Counter-cyclical policies undoubtedly have critical roles to play in supporting sustainable growth and price stability in Indonesia, particularly in the current uncertain environment. By balancing increased external risks against domestic considerations, policymakers have gained credibility — which investors have rightfully acknowledged. Standard & Poor’s upgraded Indonesia’s sovereign credit rating to BBB in May, citing in part supportive policy dynamics.
The Indonesian Finance Ministry initially opted to keep fiscal deficit at 1.8 per cent of GDP this year, arguing that it doesn’t want to add to political uncertainty by running a highly-expansionary fiscal policy that could result in increased borrowing and spook bond investors. The Ministry did recently decide to expand the 2019 deficit to 1.9 per cent, but this is still nowhere near the 3 per cent legal limit.
Markets have also acknowledged Bank Indonesia’s (BI) prudence for exercising patience, as it only started cutting its policy rate in July while most other regional central banks began much earlier. This reflects BI’s decision to prioritise financial market stability — particularly in the currency — after last year’s challenges.
But we could be approaching some limits, and policy-related risks may be on the horizon. Citing growth concerns, BI has reduced its policy rate three times to 5.25 per cent, bringing the total cuts to 75 basis points and overtaking some of the central banks that began easing earlier. This runs the risk of inadvertently adding to currency pressures if external risks escalate again, reminiscent of the back-to-back cuts in late 2017.
Also, given the lagged impact of monetary policy and sticky transmission mechanisms, fiscal policy would be more effective in boosting growth in the short run, particularly as the current environment necessitates that foreign exchange stability remains a top priority for BI. But the 2020 budget proposed by the Finance Ministry, and recently approved by parliament, envisaged a lower fiscal deficit of 1.76 per cent of GDP, meaning less fiscal support to economic growth next year, despite the government having plenty of fiscal space.
Even countries with much less wiggle room are already taking more accommodative fiscal action. For example, India is implementing corporate tax cuts, while Malaysia is hinting at a slower pace of fiscal consolidation next year to avoid exacerbating an export-led slowdown.
The good news is that critical structural economic reforms, which are far more consequential to Indonesia’s investment climate and long-term growth potential, are likely back in play. Since the election, the rhetoric and signals from Jokowi are encouraging. Although these statements are usually met with scepticism, this time may be different.
Jokowi has a ‘nothing to lose’ mentality towards making reform progress. This is not only indicative of his stronger political will, but also provides a sense of prioritisation of building on the foundations of his first term. Reforms to increase the ease of doing business, as well as physical capital accumulation via higher infrastructure spending, remain high on the agenda. What is new is the priority placed on human capital development as part of an effort to boost overall productivity growth.
Central to this effort, Jokowi has recently discussed reinvigorating labour market reforms, even though the unemployment rate has been declining in the last few years. This issue is politically sensitive, and previous attempts to revise labour laws were met with resistance. Yet it is well-known that Indonesia’s labour market is among the most restrictive in the world under the 2003 Manpower Law and its numerous implementing rules and regulations.
The simplification and reduction in severance pay rates, the introduction of a safety net to provide unemployment benefits and insurance, and retraining schemes to increase employability are some key reforms that would signal major progress on this front. The government is also embarking on vocational education reforms to better match labour skills and the needs of priority industries. Reducing regulatory rigidities could be game-changing, potentially boosting foreign direct investment, skill formation and formal sector employment — which also helps the government’s fiscal position.
The focus is not just on deciding which reforms to prioritise, but also how to successfully implement them. Early examples include more targeted efforts to enhance existing programs, such as an early upgrade of the online single submission system for granting business permits and the promotion of four ‘new Balis’ (as opposed to 10 originally) alongside accelerating infrastructure building to improve access.
As for the labour market, Jokowi’s goal is to revise the labour law by the end of the year. Although this is ambitious, it highlights the sense of urgency, as does ongoing discussions with stakeholders such as employers and labour unions. Issuing a government regulation in lieu of a law is also being considered as a way to jump-start the process. The same may be true for drafting an omnibus code on investment, which could include as many as 74 modified laws and is aimed to be completed in October.
In what seems a rare occurrence these days, financial markets have responded to signs that progress could be made on these long-term reforms. In July, when Jokowi provided specifics on his structural reform agenda — particularly bringing labour issues back into the spotlight — the currency reacted positively. Imagine if labour market reforms are actually implemented.
Euben Paracuelles is Chief ASEAN Economist at Nomura.
A version of this article originally appeared here on The Jakarta Post.