VZCZCXRO0018
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #3326/01 3320926
ZNR UUUUU ZZH
R 280926Z NOV 06
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 2243
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0123
RUEHBJ/AMEMBASSY BEIJING 3728
RUEHBY/AMEMBASSY CANBERRA 0137
RUEHUL/AMEMBASSY SEOUL 3806
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 013326 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS 
COMMERCE FOR 4430/GOLIKE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIA'S ECONOMIC RECOVERY REMAINS ON TRACK 
 
A) Jakarta 12775 B) Jakarta 13236 C) Jakarta 12543 
 
¶1. (SBU) Summary.  Indonesia's economy continues to recover 
from the impact of August 2005 rupiah "mini-crisis," with 
growth in gross domestic product (GDP) reaching 5.5% year-on- 
year (YoY) in the third quarter.  Strong external demand for 
Indonesian commodities and increased household consumption 
supported the more robust growth rate.  In contrast to the 
previous quarter, however, growth in government expenditures 
slowed significantly during the July to September period, 
due in part to decentralization which continues to disrupt 
the dispersal of government funds.  While the investment 
outlook in Indonesia has improved somewhat, fixed capital 
investment remained stalled in the third quarter, 
contracting over the same period last year.  Analysts expect 
domestic demand to continue to accelerate through the end of 
2006 and through the first half of 2007 supporting more 
robust GDP growth.  Indonesia's overall macroeconomic 
outlook continues to improve with lower inflation 
expectations, rising foreign exchange reserves, and a less 
volatile exchange rate.  A significant contraction in global 
demand, a sudden change in foreign short-term investor 
sentiment, slow progress on pro-investment reforms, and the 
failure to reduce unemployment levels are the key risks to 
economic growth and stability over the short-to-medium term. 
End summary. 
 
--------------------------------------------- ----- 
Table 1:  Real GDP Growth, 2005-2006, Year-on-Year 
--------------------------------------------- ----- 
                       2005   2006   2006   2006 
                        Q4     Q1     Q2     Q3 
--------------------------------------------- ----- 
Private Consumption     4.2    3.2    3.0    3.0 
 
Government Consumption  30.0   14.2   31.6   1.8 
 
Fixed Capital Formation 1.8    2.9    -1.0   -0.3 
 
Exports of Goods and 
          Services      7.4    10.8   11.3   12.1 
 
Imports of Goods and 
          Services      3.7    5.0    8.3    9.7 
--------------------------------------------- ----- 
GDP                     4.9    4.6    5.2    5.5 
--------------------------------------------- ----- 
Source: Central Bureau of Statistics 
 
Indonesia Reports Higher GDP Growth in Third Quarter 
--------------------------------------------- --------- 
 
¶2.  (U) Private consumption, which comprises the largest 
component of GDP at over 60%, continued to recover modestly 
in third quarter of 2006, growing 3.0% YoY as the affects of 
lower inflation and reduced interest rates began to take 
hold among individual consumers.  Headline inflation dropped 
to 6.3% YoY in October, due to the significant increase in 
the inflation base caused by the October 2005 fuel price 
hikes.  In response to lower price levels, Bank Indonesia 
(BI) loosened monetary policy further in November, reducing 
the BI policy rate (reference interest rate) by 50 basis 
points on November 7 to 10.25%.  According to BI, demand for 
loans began to improve significantly during the third 
quarter, with domestic credit increasing by Rp 18.5 trillion 
(US$ 2.0 billion) during the month of September, the highest 
monthly increase this year.  Observers expect private 
domestic demand to improve further in the near term, as more 
stable price levels and lower interest rates encourage 
private sector spending and the Government of Indonesia 
(GOI) implements planned wage increases for civil servants 
(Ref A). 
 
¶3.  (U) Strong external demand for Indonesian commodities 
resulted in robust net export growth during the third 
quarter.  Exports of goods and services rose 12.1% YoY, 
continuing the trend of strong growth during the first half 
of 2006.  Indonesia's commodity exports have been very 
 
JAKARTA 00013326  002 OF 003 
 
 
strong during the first nine months of 2006, with exports of 
coal, rubber and rubber goods, and crude palm oil growing 
44, 71, and 17 percent respectively YoY.  Growth in imported 
goods and services failed to keep pace, increasing only 9.7% 
YoY in the July to September period.  Looking ahead, most 
observers expect local demand for imports to increase in 
subsequent quarters in line with resurging private demand, 
and global demand for Indonesian commodities to decline in 
proportion to slower world growth.  While most analysts 
expect the economic impact of these trends to be moderate, a 
sharper than anticipated contraction in net exports would 
slow growth and put pressure on Indonesia's balance of 
payments. 
 
Government Spending and Investment Flat 
--------------------------------------- 
 
¶4.  (SBU) Surprisingly, given that government expenditures 
traditionally increase during the second half of the year, 
YoY growth in government expenditures stagnated in the third 
quarter, rising only 1.8%.  Analysts attributed the slowdown 
in spending to the more rapid than expected disbursement of 
funds in the second quarter as well as ongoing difficulties 
facing the disbursement of funds at at the local level.  The 
GOI plans to significantly increase spending in the fourth 
quarter of 2006, likely boosting growth through the end of 
the year.  However, the GOI has announced a reduction in 
overall spending in 2007 as a share of GDP (Ref A), and 
observers expect problems associated with disbursement at 
the local government level to persist over the short-to- 
medium term, limiting the government's ability to stimulate 
economic growth. 
 
¶5.  (SBU) Indonesia's economy continues to suffer from very 
low levels of investment, with fixed capital formation 
contracting 0.3% YoY in the third quarter.  The low 
investment numbers reveal that GOI policies aimed at 
encouraging investment have so far failed to produce 
tangible results. Looking ahead, however, analysts believe 
the anticipated pick up in domestic private consumption will 
provide some stimulus to investment over the next six to 
nine months.  According to data collect by BI, domestic 
investment approvals have almost tripled during the first 8 
months of 2006 compared to the same period a year earlier, 
and foreign investment approvals are up 20% over the same 
period.  In addition, Indonesia's recent infrastructure has 
helped reignite investor interest in large-scale 
infrastructure projects in Indonesia, particularly in the 
power sector. However, there are questions about when the 
GOI will tender any of the 10 priority projects highlighted 
at the forum.  Important legislation impacting on the 
investment climate, including draft investment, tax, and 
labor laws, remain stuck in the GOI or Parliament, leaving 
many investors skeptical of the GOI's ability to maintain a 
competitive investment climate compared to Indonesia's 
competitors in the region. 
 
¶6. (U) Indonesia's cumulative GDP growth rate for the first 
three quarters of 2006 was 5.1%, a rate generally in line 
with economists' forecasts.  Although the economy grew at a 
more robust pace in the third quarter, it is still unlikely 
to meet the GOI's target 5.8% growth rate for the full year. 
The transportation and telecommunications sector, growing at 
a cumulative rate of 12.8% during the first three quarters 
of 2006, continues to outperform other segments of the 
economy.  Manufacturing growth slightly accelerated in the 
third quarter but the sector's growth rate, at 4.1% year to 
date in 2006, is still below that of the economy as a whole. 
Growth in the agriculture and mining sectors remain 
lackluster.  Agriculture and mining production have expanded 
3.4% and 2.3% year to date in 2006, respectively. 
 
Prudent Macro Policies Expected, But Risks Remain 
--------------------------------------------- ---- 
 
¶7.  (SBU) Most economic observers expect the GOI and BI to 
continue to pursue prudent monetary and fiscal policies over 
the next several quarters.  These policies have stabilized 
 
JAKARTA 00013326  003 OF 003 
 
 
the rupiah, lowered inflation expectations, and contributed 
to the significant accumulation of foreign exchange reserves 
in 2006.  The GOI has limited spending in 2006 and expects 
to further reduce spending levels during 2007 in order to 
reduce Indonesia's external debt level and enhance investor 
confidence.  In its November 7 statement announcing the 
lowering of the BI rate to 10.25%, BI cited "economic 
concerns calling for vigilance in the months ahead" 
including continued inflationary pressure in 2007.  BI added 
that "the Board of Governors...sees the need for more 
measured, cautious operation of monetary policy to maintain 
macroeconomic stability in the medium and long-term and 
consolidate the momentum for sustainable economic recovery." 
Despite these cautious words, there is some concern in the 
financial sector that in its efforts to support growth, BI 
will lower interest rates too quickly or too far, leading to 
renewed inflation and/or rupiah volatility. 
 
¶8. (SBU) The biggest risks to continued economic growth and 
stability in Indonesia in the short term are negative 
external developments.  A sharp drop in global demand for 
Indonesian products, especially commodities that have 
provided significant support for GDP growth in recent 
months, or a shift in foreign portfolio investor sentiment 
away from Indonesia could put renewed pressure on 
Indonesia's balance of payments and undermine Indonesia's 
hard-won macroeconomic stability.  However, continued strong 
growth in the region, particularly in China, is expect to at 
least partially offset an anticipated slowdown in the 
economic growth in the United States. Longer term risks to 
Indonesia's economic outlook include the slow pace of 
infrastructure investment and the relatively slow growth in 
labor intensive sectors like garments, footwear, and 
electronics.  New investment in infrastructure projects is 
particularly important given that much of country's 
electricity grid, road system, and ports are already 
operating at maximum capacity and the quality of those 
facilities has eroded substantially over time. 
 
PASCOE