Global Conditions Pose Risks for Growth and Inflation Outlook in Indonesia, New World Bank Report Says

Stable, smooth-functioning financial sector is key to COVID-19 recovery, longer-term growth

Jakarta, June 22, 2022 -Indonesia's economy is projected to grow 5.1 percent in 2022 and 5.3 percent in 2023, as the pressures of deteriorating global economic conditions, higher inflation, and tightening external finance begin to weigh, according to the June 2022 edition of the World Bank's Indonesia Economic Prospects report, released today. Risks to the outlook are tilted to the downside.

Indonesia's growth momentum in 2021 carried into early 2022, with the economy growing at 5 percent in the first quarter (year-on-year), according to the report, Financial Deepening for Stronger Growth and Sustainable Recovery. The pick-up in domestic demand since the end of last year provided relief to the private sector, especially medium, small, and micro enterprises that suffered disproportionately during the pandemic. The domestic recovery also enabled some fiscal consolidation, while monetary policy has remained appropriately accommodative. This has enabled a pick-up in bank lending in support of the recovery.

However, the Russian invasion of Ukraine has compounded pandemic-related challenges. Commodity prices have risen sharply and are expected to remain high in 2022-2023. While Indonesia has benefitted in the short-term from a windfall in commodity earnings, prices have started to rise and foreign financing has become tighter. This has intensified policy challenges associated with rising energy subsidies and created headwinds for monetary policy. The report analyzes both issues in depth.

"Indonesia's economic growth following the pandemic comes amid an increasingly challenging global environment," said World Bank Director for Indonesia and Timor-Leste Satu Kahkonen. "Although growth is projected to accelerate in 2022, global developments continue to pose significant downside risks that could be detrimental to Indonesia's long-term recovery. It is important to sustain structural policy reforms to support growth and to reduce reliance on near-term macroeconomic stimulus."

While energy subsidies can help contain prices in the short-term, the case for subsidy reform remains strong. Having an exit plan to shift from providing blanket benefits toward more targeted support for the poor and vulnerable will be important.

In addition, a stable and smooth-functioning financial sector is key to the recovery from COVID-19 crisis and longer-term economic growth, including through investments in services such as health care and education. As such, the report focuses on efforts to deepen Indonesia's financial sector to sustain recovery momentum from the pandemic.

"Although the Indonesian financial sector has proved to be resilient during the pandemic, further efforts to overcome structural constraints could accelerate inclusive and sustainable economic growth," said World Bank Indonesia and Timor-Leste Lead Economist Habib Rab."Targeted reforms can make the financial sector deeper, more efficient and more resilient."

The report proposes three areas of reform to strengthen Indonesia's financial sector. The first would increase the demand and supply of finance by expanding access to and usage of financial services, broadening and improving the quality of financial market products, and mobilizing long-term savings. The second would improve the allocation of resources by promoting competition in the banking sector, strengthening the insolvency framework, and enhancing consumer protection. The third would strengthen the capacity of the financial system to withstand shocks by improving the effectiveness of financial sector oversight; strengthening the crisis preparedness and resolution framework; and promoting climate and natural disaster-related risk management.

The Indonesia Economic Prospects is supported by the Australian Department of Foreign Affairs and Trade.