Indonesia is currently in the process of transforming from a resources- and consumption-based economy to a more manufacturing- and investment-oriented one, working to build an industrial base that will allow it to reduce its dependence on imports and keep more value within the economy. It is a vital transition, one that recognises the new realities of the global economy and at the same time sets the country up for long-term, sustainable growth. If Indonesia successfully adjusts and realigns the economy, it will insulate itself from commodity price swings and ultimately avoid the middle-income trap. “During the [Susilo Bambang Yudhoyono] era, it was more a commodity story,” Edimon Ginting, the deputy country director at the Asian Development Bank (ADB), told OBG, referring to the government of the former president. “Now it is more of an investment story. The country is moving towards new sources of growth outside of commodities.”
Still, Indonesia remains very much a resources and consumption economy. Natural resource rents as a percentage of GDP were 7.1% in 2012, according to the World Bank, while mineral fuels and oils, and fats, oils and waxes were tied as the top exports in the country in 2014, each with 14.43% of the total. Thailand’s natural resource rents were only 4.3% of GDP in 2012, the Philippines’ were 3.5% and China’s were 5.8%.
There are some signs that Indonesia has already started to become more diversified. Exports of some commodities have been dropping fast: exports for the minerals, fats and oils category were down 14.3% in 2014; rubber and rubber articles declined by 23.9%; and ores, slag and ash were off 71.2%, according to Ministry of Trade data. Although Indonesia’s manufacturing industry has recently seen slower growth compared to previous years, manufactured exports appear to be on the rise. Vehicle exports grew 14.3% in 2014, while organic chemical products exports were up 20.6%.
The country is in a good position to make the investments needed. With oil prices on the decline, it has been able to redirect money that would have otherwise gone to fuel subsidies to infrastructure, and it has done so without angering the population. The key, analysts say, is to take advantage of the situation and redeploy the money effectively to more productive investments in the economy. If the spare funds go to infrastructure or directly to manufacturing, Indonesia will achieve more sustainable growth. If the money is misspent or wasted, the country will have trouble transitioning from the commodity boom to more balanced growth. “How we use the savings is the most important thing,” Eddy Handali, rating director at Fitch Ratings Indonesia, told OBG.
Debt levels in the country remain manageable and other measures of soundness suggest reason for optimism. The country’s debt to GDP ratio is currently around 30% (it was 28.7% in 2013), one of the lowest ratios in the region and down considerably from 60% a decade ago. Private debt is at about the same level overall and is mainly long term.
And while the currency has been falling, it is considered to be at a good level and relatively stable following the rapid drops experienced in 2014. Growth has slowed, but the country is still considered attractive to foreign investors. Fitch affirmed the country’s rating in late 2014 at “BBB-”, with a stable outlook and noted the low debt, improving trade situation, well-capitalised banks and stable growth. “We are quite pleased with the growth. The growth is slower than historical levels, but still considered quite high. Most important, growth is quite stable for Indonesia,” Handali said.
Willing to Compromise
The government and the monetary authorities have been actively pushing to promote the reform and restructuring of the economy. The central bank has been keeping interest rates relatively high to maintain the current account deficit below 3%. The government, meanwhile, is undertaking a number of initiatives to increase investment in manufacturing to make the economy less resource-dependent. It is investing in infrastructure, so that investors are more confident about manufacturing in the country, and is working to improve the process for gaining investment approvals. The new president, Joko Widodo, is committed to keeping the economy open and encouraging investment that will help industry to develop. However, the process will not be easy.
The central bank has already received considerable pressure from the government and the public. Concern was expressed in private and in print that interest rates were too high and that keeping rates there will jeopardise growth. While the cutting of rates in early 2015 may have been done independent of outside influence, the move suggests that the commitment to holding the line is not as strong as first believed.
More generally, analysts are concerned that the reforms needed in Indonesia to get the real sector better established will be difficult to achieve. While they recognise that Widodo is a strong president and that he is sincerely working towards positive changes in the economy, they wonder whether he will be successful in achieving all he has set out to accomplish. They continue to see land acquisition, bureaucratic approvals and local autonomy, for example, as hurdles that may be difficult to overcome. “This is Indonesia,” Handali said. “Do not expect fast structural reform.”
The attitude of international investors so far has been mixed. They certainly like financial assets in the country and are huge buyers of local currency bonds, owning nearly 40% of the market at the end of 2014 (up from less that 3% in 2004), according to AsiaBondsOnline.
But it is not so clear whether investors are as eager to deploy funds for use in the real economy. While foreign direct investment (FDI) hit record levels in late 2014, growth stagnated in the last three quarters of the year, according to Bank Indonesia statistics.
And analysts say that early 2015 looked weak as well. Inflow from a number of countries remains strong – the Japanese remain quite committed to moving more manufacturing to the country – but in general investors are cautious and proceeding slowly when it comes to funding large-scale manufacturing projects. “If we look at FDI anecdotally, we have not seen an increase” Helmi Arman, economist at Citibank, told OBG.
The worry is that investors will be chasing mainly yield and that they will remain hesitant to make more permanent investments. The purchase of bonds is certainly appreciated, and financial investors are seen as important parts of the puzzle, but the rush of money does not directly help transform the economy and leads to concerns that it could rush out just as easily as it came in. “I do not know if [investors] are positive on fundamentals or just looking for yield,” Handali said.
If Indonesia is able to get the mix right, however, the country has the potential to grow in a far more sustainable manner. It will become less dependent on commodities, less dependent on foreign inflows of funds and better able to generate wealth locally. A manufacturing base would leave more value locally and insulate the country from global economic shocks.
The trick, analysts say, is in the implementation. Almost everyone can agree on what needs to be done and consensus exists on how to do it. The question is whether what is needed can be accomplished and within a reasonable time.
Some analysts see Widodo as uniquely qualified to help the country navigate the challenging transition. While they agree that many obstacles will slow and potentially stall the process, especially when it comes to land acquisition and local permissions, a strong leader can have a meaningful impact on the process. He can work with various interests along the way to get them to agree to allow key projects to proceed, and this sort of involvement could make the difference and provide some momentum for development.
Observers have already noticed a change in the way the government is working, and this suggests that stumbling blocks encountered in the past may be overcome more easily by the Widodo administration. “I do not think the threat will be from policy; the threat will be from implementation,” Ginting told OBG. “The challenge will be in implementation. But the government is now more business-like, and less bureaucratic.”
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