VZCZCXRO0502
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1007/01 1430511
ZNR UUUUU ZZH
R 220511Z MAY 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9071
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 1998
RUEHBJ/AMEMBASSY BEIJING 5062
RUEHBY/AMEMBASSY CANBERRA 2533
RUEHUL/AMEMBASSY SEOUL 4611
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 001007 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS 
COMMERCE FOR 4430/KELLY 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN 
DEPARTMENT PASS EXIM BANK 
SINGAPORE FOR SBAKER 
TOKYO FOR MGREWE 
USDA/FAS/OA YOST, MILLER, JACKSON 
USDA/FAS/OCRA CRIKER, HIGGISTON, RADLER 
USDA/FAS/OGA CHAUDRY, DWYER 
USTR WEISEL, EHLERS 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON EAGR ID
SUBJECT: INDONESIA: STRONG FIRST QUARTER GROWTH BUT RISKS MOUNT 
 
REF: A) Jakarta 848 B) Jakarta 871 
 
¶1. (U) Summary.  Indonesia's economy grew 6.3% (y-o-y) in response 
to strong internal and external demand as well as an increase in the 
rate of investment.  Analysts attributed the strong performance in 
part to the lagged impact of looser monetary policy in 2007.  The 
manufacturing sector recorded modest growth, while the 
transportation/communication and utilities sectors expanded rapidly. 
 Economists expect inflationary pressure to prompt tighter monetary 
policy and reduce GDP growth later this year.  The outlook for job 
creation and poverty reduction in 2008 also remains poor.  End 
Summary. 
 
Strong Investment and Exports Support Growth 
-------------------------------------------- 
 
¶2. (U) Indonesia's first quarter 2008 growth rate was 6.3% (y-o-y), 
due to strong expansion of exports, investment and domestic demand. 
After slowing in late 2007, Indonesia's exports rebounded during the 
first three months of the year due to strong performance in the 
commodity sector.  Exports as a whole rose 15.0% in the first 
quarter.  Palm oil, rubber, and coal exports rose 17.1%, 7.1%, and 
7.0% respectively (y-o-y) during the same period.  Growth in exports 
to the European Union, Japan, and the US outpaced other 
destinations.  Investment growth was also strong, surging 13.3% 
(y-o-y) during the quarter.  Analysts attributed the strong 
investment performance to the lagged effect of looser monetary 
policy in 2007.  Domestic demand remained healthy, increasing 5.5% 
(y-o-y) over the period and accounting for roughly half of the 
overall expansion in GDP.  Imports continued to increase rapidly, 
with strong growth in electrical and other mechanical tools.  The 
weakest component of GDP was government spending, which grew only 
3.6% (y-o-y) during the quarter. 
 
¶3. (U) Growth across sectors varied widely, with transportation, 
communication and utilities (electricity, gas, and water) expanding 
much more rapidly than other sectors.  However, utilities 
contributed little to overall growth, given the limited size of the 
sector.  Agriculture growth expanded rapidly during the first 
quarter, jumping 6.0% (y-o-y), due to better weather and rising crop 
prices.  Growth in the manufacturing sector improved modestly, at 
4.3% (y-o-y), after slowing to 3.8% (y-o-y) in the final quarter of 
¶2007.  The poorest performing sector was mining, which contracted 
2.3% over the previous year. 
 
Inflation Risk Rising 
--------------------- 
 
¶4. (U) External sources of inflation are the biggest risks to growth 
and stability this year.  Soaring food prices have already pushed 
CPI inflation to 9.0% (y-o-y) as of the end of April.  The expected 
continued strength of global prices for imported agricultural 
commodities, such as soybeans, wheat and rice (imports of rice are 
forecast toward the end of the year; ref A), will put additional 
pressure on the CPI.  The price of flour in Indonesia continues to 
soar, rising 13.1% since early January.  Rice prices have also begun 
to climb, increasing 8.3% since the beginning of the year.  Market 
analysts and government officials expect Indonesia's inflation rate 
to rise above 11% if the government implements its proposed fuel 
price increase (ref B).  HSBC economists predict CPI inflation will 
soar in the next few months and could hit 15% before the end of the 
year. 
 
¶5. (SBU) Most market analysts expect the central bank - Bank 
Indonesia (BI) - to raise interest rates further before the end of 
the year to control domestic inflation.  Government officials have 
stated that they expect BI to increase rates by at least 250 basis 
points if the government moves ahead with plans to reduce fuel 
subsidies.  Higher rates are likely to curb investment and domestic 
demand.  Yet, experts do not agree on the extent to which BI should 
raise rates.  Given that a large portion of food and fuel inflation 
is imported, higher domestic interest rates may not be an effective 
 
JAKARTA 00001007  002 OF 002 
 
 
tool in fighting inflation in Indonesia.  If higher interest rates 
slow domestic demand and economic growth but fail to control 
inflation, pressure on poor household budgets will likely mount. 
 
¶6. (U) Other economic analysts argue the food and fuel prices will 
quickly spread to the broader basket of consumer goods and prompt 
rapid increases across the board if BI does not act decisively to 
control inflation.  In addition, an increasing number of investors 
in the region are taking a more cautious approach to Indonesia in 
advance of the 2009 election, according to market analysts.  If the 
government fails to secure the budget by reducing fuel subsidies, or 
is slow to fight inflation, investors may begin to lose confidence 
in Indonesian assets.  A reverse in capital flows would weaken the 
currency and exacerbate imported inflation. 
 
Outlook for Job Creation Weak 
----------------------------- 
¶7. (U) Slower growth and structural inefficiencies mean the outlook 
for job creation this year remains poor.  The open rate of 
unemployment is roughly 9 percent and Indonesia faces a lingering 
underemployment problem, particularly in the rural sector. 
Although the prices of many Indonesian crops have reached historic 
highs, structural inefficiencies in the agriculture sector impede 
most farmers from taking advantage of higher food prices.  The vast 
majority of Indonesian small-scale farmers remain net purchasers of 
food.  Other industries are also unlikely to net significant 
additional jobs this year.  High commodity prices rather than higher 
export volumes drove Indonesia's commodity export performance in 
recent quarters, due to limited investment in new productive 
capacity, according to analysts.  The value of imports grew 13.2% in 
2007, while the volume increased only 4.8%, according to the Central 
Bureau of Statistics.  As a result, potential job creation in the 
natural resources sector remains limited in the near term, even if 
commodity prices remain high.  Analysts also predict that the 
labor-intensive manufacturing sector will slow later this year in 
response to reduced demand from the U.S. and Japan. 
 
HEFFERN