Testing time for Indonesia

Indonesia’s economy is growing at its slowest pace in five years, the budget is being consumed by a soaring fuel subsidy bill, the legislature is deeply divided and investors fear that United States interest rate rises will spark a pullback from emerging markets.

Incoming President Joko “Jokowi” Widodo will find a daunting in-tray when he takes charge of the fourth-most-populous nation on Monday. Swept into power on a wave of hope for reform in July’s presidential election, the former furniture salesman faces growing political uncertainty at home and an increasingly unfavourable global economic outlook.

As growth weakens across many emerging markets from Latin America to Asia, Mr Widodo is pledging to begin the reform process demanded by investors. There is a lot at stake. If he fails, the country risks losing investment and jobs to more competitive nations, potentially triggering social unrest.

Foreign investors who bought into the Widodo story, believing he can fix problems such as inadequate infrastructure and endemic corruption, have already checked their enthusiasm in the past few weeks as opposition parties loyal to failed presidential candidate Prabowo Subianto have shown their teeth.

With a majority of seats in the legislature, they have secured parliamentary positions and abolished direct elections for local leaders — the system by which Mr Widodo rose from obscurity to the presidency, first as Mayor of his home town and then as Governor of Jakarta.

The political outsider faces a deteriorating external economic environment, with little room for manoeuvre at home, where annual growth has hit a five-year low of 5.1 per cent after peaking at 6.5 per cent in 2011.

Forecast US rate increases next year and the end of quantitative easing by the Federal Reserve are predicted to suck money out of emerging markets, in a possible replay of last year’s “taper tantrum”. At the same time, demand for Indonesia’s commodities — which account for around 60 per cent of exports — has slackened significantly because of the slowdown in China.

“Indonesia has the potential to reach double-digit growth if the new government can push through the necessary reforms and attract more foreign investment,” says Dr Raden Pardede, the vice-chairman of the outgoing President Susilo Bambang Yudhoyono’s economic advisory committee. “But if we don’t act immediately, we may get stuck in a downward spiral, with growth slowing, investors pulling their money out and more people losing their jobs.”

Mr Glenn Maguire, chief Asia economist at ANZ bank in Singapore, says Mr Widodo’s plans to revamp healthcare and education, cut the US$21 billion (S$26.9 billion) fuel subsidy Bill and upgrade ailing infrastructure could be blocked by the opposition.

“If it becomes more a story of the old Indonesia continuing as opposed to a new Indonesia emerging, then you have to be wary about what is going to happen to capital flows, especially as we move into the commencement of a Fed tightening cycle in the first quarter of 2015,” he says.

DOUBLE-DIGIT GROWTH?

Indonesia’s position reflects the challenges faced by other large emerging markets such as Brazil and Turkey. But the changes in China, the biggest emerging market of them all, also present Indonesia with a “once-in-a-century” opportunity to transform its prospects, said Dr Pardede.

With wages in China rising sharply, manufacturers are looking for cheaper production centres. So far, they have preferred countries such as Vietnam and Bangladesh to Indonesia, which has seen its manufacturing industry shrink as expensive logistics, stringent labour laws and poor education keep investors away. Dr Pardede says the new government has a small window to reverse this situation. He argues that if Indonesia can reform, the economy can grow at 10 per cent a year by 2019.

The alternative, he says, is for the country to be stuck in the slow lane, with annual growth of 5 per cent and not enough jobs created to absorb the two million young people who enter the workforce every year in this nation of 250 million.

That raises fears about social stability in a country that has the highest rate of growth of inequality in Asia outside China and has gone backwards on development indicators such as the rate of child malnutrition.

Most economists scoff at talk of double-digit growth in Indonesia. The World Bank forecasts that the economy will grow at 5.2 per cent this year and 5.6 per cent in 2015 and 2016. These levels of growth are still attracting long-term investors to Indonesia, including most recently Ikea, the Swedish furniture retailer, and BBVA, the Spanish bank.

The main attraction is the mushrooming of the Indonesian middle class, with Boston Consulting Group predicting that the consuming class — defined as households spending more than two million rupiah (S$209) a month — will double from 74 million to 140 million people by 2020.

But while consumer goods companies are making fat profits, the 40 per cent of Indonesians who live on less than US$2 a day have been left behind by the boom.

More than 37 per cent of Indonesians under five are stunted, too short for their body weight, because of poor diets and insufficient healthcare. Worryingly, the rate has increased from 28.5 per cent in 2004 and it remains higher than in far poorer countries such as Vietnam. Little can be done about stunting after a child’s first 1,000 days, including time spent in the womb. So, more than a third of Indonesian children will suffer irreversible brain damage.

“This is a national emergency,” says Mr Cristobal Ridao-Cano, a World Bank economist. “Indonesia can’t aspire to be a more prosperous and equal nation when so many children are stunted.”

The solutions can only start to be implemented if Mr Widodo makes headway on reforms. “Investors always say they want to see four things: A fuel subsidy cut, bureaucratic reforms, more electricity and better infrastructure,” says Mr Widodo. “I will start delivering as soon as I’m inaugurated.”

Foreign investors are concerned. One executive at an oil company says he was encouraged by meetings with Mr Widodo’s advisers, who want to streamline regulations to boost investment in exploration and production. But he worries that Mr Widodo’s position is too weak to overcome vested interests in the bureaucracy. “If it is business as usual, oil companies won’t be accelerating their investments,” he says.

Mr Maguire says Indonesia cannot afford to delay. “There is a lot of competition in South-east Asia to attract the production platforms that are migrating south from China, Japan and South Korea,” he says.

“Indonesia has a very large and cheap labour force but it is penalised by its expensive, inefficient distribution of electricity and other inefficiencies.”

These supply-side issues are among the key problems Mr Widodo promises to fix. Investors and Indonesians are waiting nervously to see if he is up to the task. THE FINANCIAL TIMES

ABOUT THE AUTHOR:

Ben Bland is the Indonesia Correspondent for the Financial Times.