How fast things change. At the turn of the year, and for a large part of the last one, Indonesia was lumped unceremoniously into a basket containing Brazil, India, Turkey and South Africa, the so-called “fragile five”, notionally the world’s most friable countries.
These nations were deemed to be those most vulnerable to tapering measures as the US Federal Reserve winds down its quantitative easing programme, largely due to their high — and rising — current account deficits.
But in recent months, the wheel of economic fortune has turned again. Indonesia’s currency, the rupiah, has regained much of its strength. Domestic stock prices are on the march again, along with bond prices, as flighty investors start to return. To describe Indonesia as a global investor darling is to exaggerate, but emerging market funds have suddenly been reminded of why (yield, economic growth, a chunky and ambitious population) they originally fell in love with the largest economy in southeast Asia.
Analysts have been quick to talk up Indonesia’s considerable potential. “Strong consumption demand, gradual easing of external imbalances and inflationary pressure, and a generally benign external environment have combined to engineer a substantial improvement in Indonesia’s outlook,” Deutsche Bank strategist Mallika Sachdeva said in an April 11 research note.
HSBC’s chief Asean economist Su Sian Lim agrees. “Indonesia’s economy continues to grow very strongly, and it has been attracting significant inflows of foreign direct investment [FDI],” she says. “Investors have suddenly remembered what they originally liked about Indonesia — and those factors haven’t really changed. They are the same positives that existed two and three years ago.”
A STUBBORN ECONOMY
Rather perversely, much of Indonesia’s recent perceived weakness, at least in the eyes of global investors, can be explained by its stubbornly resilient economy. Gross domestic product (GDP) grew by 5.78% in 2013, down slightly from 6.23% the previous year, but still outperforming most sizeable Asian nations. Inward FDI jumped 22% year on year in 2013, to just shy of $25bn, according to Indonesia’s Investment Coordinating Board. And while exports dipped by just 5% year on year in 2013, to $187.3bn, imports, according to the CIA World Factbook, barely budged, remaining static at around $180bn.
It is this “weakness” — strong economic data reflected in a persistently high import bill, with corporates happy to invest and consumers happy to spend — that has been the bane of finance and economic officials in Jakarta. “It’s these paradoxical factors that have bitten Indonesia on the backside,” notes HSBC’s Su. “Imports have been way too strong, causing external imbalances in both trade, and in the broader current account.”
But other factors have militated against Indonesia in the past nine months. The most notable problem is the current account deficit, an issue that sometimes seems both unsolvable and intractable. The widest measure of the flow of goods, services and money across Indonesia’s borders settled at around 2% in the first quarter of the year, officials at Bank Indonesia (BI) said in late March, compared to 1.98% in the final three months of 2013 and a record 4.4% in the second quarter of last year.
Investors point to two specific deficit related issues that Indonesia appears either unable or unwilling to resolve. The first, superficially outside Jakarta’s control, involves the outward flow of capital by global corporates, under pressure from investors to repatriate capital to Europe and North America. Indonesia has struggled for the past several years to stem these outflows, which are closely tied to the income component in the current account.
The repatriation factor has left Jakarta looking passive and weak-willed, dependent on a concerted developed world recovery and the investment decisions of chief executive officers based in New York, London and Stuttgart. Unless Indonesia itself takes steps to rectify this situation, “the element of downward pressure on the current account deficit is likely to persist,” HSBC said in an April 8 research note.
There is a way for Indonesian officials to appear active and heroic. Tinkering with the tax system to encourage the “retention of foreign corporate profits onshore” would trim outflows pretty much instantly, JP Morgan said in its March Indonesia report.
OIL PRICE PRESSURE
All countries have a glaring shortcoming with a simple solution that, for politically unpalatable reasons, cannot be exploited. Indonesia’s leads us to the second standout drag on the current account: the age-old issue of domestic oil consumption.
Oil prices remain heavily discounted, thanks to the subsidies that buy votes and maintain social stability, at great and rising cost to the nation’s financial stability. Indonesia hasn’t stood still on this issue — the price of gasoline rose 44% year on year in 2013. But it remains ludicrously low, even compared to sovereign neighbours, at Rp6,500 ($0.55) per litre, forcing Indonesia to swallow a sizeable monthly net deficit in oil products. And with presidential elections slated for July 9, and Indonesia’s new political leader set for inauguration on October 20, it’s hard to see this issue being addressed soon.
JOKOWI FACTOR
This leads us to the big X factor in Indonesia’s immediate future, in the form of the slender and articulate frame of Joko Widodo. The down-to-earth Jakarta governor, having risen from obscurity in 2012, now stands on the cusp of the presidency of the world’s third largest democracy. Widodo, known as “Jokowi” at home, is leading in the polls, and is the favourite to take over from the outgoing two-term president Susilo Bambang Yudhoyono this autumn.
Analysts are broadly positive about both Jokowi’s prospects and politics. “A net-positive for the economy”, says HSBC’s Su. “He’s widely viewed as reform minded, most importantly on the issues of fuel subsidies, but also in terms of improving infrastructure and cutting car usage in key cities.”
The prevailing view in Jakarta is that a Widodo win would give investors the feeling that Indonesia’s economy is in the hands of a man able to blend populism and business.
How this will translate into policy is a moot point. Concerns linger over his thin résumé at federal level: some analysts, while willing to talk up his potential, fear that he remains a callow individual who will struggle to rein in and control Jakarta’s political factions, lobbyists and corporate titans. “He’s a great public narrator — he can speak in words that both business voters and retail voters understand,” says a leading Indonesia-focused investment banker. “But it remains unclear how good he will be at governing.”
Two parallels to recent and current global leaders are drawn by local media. In some quarters, Jokowi is viewed as a potential Indonesian Lula, vested with the same magical powers as former Brazilian president Luiz Inácio Lula da Silva, who transformed his nation from simple commodities exporter to beacon of Latin American hope and Olympics host. Others compare him to Barack Obama, who spent four years of his formative life in the Asean nation. Like the US president, Jokowi has a simple, comprehensible and compelling message of unity.
Many, however, fret that this message will get lost in the cauldron of Indonesian politics, becoming diluted as he seeks to balance the needs of a demanding business community, an aspirational middle class and the broader needs of a vast, largely impoverished and vote casting underclass.
There are reasons to be optimistic — and to believe that Jokowi, should he prevail in the July 9 poll, will be able to succeed where even the leader of the free world has struggled. Take his decision in 2013 to hike the minimum wage steeply and to bring it in line with living costs. More than a few business interests cried foul. Others fretted about the popularity of a socialist-minded future president.
Yet critics were mollified by his decision this year to push through a far more modest wage hike for millions of lower earning public servants and indentured labourers. “His reasoning,” notes HSBC’s Su, “was that if he had pushed wages up too sharply, it would have hurt business interests and investment. This gives us an insight into what sort of economic policy — pragmatic, and hopefully also business minded — he may pursue if elected.”
ECONOMIC IMPROVEMENT
Going forward, Jokowi, and more generally the country he hopes to rule, may also turn out to be the beneficiary of good fortune. After a ruinous past year, which saw the rupiah enfeebled and the current account deficit widen to record levels, Asean’s largest economy again appears to be in the ascendancy. Growth is expected to come in at between 5.5% and 5.9% in 2014, according to Bank Indonesia, while Paul Gruenwald, chief Asia Pacific economist at Standard & Poor’s in Singapore, sees GDP expanding at “close to 6%”.
Interest rates were kept on hold at 7.5% for the fifth straight Bank Indonesia meeting on April 8, at which the central bank tipped annualised first quarter GDP growth to come in at 5.77%. It appears confident that inflation will remain within its stated target range of 3.5%-5.5% in 2014, a considerable drop from last year’s 8.38%, so long as oil prices remain under control.
Indonesia’s export-geared economy should benefit from improving economic conditions in Europe and North America, though concerns remain about softening growth in China, a major importer of Indonesian coal and foodstuffs. “A lot of Indonesia’s problems, particularly the current account deficit, will dissipate as the global economy continues to pick up steam, causing Indonesian export numbers to improve,” says S&P’s Gruenwald. A further sign of improvement came in February, when Indonesia posted a small trade surplus.
Inflation easing down, growth ticking up, interest rates steady, the potential for exports to move upward, a new president on the horizon able to blend business pragmatism with retail populism, and exports likely to push north as the global economy firms. Investors are already forgetting to remember Indonesia’s fragile five designation as they pour back into domestic stocks and bonds. How fast things change.