Tuesday, December 20, 2016

The politics of Indonesia’s economic future

Under the leadership of President Joko Widodo (or Jokowi), the political economy has to be turned on its head. More than for his post-Soeharto predecessors, for Jokowi the economic outcomes appear critical to maintaining his continuing grasp on political power. The political logic is straightforward. If Jokowi is seen as a certainty for re-election in 2019, potential adversaries in the Jakarta political establishment will see their interests in lending support to his re-election campaign. Public approval that would flow his way from strong economic growth and benign inflation will be his greatest political asset, and failure to deliver will be the potential weak link in his presidency.

A glance at opinion polls over the past several years reveal that the hip pocket rules. Political leaders live and die by the average voter’s perception of their household’s economic situation.

Jokowi’s political instincts are tuned to this reality. His political education, as a regional mayor far away from Jakarta’s high political horse trading, taught him the importance of social policy and support for small businesses in making the average citizen go to the ballot booth feeling more prosperous and well-disposed politically. This instinct explains the preoccupation that insiders say he has about keeping Indonesia’s often volatile inflation rate in check. His flagship infrastructure program is organised around giving him the opportunity to point to completed projects in 2019. Foreign policy, to the extent that he thinks about it at all, is mainly a tool for securing foreign direct investment.

So what is the economic outlook as Jokowi reaches the half-way mark of his first term, and the 2019 polls become sharper in the public mind?

In this week’s lead essay, former trade minister and economic advisor, Mari Pangestu, tracks how Jokowi has taken steps to put Indonesia’s fiscal situation back on track, in the first of our annual series that reviews economic and political developments across the region in what has been a turbulent year.

Despite the challenges at home and abroad, Indonesia continues to enjoy solid if not spectacular growth. The economy should grow at around 5 per cent again this year — much like last year, but much lower than the 7 per cent the new government had targeted. Compared to downward slide in global growth, including that of China and its ASEAN neighbours, Indonesia is doing quite well.

But the big risk that Jokowi faces is on the fiscal front. Much of the impetus to growth has come from the government sector. Unrealistic tax revenue targets were set to support the priority put on infrastructure, health and other sectors. Despite the average growth of tax revenues in the past three years being less than 10 per cent, these targets required a 30 per cent growth in government revenues. Revenue growth has only in fact been 8 per cent. So how Jokowi is going to balance the books and avoid inflationary pressure in the run to the election is the hot issue.

In a deft move Jokowi used his latest cabinet re-shuffle to swing Sri Mulyani into the key finance ministry. Highly respected and experienced, Mulyani is positioned to re-set the fiscal course.

It’s widely accepted in Jakarta political circles that Mulyani’s top priority is ring-fencing revenue for pumping into infrastructure—while making drastic cuts to other programs. Though there’s concern that worthwhile, longstanding programs, whose political and economic benefits might not be so quick to appear, will fall victim of a preoccupation with quick wins on the infrastructure front, the pressure is all on getting the books into shape and avoiding a fracture in economic confidence.

‘Sri Mulyani hit the ground running’, Pangestu reports. ‘She took charge of implementing the ambitious tax amnesty program, which faced considerable scepticism and implementation problems. The President undertook a huge and intensive public outreach campaign to the private sector. This included his calling on large corporations himself to seek for their participation and commitment. The result has been better than expected in terms of the tax amnesty targets, but less so on the tax reform front’.

The task of getting momentum behind growth and putting the structural reforms in place to do that has only just begun. The President and the Finance Minister has announced that there’s more to come. Growth is weakening so without reforms that deal with the narrow tax base and the expenditure side, fiscal sustainability remains at risk.

Private investment growth, including in infrastructure, needs a kick. The 14 economic regulation packages under Jokowi so far have fallen short on reform even though they were supposed to be aimed at reducing the costs of doing business and facilitating trade and investment. What they haven’t done is deliver real improvement to the investment environment. And there is continued ambivalence at the top on protectionism and localisation policies that leave foreign and domestic investors wondering whether Jokowi wants to take the country backwards or forwards.

Preventing Indonesian growth from drifting backwards or better, lifting it towards its potential of 7 per cent, as Pangestu concludes, will require dealing with these issues. And so too, among other things it appears likely, will continuity in Jokowi’s presidency.

May we take the opportunity of launching our year-in-review series to thank you for all your support over the past year and wish you the very best for the holiday season and the New Year.

The EAF Editorial Group is comprised of Peter Drysdale, Shiro Armstrong, Ben Ascione, Ryan Manuel, Amy King and Jillian Mowbray-Tsutsumi and is located in the Crawford School of Public Policy in the ANU College of Asia and the Pacific.


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