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Indonesia Economic Quarterly October 2016 Pressures easing Ndiam Diop Practice Manager, Macroeconomis and Fiscal Management, South East Asia and the Pacific October 25, 2016 Key takeaways Macroeconomic pressures easing Thanks to good


  1. Indonesia Economic Quarterly October 2016 Pressures easing Ndiamé Diop Practice Manager, Macroeconomis and Fiscal Management, South East Asia and the Pacific October 25, 2016

  2. Key takeaways Macroeconomic pressures easing  Thanks to good macro-fiscal management, short- term macro pressures, in particular fiscal risks and inflation, have eased. This should support growth:  Low inflation and stable Rupiah => monetary policy easing  Greater policy predictability  Allows policymakers to focus more on structural reforms Fiscal spending reforms key to inclusive growth  Efficient and effective spending of public resources critical to strengthening human capital and reducing poverty and inequality. It requires:  Spending resources in the right areas & right  Better fiscal allocation across programs within sectors (social assistance, agriculture, education)  Public spending in rural water and sanitation provides an example: smart spending has borne results Recent fiscal reforms are lowering poverty and inequality

  3. Macroeconomic pressures easing Fiscal spending reforms and inclusive growth Fiscal policy and welfare 3

  4. External conditions remain unsupportive to growth World Bank projections for global growth by date of forecast 3.5 Average growth (2000-2008) 3 Actual growth 2.5 Jan-15 Jun-15 Jan-16 Jun-16 2 2013 2014 2015 2016 2017 2018 Source: World Bank Global Economic Prospects; WDI 4

  5. But key domestic risks have eased, reducing macro- fiscal pressures Eased Remain Fiscal risk Domestic Tax amnesty take up Credit growth Private investor sentiment Risks Brexit US Fed rate hike External Commodity prices Lower global growth China rebalancing and deleveraging 5

  6. Prudent fiscal policy choices and high tax amnesty take-up reduced fiscal risks Monthly fiscal deficit (% GDP) 0.5 • Expenditure cuts and expanded fiscal deficit 0.0 for 2016 announced in -0.5 July -1.0 • The draft 2017 Budget contains more realistic -1.5 revenue targets 2016 -2.0 • Successful -2.5 implementation of 2015 Phase I Tax Amnesty -3.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec program Source: Ministry of Finance; World Bank staff calculations 6

  7. Sound macro management and record low global bond yields helped stabilize the Rupiah Index, January 4 2016 = 100 110 USD/IDR 108 106 104 102 JP Morgan EMCI 100 98 96 Jan-2016 Apr-2016 Jul-2016 Oct-2016 Source: BI;JP Morgan; World Bank calculations

  8. Improved rice import management helped inflation moderate further Year-on-year growth, percent 16 Rice 12 8 4 Core BI inflation target Headline 0 Sep-13 Sep-14 Sep-15 Sep-16 Source: BI; World Bank staff calculations

  9. Improved macro-fiscal environment should help near- term growth  There are no signs in the data of a pickup in activity as yet 3 mma, percent yoy (LHS); consumer confidence index (RHS) 40 160 30 140 Retail Sales Index Consumer Confidence Index 20 120 10 100 0 80 -10 60 -20 40 -30 20 Motorcycle Sales -40 0 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Source: BI; BPS; World Bank staff calculations  But improved macro-fiscal conditions may help going forward:  Low inflation and stable Rupiah => monetary policy easing  Low fiscal risk => using fiscal policy to stimulate the economy  Greater policy predictability and improved investor sentiment 9

  10. Macroeconomic pressures easing Fiscal spending reforms and inclusive growth Fiscal policy and welfare 10

  11. Public spending reforms crucial to greater access to services and inclusive growth Education Student Growth, poverty Funding, services, health performance, Inequality, jobs human capital, Maternal mortality services, Other Assets infrastructure rates Source: World Bank staff.

  12. Re-allocation within the budget can help make growth more inclusive Effectiveness at reducing inequality relative to spending Index (LHS); percent of GDP (RHS), 2012 • Direct social assistance 120 4.0 transfers are the most effective 3.5 at reducing poverty and 100 inequality, followed by 3.0 education and health spending 80 • In 2012, total spending on SA and 2.5 health sectors was small relative 60 2.0 to energy subsidies • Subsidy reform and expansions of 1.5 40 SA programs since 2012 have 1.0 helped, however more can be done 20 0.5 • In addition to increased SA spending, re-allocation with the 0 0.0 SA budget is needed : Direct Education Health Subsidies Transfers (energy only) • One rupiah spent on PKH (all HH targeted SA) reduces inequality by 2.5 Effectiveness Index (LHS) Budget (RHS) times more than a rupiah spent on Rastra, yet Source: Susenas 2012, World Bank calculations. Rastra’s budget is more Note: Effectiveness Index is Change in Market Income Gini to Final 12 Income Gini / Budget as % of GDP than 10 times higher.

  13. In agriculture, much of the rising spending goes to private input subsidies rather than public goods • Central government spending on agriculture and irrigation In 2015, 47% of CG IDR trillion (LHS); Year-on-year growth, percent (RHS) public spending was used to 100 6 Extension services Irrigation subsidize private Other agriculture subsidies Fertilizer subsidies 90 inputs rather than R&D MoA non-social aid 5 80 MoA social aid provide public goods. Only 3% 70 4 was spent on R&D 60 and extension 50 3 services Growth in agriculture 40 value added 2 • Increased central 30 spending on 20 1 agriculture has not 10 led to similar 0 0 increases in 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 agriculture output Note: Spending figures refer to realized spending up until 2015 and the revised Budget for 2016. MoA reclassified the majority of its social aid spending to goods and services in 2016. • Reallocation => Source: World Bank COFIS database using MoF data higher productivity 13

  14. In education, better spending is required to achieve outcomes Example of the teacher certification program • Increasing enrollment Challenge • Improving learning outcomes • Teacher certification program Policy response • Large fiscal investment: doubling of teacher pay following certification • Certification required a university degree, other training, and experience Design • Requirement to demonstrate competency was dropped • Many teachers were incentivized to upgrade their Evaluation qualifications • But no impact on student learning (test scores) • Teaching has become a popular profession New opportunity • Prioritize demonstrated professional competencies over education level and seniority 14

  15. In sanitation, targeted public investments triggered much larger investment by rural communities Investment in rural sanitation, 2 data samples USD million, LHS; ratio, RHS Government spending directed to: 70 14 Community Contribution • creating demand for safe 60 12 sanitation and hygiene Local Government Spending through community 50 10 empowerment and Ratio of community to behavior change government contribution 40 8 • increasing the supply of (RHS) affordable and 30 6 aspirational sanitation facilities by the private 20 4 sector 10 2 • enhancing the enabling policy environment 0 0 Households purchase 28 district in East Java 277 districts latrines Source: World Bank, STBM 15

  16. …leading to good outcomes: rapid rise in access to sanitation in rural areas Access to improved water and sanitation, percent Government is achieving Rural Water Rural Sanitation its goals in WASH (urban + rural) 100% • MDG for water supply achieved (87% in 2015) 80% • MDG for sanitation narrowly missed (61% in 60% 2015; the target was 62.4%) 40% Government now targeting universal access to improved water supply and 20% sanitation services by 2019, in line with the SDGs 0% 2000 2002 2004 2006 2008 2010 2012 2014 Source: SUSENAS, BPS 16

  17. Macroeconomic pressures easing Fiscal spending reforms and inclusive growth Fiscal policy and welfare 17

  18. Fiscal policy (2012-14) did relatively little to reduce poverty and inequality… Baseline Fiscal Policy Impact on • Indonesian taxes and government Poverty and Inequality 2012-14 spending reduced poverty by 1.1-1.4 2012 2013 2014 Average percentage points and the Gini coefficient by 2.6-3.3 points (over 2012-14) 0 • Relatively small reductions by international -0.5 standards, partly due to: • personal income tax collection is low -1 with poor compliance -1.5 • social assistance spending is low -2 • health spending is low and much of it is not on the primary care which most -2.5 benefits poorer households -3 • education spending is high and has some impact on inequality, but not to -3.5 the degree seen in other countries Poverty (percentage Inequality (points of Gini) • points) Also partly due to high spending on energy subsidies which predominantly benefit richer households . Source : The 2012 result is from a fiscal incidence paper (World Bank and Ministry of Finance 2015), and the 2013 and 2014 results are from a coming update to that paper. The analysis is based on the Commitment to Equity framework (commitmentoequity.org), and applies standard fiscal incidence analysis to the majority of GoI taxes and spending

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