Indonesia’s economic challenges
President Joko ‘Jokowi’ Widodo’s chances of re-election on 17 April 2019 will very much depend on how he handles the national economy. External factors, such as China’s economic slowdown and the trend of trade protectionism have put pressure on Indonesia’s trade balance. The tightening of monetary policy in the US and other advanced economies has triggered capital outflows from emerging markets, including Indonesia. These developments have strained Indonesia’s current account deficit and weakened its currency.
Moreover, the rise in world oil prices and the weakening rupiah have impacted the economy, putting pressure on the state budget and on domestic prices. Internally, the government has to tackle issues like the widening fiscal deficit, slow investment growth, sluggish manufacturing sector performance, and the increase in the borrowing cost for businesses.
In line with rising public pessimism about the economic situation, Jokowi’s political opponents have criticized him for mismanaging the economy. They have argued that he is responsible for the country’s stagnating growth and for the rising external debt that has increased the country’s financial vulnerability. They also claim that the government has failed in maintaining the value of the national currency. The rupiah (Rp) depreciated beyond the so-called psychological barrier of Rp 15,000 per US dollar in October 2018, and this was despite Bank Indonesia having raised its benchmark interest rate five times since May, to 5.75 per cent. The question then, is how strong Indonesia’s economic fundamentals actually are.
Relatively strong fundamentals
If one were to look at key macroeconomic indicators such as growth, inflation and foreign reserves, the Indonesian economy offers no real reason for concern. Compared to the 1998 Asian Financial Crisis, the 2008 Global Financial Crisis, the 2013 Taper Tantrum, and the recent emerging market crisis, the Indonesian economy exhibits relatively stable growth, coupled with low inflation rate and higher foreign exchange reserve. Moreover, Indonesia’s external debt level is also relatively low, at 34 per cent of GDP, compared with 116 per cent during the 1998 Asian Financial Crisis.
Nevertheless, there is one potential source of vulnerability in the economy, and that is its expanding current-account deficit. The tightening of monetary policy in the US and Euro region, together with general tightening of financial conditions have exerted considerable pressure on the financial stability of emerging market economies, including Indonesia. Portfolio investors have been withdrawing their investments from these markets, particularly those with a large current account deficit, such as Argentina and Turkey. Both have seen their currencies plummet since the beginning of this year. To a lesser extent, Indonesia is vulnerable to this type of capital outflow since a large proportion of its current-account deficit is financed by portfolio investment. Failing to manage its current-account deficit will certainly put Indonesia under increased risk of financial instability.
Economic challenges
While the key indicators are strong and the country’s economic fundamentals remain resilient, there are challenges that loom ahead for the administration.
First, it must find ways to deal with the current-account deficit. A large current-account deficit dominated by portfolio investments makes for economic vulnerability. The government’s efforts to attract FDI need to be complemented with reforming regulations that constrain the expansion of its manufacturing sector and export performance, including revision of the 2003 labour law to boost the growth of labour-intensive exports.
Second, given the expected tighter fiscal space, the government should re-evaluate all projects listed as national strategic projects and be more selective in prioritizing them, in particular those related to infrastructure and to energy subsidies. Going forward, it needs to consider adjusting gradually the domestic price of fuel following changes in global oil prices. To cushion the social impact, the government will need to provide social assistance to those most impacted by the price adjustment. At the same time, the government needs to signal that fuel subsidies are no longer viable, particularly when oil prices are increasing and the rupiah is weakening.
Finally, the government must carefully implement and monitor its import restriction policy, including the local content requirement (TKDN) policy and the mandatory use of a 20 per cent blended biodiesel (B20) mix. Local content requirement, if too restrictive, may adversely affect industrial performance and its competitiveness. A more buoyant environment for export should be prioritised. The B20 policy also needs to be supported by a clear implementation strategy for fear of it failing, as in the past.
Dr Siwage Dharma Negara is Senior Fellow and Co-coordinator of the Indonesia Studies Programme at the ISEAS-Yusof Ishak Institute. This article is condensed from his Perspective piece which can be found here: https://www.iseas.edu.sg/images/pdf/ISEAS_Perspective_2018_67@50.pdf