Tighter economic policy and weaker external demand have helped to cool the economy from the rapid growth rates seen in 2010, but inflationary pressures have not receded and credit growth is still buoyant. Activity is expected to grow at below-trend rates over the next two years, notwithstanding support from large infrastructure programmes. Inflation may fall to about the middle of the central bank’s target band.

Growth has continued to moderate in 2011, as higher interest rates and tighter credit to the private sector slowed investment in housing and foreign trade weakened. In 2012, export growth will be held to around 7% by weak world demand and a decline in competitiveness, but the impact on activity may be partially offset by increased public spending and a cut in income taxes. Nonetheless, real GDP is set to grow below potential in 2012. Together with a fall in import prices, this should help disinflation, permitting some reduction in policy interest rates. With domestic demand and foreign trade picking up in 2013, GDP growth should recover to close to 10%. The downward trend in the current account surplus should continue, despite an improvement in the terms of trade, with the surplus falling about 2% of GDP by 2013.

Growth has moderated and, against the backdrop of a weakening global economy, is projected to remain relatively subdued and reliant on private consumption in the near term. Despite the cooling in activity, inflation remains persistently above the Reserve Bank of India’s comfort level. With inflation expectations also high, price pressures are likely to recede only gradually in response to easing demand and a stabilisation of commodity prices. An improvement in external conditions and some strengthening in business investment should lead to a pick-up in growth in the second half of 2012. The government needs to adhere to its strategy to further reduce the fiscal deficit to support monetary policy in achieving a sustained reduction in inflation.

The economy’s orientation towards domestic demand and strong consumption and investment growth shields it from weaknesses abroad. Economic growth is thus expected to exceed potential rates in the next two years despite the slowdown in the OECD area. Inflation has eased for now but pressures are likely to emerge again soon. While Indonesia is likely to be less affected by a slowdown in world trade than other economies, changes in global risk aversion could reverse the capital inflows of the past few years and restrain growth.

Although confidence has weakened amid the global slowdown and financial turmoil, growth momentum seems likely to be sustained, supported by still-high oil prices. The food price shock has dissipated and the strong harvest in 2011 is now reinforcing disinflation. With credit growth moderating and the output gap remaining negative, inflation is projected to fall towards 5% in 2013. The budget is expected to be balanced or in a small surplus in 2011, aided by high oil prices, but to return to deficit in 2012-13 due to a large rise in spending next year. The already wide non-oil budget deficit is projected to increase slightly in 2012 before falling back gradually. The current account surplus should narrow due to buoyant import growth. A sharp oil price correction and renewed turbulence in financial markets remain the key risk factors.

The pace of recovery has slowed as a result of weak external demand, negative effects of the global slowdown on consumer and investor confidence and domestic labour unrest. As these factors ebb, growth should pick up somewhat in 2012, but remain below potential for a fifth consecutive year. As confidence returns, output growth should accelerate more decisively in 2013. Inflation is at the upper end of the central bank’s target range, but in the absence of further rises in commodity prices and given the negative output gap should ease to the middle of the target range by 2013.