For the detailed note with charts, please download the PDF

Indonesia assumes the ASEAN chair

Indonesia assumed the presidency of ASEAN for the year, close to the heels of the conclusion of a successful G20 Summit in 2022. This year’s theme ‘ASEAN matters: Epicentre of Growth’ underscores the economic journey and development that this region has witnessed in the past two decades, looking to a sustainable, stable, and inclusive path ahead, accompanied by a strong and efficient institutional as well as bureaucratic backbone. The governments will also navigate through geopolitical flashpoints, including rising tensions between the US and China, both of which are the region’s key investment and trading partners.

As we discuss in this note, Indonesia seeks to strengthen its economic heft against the backdrop of a thriving ASEAN-6 region, which enjoys several structural and cyclical tailwinds, just as we keep an eye on the risks as well.


Structural tailwinds

• Favourable demographics

Indonesia is the most populous country amongst the ASEAN-6 countries at 273mn, and fourth largest in the world. This carries considerable demographic dividends, as the population is not only relatively young compared to the region but also enjoys a favourable proportion of working age population, rising by an average of 1.8% for the past decade. Median age is low at ~29 years, and the working age population makes up two-third of the total count, with its share likely to remain in the region over the coming two decades, according to the Central Bureau of Statistics. The Java province is the economic heart of the archipelago, accounting for around 55% of the population and more than half of the national output.

Alongside overall population growth, urbanisation has also been growing at a steady pace, standing at 57% of the population, according to the World Bank. Beyond the temporary downshift in status during the pandemic, the economy is expected to be recoup the upper middle-income status in the next couple of years. Plans are to expand the size of the middle class from the current a fifth of the population to 45-50%.

While these dynamics provide a unique window of opportunity to boost growth via an expanding labour pool, and competitive wages, likely leading to higher per capita GDP, the natural conclusion is that ensuring ample quality employment generation and appropriate education/ skill training will be few of the key priorities for the administration for the medium-term.

• Rich in natural resources

Indonesia is endowed with abundant natural resources, spanning agricultural commodities (e.g., palm oil, rubber), crude oil and metals/ minerals, for instance coal, iron ore, copper ore, nickel, crude oil, natural gas, and tin. Half of the economy’s export basket comprises of primary commodities, implying relatively high sensitivity of the trade sector’s performance to the global price cycles. Nonetheless, during boom times, high prices have had a beneficial impact, particularly on resource-rich provinces. 

While the country was a traditional ore commodity exporter, in the past decade there have been concerted efforts to attract more manufacturing capabilities in downstream industries, including steel production, aluminium, glass, electric vehicle (EV) batteries, amongst others. Besides ferrous commodities, the country also has the third largest tropical rainforest in the world and is home to the world’s largest tropical peatlands and mangrove forests, which store vast amounts of carbon that mitigate climate change impact, according to the World Bank.

• Strong investment push and integration

 
The country is the tenth largest economy in the world on purchasing power parity (PPP) basis and is within the top 20 in the world in nominal GDP terms. On PPP basis, its share is the biggest amongst the regional peers. In real terms, the economy expanded by an average 5% yoy in the decade before the pandemic, while the pace of growth decelerated from 6% in early 2010s to the 5.0% handle between 2014-2019.

Per capita GDP has risen by close to seven times - from sub-USD600 in 1990 to ~USD4,340 last year, helping to lower the proportion of population living below the poverty line to sub-10%. Beyond the National Medium-term development plan for 2020-24 (partly derailed by the pandemic), plans are to double the GDP per capita within this decade, assuming a higher 6% average growth between 2025-2030.

Plans are afoot to relocate the National Capital City from Jakarta to Eastern Borneo, with the city named as Nusantara and due to be completed over the coming two decades. With the country heading into Presidential elections in 2024, the next administration will be expected to carry forward the capital’s infrastructure projects, meet financing needs, besides movement of key government offices and regulators over the course of the coming years.

The country’s overall economic, strategic, and diplomatic interests reflect a preference for ‘maintaining a balanced stance’ towards geopolitics, refraining from getting drawn into bilateral skirmishes, whilst defending its own as well as ASEAN region’s territorial sovereignty. In the economic sphere, governments have keenly engaged in regional and bilateral trade/ economic agreements. Besides being one of the founding members of the ASEAN bloc, Indonesia ratified the Regional Comprehensive Economic Partnership (RCEP) agreement last year and has finalised/ is in consultation phase of over 40 multilateral/ free trade agreements, according to the ARIC. 

• Digitalisation strides

Indonesia’s digital population is estimated to have witnessed the fastest rise amongst Southeast Asian neighbours. Internet users make up about 80% of the population (DBS), with the shift expedited by the pandemic. Amongst the new joinees, more than half are from non-metro areas, putting paid to the idea that digitalisation has helped surmount the urbanisation gap [e-Conomy SEA by Google, Bain & Temasek study 2020].

Additionally, over 90% of the new consumers plan to continue using these digital services, proving to be sticky digital consumers. Adoption of urban digital users is the highest at 89% for e-commerce, 60% for groceries, 79-80% for transport, and food delivery, according to the 2022 edition of the above study.

This deepening penetration and growing interest in applications has led the gross merchandise value (GMV) to jump by 22% to USD77bn in 2022 and is on course to nearly double to USD130bn by 2025, according to the same study. Separately, digital payments have also scored high penetration, with value of e-transactions up by 26.1%yoy in Jan23 and digital banking transactions up by 28% yoy.

Besides wider consumer push, Indonesia’s digital revolution is also thriving. For instance, a survey by Startup Ranking showed that this is the only country within ASEAN to make it to the top ten for the number of start-ups, majority of which are concentrated in Jabodetek area (i.e., Jakarta-Bogor-Depok–Tangerang–Bekasi, which is the Jakarta metropolitan area).

A young and digitally aware population sets the base higher for development opportunities, including better soft infrastructure, pass through to high labour productivity, improved manufacturing capabilities, financial inclusion, strengthening social infrastructure and positive spillovers of new technologies such AI/ Internet of Things, amongst others.


Cyclical tailwinds

• Positive tailwinds from China’s reopening

China’s reopening and the government’s pro-growth stance bode well for the ASEAN-6 region on a whole, as we discuss in the later section, spanning trade, investments, and tourism.

Trade linkages with China have risen sharply in the past seven years, displacing other markets such as intra-region, US, and EU. Key exports to China comprise of mineral fuels, oils and products, iron and steel, animal or vegetable oils/fats, and pulp of wood or of other fibrous cellulosic material etc.

Investment ties have also strengthened over the past five years, with China’s share rising from less than 2% of total inflows to a little over 15% last year, emerging as the second biggest source of foreign direct investments (FDI). This encompasses an increase in China’s interests in Indonesia’s downstream resource industry and manufacturing sectors (77% of inflows in 2022), besides wholesale and retail trade, transportation, and utilities. This also includes projects like the development of the Jakarta-Bandung high speed railway project, Zhejiang Huayou Cobalt Co cooperation with PT Aneka Tambang Tbk & Shandong Xinhai to develop cathodes and ferronickel projects, and the formation of the Weda Bay industrial Park, amongst others.

Compared to Thailand, Vietnam, and Malaysia, the tourism industry is a relatively small part of the Indonesian economy (direct contribution of ~2% of GDP), with tourists from China accounting for 12-14% of arrivals in pre-pandemic years i.e., 2015-2019.

• Moving up the commodities value chain and strong FDI interest

After a bumpy ride through 2020-21, domestic and foreign investment flows improved sharply in 2022. We discussed this healthy growth in FDI in Indonesia’s medium-term catalysts and earlier in Indonesia 2023 Outlook: Setting sights higher. Total investment (realised) rose by 24% yoy in 2022, whilst foreign investments marked a steeper jump at 45% yoy. More than half of the FDI flows went to the secondary sector (includes metal processing, chemicals & pharma), a third to tertiary (includes utilities, transportation), and the rest towards the primary sector. Singapore, China, and Hong Kong SAR were the top three investors last year.

Commodities will continue to be a backbone for the economy, but the government is single-mindedly focused on expanding its footprint in the downstream industries. Towards this, export of raw minerals is being successively banned, including the upcoming stoppage on raw bauxite shipments, with copper likely on the list next.

One such example is nickel, an important component for production of stainless steel and EV batteries. Home to the world’s largest nickel reserves, the authorities have been actively attracting regional and global players to set up manufacturing facilities across the value chain in the archipelago. The Indonesia Battery Corporation was formed in 2021, by a partnership of four major state-owned oil majors: Pertamina, electricity company PLN, mining holding company MIND ID, and nickel & gold miner PT Aneka Tambang (Antam). 

Development of the domestic EV industry has been accorded a national priority, enjoying a mix of fiscal and non-fiscal incentives. Hyundai Motor Group is reportedly building a large factory for EV battery production, in collaboration with South Korea’s LG. There is also significant presence of investors from China in this space. France’s Eramet is partnering with Germany’s BASF to plan the development of a HPAL complex in the area to process nickel and cobalt, which are essential materials for the manufacturing of batteries used in EVs.

Besides potentially higher exports, Indonesia also plans to boost domestic EV sales, which currently stand at less than 1% of registered vehicles, even as the country accounts for most the motor vehicles sales amongst the ASEAN-6 markets. In this spirit, incentives (subsidies and tax breaks) were outlined in Mar23 to draw 200k eligible buyers towards electric motorbikes to meet the goal of 10% of the population to reach green vehicles by 2024. For the industry, incentives have also been assured to carmakers, who have a domestic manufacturing facility and tap at least 40% of local inputs. Thailand is a key competitor in the region.  

Efforts to make the country attractive for investments continue to be a medium-term strategy (for instance Omnibus), with positive strides towards lowering entry barriers, easing labour regulations, predictable taxation/ legal/ contractual rules, and facilitating land acquisition, as demonstrated by a myriad of reforms (under the Omnibus channel) introduced through the pandemic.

• Green transition

 
Authorities are laying the ground to increase the proportion of renewable energy in the domestic energy mix and lower the reliance on fossil fuels to facilitate the shift towards the net zero emission target by 2060. This will involve a keen balancing act as growth needs to be tracked while maintaining affordable and dependable energy supplies. At present, coal dominates the energy supply mix, with high domestic reserves also making Indonesia the largest global coal exporter. 

In the near-term, under the aegis of the G20 leadership last year, Indonesia launched the Energy Transition Mechanism (ETM) platform, facilitated by ADB, and intended to act as the central coordination mechanism to advance the retirement or repurposing of coal/ other fossil power plants, and eventually replace these facilities with clean energy plants. The state utility player PLN, PT SMI, sovereign fund Indonesia Investment Authority (INA), and few other state-owned entities & private sector firms plan to support such projects. Concurrently, under the umbrella of Indonesia’s Just Energy Transition Partnership (JETP), a coalition of countries, including the US, Japan, Britain, Canada etc., will mobilise USD20bn to help finance Indonesia’s efforts to shut coal plants and shorten the run-up to peak emissions to 2030.

While this financing support will be timely, significant requirements lie ahead. A study by the Planning ministry estimated that Indonesia will need USD150-200bn per year over a decade to meet its goal to reach net zero emissions by 2060. This will require phasing out of fuel subsidies and reallocation of other investments to make sufficient room in the public books, besides pursuing higher private sector and multilateral agencies’ support.

Pulling it all together

After the pandemic-led economic scarring, the economy’s real GDP has returned to trend, with the growth rate expected to average 5% this year and next – back to the pre-Covid five-year average. For 2023, Indonesia’s growth pace is likely to be amongst the strongest in the ASEAN-6 complex, together with Philippines and Vietnam. Afore-discussed cyclical as well as structural tailwinds are expected to be key pillars for the economy.

Vibrant ASEAN-6 backdrop

We expect ASEAN-6 to be carried by structural tailwinds from favourable demographics, increasing regional integration and supply chain diversification, besides digital adoption gains. A rebounding China and terms of trade relief from correcting energy prices would keep ASEAN economies resilient from the challenging global economic climate beset by still-elevated inflation and tighter monetary conditions in advanced economies.

ASEAN-6 has tended to emerge stronger following major crises, and this time will be the same. Following the 1997/98 Asian Financial Crisis (AFC), the region achieved robust economic expansion of ~5% over the past two decades. The bloc has punched its weight above global growth of 3.6%, as it benefitted from greater regional economic integration and China’s growth success, coupled with much improved fundamentals.

With strong economic expansion, ASEAN-6’s prominence has increased over the past two decades. Its nominal GDP is set to exceed USD 4trn by 2025. This would make it the fifth largest (as a bloc) globally, just behind the US, China, Japan, India, and Germany, and fourth within Asia.


Structural tailwinds

• Favourable demographics

ASEAN-6, as a region, will continue to reap demographic dividends over the coming years. Not only is the region the third most populous behind China and India - boasting a population of 600mn - more importantly, it has a young and steady share of working age population. ASEAN-6’s median age was 33 years as of 2022, lower than other Asian peers such as China (39), Japan (49), or South Korea (44), but higher than India (28).

ASEAN-6’s share of working age population is set to be rather steady at close to 65% in 2050, based on projections by the United Nation. This is a stark contrast to the much faster declines in Japan and South Korea, which would approach 50%, while China drops to below 60% in around 30 years.

Against a favourable demographic backdrop, ASEAN-6 excluding Singapore offers competitive labour cost advantages for a reasonably skilled workforce. It compares well with Asian peers especially vs China, even though India’s wage cost is still lower.

• Continued regional integration; Supply chain diversification

ASEAN-6’s trade and investment flows will likely benefit further from continued regional integration with Asia, having already made significant strides in this area. The region is already relatively open to trade, aided by previous liberalisation efforts.

These included the establishment of the ASEAN Free Trade Area in 1992, which eliminated tariff barriers among Southeast Asia economies that supported intra-ASEAN trade, and the eventual signing of the ASEAN Economic Community (AEC) blueprint in 2015.

The AEC envisions an eventual single market and production base, where there would be free movement of goods, services, investments, capital, and skills, but much has still to be done for this diverse region before the goal can be achieved. ASEAN also had various other agreements with China, India, Japan, South Korea, Australia, and New Zealand.

The RCEP trade pact between 15 member economies, including the 10 members in ASEAN, came into force in January 2022 after eight years of negotiations. The move towards a large unified market supported by RCEP would, therefore, lend a helping hand in further trade integration over the medium-term, amid improved efficiency and regionalisation of supply chains, coupled with modest gains from goods tariffs reduction.

Persisting US-China geopolitical tensions are not positive for the global economy, but at least offer ASEAN-6 an opportunity to attract FDI from supply chain shifts, as companies adopt a China+1 diversification strategy. To be sure, individual Southeast Asian economies would be unable to replace China as a manufacturing base. Yet, as a bloc, it can rival China in attracting FDI.

The diverse region has multiple competitive advantages to offer, complemented by the region’s tight trade integration – ranging from Singapore’s high value-add capabilities to electronics testing and assembly expertise in Malaysia, assembly activities in Vietnam, or autos in Thailand, and commodities in Indonesia.

• Digital adoption gains

 
Southeast Asia has continued to reap economic gains from a rapidly expanding digital economy. The region’s consumer digital adoption leapfrogged during the pandemic, as consumers and businesses are forced to adapt during lockdowns.

The digital economy’s gross merchandise value (GMV) approached USD200bn in 2022 - a 2x increase in three years, according to Google, Temasek and Bain, e-Conomy SEA 2022. e-Conomy SEA 2022 also highlighted that the region is in a ‘digital decade’. The digital economy’s GMV is, therefore, on course to exceed USD300bn in 2025, growing by 20% compound annual growth rate from 2022.

ASEAN-6 digitalisation’s growth will be supported in the post-pandemic era and digital decade. First, the region is already populated by young and tech-savvy users amid rising internet and high smartphone penetration. Total internet users rose to 460mn in 2022, adding 100mn over the past three years. Users are likely to rise further, who are going to continue to demand for digital services, for example in e-commerce, online travel, or digital financial services. Second, further investments to be made to digital infrastructure over the coming years would improve connectivity especially to rural areas and speed of access to digital services when 5G comes into play.


Cyclical catalysts

• China reopening

China’s ongoing reopening is likely to cushion and provide an offset to the uncertain global economic environment driven by still-elevated inflation and tighter monetary conditions in advanced economies. We expect ASEAN-6 to be a key beneficiary of China’s reopening from the tourism and export channels.

Returning Chinese tourists are likely to drive the next leg of ASEAN’s ongoing international travel and tourism activity. Activity is yet to recover to pre-pandemic levels despite the rebound in 2022. Some remnant reopening boost is, therefore, still to be reaped, driven by some Chinese revenge travelling, gradual improvements in flight capacity, and efforts by some ASEAN countries to spur tourism activity.

Positive spillovers would be felt in related services sectors such as transport, accommodation, and food and beverage. The entire region will benefit, but Thailand will no doubt see the biggest positive impact. Not only does Thailand have a large exposure to international tourism (receipts of 12% of GDP), especially from Chinese visitors (30% of total arrivals) pre-pandemic, travel interest from China also remains strong.

China’s post-pandemic economic rebound and recovering domestic demand would support ASEAN’s exports, mitigating some of the weakness from advanced economies’ demand. ASEAN-China’s trade relationship has deepened over the years, with China a major and growing export destination over the past decade.

The nature of China’s rebound matters. A pick-up in China’s consumer spending and final demand for consumer electronics could support ASEAN’s electronics exports, but ultimately, electronics exports would still depend on advanced economies’ consumer spending, given a sizeable part of shipments are intermediate goods. Improvements in China’s business investment and stabilisation in the residential property market would support ASEAN’s commodity-related/raw material exports, and in this regard, Indonesia and Malaysia are poised to benefit more.

• Terms of trade relief from oil

Correction in global oil prices in early-2023 is a positive terms of trade development for ASEAN-6’s net energy importers. Our oil & gas team’s average forecast of ~USD85-90/bbl for 2023 would be lower than 2022’s ~USD100/bbl.

Within ASEAN-6, Thailand is the largest net oil importer (in terms of GDP), coming in at 7% of GDP in 2022, and it suffered significantly from the upside oil shock in 2022. In 2023, Thailand’s current account balance would benefit from the positive terms of trade gains from the drop in oil prices, alongside recovering tourism receipts, notwithstanding slower exports. Malaysia and Singapore also import a significant amount of oil but are negated by their sizeable oil exports – with Malaysia running a slight 0.5% deficit in 2022, but small surpluses in some years, while Singapore’s net oil trade deficit was 1.8% in the same period. Indonesia, Philippines, and Vietnam are in the middle of the range, with net oil deficits of 2.2% of GDP and ~3% for the latter two in 2022, also implying some terms of trade relief.

Risks

The ASEAN-6 region offers multiple structural and cyclical tailwinds as we discuss in the earlier sections. Nonetheless, there are risks that will need to be monitored closely.

Firstly, a slowdown in global growth would hurt trade/ investment channels this year, even if outright recessionary risks might be averted. Next, unexpected sharp gains in the commodity universe from China’s reopening could be a fresh blow to macro imbalances for emerging markets, including the ASEAN-6 region. A renewed lift in inflation could necessitate further tightening measures from the respective central banks, placing a speed brake on growth.

Lastly, fluid geopolitics are potential ‘unknown unknown’ flashpoints, which could not only make the regional financial markets volatile but also create diplomatic and security fissures, posing a fresh risk to growth prospects.

To read the full report, click here to Download the PDF.