To say the least, Indonesia is a complex and diverse country – with its 255 million people (of whom 88 per cent are Muslims), 700 languages and 400 cultures spread across 17,000 islands. By means of rapid, ambitious reform programmes – ten in about six months – a politically young, promising President Joko Widodo (“Jokowi”) is trying to build a stronger democratically based economic and political platform. Events in Jakarta seem to be moving in the right direction, but many observers see a major risk of political setbacks in light of the country’s political history.
Indonesia’s current economic and democratic journey began during the Asian financial crisis of the late 1990s, when the authoritarian government headed by General Suharto came to an end. The election of Jokowi in 2014 was widely viewed as the first real confirmation of increased democratic rule.
Major potential – major risks of setbacks
In economic terms, Indonesia can be described as a potential powerhouse. A number of imminent changes will create major future opportunities, if these forces can be channelled in the right direction, but they might also get out of control. The economic deceleration of recent years has revealed long-term under-investments in infrastructure and education.
Five political priorities are emerging:
- Job-creation policies – especially for young people.
- Investing in transport systems and energy supplies.
- Slowing and reversing growing economic inequality.
- Ensuring food prices that everyone can afford.
- Putting Indonesia on the regional and global map.
After a few political setbacks following the 2014 presidential election, Jokowi now seems to be enjoying a political tailwind. Yet he is forced to continue navigating in a political system dominated by party oligarchs who apparently want to slow down developments. Jokowi faces a difficult balancing act to get things done and to launch reforms quickly, while not jeopardising the advances newly achieved by democratic rule. Meanwhile he needs to persuade local governments to accept and implement the decisions made at the national level. In some respects this process is reminiscent of China and the need to take “small steps” in order to avoid losing social and political stability.
According to various surveys, Jokowi and his presidential office are gradually gaining the trust of the Indonesian people. But economic developments will be crucial to Jokowi’s – and Indonesia’s – future. Government bureaucracy and ineffective organisations are probably one reason why Jokowi has chosen to again give the military certain key positions, in order to implement his economic policies. This also raises fears that the country will backslide several decades from a democratic standpoint.
But current developments point to political stability for the next 1-2 years, ahead of the 2019 presidential election. Some factors are beyond Jokowi’s control, for example the global economy, events in China and commodity prices. But he must demonstrate progress in one area: corruption. If he fails in this vital area, he is likely to lose the confidence of voters in the next presidential election.
Demographic opportunities – and threats
The large percentage of young people in the population is perhaps Indonesia’s most important potential growth factor for at least the next decade. But it is also one of Jakarta’s major challenges. Consumption may grow, but jobs must be created to bring down youth unemployment that exceeds 30 per cent today. Each year about 2.5 million people join the Indonesian labour market. Stable job growth, in turn, requires major investments in infrastructure – transport and energy supply –that can reduce high logistic costs, as well as education to make Indonesia less commodity-dependent. To achieve full economic prosperity, bureaucratic processes and regulations both national and local levels need to be simplified or eliminated. Financial markets must be reformed and opened up to expand access to capital.
Despite slower global growth and plummeting commodity prices, GDP growth has been a solid 5 per cent even though commodities account for some 60 per cent of exports. Helped by more expansionary fiscal and monetary policies and a weaker currency, growth is expected to stay at about 5 per cent over the next couple of years. Although this is good compared to other countries, especially in its region, it may be too weak to generate enough new jobs. But in the short term, Indonesia’s dynamism is mainly attributable to increased private and public sector consumption as well as capital spending. Gradually stronger exports will also contribute to growth; sizeable currency depreciation against the US dollar in recent years has softened the negative impact of falling commodity prices.
Other countries affect the Indonesian economy mainly via three channels: a) trade/commodity prices, b) capital flows/US interest rates and c) the geopolitical situation. All channels pose downside risks to the country’s growth that can only be partly offset by stronger domestic demand. There are thus many indications that Jokowi’s desire for 7 per cent growth cannot be fulfilled in the next couple of years.
Inflation pressure is under control and is within the central bank’s 3-5 per cent target range. This has enabled the Bank of Indonesia to cut its key interest rate three times in 2016, to 6.75 per cent. The bank is expected to continue lowering its key rate. Exchange rate volatility is a source of uncertainty but today the central bank has a currency reserve of more than 100 billion dollars, which is an effective tool for stabilising the rupiah. Since a weak currency compensates for squeezed commodity prices, there are many indications that Indonesia will accept currency depreciation, but only to a limited extent. As a G20 member, the country has pledged to abstain from competitive devaluations. Corporate loans in foreign currencies – 50 per cent of total debt – also justify caution in allowing the rupiah to weaken.
Fiscal policy will play a key role
A growing need for large-scale infrastructure and educational investments will require greater room for fiscal stimulus. The abolition of most energy subsidies has made some new capital spending possible. Public sector debt today is below 30 per cent of GDP. There is thus room for the Indonesian government to borrow, but this is not enough. The need for capital can either be met from abroad or the government must increase fiscal flexibility by raising taxes.
Indonesia’s tax revenue is only 15 per cent of GDP. Most people pay little or no tax. Broadening the tax base is one path forward, along with better tax-collection systems. Otherwise the risk is that too heavy a burden will be imposed on companies, from which taxes are more easily collected.
The country thus needs large public infrastructure spending in the next few years. Logistics cost nearly 25 per cent of GDP. The figure in Thailand is 20 per cent and in China 18 per cent. Indonesia must quickly develop its financial markets in order to meet future capital needs and fund infrastructure and educational investments. Spending in these fields will ultimately also be crucial to democratic development.
A generally sound and stable financial system
To enable private consumption to grow as an economic driver, Indonesia needs a well-developed banking market that allows lending to households. Meanwhile it must avoid letting future growth be too dependent on credit expansion, which would increase the risk of new financial imbalances.
In terms of capitalisation, the financial system can be regarded as generally sound and stable. The authorities have also taken steps to increase banking supervision. But there are risks and weaknesses. The rapid growth of private sector debt in recent years, for example denominated in US dollars – though from low levels – poses a risk of increased credit losses. The weak rupiah and low commodity prices have boosted risks as well. The share of doubtful loans is also clearly rising (today about 3 per cent of the total).
Increasingly important international role
Indonesia plays a critical strategic role in South East Asia, a region that is increasingly important to the global economy. Jakarta has a strong international platform as a member of G20, ASEAN and OPEC. In two years it will also host the annual meetings of the IMF and the World Bank. Its relationship with China is two-edged: at the economic level it is crucial; at the political level, there are obvious areas of conflict which imply that Indonesia’s relationship with the US will strengthen instead.
Jakarta has expressed its willingness to join international trade agreements such as the Trans-Pacific Partnership (TPP) and deepen its relationship with the European Union. At present, it is unclear what this means in practice. Despite Jakarta’s signals of openness and promotion of foreign investments, protectionist roots that extend deep into the society are discernible. When the country has achieved higher levels of economic, financial and political stability, the potential for decreased protectionism will improve.