Cablegate: Confidence Low Despite Strong Q2 Gdp

VZCZCXRO1480
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #1644/01 2420730
ZNR UUUUU ZZH
R 290730Z AUG 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 9933
RUEATRS/DEPT OF TREASURY WASHINGTON DC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RUEHKO/AMEMBASSY TOKYO 2434
RUEHBJ/AMEMBASSY BEIJING 5345
RUEHBY/AMEMBASSY CANBERRA 2972
RUEHUL/AMEMBASSY SEOUL 4866
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 001644

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA/MALACHY NUGENT
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: CONFIDENCE LOW DESPITE STRONG Q2 GDP

REF: Jakarta 1487

1. (SBU) Summary. Indonesia's economy expanded a 6.4% in the second
quarter of 2008, mainly on strong export and investment performance.
High prices, particularly in food commodities, continue to
undermine the gains from faster economic growth. Indonesian
confidence in the economy and government remain very low by
historical standards, despite an increase in July. Government
policies to offset the impact of rising prices on the poor exclude a
large portion of the near poor community. End Summary.

GDP Growth Unexpectedly Strong
------------------------------

2. (U) Indonesia's GDP expanded 6.4% (yoy) during the second
quarter, beating most market forecasts. Export growth remained
strong in the second quarter, rising 16.1% (yoy), supported by high
commodity prices. The prices of many commodities have declined
significantly since that time, however, dampening the outlook for
export growth in the second half of the year. Import growth
remained robust, increasing 16.7% (yoy) during the second quarter.
If import growth remains high and lower commodity prices hamper
export growth, Indonesia may face slower growth and pressure on the
Rupiah later this year, as the trade balance weakens.

3. (U) The pace of investment and domestic consumption remained
strong in the second quarter, but decelerated from the previous
quarter. Investment rose 12.8% (yoy) in the second quarter, down
from 15.4% (yoy) in the first three months of the year. Growth in
domestic consumption fell to 5.5% (yoy) in the second quarter, down
from 5.7% in the previous quarter. A recent GOI report noted that
the importance of domestic consumption to economic growth has
declined this year, falling to 42% in the first half of the year,
down from 52% in 2007.

4. (SBU) Credit growth continues to rise in Indonesia, indicating
investment may remain strong during the rest of the year. Credit
grew almost 35% (yoy) in July according to Bank Indonesia. The
banking sector has largely balanced credit growth across consumption
loans, working capital loans, and investment loans. While loan
growth has increased significantly over the past year, deposit
growth has slowed, likely due to negative real interest rates (the
inflation rate is now roughly 300 basis points above the overnight
interest rate). If these trends persist, liquidity constraints
could curb loan growth later this year. Moreover, rapid loan growth
usually causes deterioration in loan quality, which could prompt
more conservative loan practices moving forward.

High Food Prices Undermine Gains from Growth
--------------------------------------------

5. (SBU) High food and overall prices continue to strain household
budgets. Headline inflation rose to 11.9% (yoy) in July, driven in
large part by a 19.9% (yoy) increase in the overall price of food
(reftel). Food price increases continue to hit the lowest income
groups, which spend roughly 60% of their incomes on food, the
hardest. The price of rice, Indonesia's most important staple food,
has stabilized in recent months, although the price is up 16.4% on a
yoy basis. If the international price of rice, which also declined
significantly in June and July, rises again before the end of the
year (when Indonesia traditionally imports rice), domestic rice
prices could rise again, hurting consumers. The current
international price of rice is between $550 and $700, depending on
the quality. World Bank economists believe that rice prices over
$700 per metric ton encourage smuggling out of Indonesia, putting
additional pressure on domestic supply. While rice harvests in 2008
are not low by historic standards, the international rice market
remains thinly traded and subject to significant volatility.
According to rice market analysts, major buyers are currently
waiting for lower prices, temporarily suppressing demand.

JAKARTA 00001644 002 OF 002

6. (SBU) According to World Bank estimates, the rise in food prices
in Indonesia has significantly undermined the positive impact of
economic growth on poverty reduction. The official poverty rate
fell to 15.4% in 2008, from 16.6% in 2007. However, according to
World Bank estimates, the poverty rate would have been two
percentage points (or 4.5 million people) lower in the absence of
food price inflation. World Bank officials also estimate that every
additional 10% increase in the price of rice in Indonesia not only
erodes all gains from economic growth, but also increases the number
of people living below the poverty line by as much as 2 million.

Food, Fuel, Jobs Remain Top Concerns
------------------------------------

7. (U) Despite some improvement in July, consumer confidence and
confidence in the government are at historic lows in Indonesia.
Danareksa Research Institute's Consumer Confidence Index rebounded
in July, most likely in response to the government's direct cash
transfer program and steadier rice prices. However, the consumer
confidence index, at 73, remains well below the 80 average level
recorded in 2007. The key concerns of consumers are the price of
basic foodstuffs, the price and scarcity of fuel, and the lack of
jobs. Concern over each of these factors worsened from June to July
in contrast to the overall trend. Consumer concern over general
inflation declined significantly over the same period.

8. (SBU) Danareksa's confidence in government index also improved in
July, but remains well below the level seen in 2007. The index
dropped to 80 in June from over 100 in late 2007 before rebounding
to roughly 82 last month. According to Danareksa analysts, a score
of 100 or more is necessary for the current government to remain in
power. The sharp decline in the index is almost entirely due to the
high and volatile price of food and the scarcity of job
opportunities. The other components of the index, namely the
government's ability to maintain public safety, to support public
infrastructure and to ensure legal certainty, remain at or near 100.

Government Policies Overlook Near Poor
--------------------------------------
9. (SBU) The Government of Indonesia's (GOI) policies to offset the
impact of rising prices on the poor have succeeded for those
receiving benefits, but the programs exclude a large portion of near
poor community. According to the World Bank, two of the
government's largest pro-poor programs, the direct cash transfer
program and the subsidized rice program, have been very effective in
offsetting rising food and fuel prices for the 19 million poor
households that receive benefits. However, the program entails
considerable leakages. The means testing used to identify the 19
million households placed on the list of poor families is very labor
intensive and subject to error. Because the list is static, it also
misses many families that were just above the poverty line before
the study, but have now fallen below that level, and retains
families that have moved out of poverty. Economists believe the
latter is a particular problem in Indonesia's outer islands, where
economic growth has increased significantly in recent years. The
GOI is planning to conduct an updated survey this year.

10. (SBU) More targeted pro-poor policies are difficult to implement
in Indonesia, according to experts. Most economist feel large
public works programs that provide low wage jobs are the best way to
target poor households, as only individuals with true need apply to
work. However, analysts and government officials have noted that
these programs are often ineffective in Indonesia, as public
officials divert large portions of the project's resources through
corrupt practices.

HUME

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