Bill Guerin, Jakarta – Indonesia is on the upswing, with strong export and economic growth combining to drive the Jakarta Stock Exchange Index up by more than 55%, accounting for the world's third-best stock-market performance in 2006.
That good news was underpinned by surprisingly strong political stability and improved macroeconomic fundamentals, seemingly flouting the country's recent reputation as a haven for international terrorists and economic mismanagement. So can the perennial sick man of Southeast Asia maintain the positive momentum into 2007?
Consensus forecasts indicate that the Indonesian economy, driven by stronger private consumption and buoyed by lower interest rates, should grow between 5.5% and 6% this year. Exports were the highest ever recorded at US$8.92 billion, as the country cashed in on high global prices for energy and natural resources. Full-year exports in 2005 were on course to hit a whopping $100 billion.
A series of interest-rate cuts, a strengthening of the local currency and a steady decline in monthly inflation rates helped to pump up the Indonesian bourse. Those big gains were attended by strong performances of several listed blue-chip state-owned enterprises, including Bank BRI, Mandiri and Telkom. Despite dipping nearly 4% on Wednesday's news of new foreign-investment curbs in Thailand, financial analysts believe the stock market is primed for another bumper year.
Improving economic fundamentals is a big part of Indonesia's good news story. Government policymakers have recently reined in galloping inflation, which was a moderate 6.6% last year, a striking improvement on the runaway 17.1% recorded in 2005. At the same time, the local currency, the rupiah, strengthened against the US dollar in line with other regional currencies, appreciating from 9,823 to the dollar last January to 9,034 by year's end.
Aggressive monetary loosening, where the central bank cut its key interest rate eight times from May to year's end, brought the benchmark rate down from 12.75% to 9.5% and contributed largely to stock-market optimism. In line with the improving fundamentals, investment-approval figures last year were also substantially up.
Recent figures from the Investment Coordinating Board (BKPM) show that approvals of foreign direct investment rose 18% to $13.9 billion over the same period in 2005, with approvals from neighboring Malaysia topping the list with $2.2 billion committed. Likewise, domestic-investment approvals were up almost 300% to Rp157.5 trillion (about $17.37 billion).
Cloudy investment horizon
But that's where the clouds re-enter Indonesia's investment horizon. Actual realized foreign investment, as opposed to investment approvals, dropped by 46% year on year, falling from $8.67 billion in 2005 to $4.69 billion last year. Despite a highly touted new Economic Partnership Agreement with Japan, Indonesia's main foreign investment source, total Japanese investment from January to November 2006 dropped dramatically to $430 million, down 61% over the same period in 2005. Realized investment from China, which is currently on a global spending spree trying to secure energy resources, was also surprisingly down by 43% year on year to $114.8 million.
Muhammad Lutfi, head of the BKPM, told local media last month that the dip in Japanese sentiment was a reflection of investor concerns about the uncertain legal environment, a prohibitive tax regime, and lack of infrastructure and quality workers. Central-bank governor Burhanuddin Abdullah recently echoed that assessment, warning that despite improved macroeconomic indicators, there were still substantial "structural problems" with the economy, including bureaucratic hassles, poor infrastructure and low productivity.
Those high-risk perceptions among foreign investors were reinforced in October, when the government unexpectedly terminated US oil-and-gas giant ExxonMobil's 1995 contract to operate a 222-trillion-cubic-foot block of natural gas in Natuna in the South China Sea. State-owned oil giant Pertamina had a 24% stake in the block, while Exxon had maintained a 76% holding.
ExxonMobil said the contract allowed for two more years, and talks about extending those rights are set to commence this month. Energy Minister Purnomo Yusgiantoro hinted at the government's position when he told reporters last week that he wanted to "maximize" Natuna's production and that Pertamina should have "more share" in the joint venture.
In a similarly arbitrary government move, Vice President Josef Kalla called on US mining giant Freeport McMoRan Cooper & Gold, by far Indonesia's largest taxpayer, to triple the amount of revenues it is now contractually obliged to share with the government, on the odd logic that world prices for ores had recently jumped.
The slow pace of economic reforms, including delays in passing new tax and investment laws, continue to dampen the business and investment climate and undermine the government's ability to create badly needed jobs. Meanwhile, proposed business-friendly amendments, backed by the government, to the 2003 Labor Law were abandoned because of strong trade-union opposition, which led to nationwide protests.
Underlying weakness in the banking sector also remains a cause for concern. Nearly a decade after the 1997-98 Asian financial crisis blew holes through most Indonesian banks' balance sheets, after rounds and rounds of debt restructuring, non-performing loans (NPLs) still account for 16% of all credits outstanding in the banking system. That high ratio continues to discourage banks from issuing new loans.
Rather, many leading banks prefer to park their funds at the central bank, where they can earn no-risk 12% returns. According to remarks made by Vice President Kalla at a seminar last month on bureaucratic reform, many bankers fear signing off on new loans because of post-crisis laws that allow for imprisonment of credit officers if the loans eventually go sour.
The expanding role of the banking system in provision of financing is a key factor in macroeconomic predictions, with credit expansion in 2007 forecast at 15% to 18%. However, with NPLs still a major problem, bank lending grew by a mere 7.3% from January to September last year.
At the same time, undercapitalized Indonesian banks are opening new opportunities for foreign investors. Three small and medium-sized Indonesian banks were snapped up by foreign investors in 2006, including Bank Indomex, which was bought by the State Bank of India, Bank Haga, and Bank Hagakita, which was purchased by the Netherlands-based Rabo Bank.
Meanwhile, the Industrial and Commercial Bank of China (ICBC), the world's second-largest bank by market value, is in talks to acquire a 90% stake in Bank Halim – owned by Rachman Halim, whose family owns Gudang Garam, Indonesia's biggest cigarette maker. If the deal goes through, it would represent ICBC's first acquisition of a financial institution outside of China.
Waning terror threat
Coordinating Minister for Security, Political and Legal Affairs Widodo Adi Sucipto told reporters last week that terror attacks in 2006 were reduced both in effectiveness and number. In 2005, 19 terrorist-related bombings killed 49 and injured 183. Although Indonesia was still hit by at least 17 bombings in 2006, only four people were injured and there were no associated deaths, he said. Widodo also said there were a number of terrorists still at large and emphasized that strengthening national security would create an environment conducive to economic growth.
The terrorist threat, particularly attacks that targeted foreign interests, including the 2003 bombings of the Marriott Hotel in Jakarta and a botched attempt in 2004 to hit the Australian Embassy, had badly undermined foreign investor confidence in the government's ability to protect their interests. Under President Susilo Bambang Yudhoyono, Indonesia has redoubled its efforts to ferret out Muslim radicals.
His government has imprisoned or killed hundreds of terror suspects since taking office, winning plaudits from the United States, which was previously critical of Jakarta's perceived half-hearted efforts to curb radical anti-Western elements. Washington, meanwhile, has apparently rewarded those efforts through a yet-to-be-negotiated bilateral free-trade agreement.
Yudhoyono has also arguably maintained his clean-hands reputation as an honest broker throughout his more than two years in power. For instance, his decision to make Lapindo Brantas pay Rp3.8 trillion to cover the costs associated with a gas-drilling accident that resulted in an unprecedented toxic mudflow that inundated villages and transportation infrastructure came at the expense of the politically powerful Bakrie family. (Aburizal Bakrie is currently, and perhaps ironically, coordinating minister for welfare.)
That said, the early release from prison of Tommy Suharto, the son of former president Suharto who was sentenced to 15 years in 2002 for masterminding the murder of a judge, fleeing justice, and illegal possession of firearms, explosives and ammunition, was seen as a major setback to those fighting for judicial reform. The slain man, justice Syafiuddin Kartasasmita, had earlier found Tommy guilty of corruption and punished him with a 15-year sentence.
Still, the improving macroeconomic picture has provided few openings for the political opposition to criticize the president and his government's economic policies. That's significant, as Indonesia this year enters the beginning of a new election cycle, with general elections due in 2009. Yudhoyono's administration had promised to cut the national poverty rate, now hovering around 16%, by half by the time his term is up. So far, no noticeable progress has been made on that front, as the World Bank estimates that some 42% of the country's 220 million people earn only $1-$2 per day.
Those still-dismal figures and the government's inability to translate buoyant economic growth into more jobs could become politically potent issues at the next polls. So, too, could opposition charges that his government has not done enough to clean up endemic official corruption. Vice President Kalla is on record as saying last month that the government's current anti-graft drive actually obstructs the functioning of the economy, by making state officials, fearing possible allegations of corruption, hesitant to make important decisions.
How much political capital Yudhoyono might be willing to expend to address the still-many structural and legal problems holding back the Indonesian economy is very much a wild card. What is clear is that Yudhoyono still faces plenty of important reform issues that, if faithfully pursued, would go a long way toward knocking Indonesia into a more stable and upward economic trajectory.
[Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has been in Indonesia for more than 20 years, mostly in journalism and editorial positions. He specializes in Indonesian political, business and economic analysis, and hosts a weekly television political talk show, Face to Face, broadcast on two Indonesia-based satellite channels. He can be reached at softsell@prima.net.id.]