Monetary and fiscal policies should remain prudent and data-dependent. GDP growth has rebounded from the COVID-19 recession and inflation has declined markedly, but exposure to global uncertainty remains high. Government spending and revenue are low in international comparison and future spending pressures require an increase in tax revenues. The tax bases for VAT and income taxation should be broadened and spending should be made more efficient.

Output increased by 5.0% in 2023 (Figure 1). Private consumption remains the main engine of growth, while export volumes have benefited from buoyant global demand for commodities. International tourism has largely recovered from the decline caused by the pandemic. Investment has remained dynamic, partly due to public infrastructure projects. However, growth in recent years has been insufficient to bring convergence in income towards advanced economies; GDP per capita has remained around one quarter of the OECD average since 2010.

Inflation has returned to target. Headline inflation peaked at 6.0% in September 2022 amid surging food and energy prices. High interest rates and currency strengthening have tamed price growth. In October 2024, headline inflation was 1.7%, within the central bank’s 1.5% - 3.5% target band. Bank Indonesia’s policy rate was lowered to 6% in September 2024.

GDP growth is projected to remain robust, at 5.1% in 2024 and 5.2% in 2025 (Table 1). Consumption will remain strong and private investment is likely to pick up. The fiscal deficit will be widened somewhat by public spending on the new capital city, Nusantara, but is projected to remain below the 3% limit. Bank Indonesia is expected to continue reducing the policy rate in late 2024 and in 2025. Renewed inflationary tensions and pressure on the Rupiah present downside risks which could slow down interest rate cuts.

While fiscal balances are set to remain within target over the projection period, they will come under strain over the longer term. Spending pressures will grow due to the green transition and increasing demand for public services by a more affluent and older population. There is scope for structural increases in revenues to cover greater spending needs. Broadening the tax base, including through fewer exemptions and stronger enforcement is needed, as well as increasing enrolment in old-age pension schemes. The planned rollout of the “free nutritious meal” programme in schools should be gradual and targeted on the poorest. Greater attention to the efficiency of spending is required, including through further reductions of energy subsidies and cost monitoring for new spending.

Real income per capita has more than doubled over the past quarter of century, and extreme poverty has declined. However, over the past decade economic growth has not been sufficient to bring further economic convergence in GDP per capita (Figure 2), reflecting slowing labour productivity growth. Indonesia has room to benefit more from integration in global value chains. Education, skills, and participation in formal employment should be enhanced, while the environment for business can improve further. Pro-active industrial and trade policies should be targeted, monitored, and time-bound.

Unemployment has receded, but the labour market remains fragile and informality is high. The unemployment rate has fallen from 7.1% in mid-2020, at the peak of the pandemic, to 4.9% in mid-2024, below the pre-pandemic prevailing range of 5–5.5%. Indonesia should reduce the gender gap in the employment rate, as well as informality, to make the most of its workforce. Shifting the funding of maternity leave from employers to social insurance would bolster formal employment among women.

Reaping the demographic dividends from a young population requires quality education. Basic education is almost universal in Indonesia, but the quality is often poor, with significant variation across provinces, contributing to a shortage of skilled workers. Campaigns to strengthen skills training must be continued, including through incentives for employers. In primary and secondary education, harmonising curricula and increasing funding is essential.

Further improving the business environment would boost productivity and help achieve economic convergence. There is scope to lower barriers to foreign investment and trade, better enforce competitive neutrality, as well as rationalise and improve the governance of SOEs. Reducing non-tariff barriers to trade such as import and export licenses would broadly increase productivity and trade integration.

Greater efforts in combatting corruption and abuses of market power would also help foster a more competitive and productive business sector.

The government aims to expand economic activity around raw material extraction, but this policy requires caution. Industrial policies to spur domestic downstream nickel processing have attracted investors’ interest. However, there are implementation risks, including overshoot in processing capacity and fiscal impacts.

Indonesia has further scope to harness digitalisation. Geographic, gender and age-related gaps in individuals’ access to, and adoption of, the Internet and related tools need to be closed. Access and adoption among business also lags developments in peer countries. Faster deployment of 5G technology and fixed broadband is key. Digitalisation skills are still insufficient and STEM education must be broadened.

The digital sector represents a growing share of the economy. Digitalisation is advancing and digital-technology unicorn companies are emerging. However, disparities persist across individuals and firms in access to, and use of, digital technologies. Faster broadband deployment to overcome geographical, education, gender, and income gaps in the adoption of digital technologies is a major challenge.

Investing in high-speed broadband is crucial (Figure 3). Improvements in Indonesia’s mobile and fixed communications systems are compromised by complicated procedures for obtaining access to public infrastructure. In telecoms services, the absence of an independent regulatory body is a concern.

Aligning education and digitalisation is essential. The latest PISA scores show that many students have relatively low educational attainment and insufficient skills to make full use of digital technologies. The education system could also benefit from a greater use of digital tools.

Much of Indonesia’s economy makes relatively little use of digital tools. Enhancing digitalisation across all business sectors, including agriculture, would help spur productivity and growth. Access to finance is difficult for digital firms that mostly have intangible assets that are not accepted as collateral. Further promoting the digitalisation of the business sector and SMEs is also needed. Removing regulations that weigh on digital firms (e.g. by limiting e-commerce activities) would help. Easing access to government data for business purposes could open new opportunities and generate additional benefits, provided digital security is better guaranteed.

Indonesia is vulnerable to the impacts of global warming. In addition, the country’s goal of reaching net-zero greenhouse gas (GHG) emissions by 2060 is challenging in the context of economic convergence. Decarbonisation needs to be further stepped up, in particular by accelerating the decommissioning of coal-fired power plants, expanding renewable energy generation, implementing carbon taxation, modernising the electricity grid, and investing in mass urban transport and rail transport. Mainstreaming climate-change adaptation requires strengthening institutional capacities, governance mechanisms, and planning and programming frameworks, also with international support.

Replacing fossil fuels so that GHG emissions peak no later than 2030 and reach net zero by 2060 (Figure 4) requires considerable investments. The economic and human cost of business-as-usual emission scenarios is large and Indonesia has committed to ambitious targets for reducing GHG emissions. The cost of mitigation efforts will be concentrated over the next few years. The Just Energy Transition Partnership can make Indonesia a model for ensuring a green transition.

Reducing the environmental impact of the energy sector is a policy priority. Shifting to low-emitting energy sources such as solar, wind and geothermal requires considerable investment, including in the electricity transmission system. To enhance private investment, it is important to ensure that the state-owned vertically integrated energy company acts responsibly as the sole off-taker on the energy market.

The transition to a more price-based energy market needs to be accelerated. Regulatory responsibilities should be transferred to an independent authority with sufficient powers and financial resources. The implementation of an appropriate carbon tax should be accelerated.

Transport is the second-largest source of GHG emissions. Efficient and extensive urban and inter-city mass transport systems must be developed to lower emissions and cope with surging traffic. Accelerating the replacement of traditional combustion engine vehicles with zero- or low-emission alternatives will be essential.

Indonesia also needs to step up its adaptation policies. The risk and cost of more frequent flooding and drought will increase with climate change. Better land-use regulations, as well as wider insurance coverage, can help mitigate the impact on businesses and people.

Resolute action to protect forests and the ocean must continue. The rate of deforestation is the lowest in 20 years. However, further efforts are needed to protect peatlands and forests as part of mitigation strategies and to help reduce the impact of climate-related natural disasters.