Indonesia Economy

March 15, 2010Indonesiaby EW World Economy Team


Indonesia is the world's most heavily populated, Muslim-majority democracy in the world and it ranks as the world's fourth most populous country overall. The nation has a population of 249.9 million as of 2013 and a GDP of $868.3 billion in 2013 according to the World Bank. It ranked as the 16th largest economy in the world by nominal GDP, and 102nd largest GDP per capita based on purchasing power parity (PPP) in 2013. It is the largest economy in Southeast Asia and is considered an emerging market and a newly industrialized country.

Indonesia relies heavily on its own state to drive its economy, with the government owning 141 businesses in key industries. The state also controls prices on a range of basic goods including fuel, rice, and electricity. Nevertheless, since the 1990s, private interests have controlled 80 percent of the economy.

Indonesia is a member of the G-20 major economies. In 2012, Indonesia surpassed India as the second fastest growing G-20 economy (following China), but has since fallen back to third, as of 2014.

Economic History

Indonesia's early economy revolved around agriculture, shaped largely by its geographical location and relative isolation. The archipelago was known in ancient times for its abundance of natural resources. Among these were spices, such as nutmeg and cloves from Maluku Islands, pepper and cubeb from Southern Sumatra and West Java; other foodstuffs such as rice; and natural mineral resources including gold, copper, and tin. The area also produced camphor resin from the port of Barus, sappan and sandalwood from the Lesser Sunda Islands, hardwoods from Borneo, ivory and rhino's horn from Sumatra, and exotic bird feathers from eastern Indonesia.

This abundance of natural resources eventually led, around the 4th century A.D., to the development of trade interests in the area. Because of its strategic location along the trade route between India and China, and thanks to its abundant resources, Indonesia soon became a strong, cosmopolitan trading empire by the 7th century. By the ninth empire, Muslim nations had discovered Indonesia and the archipelago's trade empire expanded along Islamic trade routes. Thus, by the 14th century, Indonesia had become a thriving trade economy.

The Portuguese first reached Indonesia in the early 16th century. They brought with them both a desire to dominate local trade and to spread Roman Catholicism through the nation. Yet, they were largely pushed out by other European nations; ergo, by the early 17th century, the Dutch East India Company had begun dominating business in the region. Its main business centered on intra-Asian trade and direct spice trade between the Indonesian archipelago and Europe. Between 1602 and 1796 the Dutch East India Company sent almost one million Europeans to work in Asia on 4,785 ships and brought home more than 2.5 million tons of Asian trade goods.

The Dutch East Indies came into existence in 1800. Much of Java became a Dutch plantation and revenues steadily increased throughout most of the 19th century. These funds were reinvested into the Netherlands, which was teetering on the brink of bankruptcy. Thus, between 1830 and 1870, the equivalent of 25 percent of the Dutch Government's annual budget flowed out of Indonesia. This system came to be called the Cultivation System, and while beneficial to the Netherlands, it brought significant financial hardship to Java. The Javanese often suffered famine and epidemics during this period.

While this exploitation had its costs, it also led to the foundation of industrialization in Indonesia. After 1900, the Dutch began a program of vast infrastructure upgrades of ports and roads with the goal of modernizing the economy, facilitating commerce, and speeding up military movements. However, the Japanese invaded during World War II, casting the Indonesian economy into ruins.

Consequently, in 1945, the nation declared its independence and spent the next few years embroiled in civil war. The 1950s saw an Indonesia with a gutted economy, impoverished work force, and minimal trade or economic development. The economy began to grow, but deteriorated again in the 1960s when a young administration took power and allowed political instability to lead to widespread famine and 1,000 percent inflation.

In 1970, the New Order Administration took power and created an economic climate that led to one of the biggest eras of economic growth the nation had seen in modern times. Unfortunately, this growth masked symptoms of mismanagement and corruption. Thus, in 1997, the Asian Financial Crisis occurred, with Indonesia at ground zero. Inflation again soared to 72 percent in 1998, but slowed to just 2 percent by 1999.

In 2004, Indonesia faced another "mini-crisis," resulting from increases in international oil prices. The government had to cut fuel subsidies, and consumer fuel prices soared. Inflation spiked to 17 percent by 2005. Recovery began in 2005 and by 2006, the economic forecast appeared more positive.

Current Economic Situation

Thanks to its abundant natural resources and relative self-sufficiency, Indonesia largely avoided the consequences of the Global Recession in 2008. However, the economy has been experiencing slowing growth for the last four years.

Policy reforms to improve the Indonesian investment climate should spur economic recovery in 2015. Reform of fuel subsidies has already freed up a significant portion of the government's financial resources for spending on social and physical infrastructure. Inflation has subsided to more moderate rates, and the nation's trade deficit should ease.

Agriculture still makes up an enormous portion of the Indonesian economy, accounting for 14.3 percent of GDP in 2013—much higher than most industrialized nations. Industry now accounts for 46.6 percent of the economy and services account for 39.1 percent.

The nation still battles issues of labor unrest, inequality, and inflation that hamper its growth. Foreign investment has grown recently thanks to upgrades in the country's credit ratings by Standard & Poor's, Fitch Ratings, and Moody's.

Economic Forecast

Economic growth has weakened in recent quarters, but activity should pick up later in 2015 and 2016. Increases will result from increased public infrastructure spending, domestic consumer confidence recovers, and the rupiah—Indonesian national currency—depreciates in value, thus increasing trade.

Unfortunately, Indonesia's future development remains hobbled by infrastructure bottlenecks in transport and logistics, as well as in electricity and water treatment. Confidence in the Widodo administration's growth-oriented policies has also begun to wane.

The Indonesian economy is expected to expand by 5.1 percent in 2015 and 5.7 percent by the end of 2016.

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