With the world's third-largest democracy
and Asia's fifth-largest economy, Indonesia has
emerged as a regional bastion of political
stability and economic dynamism, assuming a place
of pride among developing nations. But with global
economic clouds on the horizon, the country looks
increasingly vulnerable to losing some of its
newfound luster.
Unlike China's fast
growth, Indonesia's economic boom has relied more
on commodity exports than shipments of
high-value-added manufactured products. About half
of Indonesia's exports are basic commodities,
including coal, coffee, copper, natural gas,
nickel, oil, rubber, tea and tin, making its
economy highly vulnerable to volatility in global
commodity markets.
Exports have fallen for
five straight months, with August
registering a
worse-than-expected contraction of 24.3% from a
year earlier. Fitch Ratings, a sovereign-risk
credit-rating agency, recently categorized the
country as "highly vulnerable to systemic stress",
alongside China, Mongolia and Sri Lanka in Asia.
As China shows signs of a slowdown, demand for
Indonesian commodities is expected to fall further
in the months ahead. About 15% of Indonesia's
exports are shipped to China.
A domestic
consumer and investment boom, meanwhile, has
buoyed growth but also placed heavy pressure on
the current account. For the first time in four
decades, Indonesia registered a current-account
deficit for two months in a row in April and May.
The trend has sparked market speculation that the
country could register a record trade deficit in
2012. International reserves have dwindled in the
process, falling 15% from August 2011 to July this
year.
Before these statistical dips,
Indonesia was viewed widely as a reservoir of
countercyclical resilience. Three years after the
2008 global recession, Indonesia outpaced its
pre-crisis (2003-07) average growth clip with a
robust 6.5% expansion in gross domestic product,
bucking the slower post-recession trend seen in
many developing countries. To sustain that
resilience during the impending slowdown, however,
Indonesia will need to address two structural
challenges: lagging infrastructure and
over-reliance on commodity exports.
Rising star Indonesia's economic
emergence has shone against the gloomy backdrop of
its recent past. It was arguably the worst-hit
country during the 1997-98 Asian financial crisis,
with its economy contracting by a staggering 20%
and the value of the local currency plunging by
80%. The economic catastrophe ignited a major
political upheaval, culminating in the demise of
Suharto's three-plus decades of authoritarian rule
and a transition toward democratic rule.
Jakarta has clearly learned lessons from
that tumultuous economic past. Where local banks
collapsed under the weight of poor lending
decisions in 1997-98, their current gross ratio
non-performing assets is among the region's lowest
at around 2%, according to Fitch.
Indonesian banks' return on average assets
of 2.6% is currently more than twice as high as
comparable financial institutions in India,
Malaysia and Vietnam, and substantially higher
than Philippine and Thai banks, Fitch reports.
This month, Indonesian monetary authorities
maintained the benchmark interest rate at 5.75%, a
record low it has maintained for eight consecutive
months.
While the International Monetary
Fund recently narrowed its 2012 economic-growth
forecast for Asia, Indonesia is still expected to
expand by more than 6% this year. GDP grew by 6.3%
and 6.4% year on year in the first and second
quarters respectively, the fastest rate of any
large global economy outside China. Despite fears
of overheating, inflation actually fell month on
month in September and is viewed as manageable at
4.3% on an annualized basis.
Strong flows
of foreign direct investment have contributed to
the resilience. FDI flows rose from US$10.8
billion in 2009 to $18.9 billion in 2011. In the
first half of this year, Indonesia attracted $12
billion in FDI, raising government hopes of a
record $25 billion inflow for the full calendar
year. The inflows have gathered pace despite
rising resource nationalism and protectionism,
lingering concerns about the country's inefficient
and perceived-as-corrupt courts and bureaucracy,
and creaky infrastructure.
Better
balance Political devolution spearheaded by
President Susilo Bambang Yudhoyono's
administration has allowed for a more balanced and
equitable distribution of investment, public
spending and economic growth across the sprawling
archipelago of 250 million people. As structural
inflation - the inevitable rise in labor and
related costs in rapidly growing economies -
erodes China's competitiveness, lower-cost
Indonesia has benefited from a recent inflow of
investment relocations from mainland China.
Based on a recent International Labor
Organization report, Indonesian workers earn about
$148 per month against $190 for average workers in
Chinese manufacturing hubs such as Shenzhen, a
substantial wage differential for multinational
manufacturers. Chinese entrepreneurs from the Aigo
Entrepreneurs Alliance expressed plans last year
to relocate their textile factories to Indonesia.
In August 2011, Chinese companies signed $10
billion worth of investment projects in cement,
infrastructure, agriculture, and real estate in
Indonesia.
Japanese investors have also
poured in capital. After major disruptions in
their Thailand-based production facilities last
year, just months after the Fukushima tsunami and
nuclear disaster, leading Japanese car
manufacturers including Toyota, Nissan and
Daihatsu pledged $1.8 billion worth of investments
to improve and expand their Indonesia-based
production facilities. Annual car sales in
Indonesia have risen rapidly and are expected to
reach about a million new vehicles this year.
Indonesia's expanding and increasingly
sophisticated domestic market is part of the
attraction. It is now among the world's largest
markets for consumer products and electronics and
among the world's top four biggest subscribers to
social-networking giant Facebook.
Indonesia now has a 50-million-strong
"bourgeoisie" market, which is projected to reach
around 150 million by 2014, according to the
Japanese bank Nomura. Consulting firm McKinsey,
meanwhile, estimates Indonesia will become the
world's third-largest consumer market - trailing
only China and India - by 2030. Riding that
optimism, Yudhoyono has announced his goal of
setting the country on course to become one of the
world's 10 largest economies by 2025.
Persistent weakness Yet all
these positive assessments and predictions mask
persistent structural weaknesses. In particular,
Indonesia's competitiveness is undercut by its
weak infrastructure and corrupt bureaucracy.
Experts believe that without a fast and major
upgrade of both, the dual inefficiencies will be
an increasingly substantial drag on growth,
crucially at a time when the global and regional
economy is expected to slow.
Decades of
corruption, legal uncertainty and misappropriation
of public funds have all conspired to retard
Indonesia's infrastructure development. In the
2010 Logistics Performance Index - a World Bank
measure of overall infrastructural competitiveness
and efficiency - Indonesia ranked 75th, well below
regional peers in Malaysia, Thailand and even the
laggard Philippines.
Indonesia's "ease of
doing business" ranking in the World Bank's annual
survey slipped from 126th in 2011 to 129th this
year. It also scored poorly in global comparative
indicators such as electricity supply (161st),
starting a business (155th), and contract
enforcement (156th). It also slid by four spots in
the 2012-13 Global Competitiveness report, from
46th in 2011 to 50th this year. The independent
report characterized Indonesia's infrastructure as
"largely underdeveloped", while the institutional
framework is undermined by "corruption and
bribery".
To improve the situation, the
government pushed through a new land-acquisition
bill, approved in December 2011, to hasten
infrastructure development. Officials say they
plan to double spending on roads, railways,
airports and ports to $140 billion within the next
five years. Total infrastructure spending is
scheduled to hit $250 billion from 2011 to 2015.
If actually realized, Indonesia's
investment-to-GDP ratio would jump from 3.9% in
2009 to 5.9% in 2015, according to Morgan Stanley,
an investment bank. The accelerated spending would
supplement a larger, longer-term $600 billion
infrastructure spending plan to be implemented
between 2011 and 2025.
Diversity
dilemma Where all that money will come
from, however, is still unclear. Indonesia has a
major tax-collection problem: 80% of state
revenues are currently derived from a narrow tax
base, amounting to only 12.7% of GDP. That's well
below the regional average, which ranges between
14% and 22%. Inefficient energy-subsidy schemes
also eat into the state's budget and raise wider
concerns about the quality of current and planned
public spending.
Better infrastructure is
crucial to diversifying the economy away from raw
commodity exports toward more value-added
manufacturing. While Indonesia has registered
significant gains in labor productivity,
representing by some measures a 60% rise from the
previous decade, its overall manufacturing sector
suffers from anemic annual growth compared with
other economic sectors.
Recent
nationalistic efforts to shift investments into
manufacturing by raising restrictions on the
mining sector, which currently accounts for 12% of
GDP, have backfired badly. New rules requiring
special licenses for mineral exports have led to a
major decline in outward shipments and fueled
complaints from piqued multinationals about the
rising costs of government corruption. New laws
and regulations have also aimed to limit foreign
ownership in mining and banking ventures.
Despite these challenges, Indonesia's
strong macroeconomic fundamentals, robust domestic
demand and relatively healthy corporate and
financial sectors provide room to maneuver amid
rising global economic uncertainties. The
government also has considerable room for fiscal
stimulus and other schemes such as direct cash
transfers. But without efforts to overcome
structural weaknesses and endemic corruption,
Indonesia's resilience will be tested by any
sudden shift in market and investor sentiment.
Richard Javad Heydarian is a
foreign affairs analyst based in Manila. He can be
reached at jrheydarian@gmail.com.
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