. These have surged in recent months, but they can be volatile.
Finally, recent policy developments have increased regulatory uncertainties. Add to that the usual difficulty of predicting policy ahead of elections, which may impact on investment of all kinds.
Given uncertain prospects for global investment flows to major emerging market economies like Indonesia, the good news is that Indonesia’s external balances are adjusting. The current account deficit shrank significantly in the fourth quarter of 2013, to $4.0 billion, or 2% of GDP. This is a welcome reduction from the record high of $10.0 billion in the second quarter of 2013—that’s 4.4% of GDP. The stock market rallied, gaining 9% in local currency terms, bond yields fell, and the Rupiah climbed back by 7% against the USD, year-to-date, recouping some of last year’s significant losses. Banking and portfolio inflows also rose in the final quarter of 2013*.
But some caution is warranted. The adjustment has been narrowly based on tighter monetary policy and currency depreciation over the second half of 2013, and slower investment growth. Indonesia remains vulnerable to a renewed deterioration of global market conditions.