Is the Indonesian economy in trouble?

Author: Peter McCawley, ANU

Suddenly there are signs of pressure in the Indonesia economy. Until recently, the economy seemed to be doing well. But growth is now slowing, inflation is rising, the balance of payments is under pressure, and the value of the rupiah has slumped. Why the change in economic fortunes?

An Indonesian man waits for customers at a street money changer in Jakarta on August 28, 2013.  (Photo: AAP)

The latest developments in Indonesian markets reflect both long-term and short-term factors.

The longer-term factors include a range of issues which have been a source of comment within Indonesia for some time. At the broadest level, something of an inward-looking mood appears to have been influencing policies during the past year or so. Senior policy makers have emphasised that the broad approach being promoted, which is one of looking for ways to strengthen Indonesian industries, is not protectionist. Policies of this kind, policy makers argue, will strengthen the resilience of the Indonesian economy by providing greater economic security which will shield both Indonesian producers and consumers from the vagaries of uncertain international conditions.

There is much to be said for the long-term aim of building up domestic Indonesian industries and emphasising key goals such as food and energy security. But a number of well-publicised policies during the past few years have been somewhat interventionist, and have arguably had an anti-market flavour about them.

Policies in the mining sector, for example, have not been especially successful in promoting growth. Output has been falling steadily for over a decade in the oil sector, a previous source of strong exports and government revenues during the 1980s and 1990s. Indonesia, formerly a significant oil-exporting nation, has now become an oil importer and the rising levels of oil imports have become a significant strain on the balance of payments.

In the non-oil mining sectors, investors view some key policy approaches as being excessively interventionist. Mining firms in various industries have been told to install smelters and to process their resources before export. Government directives to this effect are expected to be implemented regardless of whether additional processing in Indonesia is profitable or not.

These directives, along with a range of other structural policies in other sectors, appear to have had the unintended effect of holding back the expansion of exports while adding to the national import bill.

In good times, when the international economy is strong and when international financiers are keen to invest in emerging market economies, developing countries such as Indonesia perhaps have room to take risks with experimental structural policies. But when international conditions are more difficult, markets and investors are less tolerant.

The short-term problem for Indonesia now is that markets have suddenly turned less tolerant, due to three recent developments. First, the slowdown of economic growth in China has led to a fall in demand for Indonesia’s exports. Second, US Fed chairman Ben Bernanke’s indications that the remarkable period of loose monetary policy in the US might be drawing to an end has led to something of a global flight of capital from emerging markets. And third, India’s current economic woes have led to concerns that these problems might spread to other countries across the region through a process of contagion, as was the case in the Asian Financial Crisis of 1997–98.

But it is too early to see the current developments in Indonesian markets as a threat to longer-term growth. For one, policy makers have responded swiftly. On 23 August, Indonesia announced a package of comprehensive fiscal and monetary policies as a response to the pressures in the financial and trade markets. And, to strengthen the package, just a few days ago (29 August) the central bank Bank Indonesia increased interest rates to 7 per cent.

For another, Indonesia has a very strong team of economic policy makers. Vice President Boediono has many years of experience in both monetary and fiscal policy matters, including during the Asian Financial Crisis. He is supported by the Minister of Finance, Dr Chatib Basri, and the Governor of Bank Indonesia, Agus Martowardojo, both of whom are known for their firm commitment to sound economic policies.

Finally, some of the short-term pressures that Indonesia is facing may even prove to be a blessing in disguise. The recent period of strong growth during the past few years may have lulled some policy makers in Indonesia into believing that economic success is guaranteed. If so, an economic rap over the knuckles to remind them that international markets are both fickle and powerful may be no bad thing.

Peter McCawley is a Visiting Fellow at the Crawford School of Public Policy, Australian National University.

6 Comments

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  • Ken Ward

    In the light of this analysis, it is regrettable to have to point out that Indonesia is approaching that period of the five-year electoral cycle in which the implementation of wise economic policies is least to be expected. In 2014, parliamentary elections will take place in April and the first round of the presidential poll in July. Whereas SBY was re-elected in 2009 after his Democrat Party had come out on top in the parliamentary election, enhancing rather than undermining stability, next year a successor to SBY must be elected and the Democrat party is in dire trouble because of a string of corruption scandals and poor leadership. At this stage, it seems that the Democrats’ presidential candidate will be SBY’s brother-in-law, former army chief of staff Pramono Edhie, his wife’s younger brother. If this indeed takes place, it will be further proof of the unfortunate strength of the dynastic impulse in Indonesian politics. But, if the Democrats perform woefully in April as expected, Pramono’s prospects will be grim. SBY will suffer a double blow as he sees his party’s prospects for survival thrown into doubt and his family’s prestige grievously harmed. But an awkward aspect of Indonesia’s constitutional arrangements will then come into play, as SBY’s mandate lasts until 20 October 2014. Although he hasn’t yet thrown his hat in the ring, Jakarta’s governor, Jokowi, is the favourite to win the July presidential poll. If he retains his current level of popularity, Jokowi is likely to win outright in the first round, as SBY himself did four years ago. But the president-elect will then have to cool his heels until October during the three-and-a-half month hiatus before he can be inaugurated as president and he can appoint his own cabinet. After his victory in 2009, SBY made the mistake of leaving his full cabinet in office for three months, competent technocrats, party hacks, dead wood and all, thereby allowing a lame-duck atmosphere to sink in even though he himself had received a powerful, fresh mandate. Foreign embassies complained at the time that it was almost impossible to transact any business with the Indonesian government. This risk will be even more serious next year if the scenario outlined above plays out and SBY is stung by a dual defeat. The president and vice-president will themselves be lame ducks, not just the cabinet. As politicians, bureaucrats and the public seek to adapt to a new distribution of power before the handover actually occurs, we are unlikely to see forthright leadership or bold economic policy-making.

    • Peter McCawley

      I agree with all of Ken Ward’s observations. Indonesia has become a vibrant democracy in the Era Reformasi since the Soeharto Orde Baru. There are many obvious advantages but one disadvantage is that economic policy-making is often more cumbersome. As Ken says, there is a real risk of economic policy-making drifting during 2014 simply because of the timing of key events. And, as well, we know little about the economic policies of the key candidates. Governor Jokowi, who is doing well in the polls at present, does not really have a track record at all on national economic issues. Indonesia has a record of “muddling through” various periods of uncertainty with a reasonable degree of success. We may have to hope that the “muddling through” strategy works again. But it is hardly an ideal approach to economic management.

  • Ashim Kumar Chatterjee

    The low cost of capital in developed economies and low notional profit of their businesses were factors, along with a large demand base for all kinds of goods and services from the middle class in emerging economies like India and the possibility of the middle class expanding, which brought investment to India. All of these factors remain unchanged in favour of emerging economies and the most basic of the factors – growth of population – remains constant or positive unlike in developed countries. It is difficult to accept that return to growth of 2.5 per cent rate in US economy because of policy based stimulation can create conditions for developed country potential to outstrip that ofr emerging economies. In a market based international economic order in which most of the countries have no demographic advantage, the current flight of capital from emerging economies can only be viewed as temporary. Fortunately, the problem is that some of the emerging economies are democracies too with very high dose of political pluralism. Therefore, their resilience to meet the situation and get over it is huge. Some of the emerging economies do have, however, the crippling problem of energy insecurity. Countries like India and China should naturally cooperate with each other in energy security related matters with solar, wind energy, and end their dependence on fossil fuel energy. They should invest more in their urban, industrial and agricultural infrastructure development under state control and move towards solid state capitalism, which will deal very severe blow to developed economies of North America, Europe and in Asia Pacific region. These countries have not benefited from foreign institutional investments in stock market in any case as that encourages speculation and distorts the stock markets. Emerging countries like China and India have already created the technological capacities to be able to ignore and discriminate against technologies of developed countries but carry on with their development and the improvement of the life of their people. North America, Europe, Japan should do some SWOT analysis – short and long term.

    • Peter McCawley

      Ashim Kumar Chatterjee draws attention to a number of key issues that need attention for Indonesian development strategy. I will focus on just two.

      First, the suggestion that developing countries need to work to strengthen their own institutions — such as stock markets — in their own way seems a sound approach. It is true that local institutions, including many types of local markets, need to be moulded to suit local circumstances. Indonesian policy-makers have themselves been emphasising this approach in recent years. In some cases, success has been mixed. However, the general approach of strengthening local institutions in ways that suit local conditions is welcome.

      But second, the policy of “going local” surely needs to be tempered with the sensible adoption of international ideas and technologies when suitable. For example, Indonesia (along with almost all other developing countries) has benefited enormously from being in the position to obtain something close to a free ride in the adoption of some key modern technologies in recent years. One example is the telecommunications revolution (computers, enormous amounts of software, mobile phones, and so on). Another is modern aviation technology.

      Thus surely a balance is needed — it will often be a good approach to design local institutions to fit local circumstances, but it will often be sensible to adopt modern approaches and technologies when they can be adapted to Indonesian conditions. Indeed the well-known slogan of “Act locally, think globally” would seem to apply, even though the slogan has generally been used in other contexts!

  • ST

    Indonesia does not have the firepower to withstand hot money repatriation from its economy. The entire growth cycle in Indonesia during the past few years has been anchored on two phenomena namely:

    The inflow of cheap money from overseas courtesy of the Fed monetary policy.

    The growth in the commodity demands from China, India and a few other countries.

    Both of these so called phenomena are contracting now and Indonesia just doesn’t have enough monetary firepower to withstand the foreign exchange leaving its system.

    • Peter McCawley

      It’s clear that the Indonesian authorities consider the inflow and outflow of hot monies is a problem. But it is probably manageable. The Indonesian authorities have (very wisely) allowed the forex rate to depreciate considerably in recent months. This is a great help. It will probably go a long way towards responding to the problem.