While Europe’s very own Greek tragedy (or Franco-German banking crisis, as some would argue) has continued to play out over the last few months, the Indonesian economy, like others in the Far East, has so far escaped relatively unscathed.
Economic growth in the world’s fourth most populous nation and third biggest democracy came in at a healthy 6.1 percent (to $707bn) in 2010, after a mild slowdown (to 4.6 percent) in 2009, giving a five-year average of 5.7 percent per annum. Underpinning growth has been buoyant domestic demand accompanied by a stronger rate of investment (32.5 percent of GDP in 2010 vs. 24.9 percent in 2009), according to Fitch Ratings.
Largely absent has been the emergence of potentially risky external imbalances, given that rising savings rates have largely matched rising investment. Against this backdrop, the ratings agency in February 2011 raised its outlook for the Indonesian economy to ‘positive’ from ‘stable.’
In a note, Andrew Colquhoun, Senior Director and Head of Asia-Pacific Sovereign Ratings at Fitch, said: “The positive outlook reflects Fitch’s view that Indonesia’s favourable macroeconomic prospects are likely to see the credit profile strengthen further over the next 12 to 18 months, despite near-term risks from inflation and potentially volatile capital flows.”
Colquhoun also noted faster progress in tackling long-standing issues including the low tax take, infrastructure deficiencies and corruption. But these problems are lingering.
Local and foreign-currency debt is presently rated at BB+, one step below investment grade, and followed Moody’s upping of Indonesia’s rating the previous month to the corresponding grade of Ba1.
In April, Standard & Poor’s followed suit, increasing the country’s long-term foreign currency rating one notch to BB+ from BB, with a positive outlook – the rating also one level below investment grade. In August, the Japan Credit Rating Agency raised its outlook to ‘positive’ from ‘stable.’
The recent upgrades mark the first time in a decade that Indonesia has been just one notch away from an investment-grade credit rating – in part due to President Susilo Bambang Yudhoyono targeting economic growth of as much as 6.6 percent per annum on average through the remainder of his term, ending in 2014.
It wasn’t always this way, of course. In 1998 the economy was in a perilous state as the East Asian economic crisis unfolded.
Real GDP contracted by 13.7 percent, with the economy hitting its low point in mid-1999. Inflation, which reached 75 percent in 1998, slowed to two percent in 1999 as the country implemented structural economic reforms in agreement with the IMF.
Later, inter-communal violence reared its ugly head – a three-year conflict on the Maluku Islands leading to thousands of deaths and the displacement of many others. Inter-religious problems were eventually resolved and proved that in this part of the world at least, differences could largely be overcome.
Modern prospects
Fast forward to 2011 and the inflation picture for the country remains a relatively benign one – consumer prices in September 2011 were up 4.61 percent year-on-year, against 4.79 percent the previous month and 7.02 percent in January. Core inflation, which excludes volatile and administrative price components, was 4.93 percent up on the year, easing from 5.15 percent in August.
However, Credit Suisse is forecasting inflation to pick up to seven percent by April 2012, largely due to depreciation in the value of the rupiah and a robust economy. It also envisages two interest rate increases of 25 basis points each in the second half of 2012. One caveat, though, is the rapidly changing global economic landscape as the eurozone crisis and structural problems in the western banking system continue to remain unresolved.
Because of this deteriorating economic backdrop, Bank Indonesia (BI), which has already noted the nation’s current-account surplus is on a downward trend, says it will likely move into negative territory next year as import growth outpaces that of exports, amid a robust domestic economy.
BI’s decision in October to cut its benchmark interest rate by 0.25 percent to 6.25 percent took many analysts by surprise, despite the bank’s announcement in September that it was shifting its emphasis to promoting growth rather than tackling inflation, which shows, for now, some signs of abating.
The wider narrative, as analysts see it, is that the eurozone debt crisis and relatively weak US economy will eventually hit Asia’s export-dependent economies. As recently as June, Indonesia was ranked fifth out of 27 emerging economies at most risk of overheating, according to the emerging-market overheating index compiled by The Economist.
The index uses six different indicators. These are: inflation rate, unemployment rate relative to its 10-year average, GDP growth relative to trend, excess credit (growth in bank lending minus the growth in nominal GDP), real interest rates, and forecast change in the current-account balance in 2011.
Countries are first graded according to the risk of overheating suggested by each indicator (two=high risk, one=moderate, zero=low). Hence, if growth in excess credit is more than five percent it scores two points, zero to five percent scores one point, and below zero percent scores nil. The scores from each indicator are then summed and turned into an overall index; a 100 value means that an economy is ‘red-hot’ on all six measures.
At the time Argentina had a value of 100 and Indonesia 83, along with Brazil, Hong Kong, Turkey, Vietnam and India.
If the Indonesian economy is still in danger of overheating (and the jury remains out on that one) much of it can be put down to strong consumer demand, with robust sales in the motor, motorcycle and durable goods sectors.
Data from the Association of Indonesian Automotive Industries shows car sales for the July-September period up 30 percent (to 242,172 units) compared to the same period in 2010.
Meanwhile, investment in the more general economy rose by 15 percent to IDR 65.4trn ($7.3bn) in Q3 2011, according to data from the Indonesia Investment Coordinating Board. Of this, foreign direct investment made up IDR 46.4trn, or more than 70 percent of the overall total.
Elsewhere, credit growth remains high. However, BI recently announced that, effective January 1 2013, an individual will only be eligible for a credit card if they make at least IDR 3m ($335) per month. In addition, they will only be able to hold two credit cards if their monthly income exceeds IDR 10m and are at least 21 years of age.
Figures from BI show credit card transactions rose to IDR 163.2trn ($18.1bn) in 2010, up from IDR 72.6trn in 2007 ($8.1bn). In the first nine months of 2011, card transactions hit IDR 120.9trn ($13.4bn) in value.
Bad loans have yet to become a major issue though. Indeed, they were down 36 percent year-on-year through August 2011. However, BI does have the inevitable interest rate weapon at its disposal – one it has already exercised with a proposed three percent per month cap banks may charge on cards vs. the current 3.75 percent.
If the government is looking to curb credit growth, then so too is it committed to reducing expensive energy subsidies. While this may have a negative impact on inflation, assuming electricity tariffs are increased next year, and fuel price hikes kick in, the government should be able to adjust policies to ensure those price adjustments do not spill over into overall inflation.
Long-term development
One major economic issue that still needs to be addressed is the state of the nation’s infrastructure. President Yudhoyono plans to double spending on roads, ports and airports to $140bn. He will need to, given that an estimated 15 million households presently have no access to electricity. The objective is to build 20,000km of roads and add 15,000MW of power generation by the end of his term in 2014.
In September the government confirmed it is ready to offer 17 infrastructure projects worth $9.98bn under the public private partnership scheme to investors via open tender – including a railway project in Central Kalimantan worth $2.1bn.
Already on the radar, a consortium comprising Japan-based utility J-Power, Japan-based trading conglomerate Itochu and Indonesia-based coal miner Adaro Energy has been selected as the preferred bidder for the Jawa Tengah plant, estimated to be worth IDR 30trn ($3.3bn). The project involves the construction of two 1,000MW coal-fired power plants in the district of Pemalang and is expected to be completed by 2017.
The projects form part of the nation’s 2011-25 Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI). Implementation of MP3EI will include eight main programmes comprising 22 main economic activities.
The programme aims to develop the regional economic potential in six Indonesian ‘Economic Corridors:’ Sumatra, Java, Kalimantan, Sulawesi, Bali-Nusa Tenggara, and Papua-Kepulauan Maluku.
It is also designed to promote increased national connectivity locally as well as internationally, and will complement existing development planning documents such as the Long Term National Development Plan and Medium Term National Development Plan.
The economic objective of MP3EI is to raise GDP to $4.0-4.5trn and GDP per capita to $14,250-15,500 by 2025. To achieve these objectives, says the government, real economic growth of 6.4-7.5 percent is expected for the period of 2011-14, while inflation is forecast to fall from 6.5 percent in 2011-14 to 3.0 percent in 2025.
With the implementation of the MP3EI platform, the country aims to position itself as one of the world’s main food suppliers, as a processing centre for agricultural, fishery, and natural resources, and as a centre for global logistics, by 2025 or earlier.
In a May 2011 note, Morgan Stanley economist Deyi Tan said Indonesia, with a public debt ratio of 26.1 percent (one of the lowest in the Association of Southeast Asian Nations), has room to take fiscal deficits higher in order to support infrastructure projects, without jeopardising the public balance sheet or liquidity conditions.
Lingering corruption
Of more pressing concern, however, is the issue of graft, which continues to cast a shadow over the Indonesian economy.
While President Yudhoyono may have promised “shock therapy” back in 2004 to address it, he has struggled to reverse old practices, as an underlying threat of corruption and a lack of transparency in the tendering process remains.
In August Muhammad Nazaruddin, the former treasurer of the country’s Democratic Party (the largest party in the governing coalition) was arrested in Colombia after being on the run for weeks. Nazaruddin stands accused of accepting bribes worth almost $3m in connection with tenders for the South East Asian games, to be hosted by Indonesia this year – allegations he has consistently denied.
Closer to home, anti-corruption authorities recently seized IDR 1.5bn ($168,600) in cash found in a fruit box at the country’s Manpower Ministry. The cash related to a major infrastructure project in West Papua province.
In fact, 13 years after the demise of the corrupt Suharto regime, it has seemingly been ‘business as usual;’ with government officials, businessmen and lawmakers continuing to collude on the awarding of state contracts, commercial deals, and even tax breaks, in exchange for a piece of the action.
Even where corruption has been uncovered, recent acquittals in the courts have only served to highlight flaws in existing anti-corruption legislation – not least the requirement that anti-graft courts be set up in each district and municipality. Critics say this leaves the system vulnerable to the varying quality of judges presiding over trials. Factor in the low regard in which judges are held by the general public, and the system’s overall credibility comes into sharp relief.
For its part, MP3EI calls for the creation of an effective bureaucracy supported by ‘strong and effective institutions,’ including a ‘responsible legislature’ and independent judicial organs. However, a recent raft of proposals, if approved, will actually undermine current anti-graft laws, some critics argue.
While the government recognises corruption as a major issue and is intent on attracting private investors to the country by making the economic climate more business-friendly, the proposals could yet prove to be a major shot in the foot for the country. The years ahead, in this area at least, promise to be a long hard slog unless the political will is there.
