THE QUICK COUNTS after the July 8 elections showed Indonesia’s President Susilo Bambang Yudhoyuno being reelected, with about 60% of the vote and securing the top position in 30 out of 33 provinces. In the first round of the 2004 elections, Yudhoyuno had won only 33.6% of the vote and a majority in only two provinces.
This is a resounding victory by any measure. In recent months, Indonesia’s capacity to continue growing in the face of the global financial crisis and its rising currency and stock market index have spurred some commentators to upgrade their view of this long-under-rated country.
With political prospects looking even more positive now, we are already seeing comments in the media about Indonesia becoming a super-star in the global economy. Is Indonesia really poised to make a quantum leap?
Political stability — Indonesia is superior to most BRICs countries
After a hesitant and troubled start in 1999 to 2001, Indonesia’s fledgling democracy has put down roots with remarkable speed, in what must surely be one of the most impressive transitions to democracy ever. We would argue that Indonesia’s political performance has been superior to the BRIC economies, particularly considering the enormous challenges that Indonesia has successfully coped with:
First, for a large and populous economy of this size, Indonesian elections have proceeded with remarkable and almost unique smoothness. In addition to last week’s presidential elections, Indonesia also held — peacefully — legislative elections in April. In the past few years, the country has held hundreds of local elections, all of which have also been conducted with little trouble. Unlike many other large developing economies, elections have not resulted in violence or claims of electoral rigging. And, for the most part, the losers have been gracious enough to accept the legitimacy of their opponent’s victory;
Second, since stability was achieved in 2001, Indonesian democracy has performed well in resolving difficult issues of separatism. The long and bitter insurgency in Aceh was resolved with a peace agreement, which has now resulted in former insurgents having leadership positions in the province. This is something that China and India have yet to do with their respective trouble spots; and
Third, Indonesia has also contained the many threats to its stability in recent years with a fair degree of effectiveness. Terrorism has been quelled with tough but balanced security action, complemented with political measures that won the consensus of the majority, thus making the defeat of terrorism more sustainable. Inter-religious conflicts in some outlying provinces such as Maluku have been suppressed as well. The swing to religious extremism appears to have been arrested, judging from the poor performance of religious parties with hard-line views in recent elections.
Political discord is quite often one reason developing economies fail to take off. With a bit of luck, Indonesia is likely to excel in this determinant of progress.
Economy — moderate progress is not good enough
Politics is certainly more positive now but, for Indonesia to achieve an economic take-off that raises its growth to Chinese or Indian rates of 9% and more will require a lot more than political stability. Certainly, Indonesia has done well in terms of economic growth. Despite the worst global economic conditions since 1945, GDP grew 4.4% in the first quarter of this year. Indonesia’s economic managers have performed very well in the way they have fashioned monetary and fiscal responses to the crisis.
Still, it is worth pointing out the challenges that Indonesia faces.
First, while economic growth has been resilient, Indonesia remains much more vulnerable than China or India to financial stresses. Among the more dynamic Asian economies, it is the most susceptible to volatile capital flows. For this year, it has a gross foreign debt repayment requirement of more than US$30 billion ($44 billion). Although, it should have no difficulty funding this in current financial conditions, another sharp deterioration in global investor sentiment could create difficulties. In October/November 2008, Indonesia came under huge pressure as foreigners liquidated stock and bond holdings and the rupiah tumbled, causing substantial stresses in the domestic banking sector, especially among some of the weaker small banks. It will take more years of reducing foreign debt before this vulnerability is eliminated, as Brazil has done.
Second, unlike India, Indonesia lacks a critical mass of home-grown manufacturing companies that can lead an industrial resurgence. So, in India’s case (and for China, to some extent), manufacturing sector growth could proceed even if the investment climate and infrastructure had limitations — Indonesia does not have this luxury. This deficiency in home-grown companies is one important reason Indonesia needs to raise foreign direct investment (FDI) by multiples over what it has achieved in recent years. It is encouraging to see that foreign investment has been rising steadily in recent years. However, much of that is in resources, not manufacturing. But it is a sharp acceleration in manufacturing growth that is needed if Indonesia is to sustain growth rates of 9% and above — and create enough jobs for its young and rapidly urbanising population.
Political will for reforms is critical
To do so, it needs to substantially raise FDI in manufacturing, particularly in labour-intensive activities. The good news is that Indonesia does seem to be improving in terms of global competitiveness. In the IMD survey of global competitiveness, Indonesia has moved up to 30th in the world compared with 60th in 2006, suggesting that there has been some good progress. Still, the quantum leap in FDI will not happen unless there is a sea change in two key areas:
Investment climate: Indonesia is not an easy place to do business. It ranks 129th in the world in the World Bank’s “ease of doing business” rankings, compared with 115th in 2006. One reason for this low ranking is labour legislation that deters investors from investing. Indonesia also has a terrible reputation for the kind of corruption that gets in the way of business — it ranks 126th globally in the Corruption Perceptions Index; and
Infrastructure: President Yudhoyuno had made getting infrastructure right a key part of his agenda in his first term but there has been very little progress so far, despite two well-publicised infrastructure summits. In the meantime, infrastructure constraints — power, roads and ports — have started to bite hard.
In both cases, policymakers know what needs to be done; it is political will that has been lacking. The president now has a strong position in parliament and, backed by the strongest mandate the Indonesian people have ever given a leader, he will be better-positioned to overcome the opposition of vested interests so that the underlying reforms needed to tackle these serious shortcomings can finally proceed.
If he succeeds, it is very likely that Indonesia will see a sharp acceleration in economic growth. That is the bet we would make on Indonesia.