The answer to this question
will be determined by whether the Indonesian government adopts a pragmatic
response, or doubles down on an economic course that diverges sharply from the
successful path adopted in the post-Asian crisis period.
The predominant view is that
this slowdown is a cyclical
development. Growth will rebound, led by rising government
infrastructure spending, which in turn prompts a revival of private investment
and a boost to demand. Some reforms — such as investment licensing — have also
gained traction and could help to increase investment.
Nonetheless, there are few
signs of an early turnaround. As activity grinds lower, critics will challenge
the view that this is a cyclical downturn. Instead they will ask whether the policy foundations of
economic activity can explain the slowdown.
The role of government is
being recast. The public sector is increasingly seen as the manager of economic
activity rather than the creator of an enabling environment for private
economic activity. Mainstream Indonesian political discussions accept this view
and it is increasingly reflected in the legal and regulatory framework. For
example, the 2014 industry law envisages 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 2015 Indonesian budget
positions the public sector as the main driver of growth. The re-orientation of
the budget towards infrastructure spending
and the injection of additional capital into state-owned enterprises both
signal this philosophy. Of course, increased public investment in
infrastructure is justified by the dramatic failure of the public-private
partnership infrastructure model over the last decade. But this breakdown of a
balanced public and private investment strategy is explained more by the
government’s failure to provide an enabling environment for private investors
than a lack of investor finance and interest.
External economic relationships
are being reshaped. A plethora of regulatory and non-tariff measures have been
introduced. Indonesia features among the G20 countries with the most
significant increases in tariff barriers and the most number of trade partners
affected by these increases. The 2014 Trade Law, in the same spirit as the
Industry Law, grants powers to manage trade directly. Some have suggested that
discretionary limits on imports will reduce the current account deficit without
setting back the development of the export-oriented manufacturing sector. But
both industrial and trade policy fails to grasp the nature and operation of
global value chains and technology acquisition.
Key laws framing the
post-Asian crisis recovery are being challenged. The constitutional court has
recently struck down the 2004 water law, stating that the free-market economy
harms the people.
The court has received
submissions to consider three other laws. They are: the 1999 law on foreign
exchange, which provides the legal basis for convertibility of the rupiah and
the use of foreign exchange; the 2007 law on investment that, among other
things, is the basis for the ‘negative list’ restrictions on foreign
investment; and the 2009 law on electricity, which allows private operation of
power plants.
These laws are part of the
foundation that has enabled Indonesia’s involvement in the global economy and
certainty for domestic and foreign investors. The outcome of these legal
actions will send a strong signal about the direction of Indonesian economy.
The internal contradictions
of the new model are running into harsh economic realities. The public
sector-led model cannot be adequately financed. On the domestic front, the
financial sector is small. As a consequence, the funding of significant
investments by government and state-owned enterprises will crowd out private
activity.
These challenges are
increased by the significant state-owned share of the banking sector, which
also needs to increase capital to meet medium-term goals. The need for
significant financing in the banking sector comes at a time when the thrust of
political discussion is to reduce foreign investment in the banking sector.
On the external financing
side, Indonesia has seen a necessary resort to greater reliance on short-term
capital flows, because the impediments to foreign investment mean that FDI
remains low as a share of GDP. A pick-up in multilateral and bilateral official
flows is a possibility and this could certainly help. But official flows are
not likely to meet funding needs.
Indonesia’s economic
slowdown is reducing the degree of freedom afforded to economic policy. The
public sector-led model, if it ever were viable, is becoming less so
day-by-day. The only ‘get out of jail free’ card is a turnaround in commodity
prices, but that does not appear likely in the near future. This means that
medium-term growth prospects require a meaningful re-orientation of strategy.
Indonesian policy has long responded pragmatically and boldly to economic
challenges. It will need to follow that course once again.
David Nellor is an Adjunct
Professor in the Lee Kuan Yew School of Public Policy, National University of
Singapore.
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