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Indonesia’s Robust Demand to Lift Inflation Rate, OECD Says

Indonesia’s Robust Demand to Lift Inflation Rate
Customers look at clothing at a store in a textile market in Jakarta, Indonesia. Photographer: Ed Wray/Bloomberg

Indonesia should be ready to tighten monetary policy as faster growth boosts inflation and reduce energy subsidies to focus on infrastructure needs, the Organization for Economic Cooperation and Development said.

Gross domestic product will increase 6.2 percent in 2013 from 6 percent this year, led by “robust domestic demand,” the Paris-based organization said in a report today, revising its forecasts higher from May estimates. Annual inflation will accelerate to 4.7 percent from 4.2 percent, it said.

“Monetary policy should, as planned, ensure that inflation will remain on a downward trend, using interest rates, liquidity management and macro-prudential measures,” the OECD said. “Indonesia’s infrastructure and social spending needs are substantial and will need to be efficiently financed.”

Stronger institutions and better policy will help Indonesia achieve its government’s goal of elevating the nation to one of the world’s 10 largest economies by 2025, the OECD said. Indonesia may surpass Germany and the U.K. by 2030 to be the world’s seventh-largest economy, generating $1.8 trillion in annual sales for agriculture, consumer and energy companies by that year, McKinsey & Co. said this month.

Energy Subsidies

The OECD urged a substantial reduction in Indonesia’s energy subsidies that fail to achieve social goals and have significant costs. It said cash transfers will be necessary to prevent an increase in poverty from such a move.

Energy subsidies are forecast to account for almost 19 percent of government spending in 2012 and 24.1 percent in the 2013 draft budget, while spending on social assistance and infrastructure remains insufficient, the report showed.

“Rethinking the spending mix is required to achieve the authorities’ ambitious development objectives, fund the 2014 establishment of public health insurance and at the same time eliminate the budget deficit by 2015 as envisaged in official medium-term economic projections,” the OECD said.

President Susilo Bambang Yudhoyono is increasing spending on roads, seaports and airports as he woos investment to spur Southeast Asia’s largest economy. More than a decade after the Asian financial crisis forced the nation to seek an International Monetary Fund bailout, Fitch Ratings and Moody’s Investors Service have raised Indonesia to investment grade, and growth is among the fastest in the Group of 20 nations.

‘Strong’ Demand

“Strong domestic demand is likely to push up inflation in 2013,” the OECD said. “In addition, labor markets are tight, and expected rises in the minimum wage could encourage significant wage demands.”

Indonesia may add 90 million people to its “consuming class” by 2030, the most after China and India, McKinsey said in a Sept. 18 report. Energy demand may triple from current levels, convenience stores will lead a “revolution” in retail, and the largest business opportunities will be for financial-service providers, it said.

Indonesia is currently the world’s 16th-largest economy, with GDP of about $846 billion last year, according to IMF data. That may rise to $1.8 trillion in 2017, compared with Germany’s $3.9 trillion economy and U.K. GDP of $3.2 trillion in the same period, IMF data show.

Growth of “6 percent is just extraordinary in today’s world where the U.S. is at between 1.5 and 2 percent, where Europe is practically flat and where you’re having slowdowns in China and India,” Jose Angel Gurria, secretary-general of the OECD, said in an interview today with Bloomberg Television. “There is a big challenge for Indonesia to keep up this growth in the medium- and long-term.”

Monetary Policy

Bank Indonesia kept its benchmark rate at a record-low 5.75 percent for seventh straight meeting in September. It has committed to an inflation target of 3.5 percent to 5.5 percent, and the OECD recommended the central bank move from a year-end to a year-average target.

Bank Indonesia should “achieve the inflation target and, as planned, reduce it over time,” the OECD said.

The main risk to Indonesia’s outlook is increased global risk aversion stemming from the euro-area crisis that could reverse the capital inflows of the past few years, the OECD said. Balancing that, the sovereign rating upgrades allow Indonesia to tap investment funds that are restricted to holding investment-grade assets, it said.

Indonesia “is likely to remain relatively sheltered from a slowdown in world trade, unless other Asian economies and commodity prices are significantly affected,” the OECD said.

Indonesia was a member of OPEC until three years ago when it began importing more oil than it exported and left the cartel.

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