Eco Conjoncture

Weakened by the pandemic, but solid enough to handle new shocks


The Covid-19 pandemic weakened Indonesia’s economy. Two years after the crisis, real GDP has returned to 2019 levels, but the labour market is still weak, the poverty rate is higher than before the crisis and investment remains subdued. According to the World Bank, the pandemic’s lasting impact on education and the labour market will cost the country 0.1 points of its long-term growth potential.

Today, Indonesia must deal with a new unfavourable economic environment as commodity prices have dramatically increased due to the conflict in Ukraine and sanctions against Russia. Although growth is bound to be squeezed by the Ukrainian conflict, Indonesia’s external accounts should remain healthy and inflationary pressures should remain moderate. As a net commodity exporter, the country should benefit from higher prices for its export products. Moreover, to contain the impact of rising international prices on domestic prices, the government has already increased energy price subsidies and maintained pump price controls.

Indonesia’s economy in the aftermath of the Covid-19 crisis

The Covid-19 pandemic causes a loss of long-term growth potential


The Covid-19 crisis did not spare the Indonesian economy. For the first time since 1998, Indonesia reported a recession in 2020 (-2.1%). Yet the economic decline was not nearly as bad as the onslaught of the Asian crisis (-13.1%). Moreover, the contraction was much smaller than for the other Southeast Asian countries, like the Philippines (-9.6%), Thailand (-6.2%) and Malaysia (-5.6%).

The economy rebounded mildly in 2021 (+3.7%), but this was enough for GDP (at constant prices) to return to and exceed pre-crisis levels (+1.5%). Even so, at year-end 2021, GDP per capita was still 0.4% below the 2019 level. Moreover, without the pandemic’s shock, GDP growth would have been an estimated 11% higher than it was at the end of 2019.

Even though the government adopted massive household support measures, the Covid-19 crisis raised the poverty rate[1] (from 9.2% in 2019 to 10.2% in September 2020, before slipping back to 9.7% in September 2021 according to BPS, the national statistics institute). The World Bank also estimates that the crisis triggered a 0.1-point decline in the country’s long-term growth potential. The Covid crisis will also have non-negligible and lasting consequences on education, labour market and, to a lesser extent, capital accumulation.

A structurally weak labour market that has yet to regain its pre-crisis momentum

Indonesia’s labour market is structurally weak. Structural constraints are heavy: a low participation rate for women, the relatively low level of education and the high share of employment in the informal sector, which are obstacles for the development of high value-added sectors that require a skilled labour force. The Covid-19 pandemic has accentuated these weaknesses, and the job market still has not returned to pre-crisis levels.

The unemployment rate fell from 7.1% in mid-2020 to 5.8% in February 2022, but this is still 0.9 points higher than the pre-crisis level. Youth unemployment is still holding above 17%, compared with 13.4% in 2019.


The share of informal employment rose during the pandemic and is still higher than the pre-crisis level. According to the most recent figure released by BPS, the national statistics office, informal employment increased to 59.5% in 2021, 3.6 points higher than in 2019. There are still extremely high disparities by gender, level of education and region. Nearly 94% of the active population with no schooling works in the informal sector.

The employment rate for women[2] is still moderate at only 51.6% in 2021, whereas the employment rate for men is 77.8% according to the International Labour Organisation (ILO). Moreover, women account for nearly 64% of jobs in the informal sector according to BPS.

During the pandemic, schools were closed between 18 and 24 months depending on the province, resulting in the loss of 0.9 to 1.2 learning-adjusted years of school according to ILO. For Indonesian youth, the level of education is structurally low at slightly below the equivalent of a high school level education. The decline in the level of education caused by the pandemic will not only curb the productivity of new entrants to the job market, but it will also squeeze their revenue. According to the World Bank, the real decline in the level of skills could result in a 7-10% shortfall in revenue over the professional careers of students hit by the crisis.

The share of youth (15-24 age group) not in education, employment or training is structurally high (22.4% according to BPS). In 2021, it was still 0.7 points higher than the pre-crisis level. Moreover, on average, young people who find work today earn 19% less than they would have before the crisis.

The investment rate is still in decline

The Covid-19 pandemic also strained investment, which was already structurally weak. In 2021, the investment ratio was only 31.5% of GDP, below the pre-crisis level of 33.8% of GDP. According to the IMF, the investment ratio is unlikely to rise before 2023, and will not return to the 2015-2019 average of 34% of GDP. The capacity utilisation rate is still low (at only 73.1% in Q1 2022, compared to a 2015-2019 average of 76%). Moreover, tighter monetary and financing conditions (due to higher production costs, inflationary pressures and the rise in policy rates by the Bank of Indonesia) should weigh on investment in the near term. More than 74.5% of investment is concentrated in housing and infrastructure. Investment in machinery and capital goods is still moderate at 10.7% of total investment.


A solid banking sector but domestic companies have been weakened

At year-end 2021, the financial situation of companies was satisfactory, while the banking sector was solid enough to support Indonesia’s economy.

Companies were generally more solid at year-end 2021 than on the eve of the pandemic

The corporate financial situation generally improved in 2021. At the end of the year, it was even more comfortable than on the eve of the pandemic, with the exception of a few sectors that were hard hit by a series of lockdown measures, like construction and the service industries. These sectors will also be harder hit by higher commodity prices.

Corporate debt-to-equity ratios are still higher compared to year-end 2019 levels (69.9% on average at year-end 2021, vs 65% at year-end 2019). Yet companies are now in a better position to face up to their short-term liabilities than they were at year-end 2019. Liquidity ratios (liquid assets as a share of short-term liabilities) have consolidated to an average of 1.4x at year-end 2021, and EBIT (earning before interest and taxes) were 2.3 times higher than interest burden at year-end 2021 (compared to 2.2x in 2019).

However, there is still a big disparity between export companies and those whose business is focused essentially on the domestic market. According to the central bank’s latest financial stability report, non-exporting companies had debt-to-equity and liquidity coverage ratios of 84.3% and 1.3x, respectively, compared to 62.8% and 1.4x for exporters. In the services and retail sectors, EBIT were not sufficient to cover interest payments (at year-end 2021, the ratios for these two lines of business were only 0.89 and 0.95, respectively). Moreover, companies in the services sector will be harder hit by higher commodity prices, while export companies, to the contrary, should benefit from them.

As a share of GDP, the external debt of non-financial companies is moderate and,it has declined slightly since year-end 2019. In Q1 2022, it accounted for only 14.2% of GDP, 0.6 points less than at year-end 2019. Yet once again, the risk is mainly concentrated on domestic companies with foreign currency debt, whose business does not provide any “natural” hedging against exchange rate risk.


The banking sector is still solid

Indonesia’s banking and financial sector was very resilient to the Covid-19 crisis. Officially, the situation deteriorated slightly compared with the one that prevailed at year-end 2019, but the quality of assets remains satisfactory and capital buffers are still operating adequately.

On the whole, the non-performing loans ratio reached only 3.1% in February 2022, which is only 0.6 points higher than the pre-Covid level. Yet banks are not required to report their clients’ late payments before 2023. Moreover, there are great disparities between different sectors of business.

Non-performing loan ratios are higher than the average for the banking sector as a whole in four sectors: manufacturing (5.2%), mining (5.4% in February), wholesale and retail sectors (4.1%) and hotel and restaurant services (6.3%).


Solvency ratios are still high and comfortable enough to absorb any potential losses. The capital adequacy ratio (CAR) stood at 26% in February 2022. Bank profitability has diminished sharply on the whole (ROA and ROE of 1.8% and 9%, respectively, at year-end 2021), but is still higher than for Thai and Malaysian banks, although this was already the case at year-end 2019.

Indonesia’s banking sector is thus solid enough to finance the economic recovery and to cope with the expected rise in non-performing loans triggered by the conflict in Ukraine.


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.

The government’s fiscal room for manoeuvre to support economic activity is very limited due to the narrow fiscal base. Although fiscal revenues were higher in 2021 than in 2020, they were still low to only 11.8% of GDP (vs. a 2015-2019 average of 12.7% of GDP). To increase tax revenues, the government adopted a new fiscal reform entitled the Tax Regulation Harmonization Law in October 2021. Under this reform, the VAT rate was raised by 1 point to 11% on 1 April 2022, and it will be raised to 12% in 2025.


A narrow fiscal base

The government’s fiscal room for manoeuvre to support economic activity is very limited due to the narrow fiscal base. Although fiscal revenues were higher in 2021 than in 2020, they were still low to only 11.8% of GDP (vs. a 2015-2019 average of 12.7% of GDP). To increase tax revenues, the government adopted a new fiscal reform entitled the Tax Regulation Harmonization Law in October 2021. Under this reform, the VAT rate was raised by 1 point to 11% on 1 April 2022, and it will be raised to 12% in 2025.

The number of goods and services exempt from VAT will also be sharply reduced. The draft budget bill also calls for: 1/ a new 35% tax rate on very high income individuals (more than IDR 5 bn a year), 2/ incorporating social benefits in the fiscal base, 3/ annulling the corporate tax cut (from 22% to 20%), 4/ expanding the excise tax on plastic products, 5/ introducing a carbon tax and 6/ reintroducing tax amnesty, as was the case in 2016, to encourage the declaration of undeclared assets, with tax rates of 6% to 18% of asset value. The government also raised the income tax threshold for low-income households from IDR 50 million to IDR 60 million.

All in all, the government hopes to increase fiscal revenues by nearly 1 point of GDP in 2022. Even so, they will still fall far short of the fiscal revenues reported by other countries in the region (16.1% of GDP in Malaysia over the past five years).


A sharp increase in the interest burden

In 2021, rigid expenditure (subsidies, interest payment, expenditures on civil servants) as a share of total government spending remained mild (5.8%) thanks notably to the government’s strategy to reduce drastically subsidies, adopted in 2014. In contrast, the cost of interest payment on the debt has increased steadily since 2013-2014. From only 1.2% of GDP in 2013, the interest burden has swollen to 2% of GDP in 2021, which is equivalent to 17.2% of government’s fiscal receipt (vs only 7.9% in 2013). The interest burden is thus a new source of rigidity that further reduces the government’s room for fiscal manoeuvre to face up to new shocks.

Moreover, even though Indonesia’s central bank has maintained an accommodating monetary policy, the tightening of US monetary policy and rising inflationary pressures have increased the yields on Indonesian government bonds. Over the past 12 months, 10-year rates have increased by 75 basis points to 7.3% at 31 May 2022.

Central bank financing is winding down

Since 2020, Indonesia’s central bank has financed a large part of government bond issues under the framework of major securities purchasing programmes on the primary market, as was the case in India. In 2020 and 2021, the Bank of Indonesia (BI) purchased the equivalent of 3.7% and 1.3% of GDP, respectively. Nonetheless, at year-end 2021, the debt held by foreign investors still accounted for 30.1% of total debt, vs 37.9% on the eve of the Covid-19 crisis. In 2022, the Bank of Indonesia is expected to purchase roughly the same amount of assets as in 2021 (IDR 224 trillion, or 1.2% of GDP).