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THE strengthened political mandate and the natural advantage from demography and commodity resources are clearly positive factors for Indonesia's future growth outlook.
Although the mid-term outlook for Indonesia has improved, the country is still facing some short-term challenges. In the short-term, the economy will still need to face up to cyclical pain from lower commodity prices, which will dampen the deeply cyclical story in the rural areas, banking sector challenges from the strong credit cycle of yesteryears as it has one of the larger unseasoned loan books in Asia, and reduced-but-still-present risks from private sector external debt refinancing and capital volatility. However, the recent general elections and the strengthened political mandate in favour of the incumbent president and his team means that Indonesia's mid-term growth outlook has clearly improved.
Natural advantage
Indonesia with an estimated population of around 237 million people is the world's fourth most populous country. As a republic, with an elected legislature and president, recent exit polls suggest that the official results of the 2009 presidential elections, when released in early August, will show a clear first round victory for President Susilo Bambang Yudhoyono.
Having wrapped up a firm victory in the legislative elections held in April, Mr Yudhoyono's Democratic Party has emerged as the major political force in Indonesia, paving the way for relatively encumbrance-free governance for the next five years. Expectations from President Yudhoyono's likely re-election would be for a more forceful move towards reforms, including in the areas of investment in the mining, telecoms, and retail sectors, as well as further progress in governance and transparency. The elections have underscored the country's strong credentials as the largest Muslim democracy in the world, with the focus of the government resting on improving economic matters and religion taking a less political role. This is a clear positive development and adds one more point to the already bright outlook for the country. Beyond the cyclical downturn, as global markets start to look towards the expected macro-recovery in 2010, economies like Indonesia which have strong domestic demand will likely be the beneficiaries.
To this end, not only has Indonesia one of the youngest population in the world (44 per cent are younger than 25, see accompanying chart), but it is also rich in natural resources. Indonesia is one of the top two global exporters in coal, natural gas and crude palm oil. In addition, it is also a net exporter of metal ores such as tin and nickel. Furthermore, Indonesia is less vulnerable to the current economic crisis. It sells less overseas relative to the size of its economy than any other Asian country except India. Only one household in a hundred has a mortgage, and mortgage credit-to-GDP stands at a low 3 per cent. Fiscal freedom has allowed the government to both cut taxes and hike public spending.
Strong domestic demand
While developed economies struggle with the slowdown of demand and declining demographics, Indonesia (together with China and India) could be the consumer market of the future. The aggregate population of China (1.35 billion), India (1.22 billion) and Indonesia (0.24 billion) will generate a combined GDP of around US$6.4 trillion this year, of which consumption is the single largest line item at approximately US$2.7 trillion (42 per cent of GDP).
Over the past 50 years, Indonesia's population has grown by 150 per cent. That represents a compound average growth rate (CAGR) of 1.8 per cent, comparable with India's 2 per cent and slightly higher than China's 1.5 per cent. However, population growth rates are slowing due to declining birth rates, better education and improved living standards. The United Nations forecasts that by 2020, China's population growth rate will slow to 0.6 per cent, Indonesia's to 0.9 per cent and India's to 1.2 per cent.
Similar to China and India, urbanisation is an important driver of Indonesia's growth. Like much of Asia, Indonesia's shift to urban cities has been recent; even 15 years ago 70 per cent of the population lived in rural villages. Today 110 million Indonesians live in urban areas (compared with only 20 million in 1970) and by 2010 the number of people living in cities will likely overtake those in rural areas. The UN forecasts that by 2020 around 60 per cent of the population, or around 155 million people, will live in cities, a 40 per cent increase over today. This is important for future consumption trends, because urban people spend around 80 per cent more on average than rural people. In addition, demand for infrastructure will also increase, as urban people ask for more roads, schools, hospitals, apartments, etc. Besides the urbanisation story, Indonesia is also youthful. In the past decade Indonesia's workforce increased by 23 million, more than the population of Australia. In the decade ahead, the UN forecasts Indonesia's population to grow by another 22 million, taking it to 259 million. This fast-growing young labour force is in stark contrast to the developed countries, which face a long phase of deleveraging and an ageing society.
The commodities story
Apart from the demographic advantage, Indonesia's commodity resources also provide another natural advantage in terms of income stream. Indonesia is today one of the lowest-cost supplier of commodities, geographically close to two of the fastest-growing markets in the world (China and India) and with a strategic advantage in palm oil and thermal coal, key commodities used in food and energy.
Palm oil is widely used as cooking oil, as an ingredient in margarine, and is a component of many processed foods. Since 1998, the global consumption of palm oil has more than doubled from 18 million tonnes to 41 million tonnes in 2008. Indonesia is now the world's largest palm oil producer and second-largest exporter; its exports have enjoyed a 15 per cent CAGR over the past five years compared to a 5.2 per cent CAGR for Malaysia (the world s No 1 palm oil exporter). At this rate of growth, Indonesia's palm oil exports are on track to double again by 2014. Furthermore, it has also become one of the top three global producers of rubber, cocoa, rice and coffee (see chart). Longer-term, the future for soft commodities still looks bright. A world population growing by 70 million a year will underpin demand for food, while shrinking arable land will restrict supply.
The other major important commodity in Indonesia is thermal coal. Coal is the world's principal source of electrical generation, supplying about 40 per cent of all electricity. Coal is abundant and the cheapest source of energy relative to gas, hydro, nuclear or renewable. Due to the geographical advantage to two of the fastest growing energy markets in the world (China and India), Indonesian thermal coal exports have increased by 15 per cent per annum over the past 15 years. In 2005, Indonesian thermal coal exports overtook Australia's and in 2008 the country's coal exports reached 190 million tonnes, compared to Australia's 126 million tonnes. As long as China and India can keep their pace in terms of coal demand, Indonesia's thermal coal market will be leveraged to their electricity demand. Over the last 10 years, thermal coal imports by China and India have grown 21 per cent per annum, compared with 5.5 per cent for Japan and 4.8 per cent for Europe. In 2008, both countries imported 68 million tonnes of thermal coal, just half of Japan's 135 million tonnes.
Despite the short-term challenges such as cyclical pain from lower commodity prices and reduced-but-present risks from private sector external debt refinancing, the strengthened political foundations will potentially accelerate the pace of policy reforms. These reforms, together with the ongoing structural decline in cost of capital and the natural advantage from demography and commodity resources, are likely to unleash Indonesia's growth potential of 6-7 per cent from 2011 onwards.
The writer is lead strategist, Asia Pacific, and regional head of portfolio management, Deutsche Bank Private Wealth Management
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