Indonesia's Self-Inflicted Economic Woes

Jakarta's policy makers have forgotten what attracted investors in the first place

It is a tale too common among large emerging markets. 

Just a few years ago, Indonesia was the latest darling of the international business community. Its recipe: a large and fast-growing consumer class with newfound eagerness to spend, blended with impressive macroeconomic performance, a dash of political stability and a sudden penchant for marketing. 

Economic pundits hailed Indonesia as the new "I" in the then-elite club of "BRICs," while consultancies and investment banks played up the story. McKinsey garnered huge headlines with straight-line predictions that Indonesia's economy would overtake Germany's in a scant 30 years. Heady stuff, and as Davos Man took notice, one could almost hear the chest-thumping and high-fives in the presidential palace. 

Little more than a year later, much has changed. Foreign investors no longer clamor to their embassies in search of door-opening sessions with Indonesian ministers. One commercial attaché lamented that his life has become far less interesting: "Inquiries about how to do business here have gone from an all-time high to eerily quiet in a few short months."

Success can breed hubris, and in Indonesia the government has overplayed its hand. Policy changes in the mining, retail, horticultural and oil and gas sectors have led foreign investors to reassess the risk of doing business here. Boards of foreign multinationals question the direction of economic policy. They ask, as presidential elections approach next year: Is economic nationalism a permanent feature of the business landscape, or will the current spike in protectionism give way to the more investor-friendly stance of the recent past? 

The circumstances of Indonesia's nationalist economic turn shed some light on what to expect in the future. As Chatib Basri, an economic straight-shooter recently installed as finance minister, likes to say, "In Indonesia, bad times make for good policies and good times make for bad policies." 

In the late 1980s, the global slump in oil prices prompted then-President Suharto to boost export revenues by liberalizing energy sectors other than oil and gas. After dismantling barriers to trade, Indonesia had one of the more open economies in the region. 

Following the 1998 Asian financial crisis, Indonesia's policy makers again rose to the challenge, revamping the financial sector and beginning the path of corporate restructuring. These reforms paid off within a few years. In 2008, with much of the world mired in recession, Indonesia found itself in the warm spotlight of the international business community. When the majority of emerging markets started to sputter and falter, Indonesia's economy managed to maintain its growth momentum. 

For a while, all boats rose with the rising reputational tide. With its favorable demographics and economic stardom, multinational companies flocked to Indonesia. 

In 2012, A.T. Kearney's Foreign Direct Investment Confidence Index put Indonesia at ninth place in the world. Indonesia had broken the top 20 just two years before. The survey measures future investment plans of the globe's top 1,000 corporations, so it was clear that many executives expected more good times ahead for Indonesia.

But hubris had already set in. Indonesian policy makers seemed to have forgotten what brought investors to their shores in the first place. International mining companies awoke to find deep restrictions on exports and ownership. New laws forced them to play in lower-profit parts of the value chain, and hopes faded that the central government would help intervene and level the playing field in maddening disputes with local power brokers. Nearly overnight, Indonesia shifted from being one of the world's more promising mining destinations to being one of the least desirable. 

The curse of nationalism has also affected the oil and gas industry. Officials forced ExxonMobil to replace its country manager. The government initiated a nasty legal tussle with Chevron over bioremediation, with courts eventually relying on a figure who stood to gain financially by accusing the company of impropriety. In another case—in which it is harder to tell the black hats from the white—the French giant Total is battling over a lucrative gas block in the province of Kalimantan. As oil and gas giants ponder the future, they are asking hard questions about their budgets for capital expenditures in Indonesia. 

A.T. Kearney's survey already shows some of the damage. In the recently released 2013 index, Indonesia fell 15 places to 24th. Investors say that Indonesia has dropped as a priority. While this is partly because of the reemergence of the U.S. and other economies, Indonesia's economic nationalism has been a major factor. Next year's foreign investment data may reflect a further decline.

So what now? One milestone to watch for is next July's presidential elections. In previous election years, nationalist rhetoric and policies increased and then gently declined once a new government was installed. Policy makers may also revisit recent policy changes as investment in the affected industries continues to drop. 

Thus Mr. Basri's words may offer some hope: While good times made for some very bad policies, the recent spate of bad news may signal that better policies are just around the corner.

Kurtz is the head of Asia-Pacific for A.T. Kearney, where Van Zorge is a senior fellow. Wall Street Journal