On August 16, the eve of Indonesia's 61st year of Independence, President Susilo Bambang Yudhoyono announced the optimistic growth expectations of the 2007 State Budget.
The government expects economic growth in 2007 to reach 6.3% and inflation to ease to 6.5%, with an average key interest rate of 8.5% and a rupiah rate of 9300 against the US dollar.
In July, economic growth expectations for 2006 were revised from 6.2% to 5.9%, and the price of oil was raised from $57 to $62.
A cut in fuel subsidies, which were increasingly burdening the state budget in 2005 due to record global oil prices, caused inflation in 2005 to reach 17.11%. As a result, purchasing power dropped dramatically, which caused a slowdown in economic growth in the mainly consumer driven economy.
Reactions from the market to the budget were mixed. Fauzi Ichsan, chief economist at Standard Chartered, said most of the expectations seem achievable, although the average three-month Bank Indonesia Certificates (SBI) interest rate appears to be too low. He also said to XFN-Asia that their "most optimistic forecast for 2007 GDP growth is 5.8-6.0%".
Chief economist Ferry Latuhihin of Bank Internasional Indonesia (BII) was more positive. "I think most of the assumptions that include the growth forecast are reasonable," he explained to XFN-Asia. He also observed that, although the oil price estimate seems optimistic, given expectations for a cooling of economic growth in the US and China next year.
Mohamad S. Hidayat, chairman of the Indonesian Chamber of Commerce (KADIN), also showed optimism. He told Antara news agency that if conditions remained stable the targets would be realistic.
Markets in the meantime reacted positive to the expectations. The Jakarta Composite index rose 13.5 points to 1437.8.
The President's expectations are supported by recently published strong growth figures. In his speech, he referred to the "higher than expected growth in the second quarter".
On August 14, Rusman Heriawan, the central statistics agency's chairman, announced that Indonesia's GDP grew by 5.22% in the second quarter of 2006, compared with the same period last year.
Much of the growth can be attributed to strong global commodities prices and Indonesia's high potential in resources. Most notably, the agriculture and mining sectors experienced high rates growth from increasing export revenues.
Heriawan reported that agriculture grew 5% on the same period in 2005, while the mining sector grew by 5.43%. Total exports expanded by 15.14% to $46.9bn in the first two quarters of 2006.
Increased government spending also propelled growth as budget and procurement procedures were simplified. As a result, overall government spending grew by 31.38% in the second quarter compared to the second quarter in 2005.
Lower inflation and cautious interest rates cuts have stabilised purchasing power. Inflation in the first half of the year reached 3.3% year-to-date, much lower than the same period last year when inflation amounted to 5.09%. The central bank last week lowered its key interest rate to 11.75%.
Despite these improving conditions, other indicators remain unfavourable. Consumer spending has remained slow, with growth declining to roughly 3% compared to last year.
Sluggish results were reported for the automotive and manufacturing sector, and investment did not grow.
Nevertheless, analysts remain optimistic. Senior Deputy Governor Miranda Goeltom said to Bloomberg earlier this week that, with inflation slowing, further interest rate cuts towards 10% this year are "very possible". Many also expect that government spending will further accelerate when the fiscal year approaches its end.
If the government can succeed in pushing through some of the badly needed reforms in the fields of tax, investment, infrastructure and labour, investment is also expected to increase.
Such developments would encourage consumer spending, which currently accounts for 65% of the economy, and help the government to achieve its targets for the remainder of 2006 and for 2007.