More Thoughts on the Economic Prospects for Indonesia

We begin the 2014 ‘year in review’ series, looking at developments in Asia over the year past and the prospects for the year ahead, with a look at how Indonesia is travelling and the prospects for its economy.

We begin the 2014 ‘year in review’ series, looking at developments in Asia over the year past and the prospects for the year ahead, with a look at how Indonesia is travelling and the prospects for its economy.

The contest that saw Joko Widodo (Jokowi) elected as Indonesia’s president was a tough test for democratic transition in Indonesia. His election saw a remarkable campaign, and certainly one with an edge to it — ‘one of the dirtiest election campaigns in Indonesian history‘. Yet, in the end, the President’s inauguration was a calm and dignified transition of power that bodes well for the country’s economic as well as its political future. Jokowi’s presidency offers Indonesia the promise that politics is not the preserve of the elite — those with established power and privilege — to hold and to handle as if by some self-appointed divine right — and that there will be a triumph of technocracy over special interests in running the economy. In addition, despite the worries about Jokowi’s ‘too-much-more-of-the-same’ cabinet, that remains a promise that is of truly historic significance.

There is no doubt that whether Jokowi succeeds in delivering on the promise of his presidency will depend greatly on how he is able to manage Indonesia’s economy. On that, Jokowi has been dealt a very tough job. Growth is slowing, business costs are on the rise, and the list of policy weaknesses and economic vulnerabilities is long. The Indonesian economy had been doing quite well until the past year or so, with an average growth in real terms above 6 per cent annually. However, the growth rate slipped below 6 per cent this year and the World Bank and the IMF both currently forecast that it is unlikely to recapture its lustre next year.

Jokowi has taken up the challenge, saying last July that he aims to push the growth rate above 7 per cent: a rate that would double Indonesia’s income over the coming decade.

Indeed, a revival of confidence appears to be in the making if the government can continue to convince investors that it has a constructive reform path. There are positive signals of this. Two competing forces — significant challenge on the ground versus the success of government in reviving investor confidence — will shape the Indonesian economy in 2015 and beyond.

One opportunity for Indonesia lies in the growth of its workforce and the youth of its population. This means that it is not only possible but also necessary to create jobs for millions joining the workforce each year. The slowdown in growth has come at the tail end of the resource boom, although the effect of end of the boom was not felt immediately because of the easy money in global capital markets from quantitative easing in the United States. To keep inflation under control and avoid a balance of payments crisis, fiscal and monetary authorities have been engineering a slowdown and demand-side consolidation. A policy-induced slowdown with a growth rate under 6 per cent in an economy at Indonesia’s level of development — and with its young and growing population — means that there are major structural problems in the economy.

Dealing with these structural problems and lifting growth to its true potential between 7 and 10 per cent is the big challenge for the Jokowi presidency.

As David Nellor observes in our lead this week, ‘the government lacks a parliamentary majority and, at least to date, the opposition has shown little indication that it will support the government’s program’. But there are moves by the government to centralise policymaking and make it more evidence-based and that will help avoid the interest group capture of policy that characterised the last years of the presidency of Susilo Bambang Yudhoyono. There are, nonetheless, still very strong interests opposing trade and investment reforms that are essential for the emergence of a more competitive Indonesian economy.

‘Reviving investor confidence by implementing a proactive reform agenda is thus essential. The drivers of the economic slowdown remain in place and some needed policy actions may well intensify the slowdown. Reducing subsidies hits private demand and has resulted in electricity and diesel prices rising by nearly 40 per cent in 2014. A further challenge for business activity is a cumulative increase in minimum wages of over 50 per cent in the last couple of years’.

The government can do a great deal, whether or not it has parliamentary support, as Nellor points out. The increase in fuel prices prompted by the huge budget cost of subsidies is the highest profile action. Fortunately international oil prices are coming down so that will ease the burden of higher fuel prices on consumers a little. Cutting fuel subsidies, at the same time, will ease the budget burden for a few years, providing some fiscal room to move.

Giving priority to the investment climate is a strategic move that can deliver relief on the cost of doing business without needing parliamentary involvement.

President Widodo brought a strong message back from APEC in November about the role of a coherent vision in planning infrastructure for the long term and the need to ‘focus on getting infrastructure and factories on the ground rather than worrying if that resulted from foreign investment’. It will take time to get projects on the ground. But as Nellor concludes, if the government can do that consistently with the macroeconomic constraints, there is cause for optimism on the outlook for Indonesian growth, despite the magnitude of the challenges facing the new government.

Hopes on the economic upside in Indonesia is republished with permission from East Asia Forum