Indonesia
Economic Overview
Indonesia’s economy is going from strength to strength having weathered the global economic crisis and still managing to post 4.5% GDP growth in 2009 followed by 6.1% in 2010. In 2011, that trend is set to continue with GDP growth expected to remain steady at around 7% over the coming years according to investment bank Morgan Stanley. Investors are also taking notice with Indonesia being labelled as a key emerging market to watch within the so called ‘BRICIs’ or ‘CIVETS’. The core pillars of economic growth are political stability, a young population with a large domestic market of over 240 million people and vast natural resources. This is coupled with strong economic fundamentals as a result of prudent and consolidatory fiscal measures under the guidance of the IMF over the past decade. Government policies privatising many state owned enterprises (SOEs), dismantling monopolies and liberalizing regulations regarding foreign direct investment have laid the foundations for not only future growth but for private investor collaboration on some of the key issues facing the economy.
The Asian crisis at the end of the 1990s saw Indonesia’s economy and currency collapse as well as the weakness of the banking system exposed. For the sake of recovery and through close cooperation with the IMF, Indonesia set about reducing its debt burden which stood at 83% of GDP in 2001 down to 26% in 2010 (Ministry of Finance). In comparison with developed and other emerging markets this is a very modest figure and is targeted to reduce further to 25% in 2012 which places the country well below the OECD maximum debt ratio of 30%. Indeed, if anything this figure is actually too low considering the vast sums required for infrastructure development which is a rare position for economies to find themselves in today’s global environment. The budget deficit also offers grounds for optimism standing at 0.6% of GDP at the end of 2010, even lower than the forecasted 2.1%. Spending of up to 1.8% is expected over 2011, having been approved by parliament to cover subsidies in light of higher oil and food prices. The government sales of sukuk bonds over the course of 2011 to potentially cover the deficit have also proved very popular among local and international buyers. This combined with the imminent move up to investment grade status by rating agencies and the growing optimism over the country’s sovereign debt provides the scope for increased government borrowing and spending.
Such fundamentals have proven hugely popular among investors as at a time when interest rates around the world remain at record lows. Indonesia raised $3 billion USD in global bonds in 2010 with $2 billion USD of those in US dollar denominated bonds. Dollar denominated debt provided a return of 7.4% in 2010 (HSBC) for investors making it one of the top HSBC tracked indexes for returns in Asia behind India, China and the Philippines. Such investor popularity is not however without its challenges for the economy as sudden inflows of hot cash and the risk of capital flight have generated stock market volatility and currency fluctuations. While this issue has plagued many other Asian and other emerging market economies, solid stewardship from Bank Indonesia has kept the issue in check. As opposed to adjusting interest rates, the bank intervened with liquidity management measures. As of June 2010, Bank Indonesia issued a regulation whereby investors must purchase and hold Sertifikat Bank Indonesia (SBIs) for a minimum of 28 days as opposed to trading on a daily basis, in an effort to curb sudden capital outflows. The central bank has stopped selling three month SBIs and also begun to reduce the amount of six month SBIs debt sold at auctions to direct investors towards longer term money instruments.
Inflation as a result of high food and oil prices has been a key area of concern for investors and observers of Indonesia at the beginning of 2011. A gradual decline in the headline inflation rate from 7.02% in January to 6.65% in March 2011 and 5.54% in June 2011 (Statistics Indonesia) has been encouraging and reduced pressure to raise interest rates. However, the core inflation rate which discounts volatile food and fuel prices but includes commodities such as gold has continued to rise from 4.18% in January 2011 to 4.62% in April 2011 (Statistics Indonesia). In spite of the speculation, Bank Indonesia has kept interest rates steady since the 25 point hike to 6.75% in February 2011, the first change since 2009. Rather, the central bank is utilising the flexibility in the rupiah exchange mechanism to allow the currency to appreciate and thus act as a vanguard against inflation by reducing the threat of imports. The Rupiah, which has been considered undervalued for some months, has been rising against a weak dollar and due to capital inflows. It reached 8,489 RP to the dollar at the end of July 2011 according to Bank Indonesia spot rates from the Bank Indonesia mean rate of 9,250 RP. A strengthening currency is currently to Indonesia’s advantage; however it is placing pressure on export orientated businesses and may not be a long term solution to controlling inflation. A hike in benchmark interest rates over the second half of 2011 may well be on the cards for Bank Indonesia.
Outlook
Headline figures for the country show a booming economy, yet it still remains to be seen whether the current growth is really sustainable. Indonesia has ridden commodity booms before but failed to channel the benefits reaped from it into areas of much needed development such as manufacturing, infrastructure and education. Indonesia still exports most of its natural resources and agricultural produce in primary form without taking advantage of the value added process which is being carried out in more developed countries and sold back to them. The government is keen to show that is has a clear direction on how to ensure that current growth does not tail off without a long term impact. In President Yudhoyono’s second term, there has been a flurry of target setting and policy making with long term goals in mind. The Master Plan of Indonesia’s Economy Development Acceleration and Expansion (MP3EI) for 2011 to 2025 aims to place the country as a top ten global economy by 2025 with GDP growth reaching 8-9% annually. Legislation to improve the investment climate as well as promote transfer of knowledge and reduce the amount of primary exports is also being put in place such as the Law on Mining and Minerals of 2009 that will see an end to primary mining exports from 2014. Infrastructure is also a key focus of the government with the announcement of $140 billion USD required for investment over the next five years and a streamlining of the Public Private Partnership process through BKPM.
The various policies are brought under the overarching strategy of the National Economic Development Corridors which sets out the direction for the complimentary industrial development of six delineated ‘highways’ for balanced regional development. The country’s five main islands would be divided into economic clusters that focus on that region’s unique potential and natural resources while promoting connectivity between the various hubs. By way of example, South Sumatra would become a palm oil processing hub while the Bali–Nusa Tenggara corridor would focus on tourism and act as a base for connecting tourists to the rest of the country. The plan which requires an estimated $4 trillion USD, with over 90% of that due from private sector input, is hugely ambitious. Yet, on paper at least is well thought out and is thus garnering international attention as well as support from the likes of the World Bank. However, to date its progress has been rather limited due to the slow realisation of bedrock infrastructure projects due to land acquisition issues. Coordination of local government authorities has also been lacking which has restrained investor confidence in the scheme. SOEs will most likely have to take the first steps in making the first projects a reality while state owned banks will need to be forthcoming on lending to investors to give the scheme a much needed boost and make it a reality.
The investment climate is improving as evidenced by the surge in foreign direct investment, up by over $4 billion USD in Q4 2010 and Q1 2011. Having experienced a sharp dip in FDI in 2009 in which domestic investors filled the void, Indonesia is seeing many foreign investors return and expansion by those already present. This has been spurred by improvements in the investment climate with the creation of a ‘one stop shop’ mechanism through BKPM in 2009 which centralised the investment process. Revisions to the Negative Investment List, most recently in the form of Presidential Decree No 36/2010 are also luring investors through the relaxation of the laws on foreign ownership. Further measures such as the liberalisation in port management which ended the state monopoly has opened up private sector involvement in a key area of the country’s transportation sector. The scale and scope of foreign direct investment is widening with investors moving from purely natural resource based industries and manufacturing into transport and communication sectors as well. However, while the amounts of FDI may be on the rise, the ratio of FDI to GDP has remained relatively unchanged from 2008 at approximately 2% (DBS Research). Also, while the investment climate is improving and issues such as corruption and infrastructure are being addressed, they are not being tackled as quickly as Indonesia’s regional neighbours. This is reflected in the country’s falling back of 6 places to 121st in the World Bank’s Ease of Doing Business rankings for 2011 as well as FDI figures compared to that of Vietnam for example.
Indonesia’s continuing weakness continues to lay in infrastructure both in terms of social infrastructure such as sewage and electricity transmission as well as transportation. It is the severe bottlenecks that can be witnessed in the country’s congested ports and traffic jammed highways that raise the price of goods and have a knock on effect on core inflation. Such issues serve to undermine Indonesia’s strong economic fundamentals, constrain growth as well as dampen investor interest. The various policies aimed at addressing the matter are well constructed and if enacted will see the country rise to reach its full economic potential. The improvements in the investment climate and opportunities to be found within infrastructure initiatives are also reasons for investor optimism, however to compete among its regional peers the country must go further to ensure private sector involvement. Success stories among SOEs need to be seen to build investor confidence while further state guarantees need to be in place for issues such as land acquisition to give momentum to infrastructure development. Once such foundations are in place, the outlook on Indonesia’s economy is exceptionally promising.