To offset the structural weakness of investment, in contrast, the government must pursue its reform efforts. Indeed, it tried to push through reforms during the pandemic, but implementation could prove to be difficult.
Major reforms adopted during the pandemic will be challenging to implement
In fall 2020, the government adopted major structural reforms regrouped under the “Omnibus law”. This set of laws aims to lift the structural constraints that are holding back the Indonesian economy, and its key target is the labour market. The goal is to ease bureaucratic red tape, job market rigidities and numerous contradictory regulations that are hampering job creations and investment, notably in the formal sector, which are handicapping competitiveness.
But in November 2021, Indonesia’s constitutional court ruled that the Omnibus law had not been debated and ratified in compliance with the official legislative process, although it did not find the law’s fundamentals to be unconstitutional. The constitutional court set a 2-year deadline for the legislators to present the bill again using a legislative process in compliance with the current constitution. If the changes demanded by the court are not adopted by the end of November 2023, then the law would be ruled unconstitutional.
The constitutional court ordered the government to postpone implementation of any new policies pertaining to the law that would have a major impact on job creations. Moreover, the government cannot issue any new regulations to facilitate the creation of special economic zones, the reopening of new investment sectors or to boost the country’s attractiveness for non-resident investors. However the constitutional court’s decisions are not retroactive. This means that any government decisions or corporate regulations that were made during the period after the law was adopted, as well as those before November 2021, remain in effect. The suspension of this law may weigh on investment, job creations and medium-term economic growth.
Public finances in jeopardy
The Indonesian government has only limited manoeuvring room to support economic growth and to boost spending on development. Although public debt is moderate, the fiscal base is structurally low and the weight of rigid expenditures has increased in line with the rise in the interest burden. Moreover, the government is still structurally dependent on foreign investors to finance its deficit, which places a big constraint on its strategy, especially at a time of high financial market volatility.
The pandemic crisis weakened public finances. In 2020, the central government’s fiscal deficit amounted to 6.1% of GDP, compared with a 2015-2019 average of only 2.3% of GDP. Over the same period, debt swelled to 38.6% of GDP, nearly 9 points higher than in 2019.
Public finances consolidated in 2021, but they were still more fragile than in the pre-Covid period. Moreover, the consolidation process will be slowed by economic support policies aiming to limit the impact of the conflict in Ukraine.