Few would disagree that the optimism about the Indonesian economy peaked less than a year ago. Back then, Indonesia was one of the few countries that stood out while many others were troubled by recession fears and debt problems.
Of course we are nowhere near a recession or a debt crisis in Indonesia, but optimism has eased a notch — triggered by international credit rating agency S&P’s decision to maintain Indonesia’s sovereign rating and outlook at BB+/positive in May, citing a range of policy uncertainties. This led many investors to reassess their clear-sky scenarios for Indonesia, especially as external headwinds have been blowing stronger.
So is Indonesia veering off course?
No. But clear and prudent policy-making is needed to keep investor confidence.
The government’s recent policy initiatives, and failure to implement them in some cases, have attracted a lot of attention. Apparent non-tariff barriers on horticulture imports were erected, for example, and divestment requirements for foreign mining stakes were raised and mineral exports were taxed. Add to that the apparent inability to push through a needed fuel-price increase despite prolonged political debates.
Not all of the government’s policies deserve the highest praise. The regulations on horticulture imports, for example, was delayed by at least six months due to the lack of preparation. Questions should also be raised regarding prioritization. If the concern behind the regulations was the deteriorating trade balance, it would have been more effective to slow import growth by curbing excessive fuel imports. Last year’s horticulture trade deficit of around $1 billion was dwarfed by the oil trade deficit of over $20 billion.
On the other hand, not all of the government’s policies deserve the negative attention that they have received either. The problem with many of these policies was the lack of adequate promotion. The background for the tougher regulations in mining is understandable. Indonesia’s mining sector has grown at a breathtaking pace in the past few years and signs of over-exploitation have emerged.
Indonesia has become the largest thermal coal exporter in the world despite its reserves being a fraction of those of other major exporters like Australia. The projected time of depletion of our coal reserves declined sharply since 2005, casting doubt on the sustainability of growth in mining exploitation.
The need for better management of the resource is imperative. And for the sake of more sustainable economic growth, government policies must be orchestrated to channel investments, including foreign direct investments, toward higher value-added downstream industries. This involves affecting the relative incentives between investing in upstream or downstream industries.
Subsequent policies that headed in this direction, like tax allowances for investment in selected industries, have resulted in positive results. The share of manufacturing-sector FDI has been on the rise over the past few years, and the increase in manufacturing FDI (as opposed to mining FDI) has, for a change, been followed by stronger job creation, which is a recipe for more sustainable economic growth. It is unfortunate that the application of disincentives against certain types of upstream activities has been taken out of context and perceived as a disincentive against all forms of foreign investment.
Yet despite there being nascent concern among some analysts regarding the apparent policy environment risks, we don’t think that any permanent damage has been inflicted on the medium-term outlook for investment.
However, this is not a reason for complacency. The quality of policy-making must be enhanced to avoid further perceptions of slippage. In its course of action the government must demonstrate that introduced policies are for the long-term economic benefit of the country, as opposed to short-term political reasons.
In the environment of declining oil prices, the government’s resolve in tidying up energy subsidies won’t be tested anytime soon. However, other challenges are emerging in the slide in export commodity prices — coal, palm oil, rubber. Imports are now outweighing exports.
One area of policy-making that will be in the spotlight in this environment is exchange-rate management. In times when the foreign-exchange supply from exporters is potentially subsiding, policy makers must ensure that the markets function well.
The central bank should remain in the market to balance out the structural net dollar-demand from residents. And while exchange-rate depreciation is known to be politically unpopular, policy makers should allow for any adjustments to take place — as the natural avenue to correct the growing external imbalance.
Despite Indonesia introducing many unorthodox policies, investor confidence remains strong. However, India, which now faces the risk of a credit-rating downgrade, shows how easily confidence can slip.
Helmi Arman is an economist at Citibank Indonesia.