Twenty years ago, in July 1997, the Asian financial crisis made an abrupt end to Indonesia’s ascent as a “tiger” economy (a moniker used to describe Asia’s high-growth economies at the time). The country’s currency, the rupiah, plunged by 60% against the dollar that year. Many companies, who had loaded up on debt, defaulted and banks, not able to reload ATMs quickly enough, were nationalized. It also preluded the fall of president Suharto, who had been in charge of the archipelago for more than 30 years. Although the crisis left deep scars (the economy contracted by 13% in 1998), one of the unexpected and pleasant consequences was that the country developed into a vibrant democracy. In 2014, Joko Widodo, locally better known as Jokowi, was elected president on an anti-graft platform, promising a return to high economic growth of 7% per annum.
Endangered species…?
As in the 90s, Indonesia always shows great promise but never seems to deliver. The country, with a young population of 260 million (the world’s 4th largest), already is South-East Asia’s biggest economy. But Indonesia’s economy is largely built on commodities with China being the main export market. Just before Jokowi assumed power, commodity prices plunged. However, he used the collapse in oil prices to his advantage by scrapping unsustainable fuel subsidies. Jokowi also started to address Indonesia’s other weaknesses such as poor education, infrastructure and red tape in order to attract higher-value manufacturing businesses, which so far mostly went to places like Malaysia, Thailand and Vietnam. But investments in education and infrastructure are constrained by the country’s legal deficit limit of 3% of GDP whereas public-private partnerships are not yet blossoming. Jokowi’s government has addressed some of the bottlenecks facing PPPs, like a more lenient land acquisition procedure and a centralized licensing office. In the meantime, a tax amnesty announced last year brought in much needed cash (1.1% of GDP on assets equivalent to a staggering 40% of GDP) to fund Jokowi’s projects. However, economic growth seems to be stuck at 5% for now and is not reaching the 7% that Jokowi promised back in 2014 (and that Indonesia needs to avoid the middle income trap).
He is not the “pisang”…
Still we believe Jokowi has done a good job so far, albeit at a rather slow pace. One has to realize that Indonesia is a highly diverse country with large differences in economic development across its 13,500 islands. Keeping up growth at 5% under difficult circumstances is actually quite a feat. The unemployment rate is slowly declining to about 5.4% this year, despite an increasing labour force (half of the population is aged below 30 years and annual population growth is 0.9%). The government’s balance sheet is in good shape (as witnessed by investment grade credit ratings from all three rating agencies this year; the first time since the Asian financial crisis 20 years ago) with public debt at a lowly 28% of GDP. The fiscal deficit is reaching 3%, usually not a great sign, but is directed towards productive investments in education and infrastructure. In order to fund growth in the future, the tax base needs to be broadened and tax collection must be improved (tax receipts comprise only 10% of GDP). Remaining subsidies for energy and food should be phased out (Jokowi already has implemented a social program to support the poor). Indonesia’s current account deficit is expected to narrow to 1.5% of GDP this year thanks to reviving exports of commodities, making it less dependent on foreign funding sources. However, further structural reforms need to be undertaken to attain higher sustained rates of economic growth. Adopting a less nationalistic resource policy (like the ban on unprocessed mineral exports that was introduced in 2014 and resulted in a public spat with American mining company Freeport McMoran that operates a vast copper and gold mine in Papua) by further culling the country’s negative investment list (including domestic content requirements and foreign ownership limitations) would be a step in the right direction, in our view, and eventually result in increasing FDI inflows, giving the country much-needed access to technology and labour skills.
Unlike Brazil, China or India, Indonesia has not been a very popular investor destination in the last two decades. We think this is undeserved, although Jokowi should push harder to get his agenda implemented. With the right structural reforms this country can become a tiger economy once again. Of course, investing in Indonesia is not without risk, however. Given its reliance on external financing, the Indonesian economy remains exposed to external shocks, like an increase in U.S. interest rates or a significant drop in Chinese economic growth. This could result in a temporary setback but should not knock Indonesia’s economy off its socks. On the domestic side we are somewhat concerned about increasing Islam fundamentalism (often preached in mosques funded by malign Arab states), but Jokowi seems to grasp this risk and is starting to take appropriate measures, in our view. It will not be plain sailing, but for long-term investors Indonesia is not a paper tiger and seems a rather attractive place to put money at work.
