Indonesia's VAT hike raises concerns about consumer spending and business strategies

Starting January 1, 2025, Indonesia will raise its Value-Added Tax (VAT) rate from 11% to 12%, completing an incremental increase that began in 2022. The increase aligns with the Harmonisation of Tax Regulations Law (UU HPP), designed to enhance fiscal resilience amid growing expenditures for projects like the new capital city and expanded social programs.

Consumer purchasing power under pressure

Economists and business leaders warn that the policy could weaken purchasing power, particularly for middle-class households. Gunawan Benjamin, economist at Universitas Islam Sumatera Utara, explains that higher VAT would likely exacerbate inflation and squeeze household spending. 

According to Benjamin, the middle class will feel the impact most severely through reduced disposable income and declining consumption. "The lower income class or the poor, may still be saved thanks to the government's social security program which should see its budget increased next year," he said.  

The Indonesian Chamber of Commerce and Industry (Kadin) shares these concerns. Deputy chair Yukki Nugrahawan Hanafi emphasised that domestic consumption remains critical for economic growth given global macroeconomic uncertainties. According to Yukki, implementing the 12% VAT requires careful government mitigation strategies to protect lower and middle-income consumers' purchasing power and control inflationary pressures.

Impact on consumer goods and business strategies

Consumer goods companies are preparing for a potential slowdown in sales as price-sensitive consumers reduce non-essential spending. While essential goods like rice, fresh meat, and educational books are exempt from the tax increase, middle-tier products are expected to see stagnating or declining demand.

A NielsenIQ report from 2023 indicates that brands will likely adopt various strategies to maintain competitiveness, including enhanced online promotions, price comparison tools, and increased focus on discount channels. Companies may also seek to absorb some VAT-related costs through improved logistics or renegotiated supplier contracts. 

The report also suggests that e-commerce platforms will play a crucial role in mitigating the VAT impact through promotional campaigns and flash sales. With Indonesia's growing digital economy, digital-first strategies could help brands offset reduced in-store traffic. 

“A brand’s strategy must be holistic," said Harry Deje, managing director of Burson Indonesia. "It needs to identify something that compels consumers to make purchases, something irresistible, to the point where they overlook additional costs like VAT.” 

According to Deje, consumer brands don't always have the luxury of creative solutions, and many may end up surrendering to market forces and trends. “There's no definitive winning formula. It often boils down to trial and error, needing the courage to take risks,” he concluded.