Received wisdom has it that Indonesia was the most badly hit of all South-east Asian economies when US Federal Reserve chairman Ben Bernanke’s unexpected comments about tapering on May 22, 2013 ignited an emerging-market sell-off.
The country was particularly vulnerable because of its twin budget and current account deficits, and hostage to flighty foreign capital. Labelled one of the Fragile Five – an unhappy collective term for the most susceptible emerging economies – the economy stalled while its currency tumbled.
Indonesia ended up posting 5.78% in gross domestic product growth last year, compared to more than 6% in the three previous years.
But according to finance minister Muhamad Chatib Basri, the drop was not accidental. “The slowdown,” he tells Asiamoney firmly, “was by design.”
Achieving such a goal may appear self-defeating, yet it makes some sense considering Indonesia’s unique position.
“We are a country with a young population. Most of our population are workers aged less than 30,” Basri says. “People in their initial careers will start to buy cars, motorcycles; that’s why the growth of motorcycles in Indonesia is one of the highest in the world.”
Wealth has grown markedly. In 2003, about 5% of people spent $4 per day or more; by 2010 it was 18%.
“In a country of 240m people, the additional number is about 40m people, larger than the populations of Malaysia, Singapore and Australia combined,” says Basri (in fact the three countries' combined populations are about 58m).
But this army of young consumers has demanded goods at a rate that Indonesia could not meet domestically.
“We became a victim of our own success,” Basri admits. “The economy grew at 6.5% [per annum] and people demanded things that couldn’t be entirely supported from the supply side. And if a product is not available, they are going to buy imports.”
Ninety-two percent of the country’s imports are capital goods and raw materials, and it imports more when the economy thrives. Inevitably, the current account deficit climbs. Early last year it reached 4.4% of GDP, or $10bn, which markets identified as a weakness.
It’s a classic middle-income trap; a country does well enough so that its people demand goods produced overseas, weakening its current account position and eventually, its currency.
Basri says economic slowdown was his only option: “As a minister of finance, I have two choices. The ideal one would be to expand the supply side, increase productivity, improve infrastructure, and improve the quality of human resources. But I completely understand it takes time to get there. If I cannot handle this from the supply side, my only option is to slow down demand.”
There’s an old political maxim that it’s better to appear wrong than weak. However, Basri’s version does have merit.
By his telling, two things took the heat out of Indonesia’s economy: a 44% fuel-subsidy reduction, and the decision by central bank governor Agus Martowardojo to raise rates by 175 basis points, causing the rupiah to depreciate.
“It’s a standard model for handling a current account deficit,” he says. “Within four months, we were able to manage this issue, from 4.4% to 1.9%, or $4bn. I don’t think this will be a major issue in the future.”
With that done, Basri – who steps down as finance minister when a new government comes into power in October – wants foreign investors to focus on long-term business opportunities, and macroeconomic stability.
But is that message getting through? What do capital flows say?
On the portfolio side – which, at 40% of the Indonesian capital account, is significant – he says: “The risk is still there. I don’t know but maybe the Fed will expedite the process of tapering and, later on, increase long-term interest rates in the US. If emerging markets do not prepare for this, there will be turbulence.”
In Basri’s view, controlling the current account deficit was crucial to ensuring that Indonesia is not targeted again by skittish investors when the US raises rates. “If we have been able to consolidate the current account deficit at less than 3%, this will make the market less nervous.”
Asiamoney is talking with Basri in Astana, Kazakhstan, venue for the Asian Development Bank meeting. In previous days he has been one of many to complain about the Fed’s behaviour last year, when its comments came as an unwelcome surprise to emerging countries.
There have been widespread requests for better communication. “I understand it is impossible for the Fed to provide a roadmap for this, but better communication would be very useful,” he reiterates.
Basri also points out that when the US moves from tapering to raising rates, probably in mid to late 2015, countries that gorged on cheap debt during the low interest-rate environment will be in investors’ sights. Indonesia has avoided this temptation.
Instead, it seems Malaysia, Thailand, China, Hong Kong and Singapore have more to worry about. “This may affect countries with relatively high debt,” says Basri. “And don’t forget sometimes the market over-reacts. That is why it is important to ensure that macrostability is in place.”
On solid ground
Is Indonesia economically stable? Basri believes so. He points to foreign-exchange reserves that fell from $102bn to $92bn last year as markets reeled, but are now back to $103bn plus about $60bn in bilateral lines, “because capital is flowing back”.
A key factor in Indonesia’s stability will be the new government’s policies. The country elects a new president in July, and uncertainties exist over what his policies might be and also the inevitable political paralysis pre- and post-election.
Basri believes his successor will prioritise a balance between growth and sustainability.
“Whoever becomes president needs to maintain political support by producing jobs, in order to reduce poverty,” he notes. “If you want to create jobs, you need to ensure the economy grows by 7%.”
It’s a calculated figure. Basri says that 1% growth absorbs about 300,000-400,000 new entrants into the labour market, and since there are around 2.4m entrants each year “you need to grow by 6% just to break even. If you want to reduce unemployment, you need to grow more than that. And there is no way Indonesian can achieve 7% growth without being an open economy.”
He expects the new government to adhere to this strategy. “On the campaign trail, some presidential candidates come up with nationalistic views. But once they are in power, they are constrained by economic reality. So I don’t think there will be a major change of policy because, whoever becomes president, the main concerns will be the same.”
One example Basri gives is the country’s contentious fuel subsidies: a popular policy, but a drain on public finances. “All the presidential candidates in the past, before they assumed power, disagreed strongly with fuel-price adjustments,” Basri says. “All, once they became president, adjusted the fuel price: Habibie, Wahid, Megawati, Yudhuyono.”
Besides growth, Basri believes any new leader must grapple with the more complex task of reinventing Indonesia’s economy.
“Indonesia cannot continue to rely on natural resources,” he says. “And we cannot continue to rely on cheap labour. Somehow we have to move to new stages of development.”
He wants to see a knowledge economy and investment in human capital, plus a better business environment.
“This country will be discriminated against by investors not on physical assets but intangibles, meaning policy and the investment climate: ease of doing business, combating corruption,” he says.
Infrastructure remains the most obvious growth impediment. The single biggest obstacle is land acquisition, because claims over land ownership can be lost in the courts for decades. Basri says a new law on land acquisition is about to be passed, ensuring the courts will resolve any price dispute within 90 days.
Asiamoney informs Basri that he is the fifth finance minister to offer it such assurances. Will the law go through? “It has been passed by the parliament and will be enacted by January 1, 2015,” Basri says. “You cannot amend the law unless you come back to parliament.”
To get a sense of the possibilities, a new toll road was created in just 11 months ahead of last year’s APEC meeting in Bali. That happened, Basri says, because the road went over the sea, avoiding land issues.
“I said: in Indonesia it’s easier to create miracles like Moses than to procure land.”
If the law does finally prove to be transformative, priorities will be land transportation and ports as well as a double-track railway already under way.
“The future of world trade will be based on supply-chain logistics,” Basri asserts.
Indonesia’s economic numbers are looking good, but Basri believes two related threats could dent them: commodity prices, and China.
“Maybe I’m too pessimistic,” he says, “but I will say the resources boom is over.”
Declines in commodity prices last year destroyed export revenues, and also taxation income, since so much tax revenue is based around mining and plantations. This underpins Basri’s reasoning for diversifying Indonesia’s income away from resources.
“This is why I emphasise the risks coming from a slowdown in China,” he says. “First, most products we export are primary products,” so a Chinese decline affects export demand. “Secondly, if China slows down, the demand for commodities will decline and the commodity price will decline with it. It is a double blow for us: 65% of our exports are energy and commodity-related.”So a slowdown in China offers the biggest threat to Indonesia’s economic health? Basri nods slowly. “Sure.”