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Cablegate: Indonesian Economy - Cautiously Optimistic Despite

VZCZCXRO9845
RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHJA #0469/01 0700314
ZNR UUUUU ZZH
R 100314Z MAR 08
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 8256
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 1639
RUEHBJ/AMEMBASSY BEIJING 4796
RUEHBY/AMEMBASSY CANBERRA 2137
RUEHUL/AMEMBASSY SEOUL 4460
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 02 JAKARTA 000469

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DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-SETH SEARLS
SINGAPORE FOR SUSAN BAKER
COMMERCE FOR 4430-JEAN KELLY
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR CURRAN
DEPARTMENT PASS EXIM BANK

E.O. 12598: N/A
TAGS: EFIN EINV ECON PGOV ID
SUBJECT: INDONESIAN ECONOMY - CAUTIOUSLY OPTIMISTIC DESPITE
POTENTIAL GLOBAL PRESSURES


1. (SBU) Summary: Local economists remain cautiously optimistic
about Indonesian economic forecasts for 2008 despite global and
local pressures. Indonesia's 2008 economic growth will be 6.0-6.3%,
down from the originally forecasted 6.8%, according to economists.
The U.S. economic slowdown combined with protracted high oil, mining
commodity and agriculture prices have led to these growth rate
revisions. Due to high commodity prices, the Government of
Indonesia (GOI) will spend a higher percentage - possibly up to 50%
- of its 2008 budget on food and fuel subsidies. The poor are
disproportionately affected by increased transportation and food
costs, a potential political liability for the 2009 elections. End
SSummary.

Global Economic Downturn Anticipated
------------------------------------

2. (U) Four top Indonesian economists discussed the global economic
outlook and debated the implications for the Indonesian economy
during an event in Jakarta sponsored by a prominent political risk
consulting firm on February 29. Panelists included: Fauzi Ichsan of
Standard Chartered, Sebastian Paredes of Bank Danamon, Nicholas
Cashmore of CLSA, and Anton Gunawan of Citi. They predicted that
skyrocketing demand from emerging markets and slow supply-side
adjustments would keep oil, commodity and food prices high.
Financial market instability would continue until investors
understand the true level of losses in the U.S. sub-prime mortgage
market.

Limited Near-Term Impact on Indonesia
-------------------------------------

3. (U) The panelists expect the global downturn to slow growth in
Indonesia to roughly 6.0-6.3%, significantly lower than the
government's initial 2008 forecast of 6.8%, but on par with
Indonesia's 2007 GDP growth rate. The economists based their
forecasts on the view that internal demand, which constitutes more
than 60% of Indonesian GDP, will continue to accelerate and that
Indonesia has a well-diversified export base, by product and
destination. The panelists were more cautious about the outlook for
foreign capital flows into Indonesia, given the increased aversion
to risk among global investors. However, none expected a sudden
reversal of current levels of portfolio inflows.

4. (U) Quality of near-term economic growth in Indonesia remains
questionable, according to Citi's Gunawan. The global slowdown
disproportionately affects the labor-intensive manufacturing sector,
clouding the job growth outlook. He noted that the decline in
unemployment last year - from 10.3% to 9.1% - in the formal sector
masks significant underemployment and unemployment in the large
informal sector. He also observed that while real wages are
increasing in some sectors, notably financial services, real and
even nominal wages have fallen for many manufacturing workers.

Global Prices Reduce Policy Flexibility
---------------------------------------
5. (SBU) The level and pace of inflation and its impact on monetary
and fiscal policies could create economic instability in Indonesia,
according to the experts. Continuing high globll commodity and food
prices would force the centa l bank - Bank Indonesia (BI) - to
maintain currnnt interest rate levels, potentially slowing credit
growth, according to a majority of the panelists One panelist also
noted that in recent discussoons, BI officials stated that the
central bank pa ns to use its substantial foreign exchange reservss
to maintain the value of the Rupiah in an effort to control imported
inflation. While Indonesiah(as roughly $56 billion in foreign
exchange resevves, BI cannot continue this policy indefinitely iQ
downward pressure on the currency remains signiiicant.

6. (SBU) On the fiscal side, panelists noted that high and rising
oil and food prices havei(ncreased the cost of the government's
subsidy rggime. The panelists warned that the Indonesian goe rnment
could spend as much as 50% of its 2008 bddget on subsidies,
particularly fuel subsidies, if oil remains near $100 per barrel.
Since increasd transportation and food costs disproportionately
affect the poor, the current administration is ul(ikely to cut the
subsidy programs in advance oftthe 2009 election. Panelists also

JAKARTA 00000469 002 OF 002


noted that the increased spending on subsidies and cash transfers
leading up to the election would crowd out much needed
infrastructure investment. Further, as the 2009 election season
heats up, the executive and legislative branch's appetite for reform
will diminish.

Policy Inertia Prevents Agriculture Boom
----------------------------------------

7. (SBU) Nicholas Cashmore stated that Indonesia is well positioned
to take advantage of global economic trends. Higher commodity
prices could increase agricultural sector growth, leading to higher
growth in rural communities. Cashmore conceded that the slow
approval processes for hybrid seeds, land use policies that prohibit
efficient use of farmland, and poor irrigation systems in Indonesia
are hampering the sector's ability to take advantage of current
price levels. However, he argued that the private sector now has a
strong incentive to push for policy changes and make the investments
in rural infrastructure needed to increase farm yields in Indonesia.
He also noted that the gap between wages in Indonesia and China has
continued to narrow, increasing foreign direct investment interest
throughout the country.

HUME

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