Growth robust and broad based

Indonesian economic prospects, as described by the Manila-based Asian Development Bank in its latest report, Asian Development Outlook 2007, are quite encouraging, with robust growth in the first semester and a good chance of an even faster pace of expansion in the second semester.

But even more encouraging, the key indicators point to even stronger fundamentals for sustainable growth because the economic expansion appears increasingly broad based, as all the key drivers of growth -- private and government consumption and investment -- have been accelerating.

The economy grew in terms of gross domestic product at 6.1 percent in the first half of 2007 on the back of a strong recovery in private consumption, government spending and private investment, which rose 7.3 percent, the highest rate over the past two years.

Indicators for construction-related spending, including market demand for steel, cement and other building materials, point to a strong recovery in the construction industry. Likewise, retail sales also expanded on the back of high consumer confidence fueled by declining inflation and lower interest rates.

Private consumption, due in part to the seasonal Idul Fitri and Christmas holidays in October and December, respectively, is expected to expand at a faster rate.

Government spending, which usually slows in the first half of the year due to bureaucratic inertia and procedural bottlenecks, should increase sharply in the second semester.

In fact, almost 70 percent of the government budget for capital expenditures and the procurement of goods and services for this year will likely be realized in the second half. This also fits well with the government's mid-year upward revision of its fiscal deficit from 1.1 percent of gross domestic product to 1.6 percent.

No wonder, the ADB revised upward its growth forecast for Indonesia from 6 percent to 6.2 percent this year, which is slightly lower than the government target of 6.3 percent but still higher than the 6.1 percent average it forecast for the Southeast Asian region. The ADB also revised upward its growth forecast for Indonesia next year to 6.4 percent, against the government estimate of 6.8 percent. Indonesian economic growth was only 5.5 percent in 2006.

Past experience has shown that accelerated government spending is usually followed by a higher rate of bank lending to businesses. The latest data from Bank Indonesia showed that, strikingly different from the trend over the past 18 months, bank credits to companies have been expanding at a higher rate than loans to consumers.

The prospects for Indonesia's external balance are similarly strong. Even though imports increased 1.7 percentage points faster than exports -- higher economic growth here is always accompanied by larger imports of basic industrial materials and capital goods -- the overall balance of payments will still be quite positive.

The ADB predicted Indonesia's international foreign reserves would increase from around $52 billion as of July to $55 billion in December, or equivalent to more than 7.7 months of import bills, due to robust exports, strong inflows of foreign portfolio funds and direct investment.

These factors -- improved macroeconomic fundamentals, relatively high interest rates on debt securities and deposits, and expectation of currency appreciation -- have again attracted significant foreign portfolio inflows into the stock market and government bonds, after the recent short period of big outflows as a result of the sub-prime mortgage crisis in the United States.

The rosy economic outlook, however, is not without downside risks. The government should closely monitor international oil prices, which have risen to more than $80/barrel, much higher than the average $60 assumed for the 2007 fiscal year.

Deeper structural reforms and pushing through with reform packages already launched remain pivotal to maintaining robust economic growth and reducing poverty and unemployment.

Other major barriers to businesses -- rigid labor regulations along with a weak legal system, excessive bureaucracy and corruption -- should be reduced to sustain the accelerated pace of new investment.