India and Indonesia experienced positive tectonic political change in their national elections in 2014. The actual delivery by Prime Minister Narendra Modi in India and President Joko Widodo (“Jokowi") in Indonesia has been positive, but less than the hyped-up investor expectations. The two countries are scheduled to have elections in 2019, and an important differentiation between them is inflation: It eased in both countries, but Indonesia is the clear winner.
With a nominal gross domestic product (GDP) of $2.6 trillion, India is a significantly bigger economy than Indonesia ($1.01 trillion). It is also more populated than Indonesia and was a late-bloomer on economic reforms among Asian countries. Consequently, its nominal per-capita GDP ($1,983 in 2017) is significantly lower than Indonesia’s ($3,876).
Both economies are domestically driven with independent investment cycles and unsatiated aspirational consumption demand. India is better endowed than Indonesia with human capital, especially in information technology, managerial jobs and entrepreneurship. On the other hand, Indonesia has a slight edge over India in low-end manufacturing, ease of doing business, and social and health indicators. Infrastructure development and poverty eradication have been important goals for successive governments in both countries, and each suffers from delays and lopsided implementation.
In recent years, India benefitted significantly from the decline in commodity prices, while Indonesia, being a commodity exporter, was hit by the negative terms of trade shock. The tide, however, has turned. India is at a disadvantage from higher commodity prices, while Indonesia will be a beneficiary.
Indonesia has an open capital account whereas India has been more cautious, proceeding in incremental steps in easing restrictions. This makes Indonesia more sensitive to swings in global risk appetite and capital flows. However, Indonesia scores better than India on fiscal matters. According to the International Monetary Fund (IMF), Indonesia’s general government debt is at 29.6% of GDP, while India’s is significantly higher at nearly 69% of GDP in 2018. India also has a much higher general government fiscal deficit. The IMF estimates it at 6.5% of GDP for India compared with around 2.5% of GDP for Indonesia.
Economic growth in recent years has been more volatile in India than Indonesia. Indonesia’s growth under Jokowi has been relatively steady at its long-term average. The IMF estimates India’s real GDP growth at 7.4% and 7.8% in 2018 and 2019, respectively, following 6.7% in 2017 (World Economic Outlook, April 2018. India forecast cut subsequently). This growth profile is better than Indonesia’s (2017: 5.1%, 2018: 5.3%, 2019: 5.5%). Both countries have appealing structural tailwinds, but these require reforms to unlock the growth potential.
Growth in gross fixed capital formation is improving in both economies, driven partly by higher spending on infrastructure, with more convincing signs of a pickup in capex on machinery and equipment in Indonesia. Unlike their Indian counterparts, Indonesian policymakers don’t have to deal with the twin balance-sheet challenges.
Headline consumer price index (CPI) inflation was high in both countries in 2014 when the new governments took office, but declined significantly. Inflation in Indonesia has been broadly stable in the last one year and within the Bank Indonesia’s (BI) target range of 2.5-4.5%. In contrast, inflation has been rising in India. To be sure, India’s CPI inflation is well above the official target of 4% (broad range: 2-6%). Core inflation has been moving up in India, while it is broadly stable in Indonesia following a meaningful downshift.
Both governments cut fuel subsidies early in their tenure, prompted by the collapse in international crude oil prices. While India has continued with retail fuel price adjustments, higher food-related subsidy and the cuts in goods and service tax (GST) rates could adversely affect the fiscal deficit outcome. The Modi government had already given itself more leeway in the 2018-19 Union budget by adopting a wider fiscal deficit target of 3.3% of GDP compared with the previously stated goal of 3%. Disappointingly, the Indonesian government said in March it would cap domestic coal prices and keep fuel and electricity prices unchanged until the end of 2019. The decision appears to be motivated by political consideration ahead of the presidential election next year.
India has better managed food inflation than Indonesia. Food inflation declined this year, to 3.2% year-on-year in June, while it increased in Indonesia, to 5.4% in July. The Modi government deserves credit for ensuring lower food inflation. However, it hasn’t implemented any new institutional framework that inspires confidence that stability in food inflation will be sustained and isn’t just a propitious outcome of good luck and ad-hoc policy steps. A key concern is that with core inflation already firming in the early stages of recovery, any increase in food inflation from an unanticipated supply shock will further complicate inflation management for the infant monetary policy committee (MPC).
The motivation for monetary tightening this year was different in the two economies, which have significantly improved their macroeconomic landscape compared to the “taper tantrums" in 2013 when they were included in the Fragile 5 economies. BI has been more aggressive, hiking its policy rate by a cumulative 100 basis points (bps) in three steps to 5.25%. The Reserve Bank of India’s (RBI) monetary policy committee (MPC) raised interest rates 50bps to 6.5% in two consecutive hikes.
In Indonesia’s case, higher rates were necessary mainly to defend the currency from destabilizing depreciation. India’s MPC, on the other hand, emphasized inflation concerns rather than currency defence as its main goal when it unexpectedly raised the repo rate in June. It hiked again in August and announced its inflation forecast for early 2019-20 at an elevated 5%.
Additional monetary tightening is in store for both economies, but the use of interest rates to defend the currency is a bigger risk for Indonesia than India. It will also be subject to external triggers. Inflation risk, however, is more underappreciated in India.
Rajeev Malik is a strategist at River Valley Asset Management, Singapore. These are his personal views.
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