Indonesia: Economically Shaken but Not Stirred - Yet

Could the clouds over China’s Pearl River Delta have a silver lining for Indonesia? It is one of several unknowns facing an Indonesian economy battered, like most others, by the sudden change in global fortunes. Finding answers to the unknowns will be especially important as the nation heads into an election year – legislative elections in April, presidential ones in July.

At least Indonesia seems to be making an especially strong effort at present to diversify its exports in the face of a sudden deterioration in its terms of trade as prices of key export commodities – palm oil, coffee, coal, LNG, copper, nickel, rubber – have fallen sharply. Judging by the range of exports on display at the 23rd Trade Expo Indonesia, opened last week by Trade Minister Mari Pangestu, there is some scope for restrained optimism. Evident too were many first-time buyers from countries in Africa, the Middle East, Latin America and the former Soviet Union.

As important as the range of items will be the extent to which Indonesia can attract some of the footwear, garment, toy and other labor-intensive industries which are exiting Guangdong in the face of a strong currency, wage increases, pollution controls and weakening orders from the west. Indonesia has been able to offer what was, until very recently, a fairly stable exchange rate against the dollar, lower labor costs and slowly improving transport infrastructure. Other local industries such as auto parts have also gained competitiveness, at least vis-à-vis China.

Few expect Indonesian manufactured export volumes to rise very significantly in the short term but if they can just hold their own the nation should be able to prevent the trade and current account balances falling to levels which would set off alarm bells for the currency. As it is, the nation had been expecting to end 2008 with another current account surplus of around 2.8 percent of GDP. That now looks unlikely given the fall in commodity prices. The currency has slumped by some 25 percent against the dollar in recent days, which has been unsettling but above average for Asian currencies other than yen and yuan and rather less than the falls of the Korean won and Australian dollar. But when even Korea can be on the brink despite more than US$200 billion in currency reserves, Indonesia’s US$56 billion, till recently considered more than enough, may yet be vulnerable to the global panic.

In principle Indonesia should be able to maintain a current deficit of 3 percent or so a year for a sustained period. But that may not be possible till market volatility reduces or the ability of the IMF, or Asian neighbors, to provide protection against sudden capital movements is enhanced.

Another unknown is the impact on Indonesian tourism and its craft industries – batik, ceramics, wooden furniture. It is less in the mass tourism market than its Asian competitors such as Thailand but apart from Bali it has mostly failed to exploit the diversity and quality of its tourist attractions. The country draws fewer than 6 million visitors a year, compared with much smaller Malaysia, which pulled in 22 million.

The Australian markets look likely to suffer from the collapse of the Australian dollar and, partly for visa reasons, it has lagged in developing the China market. But the potential is there. For the low volume, high-quality batik, ceramic and furniture industries the issue will be whether westerners turn to cheaper products, or will shift their consumption patterns away from throw-away items in favor of style, durability and quality.

Another issue is whether global problems will make Indonesia turn inward, or use today’s challenges to free up investment in a wide range of service industries which could attract foreign custom or (as in the case of private hospitals) keep business from migrating to Singapore and Malaysia.

Few of the more immediate questions are likely to be answered until the world calms down and shifts in trade patterns become discernible. For the majority of Indonesians however, and indeed for the government, the short term outlook is relatively stable – always assuming that the financial sector does not hit major problems. A particular relief for the government has been the decline in the oil price.

The huge rises in local prices earlier this year caused widespread discontent and a sharp fall in the government’s popularity. For a time, President Susilo Bambang Yudhoyono’s popularity fell behind that of his chief rival, Megawati Sukarnoputri. But inflation is cooling fast and the government might even be able to consider – at least if the rupiah recovers some ground – a cut in fuel prices.

In any event the huge reductions in subsides should allow the government to throw more money in other directions even while maintaining a tight fiscal stance – a fiscal deficit of no more than 2 percent of GDP. That could come as support for small businesses, cuts in export taxes and speeded up infrastructure and poverty alleviation spending. The food situation is also encouraging for consumers – though not producers.

A good rice harvest has meant self- sufficiency this year. The international price of rice has fallen from its peak but is still well above year-ago levels and roughly in line with the Indonesian domestic price – reducing the incentive for smuggling. Meanwhile prices of imported foods have been falling.

With its relatively low dependence on foreign trade, even in adverse global circumstances Indonesia should be able to keep its economy growing at 3-4 percent compared with the 6.5 percent still expected for 2008. After years of lagging demand, investment in power plants and roads is picking up and LNG projects coming to completion. Palm oil production continues to grow and over the next two years bio-diesel plants will absorb much of the increased output.

However the financial storm could yet damage the wider economy. The Finance Minister, Sri Mulyani, has been under pressure to use public resources to rescue overstretched corporations, notably the Bakrie Group whose failed speculations led to the temporary closure of the Jakarta Stock Exchange. Banks mostly remain very liquid and the government’s fiscal position should be strong enough to support its partial deposit guarantees and bail out any that fail. Nonetheless, the private sector will remain nervous at a time when the public sector’s ability to move quickly is constrained both by a slow-moving bureaucracy and a vigorous anti-corruption drive. The fall in commodity prices will also squeeze corporate cash flows and thus future investment.

If the global financial contagion does get much worse the SBY-led government can still probably look forward to several months of fairly benign conditions before it starts to show in rising unemployment and a sharp slowdown in growth. The commodity price falls mainly impact regions outside Java, which should benefit from the rice harvest and government spending. All told, conditions may get SBY through the elections.

If not, Indonesia faces the prospect of a new administration likely to have fewer strong technocrats like Sri Mulyani and Minister of Trade Mari Pangestu and headed by a Megawati whose economic notions, such as they are, tend towards the nationalist and statist views of her father, Sukarno, the country’s first leader after independence. That may not prove as bad as it sounds. Nonetheless and despite its partial dependence on the Golkar-Bakrie-Kalla axis of business interests, expectation of stable politics will help stabilize the economy.