Beyond Javanese folktales and Balinese batik textiles, Indonesia is a potential economic powerhouse with a captivating story. With a new popular president, Joko Widodo, who took office in October, all eyes are on the largest economy in Southeast Asia and how Widodo will lead the nation into the future.
“It’s the million-dollar question,” says Philip Nichols, Wharton professor of legal studies and business ethics, referring to how the new government’s plans will work out. “There are few places that have sustained growth through the entirety of the recession [like Indonesia], but it’s still a fragile place.”
While the economic spirit of Indonesia proved resilient during the global financial crisis, the country is now experiencing its slowest GDP growth in five years. And while recent governments have generally steered Indonesia in the right economic direction, the nascent administration must overcome big challenges to elevate the country to its full potential.
More generally, Indonesia has a rich, diverse culture that adds to its vibrancy at the same time it poses additional challenges. The archipelago nation is a mosaic, with more than 700 languages spoken by 254 million people spread out over 17,000 islands, and with more than 87% of residents practicing Islam, making it the world’s largest predominantly Muslim nation.
One of Indonesia’s biggest strengths is its demographic profile. It’s the fourth-most populous country in the world with an average age of just 29, which translates into a robust labor force. “Right now, they have a demographic advantage. It’s the youngest population in the region, but that won’t last forever,” notes Petar Vujanovic, head economist of the Indonesia desk at the Organisaton for Economic Co-Operation and Development (OECD). “By 2030, they’ll deal with an aging population.”
Another asset is the government’s commitment to democracy, with a focus on economic growth and development. The first direct presidential election came less than 20 years ago. Prior to that, Indonesians had been under authoritarian rule ranging from Indonesian dictators to Dutch imperialists.
In the most recent election, Widodo gained widespread popularity, pledging to fight corruption and reduce poverty. A former furniture maker, he got his political start when he became mayor of Solo, a city of 500,000 people in the middle of Java. As the son of a woodmonger, he interacts with local crowds and encourages his staff to cut down on excess, like holding meetings at luxury hotels. He flew economy class on Indonesia’s Garuda Airlines to his son’s university graduation in Singapore instead of jetting off on the presidential plane.
But as a political outsider, Widodo still needs to rely on political cronies of the old regime because his power base remains precarious.Though the cabinet he appointed was vetted by an anti-corruption commission — the first time the Indonesian cabinet has undergone any screening — members are “dominated by leaders of state and domestic enterprises. It’s a CEO cabinet,” says Budy Resosudarmo, economics professor, head of the Indonesia Project at Australian National University and currently a fellow at Harvard University.
“There are few places that have sustained growth through the entirety of the recession [like Indonesia], but it’s still a fragile place.” – Philip Nichols
Will the Economy Have Vigor?
As the largest economy in ASEAN (Association of Southeast Asian Nations), a member of the G20 and one of the few economies experiencing a growth rate greater than 5%, Indonesia has the potential to play a pivotal role in the regional and global recovery. Yet, the pace of Indonesia’s growth has reached the slowest rate since 2009. In 2014, Indonesia’s GDP growth rate was 5.1%. This year, the World Bank expects flat growth at 5.2%, while Widodo is targeting 5.7%. “We don’t think that’s achievable with recent figures. The trend is declining,” says Vujanovic. Given the slowdown in China, that might not be surprising. Still, growth may pick up before long, according to the World Bank, which forecasts that Indonesia’s GDP will rise to 5.5% in 2016 and 2017.
Beyond that, experts are cautious. “My feelings are a bit mixed,” says Resosudarmo. “Widodo seems to be taking the country in the right direction, but there may not be enough reformers in the cabinet. We see good efforts to combat corruption and poverty. Indonesian economics are not that bad but not as good as they could be.”
Some are more optimistic that growth will rise as investors will feel more confident. Reny Eka Putri, an analyst at Bank Mandiri in Indonesia, forecasts stronger economic growth with “structural reforms as keys to improving the performance of national exports and fostering confidence in investment opportunities in Indonesia.” To become a high-income country by 2030, the World Bank says Indonesia needs a 9% growth rate to escape the middle-income trap, an economic plateau where some economists believe developing countries often find themselves unable to move to the next level of development, which would mean being able to compete toe-to-toe with more economically advanced nations.
Recently, in a surprise move, Bank Indonesia cut its benchmark interest rate to 7.5% in response to global deflation pressures. With China’s slowing growth, euro zone deflation and falling commodity prices, the country is being cautious given that it depends heavily on commodity exports. “Global demand is not yet recovered, and uncertainty remains,” notes Arianto Patunru, an economics professor at Australian National University. “Domestically, the era of the commodity boom has ended, while the economy still relies heavily on non-tradables [service sector].” The move is also aimed at keeping Indonesia’s current account deficit in check. Currently, it’s about 3% of GDP.
Moreover, in addition to the slowdown in China, Japan’s outlook is also uncertain following an increase in the national sales tax that appeared to undermine a fledgling recovery. Those countries are among Indonesia’s biggest trading partners, and any hiccups there could deeply affect Indonesia’s growth, says Patunru. Adds Vujanovic: “The weakening in trade partners in the region can hold the country back for the next year or two.”
At the same time, the value of Indonesia’s rupiah has dropped to its weakest level against the U.S. dollar since November 2008, sliding some 6.5% since November 2014 alone. Bank Indonesia’s GovernorAgus Martowardojo told Bloomberg that the currency movement was “beneficial” in making Indonesia’s exports more competitive. “I’m not sure whether this is a subtle signal that Indonesia is joining the currency wars,” said Khoon Goh, a Singapore-based strategist at Australia and New Zealand Banking Group Ltd.
Even if true, however, the World Bank estimates Indonesia’s rupiah has been overvalued for some time anyway. Vujanovic explains, “It’s been depreciating on its own for a while now for a number of reasons. Trade has been underperforming, and it’s been relying on foreign sources of funding, which leads to fiscal imbalances.”
Falling Oil Prices’ Surprising Effects
While some countries are reeling from declining oil prices, it’s been fortuitous timing for Indonesia. On January 1, Widodo eliminated fuel subsidies, which had kept pump prices to $0.66 per liter and had largely benefited the rich, who could afford cars. But gas prices at the pump went on to fall lower than the earlier subsidized fuel price as oil prices dipped even further. At least so far, the trend has “muted any political reaction for the reduction in fuel subsidies,” notes Nichols. In the past, there have been violent riots over fuel costs.
“Indonesia is a net importer of [light] oil used for transportation. It was a member of OPEC, but it exited when supply did not kept up with domestic demand” in 2008, says Vujanovic. Patunru notes that creates an obvious downside effect, too: “That means there is a repercussion effect of the falling oil prices on the revenue side.”
Eliminating fuel subsidies, however, could also open up the market for foreign investment in the energy sector. Because of the government’s past price fixing, foreign companies couldn’t compete with the low gasoline prices at the filling stations of state-owned Pertamina. While the lifting of price controls might lead to an increase domestic production, don’t expect energy imports to fall anytime soon. In fact, by 2018, Indonesia may be the world’s largest importer of gasoline. Already, it’s the world’s eighth-largest consumer of gasoline. That’s not surprising, given that more than 1 million new cars and almost 8 million motorcycles are sold in Indonesia annually.
“We see good efforts to combat corruption and poverty. Indonesian economics are not that bad but not as good as they could be.” –Budy Resosudarmo
Dropping the fuel subsidies will have a major effect on the nation’s budget. Fuel and electrical subsidies have accounted for 20% of government spending, notes Vujanovic — the 2015 allocation was $18 billion. Some of the funds now are being shifted to anti-poverty programs, an area in which increased spending had been a major campaign pledge for Widodo. Indonesia now has the “fiscal space to do this with the elimination of fuel subsidies, and the new government is falling along those lines,” says Vujanovic.
Lifting more people out of destitution is a major goal for Indonesia. “The Indonesian government is committed to a social security system that protects the neediest members of society,” says Jeffrey A. Sheehan, former associate dean of international relations at Wharton. “Their means are measured, and if they need support, they get it. They don’t just get [the money] because their uncle is governor of some province. One of the key things for economic development is for people to trust the government.”
Recently, Widodo’s government began issuing national cards to give cash transfers of $15.56 a month to poor people. Half of all households survive on an income clustered around the national poverty line of $15.44 per month, according to the World Bank, although officially about 11.7% of Indonesians actually live in poverty. The income top-up program, the largest in the world, will benefit one-third of Indonesia’s population. Resosudarmo estimates “poverty will be reduced by 15%” over the next few years.
What’s more, Widodo is using mobile-phone SIM cards to be topped up at banks and post offices to eliminate the movement of hard cash, which can easily get diverted through theft and corruption. “Every time you’re moving cash around in a disparate country, you have to worry about a lot of it getting swayed,” explains Nichols. “There’s corruption even at the lowest level.” Moreover, the cards also provide expanded access to health care services and educational programs.
Widodo’s focus on these social programs will help raise Indonesia’s rank in the United Nations Human Development Index (HDI), a single number quantifying a country’s quality of life in terms of health, education and income. In 2013, Indonesia was ranked 108 out of 187. The country attained a HDI score of 0.684, a 45.3% increase from its score of 0.471 in 1980. There have been major strides but Indonesia still has a long way to go. Vujanovic notes, “Indonesia has been doing a good job over the last 20 to 30 years of reducing poverty. The benefits of growth have been shared equally among all segments of society. The strong and sustained growth has lifted all boats.”
An additional benefit of the fuel subsidy cuts: About 60% of the money saved can be used for infrastructure investment. “Infrastructure presents extraordinary challenges for a nation with thousands of islands which can be accessed with ferries and airplanes,” says Nichols. “There’s only one big port in Jakarta and it’s lacking in efficiency, thereby inhibiting interregional and export markets,” adds Vujanovic.
The good news is “the government has a strong focus on domestic and international maritime issues. It’s one way of involving businesses, and people in remote regions don’t miss out on opportunities,” explains Vujanovic.
The Forefront of ASEAN Trade
If Indonesia can greatly improve its infrastructure, an increase in trade will follow. The country is a major player in ASEAN, accounting for 40% of the region’s population. And the ASEAN trade bloc, with a combined GDP of $2.31 trillion, is the third-largest after the North American Free Trade Agreement and the European Economic Area. In addition, Indonesia’s geopolitical position can give them leverage. Resosudarmo notes, “ASEAN is equal in land mass to the whole of Latin America and its size is one of the things that can balance power in Asia against China.”
This year, the ASEAN Free Trade Agreement will come into full effect. “A big chunk of existing trade barriers will be removed,” notes Vujanovic. Essentially, most of the import and export duties on items traded between ASEAN countries will be eliminated.
Already, six ASEAN countries, including Indonesia, have a free trade agreement with China that has eliminated tariffs on most goods. This year, the remaining four will join the ASEAN-China Free Trade Area, opening up the ASEAN region even wider for investments. Watch for manufacturing to be affected significantly as foreign companies take a keener look at the robust labor force as a way to tap into the lucrative Chinese consumer market, as well as providing for the U.S. and Europe.
“The Indonesian government is committed to a social security system that protects the neediest members of society.” –Jeffrey A. Sheehan
Opening up the country to foreign investment in areas like infrastructure, manufacturing and banking, along with eliminating protectionist policies, will further boost growth if the past is prologue. Foreign direct investment flows into Indonesia have climbed sharply since Indonesia has been politically stable, according to the World Bank.
However, despite all of the advances, Resosudarmo worries Indonesia may not foster enough foreign trade, with cabinet members possibly holding onto an “inward-looking strategy dominated by protectionist interests.” In the past, Indonesia has had a rough history with outside firms. “There’s an extraordinary distrust of foreign investors. They’ve been bitten before and they’ve been bitten hard,” says Nichols.
Still, with the new leadership, foreign investors are starting to feel optimistic. For one thing, Widodo’s government is focused on making the country more conducive to starting businesses. “He knows Indonesia needs a supportive business climate in order for the country to grow,” notes Nichols. In the World Bank’s Ease of Doing Business Index, Indonesia is ranked 114th right now and the government would like to be in the 70s, adds Vujanovic.
One straw in the wind: Recently, China’s Foxconn, the world’s largest contract electronics manufacturer and maker of Apple components, signed a $1 billion deal to relocate production from Shenzhen to Jakarta to take advantage of lower wages and a younger workforce. Vujanovic notes that shifting Indonesia’s economy from agricultural and mining-based to a services and manufacturing economy is important for sparking GDP growth, and the government understands that.
Elsewhere, the World Bank has developed a strategy with Indonesia to accelerate economic development through 2025 by focusing on connectivity and logistics, access to finance for small and medium enterprises, and infrastructure and energy investment. For instance, Indonesia has the largest geothermal resource in the world, and the Geothermal Clean Energy Investment Project is aimed at scaling up its capacity by 40%. The World Bank is helping with financing but the technology transfer from foreign firms will be essential to tapping Indonesia’s abundant natural resources on a larger scale.
A Bright Future
The stars suggest a bright future for Indonesia. The country seems to be moving in the right direction. The social programs will bring millions out of poverty and harness the power of its youth for a promising economic growth trajectory. The economic strategy should be successful as long as Widodo doesn’t get sidetracked by internal political dynamics, many observers believe.
Just how Widodo leads his country through global economic challenges will determine how Indonesia will take the world stage. “Growth projections are still reasonable. I’d give him a very cautious thumbs-up,” says Nichols.
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