The economy has lost its earlier momentum, even though inflation remains stubbornly above the central bank’s target mid-point of 4.5%. Tighter monetary policy, softer external demand and policy uncertainties due to the presidential election are likely to weigh on activity during 2014. In 2015, GDP growth is projected to rise somewhat, with persistent supply constraints, including a tight labour market, and the need for continued tight macroeconomic policies holding back domestic demand.

GDP growth fell in early 2014 as investment slowed in response to tighter credit conditions. In particular, restrictions on mortgage lending and land development continue to curb real estate investment and sales. Measures to phase out excess industrial capacity work in the same direction. However, investment will continue to be supported by a greater emphasis on urbanisation needs and the opening up of sectors previously off limits to private investment. Overall, growth is expected to remain a bit above 7¼ per cent over the next two years. The current account surplus is set to shrink to 1¼-1½ per cent of GDP.

Growth is expected to gather momentum. Investment should recover as projects cleared by the Cabinet Committee on Investment are implemented and political uncertainty declines after the May 2014 general elections. The rupee depreciation over the summer of 2013 and firming external demand will underpin export growth, while the rise in rural incomes and the decline in inflation will boost consumption. However, fiscal consolidation and supply bottlenecks, coupled with still high non-performing loans and corporate leverage, will weigh on the recovery.

In contrast to the fragility in a number of other emerging market economies, consumer confidence has firmed in Indonesia. The economy has slowed, and this and stronger exports have helped to narrow the current account deficit in recent months. As a result, current account concerns have dissipated, and the currency has appreciated sharply. Inflation has started to slow, as the impact of fuel subsidy cuts has abated and food prices have eased.

The moderate recovery that was under way at the end of 2013 has been halted by the turbulence related to the events in Ukraine. Associated increased uncertainties and capital flight are now weighing on investor confidence. Consumption growth will weaken as real income growth slows and consumer credit becomes more expensive. The weak rouble will provide some support to the slowing economy and the budget.

Economic activity is expected to be driven by faster export growth, reflecting depreciation of the rand and a pick-up in world trade growth. Domestic demand will be held back by continued weak confidence and modest growth in real incomes, but will slowly benefit from the stronger external sector. However, growth will not become strong enough to reduce the substantial negative output gap.