Splintered Indonesia Election Results Could Block Economic Reform

Splintered Indonesia Election Results Could Block Economic Reform

National Democratic Party Pledges Support for Democratic Party of Struggle

I MADE SENTANABen Otto and

April 13, 2014 5:52 a.m. ET

JAKARTA, Indonesia—The splintered parliament and the coalition government likely to result from Indonesia’s legislative elections this week dim chances for quick and sweeping reforms of Southeast Asia’s largest economy.

Several key actions are at risk: the opening up industries to foreign investment, instituting labor reforms and rolling back budget-breaking subsidies that have long made Indonesian fuel prices some of the cheapest in the region.

“The next government of Indonesia will be another weak coalition like the existing” one, Bill Sullivan, a legal adviser for major mining companies, said Friday. It “is bad news for the mining sector in general and for foreign investors in the mining sector, in particular.”

Investors have been critical of President Susilo Bambang Yudhoyono, who steps down this year after having reached his statutory two-term limit, and his unwieldy coalition of six parties as well as his placement of political figures rather than technocrats in important posts.

The new legislative picture is no less complex. According to early counts of a sampling of ballots, 10 parties earned seats in parliament in Wednesday’s election, up from the present nine. Official results won’t be available until May, but preliminary tallies in the past have proven to be reliable indicators.

Pre-election prospects that the popularity of Jakarta Governor Joko Widodo would bring a clean win for his party had raised hopes for a legislature that would work more effectively with the executive branch. But the weaker-than-expected showing of Mr. Widodo’s Democratic Party of Struggle, or PDI-P, in the vote means it will need to align with other groups to be eligible to nominate him for president, given parliamentary and electoral threshold requirements.

The National Democratic Party, which took about 7% of votes in the legislative polls according to early counts, over the weekend pledged its support for PDI-P. That alignment ensures that PDI-P will be able to nominate Mr. Widodo as a presidential candidate.

Mr. Widodo said the two parties shared a goal “to revive” the presidential system, which in recent years has come under criticism for being too limited by parliamentary maneuvering.

Mr. Widodo remains the man to beat in July’s presidential elections. Though the country’s political fracturing raises the specter of horse-trading over portfolios and the likelihood of a government that will need to placate coalition partners with populist agendas, Mr. Sullivan said.

“The fragmented parliament probably means that we are back to the status quo, with coalition politics and compromises,” said Hak Bin Chua, economist for Bank of AmericaMerrill Lynch.

Indonesia’s once-booming economy stands at a crossroads, having faltered last year amid weak global trade conditions and capital flight from emerging markets. Thecountry’s growth rate slipped below 6% for the first time since 2009, while the currency fell around 26% against the dollar to its lowest in more than four years.

This year, the imbalances in trade and current accounts have stabilized somewhat, with the rupiah and stock market gaining modestly, in part due to emergency measures applied late last year, including higher interest rates by Bank Indonesia and a limited increase in fuel prices. But a broader economic recovery may be difficult to sustain with a legislature riven by competing political agendas.

“It’s crazy. We can’t count on the parliament,” said Poltak Sitanggang, chief executive of mining company Mustang Inti Corpora. “According the constitution, Indonesia is a presidential system, but actually the parliamentary system has prevailed.”

Indonesia has had a hard time implementing consistent economic policy since Mr. Yudhoyono’s first term ended in 2009 due in large part to political wrangling within the legislature and his coalition government. In 2012, for example, the government limited beef and cattle imports in a drive to build up local industry, only to reverse course when prices surged for consumers.

Politically contentious fuel subsidies are particularly thorny. They could balloon to more than $20 billion this year, taking the country’s fiscal deficit to 2.5% of gross domestic product from government projections of 1.7%, according to estimates by Bank of America Merrill Lynch.

Should Mr. Widodo win the presidency, as expected, the PDI-P would be the leading party in government. And its officials say the party is drafting a new economic agenda.

“We will welcome investors—domestic and foreign—so long as they add value,” said Arif Budimanta, a senior party official. Mr. Budimanta said his party would review the fuel subsidy policy, but it hasn’t plans to cut it soon. “When the economy grows and purchasing power improves, that might be the appropriate time to divert fuel subsidies to the more productive programs” including infrastructure, education and health, he said.

Neither the party nor its officials, however, have disclosed much more about their emerging economic policy. Most parties in Indonesia, including the PDI-P, advocate advancing industries further up the value chain, moving away from basic industries reliant on cheap labor and raw commodities.

But several industries have been dogged by mixed messages from government and prolonged deliberations, including the financial sector. In 2012, Singapore-based bank DBS moved to acquire Indonesia’s fifth-largest bank, Danamon, in a $7 billion deal that would have been the country’s largest. It collapsed a year later due to a revision of bank-ownership rules.

For companies in the country’s important mining sector, one of the biggest recipients of foreign direct investment, a recent law forcing them to build expensive smelters and refine minerals domestically was in doubt due to political maneuvering until the very day it was implemented this year. That move reflected the country’s attempt to add value to its industries, ending the usual practice of exporting Indonesian minerals for further processing abroad.

Foreign investors point to that new rule and another that requires foreign shareholders with majority holdings in most local mining companies to sell their stakes down to minority shares as signs of increasing economic nationalism in the country.