Indonesia – The Good, the Bad and the Ugly
By Bharati Bhargava
Indonesia had consistently recorded a growth rate of above 6.00% through 2010 until the last quarter of 2012. During this period, growth averaged 6.20%yoy (see fig. 1). From 2013 onwards, we have witnessed a slowdown in this momentum. In the first quarter of 2015, the economy grew at 4.71%yoy, the slowest rate of growth since Q3 2009. Meanwhile, weighed by growth concerns and global developments such as concerns about normalization of the US monetary policy, the Indonesian rupiah has been one of the worst performing Asian currencies (see fig. 2). Between 2013 and March 2015, the rupiah lost more than a quarter of its value against the greenback; the only worse performing Asian currency was the Japanese yen that lost slightly more than 27% against the dollar.
Figure 1: Growth lost momentum and slipped below 5.00% in Figure 2: Weighed by growth concerns & global
Q2 2014 developments, rupiah lost more than a quarter of its value
Source: CEIC Source: CEIC
Even with growth slowing to a five year low, S&P upgraded Indonesia’s rating outlook to positive from stable on 21 May 2015, with the possibility of being pushed up to investment grade in 12 months.
In the recent past, Indonesia has been a basket of mixed developments: from election of a new president to reforming the fuel subsidies and implementing more nationalistic inward looking policies.
Overhauling of the fuel subsidies:
Historically, subsidies have accounted for nearly a fifth of the total budget, hampering the flow of funds towards developing more important sectors such as infrastructure and maritime. For example, in 2014 revised budget estimates, total subsidies (including energy, fuel, and electricity) were more than 20% of the budget, while fuel subsidies alone accounted for more than 15%. Meanwhile, capital expenditure budget took a small share of just above 9.5% (seefig. 3). This is very evident in infrastructure being one of the main bottlenecks of the country.
The new President Joko Widodo made some radical changes in the fuel subsidies. Firstly, President Widodo was able to push for a rise in the price of subsidized fuel, freeing up nearly $8bn for other sectors. Secondly, with the declining oil prices, the new government was able to overhaul the fuel subsidies. Starting from 01 January 2015, Indonesia scrapped gasoline price subsidies and fixed the amount of the subsidy for diesel at 1,000 rupiah a liter for 2015.
Figure 3: In the original 2015 budget, capital Figure 4: …overhaul of fuel subsidies resulted in
expenditure’s share was just 9.76% of total budget capital expenditure share rising to record high in 2015
Source: CEIC Source: CEIC
Note: Original Budget Estimates Note: Revised Budget Estimates
Indonesia moved to a free-float price system for premium gasoline and reduced its diesel fuel and kerosene subsidies. Consequently, in 2015 revised budget estimates share of total subsidies in the budget went down to 12%, while share of capital expenditure shot up to 15%, the highest since at least 2000 (since data on record) (see fig.4).
Improved policy framework:
There has been an improvement in the policy environment as the central bank, Bank Indonesia (BI), under the leadership of Governor Martowardojo, has ensured policy credibility and effectiveness.
To maintain financial balance, provide a more sustainable platform for domestic growth, and contain inflationary expectations, the BI has reiterated a tight policy bias. Furthermore, the BI was able to hold ground at the May 2015 monetary policy committee meeting in spite of some pressure from the government to ease policy especially after Q1 GDP growth eased to a five year low. Meanwhile, the central bank adopted a series of macro-prudential measures such as loan to value ratio, motor cycle down payment rules etc. to boost growth.
Move towards more inward looking policies:
Indonesia, with its abundant natural resources, has been well placed to take advantage of the commodity boom. However, with the boom now off its peak and Indonesia moving towards more nationalistic policies, natural resources sector faces several headwinds in the medium term (see fig.5).
President Widodo promised to aggressively lower barriers to investment. However, recent policies have not only been non-investor friendly but have also weighed on domestic businesses. As a result, overseas foreign investments declined in the last two quarters: in Q4 2014, FDI plunged 8.5%yoy, while in Q1 2015, FDI contracted by 4.3%yoy.
Ban in mineral ore exports:
In January 2014, the government introduced regulations to ban the exports of unprocessed nickel and bauxite, and imposed an export tax on other unprocessed minerals. This led to undue confusion for mining companies and hampered work of international firms such as Newmont Mining. According to the World Bank estimates this policy would lead to a negative impact on net trade of $12.5bn and a total loss in fiscal revenues of $6.5bn during 2014-17.
Weak regulatory and compliance environment:
Due to weak policy compliance, especially visible in coal mining, the growth in non-tax mining revenue has not matched the increase in the value of production. To increase this non-tax revenue, the Indonesian government planned to raise coal royalty payments across the board to 13.5% from the current 3-7% charged to mining operation permit (IUP) holders at a time when coal prices are already under pressure. Though, the plan to raise royalties has been postponed (was expected to be implemented at the end of Q1 2015) due to strong resistance from small and medium-sized miners, it has highlighted the weak regulatory environment in Indonesia. As a result, despite the recent ‘one- stop shop’ initiative that targets to slash the time needed to get investment permits to 15 days as opposed to a multi-stop process taking up to 3-years, there was a 31%yoy fall in foreign investment in mining in the first quarter of 2015.
Figure 5: Lower commodity prices have weighed on Figure 6: Mineral exports’ share in total exports is
domestic growth declining and we believe that this vacuum will be
replaced by manufacturing exports
Source: Bloomberg Source: CEIC
Indonesia pace of reforms is mired by a quagmire of bureaucratic red-tapism and environmental, land and labor laws. A prime example is the Jakarta Mass Rapid Transit, a project under consideration since early 2000’s, but whose construction started only in October 2013. The first phase of the line was expected to be opened to public from 2018 but construction has been hampered by land acquisition issues in several areas of South Jakarta.
Recently, the aforementioned concerns are compounded by a parliament that is dominated by the opposition. Thus, worries of political stalemate hindering the progress of reforms are very real in Indonesia. Meanwhile, bureaucracy, corruption and lack of credit institutions have not only hampered effective implementation of new policies and reforms, but also delayed government expenditure.
The absence of government spending, alongside lukewarm global demand, is the key reason behind Indonesia’s low growth. President Widodo had pledged to dole out roughly $22bn for an infrastructure stimulus program. But as of April 30 2015, only $541mn was spent on roads, bridges, ports and power grids.
The Silver Lining:
Overall, the change in the subsidy structure should create positive ripples through the domestic economy by channeling resources towards more important sectors such as infrastructure. With capital expenditure’s share of budget up at 15%, we believe that there is upside potential in companies in the construction sector in Indonesia. This view is also backed by government’s promises of accelerating expenditure on infrastructure development to support economic growth. Until the end of April 2015, the government spent less than 5% of its promised $22bn on infrastructure development. Thus, enterprises in the construction sector and its allied activities could see high return on investments in the medium term.
Another opportunity is arising in the labor intensive manufacturing sector. With the commodity boom cooling, Indonesia should target to improve its manufacturing sector to reach its 2-million-a-year job-creation target (see fig.6). Meanwhile, export oriented manufacturers that reinvest their profits domestically may have an advantage, as Indonesian authorities work towards steering the current account balance towards more sustainable levels.
As a first step, Indonesia, in the first quarter of 2015, provided tax breaks to industries that create jobs or export a minimum of 30% of their production, and reinvest profits in the country. The government should continue to provide support to manufacturers. The same view was echoed by Mr. Harjanto, Director General for Manufacturing Based Industry, who proposed that tax allowances under the 2012 tax policy be made more accessible to downstream industries that absorb more labor; these industries include garments, food and beverages, leather and leather products, footwear, toys and furniture manufacturing enterprises.
Views expressed are personal views of the author and do not constitute any investment recommendation or views of any organization associated with the author