Indonesia: Gloomy politics, so how long can the bright economics last?

Indonesia’s economy

Gloomy politics, so how long can the bright economics last?

Feb 23rd 2013 | JAKARTA |From the print edition

ITS public life is dismal, but Indonesia’s economy is, for now, among the brighter performers in Asia. The corruption scandals engulfing the ruling Democratic Party underscore the disappointment of Susilo Bambang Yudhoyono’s second and final term. The president exercises only a weak grip on the helm, and conservatives in government have manoeuvred economic modernisers to the sidelines. Yet the economy zips along. It grew by 6.2% last year, and the government now aims for growth of 6.8% in 2013.

After a decade of painful restructuring for banks and companies, Indonesian businesses are ramping up spending on new factories and infrastructure. Investment now accounts for nearly a third of GDP. Annual imports of things like machinery and mechanical equipment are growing at double-digit rates.

Yet Indonesia’s investment-led boom is now posing problems. Exports are weak, because of depressed global demand and lower prices for many of the natural resources that the country sells to the world. Merchandise imports are growing strongly. The result is a collapse in the trade balance. After a surplus of almost $26 billion in 2011, Indonesia posted a trade deficit last year—its first annual deficit since the late 1960s. The current account, too, swung into deficit in 2012, ending a 14-year run of surpluses (see chart). It has all put pressure on the rupiah, recently one of Asia’s worst-performing currencies.

For Indonesian politicians, the return of an external deficit and of a weak currency has revived memories of the traumatic economic crisis of the late 1990s. At least partly in an attempt to stem the outflow, they have promoted nationalist policies designed to favour domestic businesses.

Last year the government demanded that the country’s mines eventually be majority-owned by Indonesians. Many foreign mining companies will be forced to shed some of their stakes. The government also wants to raise royalties paid by foreign miners. The prospects for outside involvement in the oil and gas industry have also been muddied. And last month America filed a complaint against Indonesia at the World Trade Organisation, claiming that a recent tightening of the licensing rules for farm imports had become a “serious impediment” for its exporters of meat, fruit and vegetables.

As well as taxing Indonesian consumers, protectionism threatens to shake the confidence of foreign investors in South-East Asia’s largest economy. This is coming at a bad moment. The current-account deficit means that the country needs foreign money to finance much-needed roads, ports and power plants. Provided that Indonesia does not drive foreign investors away, it can sustain investment without falls in the currency. It might even attract foreign capital into rupiah-denominated bonds, shares and direct investments, avoiding the currency mismatches that doomed the country in the late 1990s. The new protectionism is ill-considered.

If politicians really want to redress the current account, they should also look at the government’s own finances, and subsidies in particular. The amount the government spends on subsidising the use of fuel is more than the expected budget deficit for this fiscal year. Cutting subsidies and running a smaller budget deficit would boost the country’s savings, thus making room for higher domestic investment. Higher petrol prices after subsidies were abolished would also reduce oil imports. These have nearly quadrupled, to almost $40 billion a year, since Indonesia became a net importer of oil in the mid-2000s. But renewed openness to foreigners and a resolve to sort out the government finances demand a firm hand. Limp Mr Yudhoyono is no longer the helmsman for that.