Jakarta – The encouraging initiatives of Indonesia’s new government bode well for the country. But weakening investment and sluggish exports, coupled with unfavorable conditions globally, will continue to impact prospects for higher growth.

Indonesia’s new president and administration took office on October 20, 2014. The new government has set out ambitious development goals, particularly for the improvement of energy and other infrastructure, and social programs. Positive early steps and announcements have been made that indicate an increased focus on strengthening governance in key sectors, on more centralized, effective policy formulation, and on implementation.

The international economic backdrop for Indonesia, however, poses challenges, with growth forecasts revised down and commodity prices under pressure. Among major economies, activity has picked up in the US but has disappointed in the Euro Area and Japan. China’s economic rebalancing has continued, resulting in a somewhat slower pace of growth. Commodity prices have continued to weaken, especially that of crude oil which has fallen by approximately one-third since June. Since Indonesia is a net importer of oil, this is providing welcome support for the terms of trade, but the ultimate effect on the economy will also depend on fiscal and energy sector impacts and responses.

Reflecting in part adjustments to weaker external conditions, Indonesia’s economy is expanding at a more moderate pace than in recent years, with investment growth and exports being notably weak. GDP growth for 2014 as a whole is projected to be 5.1 percent, revised down marginally from the July projection of 5.2 percent, and more substantially to 5.2 percent in 2015 (from 5.6 percent previously), while in 2016 GDP should accelerate to 5.5 percent. The current account deficit is projected to continue to narrow in the base case, though at only a gradual pace, to 2.8 percent of GDP by 2016.

The decisive decision to raise subsidized fuel prices effective November 18, 2014, is an example of the hard, but necessary, policy choices being made by the new government. Amongst the other important bold reforms and implementation that will be required are those in three areas focused on in this edition of the IEQ: “collecting more” (mobilizing additional public revenues), “spending better” (improving public service delivery), and “facilitating business” (such as by enabling firms and workers to benefit from greater regional economic integration).

Collecting more: In the fiscal sector, revenue collection growth has continued to undershoot nominal GDP growth despite a lift to exchange rate-sensitive revenues from the weaker Rupiah. To support the government’s development objectives, a sustained effort to mobilize revenues is critical. Revenue policy reforms to broaden the tax base, simplify tax structures, rationalize tax types, and selectively revise certain rates to be in line with international levels, could help to raise revenues, as well as reduce economic distortions and lower administration costs. Improving tax and non-tax revenue administration and compliance through a more strategic, risk-based approach to compliance management will also help to address this challenge.

Spending better: One reason for the need to mobilize more revenues is that Indonesia needs more and higher quality spending on public health, especially in light of its objective of attaining universal health coverage by 2019. Current levels of public spending on health are very low, at only about 1.2 percent of GDP in 2012, the fifth-lowest health-spending-to-GDP ratio globally. To make universal health care a reality, there will thus need to be a focus not just on increasing access to, and the end-user affordability of, health services. Building more effective health care services, especially in the eastern regions of Indonesia and at the primary care level, will also be crucial.

Facilitating business: Indonesia faces both challenges and opportunities from the ASEAN Economic Community due to be implemented in December 2015. For Indonesia to benefit fully from increasing regional economic integration will require steps to support the  competitiveness of firms, especially by addressing infrastructure and skills gaps,  and reforming regulations so as to lower firms’ costs, in coordination with other ASEAN countries and especially in the service sector. Source: World Bank

More analysis related to this edition of the IEQ is contained in the World Bank’s recent Development Policy Review for Indonesia, “Avoiding the Trap”, available HERE