Indonesia Can Be a $2.5t Economy by 2025

Indonesia is currently at a critical juncture. (Antara Photo/Zabur Karuru)

By : Sourajit Aiyer | on 10:03 AM April 09, 2018
Category : Opinion, Commentary

Indonesia is currently at a critical juncture. On one hand, its economy, in nominal terms, has grown at a solid 9 percent compounded annual growth rate, or CAGR, over the last  five years, but a young and aspirational population makes sustaining that growth-momentum imperative. At the same time, President Joko "Jokowi" Widodo's government is more than halfway into its current term, and it should showcase a blueprint for its long-term economic vision as a potential plank for the upcoming election.

So if Indonesia wants to grow its economy from the current $1 trillion to $2.5 trillion by 2025, it would have to target a stellar 12 percent CAGR. That sounds daunting, but many nations have achieved decadal double-digit growth. Even India’s Maharashtra state recently announced a vision to grow its economy by 15 percent CAGR to $1 trillion by 2025. A high, yet achievable, target pushes the commitment from politicians to realize much of the economic agenda. Indonesia’s recent momentum lends a positive bias. But to what extent should Indonesia focus on each growth-driver to realize this target? This is what we explore here.

Industry Sector

About 41 percent of Indonesia’s gross domestic product (GDP) is estimated to come from industry, on the higher side of the average 30-40 percent seen in most large emerging markets. If its industry has to maintain at an average 35 percent proportion, it would have to grow at a 9 percent CAGR, less than the estimated GDP growth. Indonesia’s gross investment at around 33 percent of GDP is also in line with the average 35-40 percent seen in China, Malaysia and Thailand in their initial years of industrialization.

If it intends to hold this at this level to drive normal capacity-addition and avoid building excesses in the system by investing beyond 40 percent of GDP, its investment has to grow at a 12 percent CAGR in line with the estimated GDP growth. Investment also correlates with productive imports like machinery. In Indonesia, imports comprised 18 percent of GDP, which is roughly half of the share of investment in the economy. Recent industrializing nations have also seen their share of imports to be 50-60 percent of their share of investment. This trend has to continue, assuming it implies most imports are strictly for productive use contributing to investment. If import grows at 12 percent CAGR same as investment, its share will be 18 percent of GDP by 2025 (i.e. 55 percent of the share of investment, estimated at 33 percent of GDP).

Where should investments go? A growing economy with a large population like Indonesia needs more affordable housing and urban infrastructure. Industrial projects have to focus on underdeveloped regions for inclusive growth across islands and hard infrastructure has to connect them with commercial areas and ports. But all this also means maintaining its improvement on the Ease of Doing Business ranking, where it has already shot up 37 places over the last two years.

Services Sector

Only around 45 percent of Indonesia’s GDP is estimated to come from services; mainly tourism, trade as well as banking, financial services and insurance (BFSI). But this share is much less in comparison to the average 60-70 percent seen in most large emerging markets. Services are a significant job creator for an educated workforce. Manufacturing cannot absorb all types of talents in human capital.

In a large and relatively young population nation like Indonesia, this has to become a significant growth driver. So if services have to make up 60 percent of GDP by 2025, the country would have to grow at a stellar 16 percent CAGR, far higher than the GDP growth estimated.

While tourism, trade and financial inclusion would remain priorities, deepening the services sector through the digital economy would bring in efficiencies in public-services delivery to a broad-base of the population who are spread across its fragmented island-geography. It would also make it easier to catch leakages of a cash-based economy. It should include improving the quality of universities and skill centers, to improve employment prospects and productivity. All these would expand its purchasing power and the addressable consumer base.

 Agriculture Sector

About 14 percent of Indonesian GDP is estimated to come from agriculture, a bit higher than the sub-10 percent share seen in most large emerging markets. But while this share has to reduce, the crux has to be farm productivity since agriculture employs 30 percent of Indonesia's workforce. So if agriculture has to dip to a 7-8 percent share, it should grow at a moderate 3 percent CAGR, but this has to backed by productivity improvement. This also means investing in irrigation and market linkages to improve yield and ensure the end-grower in the rural economy gets the correct price.

Exports Sector

Around 20 percent of Indonesia’s GDP comes from export, mainly oil, electronics, rubber and timber products. Its export has to grow at a rapid 16 percent CAGR until 2025, if it has to meet the forex demand for imports and keep trade balance positive. Its advantage is that the rupiah marginally dropped against the dollar last year, while the Malaysian ringgit, Thailand baht, and China yuan etc. gained. This improves the relative competitiveness of its exports in the international market. It should push services-sector exports and not rely only on merchandise exports, since that would marry its need to push services too.

Consumption Sector

Indonesia has a reasonable share of private consumption to GDP at 66 percent, in line with the 60-65 percent seen in large emerging markets. Ideally this can maintain at current levels, since excessive consumption would reduce its healthy savings rate of 30-35 percent and create a tilt on external borrowing to fund future investment. That was one of the many reasons for the 1997 Asian financial crisis in the first place.

All in all, these segmental growth-estimates to target a GDP of $2.5 trillion by 2025 may sound over-ambitious. But its recent growth momentum has been healthy. A twin focus to combine services and exports, push agro-productivity and maintain investment, import and savings are current levels might just augur well for a long-term goal like this.

Sourajit Aiyer is an author, financial services professional and researcher for South Asia Fast Track

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