Significance: At 6.9% year-on-year, the pace of expansion in real GDP was the strongest since the fourth quarter of 2004 and was even more impressive given that it occurred despite a considerable drop in inventories; exports fared extremely well, which is an encouraging sign that Indonesia's international competitiveness is improving. For 2010 as a whole, the economy grew 6.1%.

Implications: The impressive fourth-quarter performance is bound to remind observers of Indonesia's ability to deliver strong growth in a somewhat "under the radar" fashion. In conjunction with the interest rate hike by Bank Indonesia last Friday, it should ignite another bout of enthusiasm from foreign investors, possibly leading to further stock market and currency appreciation.

Outlook: Since the fourth-quarter GDP reading was almost exactly in line with our 6.8% estimate, we are maintaining our 6.0% growth forecast for 2011; although official projections are for GDP to expand by close to 6.5%, however, we actually believe that risks are skewed more on the downside as pent-up demand in exports and household consumption are dissipating.

Solid, Broad-Based Performance

Last year was another good year for Indonesia. The economy grew by 6.1%, which, with the exception of 2007, was the best performance since 1996. The year definitely ended on a high note, with the fourth-quarter 6.9% GDP reading the highest in six years. It was a performance considerably stronger than market expectations—a Reuters poll of economists surveyed prior to the data release was calling for a 6.2% expansion—but almost exactly in line with IHS Global Insight's own 6.8% estimate. The best news was not simply the rate of growth, but rather the broad-based fashion in which it had been achieved, especially since it coincided with considerable inventory cuts.

Exports Shine, Highlight Improved Competitiveness

By far the most impressive news came from the export front. Real exports surged 16.2% year-on-year (y/y) during the fourth quarter, up from 9.6% in the third. They were up a staggering 12.8% compared with the previous three months (not seasonally adjusted) and have now exceeded the pre-crisis peak by as much as 14%. For 2010 as a whole, real exports grew 14.9%. For a country not particularly known for its export prowess, this is indeed welcome news, as it signals Indonesia's improved ability to take advantage of rising overseas demand. In fact, despite the apprehension surrounding the ASEAN-China Free Trade Agreement, which came into effect at the start of 2010, it seems that Indonesia has been able to capitalise handsomely from improved access to this increasingly important regional market. Nominal non-oil exports to China rose 64.9% y/y in 2010, whereas non-oil shipments to the United States were up just 27.5%. It is possible though, that the fourth-quarter export performance was somewhat skewed by on-time events, such as the Australian floods, which may have diverted some demand to Indonesia. If so, the positive impact will probably last through the first quarter but not beyond that.

Imports rose 16.9% y/y during the fourth quarter of 2010, bringing the annual expansion to 17.3%. At first glance, these figures would suggest that the import recovery has exceeded that of exports, but since imports had declined more during the global recession, they are pretty much just retracing those earlier losses. Indeed, whereas fourth-quarter exports were 14% above the pre-crisis peak, imports were only 5% above it.

Private Spending Grows, Government Spending Contracts As Fiscal Stimulus Ends

Import growth was propelled by robust domestic demand, both on the consumer side, as well as in investment. Real private consumption eased slightly to 4.4% y/y in the fourth quarter, marking an annual average of 4.6%. At first glance it may be somewhat surprising that overall consumer spending has not risen more since car sales hit a new record in 2010, but it must be remembered that Indonesia's per-capita income remains too low for the majority of people to be able to afford cars. In typical fashion, real government spending accelerated during the fourth quarter, up 8.3% y/y from 4.3% in the third. Given sizable declines during the first half of 2010 though, government spending actually fell by 0.2% in 2010 as a whole, which was the first contraction since 1999.

Fixed Investment Remains Strong, Inventories Are Cut Back

Real fixed investment grew by 8.6% y/y during the fourth quarter and by 8.4% for the year as a whole, reflecting improved investor sentiment, higher foreign direct investment (FDI) inflows (estimated to have doubled last year), and easier access to credit. On the other hand, inventories fell rather sharply during the fourth quarter, declining by 3.3% of GDP. This was not actually surprising, and in fact we had anticipated sizable cuts, because inventories had been steadily building during the period of January of September 2010, so some pay-back was inevitable. It is possible, however, that the inventory reduction was not entirely voluntary but rather due to unexpectedly strong demand. The utterly impressive export growth during the quarter would seem to support this hypothesis. If so, the implications for 2011 growth are quite positive.

Outlook and Implications

Since our expectation for fourth-quarter growth in 2010 was very close to the actual reading, we have not changed our 6.0% forecast for 2011 real GDP growth. We do acknowledge, however, the downside risks to this forecast stemming primarily from unfavourable base effects (especially on exports) and the loss of consumer purchasing power associated with rising inflation. Indeed, consumer price index (CPI) inflation is forecast to average 6.4% in 2011, compared with 5.1% last year. Meanwhile, the cost of capital is expected to rise as Bank Indonesia has now begun its monetary tightening cycle (we anticipate 100 basis points in total rate hikes over the course of 2011). We believe that the negative impact of higher capital costs on investment spending will be minimal, however, and will be fully offset by higher FDI inflows and improved investor sentiment as the global recovery advances into its second year.