The International Monetary Fund is concerned about the emerging market economies, and we should be too. In particular, we should be worried about Indonesia.
Indonesia was one of the most seriously affected of the emerging market economies by the market volatility triggered by the United States taking its first steps towards normalising monetary policy.
And the IMF warns that it is vulnerable to a reversal or slowdown of capital flows because of increased global risk aversion, the unwinding of global monetary accommodation, or weaker investor sentiment.
The new president, Joko Widodo (popularly known as "Jokowi"), is variously seen as a pragmatic reformer with an impressive track record in sub-national politics, and an economic nationalist in the Sukarno tradition who argues that Indonesia should reduce its dependence on foreign capital and imports.
The American economist Nouriel Roubini is warning his clients to beware the markets' enthusiasm for Indonesia's new broom. "We have reduced our gross domestic product forecasts for Indonesia due to our reassessment of the thrust of structural policies under the new administration," Roubini says.
"Promoting the economic independence of strategic domestic sectors will likely imply greater protectionism, damaging GDP growth prospects. Plans to adjust fuel prices gradually will likely keep inflation higher than we had earlier thought, while a shift in the proportion of the budget spent on social welfare will likely raise the fiscal deficit.
"Trade protectionism and a weaker budget position will also lead to a wider current account deficit and a weaker rupiah."
Higher inflation and uncertainty about structural policies, Roubini says, probably mean a trend depreciation in the currency with short-term money-market rates staying higher for longer than the market expects.Time running out
That may be too pessimistic. The Lowy Institute's Stephen Grenville points to Indonesia's globally open and market-oriented economic policies, its committed bureaucracy, and the considerable experience of the new vice-president, Jusuf Kalla.
"Jokowi may learn a key lesson of politics: good economics sometimes requires pre-election promises to be broken or at least reinterpreted," says Grenville, a former Reserve Bank deputy governor.
However, Joko's administration could be struggling to find its sense of policy direction at a time when a strong commitment to structural reform is needed to enhance Indonesia's competitiveness and reassure foreign investors.
The main risk facing Indonesia is another period of financial volatility, triggered perhaps by a combination of expected higher interest rates in the United States and concerns about the growth outlook for the emerging market economies. The current plan is for the US Federal Reserve to put an end to tapering later this year and to start increasing the monetary-policy interest rate from about the middle of next year.
The IMF says the timing may have to be adjusted, for developments on the employment and inflation front, but is it clear that the emerging market economies do not have a lot of time to get their houses in order.
Indonesia's best defence against a less supportive global investment environment – and any other adverse shocks, such as a sharp downturn in China and a consequent slump in commodity prices – is a combination of strong macro-economic policies, a well-regulated financial system and a program of reform to increase Indonesia's potential growth rate.
The immediate challenge facing the new administration is the fuel subsidy which swallows up 13 per cent of the budget and goes mainly to middle-class motorists.Infrastructure spend not enough
That money could be better used for badly needed infrastructure. Joko has promised to boost infrastructure spending but, as Roubini says, past administrations have set similar targets without success.
The president's promise to reduce the fuel subsidy gradually, while perfectly understandable, could be seen as a nail in the coffin for his infrastructure promise.
Yet capital accumulation is the fundamental driver of economic growth and strong investment is key to any plan to raise Indonesia's potential growth rate from its present, relatively mundane 6 per cent a year.
Investment that removes infrastructure bottlenecks opens the way for further business investment.
The current assessment of the Organisation for Economic Co-operation and Development is that infrastructure investment in Indonesia is not sufficient to support high rates of industrialisation, urbanisation and economic growth.
But it is by no means the only impediment to business investment and economic growth. Indonesia has a huge informal labour market because of high minimum wages and hiring and firing costs in the formal labour market. The minimum wage is more than 60 per cent of the average wage and is linked to inflation, which can result in further increases relative to the median wage.
This is an impediment to the growth of industries, such as large-scale manufacturing, that offer the best prospect of training and labour productivity growth. It also is a barrier to reducing income inequality.
According to the IMF, Indonesian manufacturers have suffered a loss of competitiveness over the past decade.
Indonesia is in a good position to build on its growth rate. It has the world's fourth-largest population and its demographics are right for growth, with the working-age population still growing and dependency ratio falling.
But to take full advantage of that "demographic premium" it needs investment and job creation, education and training, access to foreign capital, and markets that will guide that capital and labour to where they can be most profitably used.
That, of course, means that the government needs to avoid creating national champions, like former president B J Habibie's aircraft manufacturer, or expanding rural producer supports in the name of economic independence.
Can Joko stand for all that? Given time, perhaps. But it is not clear how much time he has to win the confidence of global investors. Australian Financial Review