Indonesia tries to steady its economic wobbles

With economic uncertainty in China in the spotlight over the past few weeks, Indonesia’s economic wobbles have escaped the scrutiny abroad that they are now demanding at home.

Less than half a decade ago, Indonesia was still riding the China boom. In the decade before, the Chinese economy gave the world its biggest ever resources boom, after which there’s been a dramatic collapse in commodity prices. The boom generated high incomes and investment in global resource producers. It boosted Indonesian growth and — in the nature of the political economy of such countries in which good times tend to drive bad policies — diverted the policy energy away from the productivity-raising reforms necessary for broad-based growth. Arbitrary government interventions also reduced the gains from the boom, especially in resource goods other than coal, and dampened the size of the boom.

 

The challenge of the economic adjustment that faces Indonesia is nonetheless enormous. Indonesia (like Australia) is now one of the world’s largest coal exporters. While it may be true, as Ross Garnaut suggests, that Indonesia handled the Dutch disease and its challenges better than some countries, coming off the commodity boom high is no easy path to navigate — witness Brazil’s slump towards negative growth. The end of the boom may create opportunities for a return to broad-based development. But, if that’s to happen, policy settings will have to shift sharply towards support for productivity-driven growth and lifting economy-wide competitiveness, and eschew random government intervention in the economy to support particular interests or causes.

The Jokowi government made a good start with its fuel-subsidy reforms. But thereafter economic policy thinking has drifted towards state-interventionism. The idea that the downturn was a cyclical phenomenon, and that recovery of public and private investment would soon boost demand and lift growth again, dominated. But there were few signs of an early turnaround. The view that Indonesia was simply in the throes of a cyclical downturn has lost credibility. Attention has to shift to the policy foundations to address the slowdown in Indonesian growth.

The idea that the state is the manager of economic activity rather than the provider of the best enabling environment for private economic activity has captured the ascendency. This is accepted mainstream Indonesian political thought, increasingly reflected in the legal and regulatory framework. The 2014 industry law envisaged government determining the sectors of focus and establishing upstream and downstream activities in those sectors. Exports and imports are managed using tools from outright bans to local content rules and domestic market obligations. The budget boost to infrastructure spending and the injection of capital into state-owned enterprises both signalled this philosophy. While there’s no doubt that increased public investment in infrastructure is justified by the dramatic failure of the public-private partnership infrastructure model over the last decade, the collapse of a balanced public and private investment strategy itself derives from the government’s failure to provide an enabling environment for private investors more than a lack of investor finance and interest.

The 2014 Trade Law, in the same spirit as the Industry Law, granted powers to manage trade directly. This trend in both industrial and trade policy failed to grasp the nature and operation of global value chains and technology acquisition. Key laws framing the post-Asian crisis recovery and the role of markets in sustaining a strong economy have also been under constitutional challenge.

In the past six months, the pressure on Indonesia and other emerging economies has intensified around volatility and weakness in international capital markets. The dive in the value of the rupiah — to below 14,000 to the US dollar, a level not reached since the Asian financial crisis of 1998 — and the collapse in the stock market and bond prices, with yields on bonds maturing 10 years out edging up to nearly 8.8 per cent, Indonesian policy makers have been badly spooked. In the cabinet reshuffle in August, Darmin Nasution, former Governor of Bank Indonesia, was drafted as the new Coordinating Economics Minister. It was past time for a change in policy strategy and the reshuffle a welcome development.

Indonesia’s announcement of a comprehensive package of reforms aimed at reducing inflation and stabilising the exchange rate and stimulating demand through ‘deregulation’ now signals some further change in direction. The reforms are scheduled to come into effect tomorrow.

In our lead essay this week, Chris Manning, based in Indonesia, reviews these reforms. The package is enormous in scope and encompasses many existing government initiatives, he reports. The measures announced last week are just part of a series of packages that are yet to be promulgated so it’s difficult to be definitive about what their ultimate shape will look like. But one thing is clear, Manning says: ‘it is a different package of “deregulation” reforms from that announced in the second half of the 1980s when the economy appeared similarly to be on its knees. Now the focus is more on public sector support and increasing demand, rather than market oriented reforms to improve competitiveness’.

This strategy is unlikely to correct the wobbles that now afflict the Indonesian economy. The economy may not be in meltdown, but, at 4.5 per cent, growth is well below potential and decelerating and, at 7 per cent, inflation is far too high. With direct interventions that put bans and restrictions on imports of key foodstuffs like beef, the market is not being deployed to alleviate these pressures. Despite the depreciation of the currency, inflation undermines cost competitiveness and exports are down by more than 20 per cent on last year.

There is still more to come but this round in Indonesia’s reform package is unlikely to reassure international markets that the fundamental shift of direction in policy strategy that is needed is on the way. The public sector-led model is less viable day-by-day. There will be no ‘get out of jail free’ card through a turnaround in commodity prices. Achieving Indonesia’s growth potential will require policy re-orientation that gets rid of the policy inconsistencies that handicap role of the market in unlocking investment, trade and productivity growth. Hopefully Indonesia can still respond pragmatically and boldly to the considerable economic challenges that it now faces.

Peter Drysdale is Editor of East Asia Forum. The Indonesia Project’s Indonesia Update will be held at the ANU on 18—19 September.