Indonesia Vulnerable to Economic Downturn

Indonesia looks likely to suffer more than other Southeast Asian countries in the event of an economic downturn, according to a study of the economy by the World Bank that was made available to the government earlier this month.

The report, titled “Global Economic Risks and Implications for Indonesia,” is said to have shocked President Joko Widodo, who demanded to know why the country had such a bad reputation.

On the macro side, the China-US trade war “has escalated with a fresh round of tariff hikes and President Trump ordering US companies out of China,” painting ominous picture for other nations. The trade war, the report noted, is spreading beyond trade with restrictions on the giant Chinese consumer products company Huawei and restrictions on Chinese access to the US financial sector are possible. Flashpoints, it noted, “are everywhere.”

In May, the Indonesian government was said to be preparing a massive plan to spend more than US$400 billion in building projects including constructing 25 airports and developing new power plants among other infrastructure in an effort to turbocharge growth and lure foreign investment by 2024. About 60 percent of the spending will go towards transportation-related infrastructure, according to Bloomberg.

But, according to the World Bank report, there are structural impediments that will hamper foreign investment including arbitrary rules, limitation on imports of necessary input sand many other problems. The country is also believed to be facing massive debts from mismanaged and corrupt state-owned enterprises and questions about the soundness of its shariah banking system.

With growth slowing and expected to weaken further because of the global slowdown, “Indonesia’s GDP growth will continue to decline because of weak productivity and slowing labor force growth,” according to the report, with commodity prices expected to fall, which would hurt the country’s GDP growth even more.

The current account, which records trade transactions with the rest of the world, currently runs US#33 billion per year, with foreign direct investment only at US$22 billion, with a US$16 billion annual deficit, meaning Indonesia is financing its deficit with volatile capital from portfolio investors.

FDI, the report notes, “is not coming to Indonesia.” The country is cut out of global supply chains, meaning FDI is going to other countries partly because of costly, time-consuming and discretionary non-tariff measures, confusing regulations and a hostile bureaucracy that requires letters of recommendation for all industrial inputs to make sure the necessary imports can’t be sourced locally. Restrictions on work permits for highly skilled professionals mean multinationals can’t bring in critically required staff. Import tariffs limit the import of key inputs for manufacturing. Rules are discretionary and inconsistent on the part of bureaucrats.

As a result, Indonesia is running far behind other ASEAN countries in luring investment that is fleeing China because of the trade war instigated by US President Donald Trump. Moving factories to Indonesia is “risky, complicated and would take at least a year if not more while the process is certain and much shorter in Vietnam, Thailand, Malaysia, Singapore, and Taiwan.”

By contrast, South Korean washing machine factories moved from China to Vietnam and Thailand in 60 days after the US imposed tariffs, with exports from those countries jumping soon after.

“Between June and August 2019,” the World Bank noted, “33 Chinese-listed companies announced plans to set up or expand production abroad: 23 of them are going to Vietnam and the remaining 10 are going o Cambodia, India, Malaysia, Mexico, Serbia, and Thailand. In 2017, 73 Japanese firms moved operations from Japan, China, and Singapore to Vietnam, 43 to Thailand, 11 to the Philippines and only 10 to Indonesia.”

No amount of tax incentives and/or tax holidays offered as a part of the president’s ambitious plans to lure investment “can correct these problems and make Indonesia internationally competitive in the automotive, textile, electronics, pharmaceutical and other manufacturing industries,” the report notes.

Given these problems, should a serious downturn hit, Indonesia faces big problems. Global monetary policy, the report notes, “is out of ammunition – US$17 trillion in bonds is at negative interest rates.”

Short-term stimulus policies could damage what the report calls Indonesia’s most important asset, a prudent macroeconomic policy framework. But without structural reforms, and in any case could only offer limited help. Monetary policy, the World Bank warns, “is unlikely to work effectively to increase growth.”

There is little room for fiscal stimulus which in any case would have only a modest impact at best. Revenues, given falling commodity prices, which Indonesia depends on to a large extent, “are likely to disappoint (and the actual deficit to be higher) in the event of a shock.”

The report recommends cancelling pre-shipment inspections, eliminating letters of recommendation on industrial inputs, allow for self-certification of inputs, eliminate import tariffs on inputs, relax foreign equity limits in the negative investment list and reduce restrictions on work permits for skilled professionals.

Also, although the report doesn’t cite, the country has some of Asia’s most restrictive labor laws, making it impossible to fire or discipline workers. The administration earlier this year pledged to modify the labor rules but appears to have abandoned the effort in the face of ferocious opposition from labor groups. In addition, it appears that the country is going backwards on its efforts to fight corruption, with the House of Representatives last week pushing through legislation emasculating the Corruption Eradication Commission, Indonesia’s most important corruption watchdog.