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Tuesday 22 Aug 2017 | 03:53 | SYDNEY
Tuesday 22 Aug 2017 | 03:53 | SYDNEY

Politics holding Indonesia back

With two of the three international credit rating agencies now ranking Indonesia as 'investment grade', foreign investors (and foreign journalists) have noticed the 'good news' story of the Indonesian economy. The story has actually been going on for more than a decade.

Indonesia sailed through the 2008 global financial crisis, hardly slowing, and has settled in for sustained 6%-plus growth. If you had put $100 in the Jakarta stock exchange ten years ago, you would now have $1000. The macro-economy is in good shape. Inflation has gradually fallen, the exchange rate is strong and stable, foreign reserves are high, and both the budget and the external accounts are close to balance.

Foreign capital inflows boost growth, but the underlying dynamic is overwhelmingly domestic. Most of the growth is home-made. The new middle class is buying a million cars and eight million new motor-bikes each year. Malls, cinemas and restaurants are taking over the paddy-fields around cities. Tourism is predominantly domestic. On a recent long weekend, the city of Bandung turned into a colossal traffic snarl. Such is progress.

In the prevailing optimism, forecasts of faster growth are common and credible. But the new world of democracy, for all its benefits, is not conducive to good economic policy.

Recent attempt to reduce fuel subsidies, which account for over one-fifth of budget expenditures, illustrates the point. Petrol sells for around half the international price (and one-third of the price in Australia). Most of it goes to fuel the vehicles of the middle class. The Government's proposed modest price increase was rejected by parliament. Money needed to fund schools and health facilities will be used instead to underwrite cheap motoring.

The problem is not just that democracy makes hard economic decisions difficult to implement. Economic policy-making swings back and forth between a soft version of the Washington_Consensus (derided by its critics with the abusive term 'neo-liberal') and a dirigist brand of economics driven by a belief that the people's welfare can be promoted by all-wise and all-pervasive interventions by the authorities. The dirigists are currently in the ascendency.

As well, post-colonial nationalism is never far below the surface. There has always been an understandable feeling that Indonesia's rich natural resources should not be monopolised by foreigners, and there has long been a requirement in its mining laws that foreign investors must sell a share of ownership back to domestic interests. These provisions, long held in abeyance, are now being pushed to the fore. In the longer term, there will also be a requirement to process or refine minerals domestically rather than exporting crude ore.

Foreign ownership of domestic businesses, reasonably open during the Soeharto era, is under question again, with the suggestion that majority ownership of banks (allowed since 1997) might be restricted. Various measures to restrain imports (quotas and disruptive import requirements, such as limiting the port-of-entry) are eroding Indonesia's generally open-economy credentials.

The period ahead may challenge Indonesia's new-found economic reputation. The contenders for the 2014 presidential elections will be only too ready to exploit the attactions of populist policies.

The 'Berkley Mafia' of economic technocrats who steered Indonesia towards greater reliance on markets and international openness have passed from the picture (the doyen of the group, Professor Widjojo Nitisastro, died recently) and their successors are fighting a rear-guard action to resist policy slippage, their standing and leverage in the democratic environment much diminished. The President has given them some support, but not much: good economic policies often require not just a resistance to populist hand-outs, but a readiness to take on vested interests, not to mention corrupt practices.

Meanwhile, the international environment has become much less benign. Indonesia, like Australia, has ridden the monster wave of China's demand for resources. The export boom is not over, but China's demand no longer seems insatiable and world supply (from South America and Africa) has had time to respond. At the same time, the European economic fiasco has trimmed demand for other exports and threatens to disrupt financial markets in ways that could cause sudden capital outflows from countries like Indonesia.

One of the abiding characteristics of the Indonesian economy is that good times dull the reforming ethos (just as crises are often opportunities for reform). Exigent pressures stiffen reformist sinews, while easy growth loosens this discipline. The Indonesian economy has remained resilient over long periods of indifferent policy-making and can sustain the current pace of expansion. With good policies it could do 8% growth rather than 6%  but the political environment looks unhelpful.

Photo by Flickr user tomii_boy.

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