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Indonesia enigma: where now?

Indonesia, a vast, ‘pearlstring’ polyglot nation, has been an enigma for investors over the years

There’s no question – Indonesia has made significant economic advances under the leadership of President Susilo Bambang Yudhoyono, the country’s first directly elected president in newly democratic elections, since he took control in 2004. 

Stability also seems assured as his Democratic Party emerged from the April 2009 parliamentary elections as the largest party, with nearly 21% of the vote – and analysts see this result as an indication of voting trends in the 8 July presidential poll.

But the government of the world’s third-largest democracy and home to the world’s largest Muslim population faces huge challenges stemming from the global financial crisis and world economic downturn.

So, is it a good time to invest in the country – or should investors give it a wide berth, at least in the short-term?

Indonesia’s debt-to-GDP ratio in recent years has declined steadily because of increasingly robust GDP growth and sound fiscal stewardship. The government has introduced significant reforms in the financial sector, including in tax and customs, the use of Treasury bills, and capital market supervision. Indonesia’s investment law, passed in March 2007, has addressed many of the drawbacks facing foreign and domestic investors.
Yet the country still struggles with poverty and unemployment, inadequate infrastructure, corruption, a complex regulatory environment, and unequal resource distribution among regions. The non-bank financial sector, including pension funds and insurance, remains weak, and despite efforts to broaden and deepen capital markets, they remain underdeveloped.

Economic issues in early 2008 centered on high global food and oil prices and their impact on Indonesia’s poor and on the budget. The onset of the global financial crisis dampened inflationary pressures, but increased risk aversion for emerging market assets resulted in large losses in the stock market, significant depreciation of the rupiah, and a difficult environment for bond issuance. 

As global demand has slowed and prices for Indonesia’s commodity exports have fallen, Indonesia faces the prospect of growth significantly below the 6% or more recorded in 2007 and 2008. 

Foreign investment inflow

However, the global financial crisis has yet to stem flows of investment into Indonesia: foreign direct investment (FDI) in January 2009 jumped by 61% from a year earlier. It reached USD 710 million, far more than the USD 440 million recorded in the same period in 2007, according to data from the Indonesian Investment Coordinating Board (BKPM).

“In the face of the global economic crisis, BKPM will continue to attract FDIs by continuing to reduce bureaucratic constraints, while modernising and simplifying investment processes,��? said BKPM chairman Muhammad Lutfi when these figures were announced.

On the domestic front, statistics are equally buoyant. Actual domestic investment rose by 33.3%, to Rp 0.76 trillion from a year earlier at Rp 0.57 trillion.

In total, realised investment increased by 57.8% to Rp 7.15 trillion, up from Rp 4.53 trillion in the same period last year.

However, says Lutfi: “In the long run, domestic investment growth may outgrow FDI. Last year FDI growth was around 40%, but this year it may drop to around 20%, while domestic growth will be higher than FDI in the full-year.��?

Yet, in January, the rubber and plastics industry recorded the highest domestic investment value of Rp 300 billion. The construction sector recorded the highest FDI value of USD 384.6 million, followed by the trading sector at USD 74.4 million.

So is impending FDI gloom a reality; or if or when it happens, will it last long, especially as global surveys (reported in the last UHY International Business) indicate that the Asia-Pacific region will recover from economic woes much faster than elsewhere in the world?

Says Lutfi: “There are no countries in this world that can withstand the global economic crisis, but I believe our national economy is dealing with the crisis better than most.��?

Currently, however, BKPM is focusing on investments in three sectors — agriculture, infrastructure and energy — to address the issue of a potential slowdown in investments during 2009.

Overall, BKPM projects that investment, both domestic and foreign, will grow by 10.7% to 11.2% this year, although this growth still represents a decline on the 20.5% growth recorded in 2008.

With exports already hit by the global economic slowdown reducing demand, Indonesia would still need a boost in domestic consumption and investment to achieve a 4.5% GDP growth, as targeted by the government under revisions to the 2009 state budget.

Macroeconomic outlook

After July’s presidential elections, a high-level conference is destined to bring together regional and country heads to discuss the outlook for Indonesia, and the challenges and opportunities of doing business in South-East Asia’s most populous market.

Indonesia’s main exposure to the current crisis lies in its exposure to changes in capital flows, much like it did in the Asian financial crisis of 1997-98. 

International reserves once again look small, covering around 150% of the country’s short-term debt, well below the Association of Southeast Asian Nations (ASEAN) median of almost 600%, and putting it on a par with countries in the ailing Eastern Europe region.

However, unlike 10 years ago, and unlike most countries in Eastern Europe, Indonesia is set to run a current account surplus in 2009, just as it has done every year since 1998. This current account surplus will be an important source of capital inflows, and it means that despite its piles of short-term debt, Indonesia should have more than enough reserves to cover its expected external financing requirements in 2009.

The government’s finances also look strong. Public debt fell to just 30% of GDP in 2008, from a peak of 100% in 1999. Furthermore, the fuel price subsidy bill has been slashed by a big fall in global oil prices. This has freed up funds for more productive spending in areas such as infrastructure and education.

Furthermore, in 2009 the government is also set to deliver a large fiscal stimulus, which will see the budget deficit rise to 2.5% of GDP, from 1.1% in 2008. The main goal of this stimulus is to support economic growth in the short term. And Indonesia’s corporate income tax rate is reducing – from 35% last year to 28% in 2009 and down to 25% (the highest rate) in 2010.

One less favourable contrast between now and the Asian financial crisis, however, is that, as the developed world suffers deep recession, Indonesian export demand is extremely weak.

In the region, Japan saw its exports fall by 50% year on year in December 2008; Singapore experienced a 35% fall; Taiwan a 42% drop. And Indonesia has not escaped – its own exports fell by 36% in January 2009.

Japan, its largest trade partner, is expected to experience an economic contraction of 5.5% in 2009, suggesting the export picture will remain bleak. Importantly though, Indonesia is one of the least trade-exposed countries in Asia – just 33% of its GDP was accounted for by exports in 2008.

This advantage will not be enough to help it avoid economic recession in 2009, but its economic contraction is likely to be smaller than that experienced by many of its neighbours.

Where that leaves investors is, as always, a matter of judgement – no investment in an emerging economy is without risks. The question is: does profit potential from a hugely populous nation outweigh risk? Current investment levels suggest it does.