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Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Survey of Recent Developments
Shiro Armstrong & Sjamsu Rahardja
To cite this article: Shiro Armstrong & Sjamsu Rahardja (2014) Survey of Recent Developments, Bulletin of Indonesian Economic Studies, 50:1, 3-28, DOI: 10.1080/00074918.2014.896235
To link to this article: http://dx.doi.org/10.1080/00074918.2014.896235
Published online: 24 Mar 2014.
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Bulletin of Indonesian Economic Studies, Vol. 50, No. 1, 2014: 3–28
ISSN 0007-4918 print/ISSN 1472-7234 online/14/0003-26 © 2014 Indonesia Project ANU http://dx.doi.org/10.1080/00074918.2014.896235
* The authors are very grateful to the many interviewees in Jakarta, who shared their in-sights and time, and to the members of the Indonesia Study Group at ANU, who pro-vided extensive comments. Any errors are the authors’ own. Rahardja’s views are per-sonal and do not necessarily relect the views of the World Bank and its Board of Directors. This article was published with errors in table 1. Please see Corrigenda (http://dx.doi.org /10.1080/00074918.2014.922160).
SURVEY OF RECENT DEVELOPMENTS
Shiro Armstrong* Sjamsu Rahardja*
The Australian National University World Bank
SUMMARY
As Indonesia heads to the polls in 2014, its economy is slowing. The end of the commodi-ties boom and the global return to more normal monetary policy has exposed some weak-nesses. Exchange-rate depreciation has absorbed some of the adjustment; but structural rigidities are still likely to limit the expansion of non-commodity sectors, and the increased fuel-subsidy bill for imported oil is putting pressure on the current account and the budget. The immediate focus is on demand-side consolidation to manage inlation and the current-account deicit.
For an economy like Indonesia’s to be overheating, and for monetary and iscal authori-ties to be engineering a soft landing, when growth is below 6%, points to major structural problems. If Indonesia is to prevent the current rate of growth from becoming the new nor-mal, there will need to be a substantial supply-side response to lift productivity, as well as a restructuring of the economy and the introduction of policies that make the economy more lexible in adjusting to shocks. The current economic slowdown has yet to trigger sweeping reforms; policy coordination remains problematic as Indonesia enters a big political year.
Compared with its neighbours, Indonesia is largely on the outside of the regional pro-duction networks, and its manufacturing sector does not play into factory Asia. Now, faced with lower commodity prices globally—and growth in non-resource sectors is critical— the lack of a large manufacturing base appears to be a weakness. Indonesia is attracting more foreign direct investment than ever and is climbing the global rankings of preferred economies in which to invest, but this is occurring without improvements to its investment environment or competitiveness. Indonesia can participate more fully in global supply chains and increase its potential for growth by upgrading its infrastructure, improving its investment environment, and using regional initiatives strategically to make strong com-mitments that reinforce its priorities for domestic reform.
In its hosting of APEC in 2013, Indonesia championed infrastructure investment where the lack of structural reform and macroeconomic constraints are inhibiting much-needed expansion, both in Indonesia and in the region. The positive outcome, albeit only a small step forward for the Doha Round, at the WTO Ministerial Conference in Bali, in December, also builds momentum for better regional and global cooperation. The priority now is for Indonesia to commit to, and show leadership in, the Regional Comprehensive Economic Partnership (RCEP) and the implementation of the ASEAN Economic Community.
Keywords: economic stabilisation, macroeconomics of development, policy reform, protectionism, mineral processing
JEL classiication: D72, O11, O24, O53
POLITICAL DEVELOPMENTS
The year 2014 is an important one politically. Parliamentary elections will be held in April, and then in July Indonesians will directly elect their president for only the third time. If no presidential candidate receives more than 50% of the vote, there will be a run-off election in September. These are opportunities to entrench the country’s democratic system. Since the fall of Soeharto, during the 1997–98 Asian inancial crisis, Indonesia’s democratisation has become an exemplar in South -east Asia, and decentralisation of power to regional governments has helped to cement this process. Improvements in governance are still crystallising, but dem-ocratic Indonesia has enjoyed relative political stability and economic prosperity. Yet corruption scandals and an ineffective coalition government have charac-terised President Yudhoyono’s second term (McRae 2013). The investigation of corruption scandals by Indonesia’s Corruption Eradication Commission (Komisi Pemberantasan Korupsi [KPK]) continues to uncover charges of corruption linked to political igures, mostly to those from parties supporting the current govern -ment (members of the coalition secretariat).1 In addition to a bribery case
involv-ing the upstream oil and gas regulator (SKK Migas) (see Allford and Soejachmoen 2013), the investigation of Akil Mochtar, the ex-chairman of Indonesia’s Con -stitutional Court, has seen members of the powerful political clan of Ratu Atut (the governor of Banten and a senior member of a party supporting the coalition) arrested for alleged corruption and cronyism.
Among the many storylines that may play out in the parliamentary and presi-dential elections will be that of the Jakarta governor, Joko Widodo (known as Jokowi). Jokowi’s popularity stems from his success as the mayor of Solo, in Cen-tral Java, and his ability to connect with voters in Jakarta and with young voters. Half of Indonesia’s population is under 29 years of age, and up to 59 million of 190 million voters in the forthcoming elections will be young voters, from irst-time voters (17-year-olds) to those aged 29. Jokowi holds a large lead in presidential polling2 and is a political outsider relative to most other candidates, who come
from the political establishment or the military.
On 14 March, Jokowi was nominated by his party, the Indonesian Democratic Party of Struggle (Partai Demokrasi Indonesia—Perjuangan [PDI–P]), in which party leader and former president Megawati Sukarnoputri alone has the author -ity to choose its presidential candidate. The inancial market responded positively to Jokowi’s nomination—the Jakarta Composite Index (the benchmark indicator of stock prices) rose by 3.2% on the day of the announcement (Kompas, 15 Mar 2014). The question now is whether PDI–P will win the required 25% of the leg -islative vote or 20% of the parliamentary seats to nominate its own presidential
1. The coalition secretariat (sekretariat gabungan) consists of the Democratic Party (Partai Demokrat), Golkar, the United Development Party (Partai Persatuan Pembangunan), the National Awakening Party (Partai Kebangkitan Bangsa), and the Prosperous Justice Party (Partai Keadilan Sejahtera).
2. Jokowi enjoyed 43.5% support in January (Kompas, 8 Jan 2014), while the second-placed Prabowo, from Gerindra, attracted only 11.1%. Other polls have consistently shown Joko-wi as the leading potential presidential candidate.
Survey of Recent Developments 5
candidate, without which it may have to form a weak coalition.3 Such an outcome
could undermine the effectiveness of the new government, as it has done to that of the current government.
There is much speculation as to what a Jokowi presidency and a PDI–P-led government would mean for Indonesia. If Jokowi were elected, much would depend on whom he invited to take part in his economic policy team and selected for key economic policy positions in cabinet. Jokowi is less experienced in foreign policy and diplomacy than Yudhoyono was when he came to power, given that Yudhoyono became effective in diplomacy as a minister in the Wahid and Mega -wati presidencies.4
MACROECONOMIC DEVELOPMENTS Economic Growth
Indonesia’s economy continues to face external pressures. The announcement in June 2013 by the US Federal Reserve that it would start to suspend the pur-chase of assets, or to taper quantitative easing, has tightened external inancing conditions for emerging markets, including Indonesia. This pressure is unlikely to lift while the United States continues its economic recovery and the US Fed-eral Reserve returns its monetary policy to more normal settings. These circum-stances have also put pressure on the rupiah, as global portfolio investors adjust to tighter liquidity and rebalance their exposures from emerging countries, which are perceived to be at risk from rapid capital outlows (Allford and Soejachmoen 2013). Another source of pressure is the continued deicit in the current account. Subdued international commodity prices have reduced Indonesia’s export rev-enue, around 60% of which was derived from commodity exports. That trend seems to have reversed briely, as miners rushed out mineral exports in the last quarter of 2013 before the export taxes and bans on unprocessed minerals were implemented in January 2014 (see ‘Mineral Export Policies’, below). There is a considerable negative balance in the oil and gas trade, which continues to increase and which is putting pressure on both the current account and the government budget, despite the adjustment to subsidised fuel prices in June 2013.
Policymakers in Bank Indonesia (BI) and the Ministry of Finance are trying to pilot a ‘soft landing’ for the economy by, for example, adjusting BI’s policy rate and allowing the exchange rate to absorb some of the pressures. Other measures include relaxing import quotas on beef and some other foodstuffs. But subdued commodity prices and the return to tighter global credit have exposed the economy to risks, as infrastructure bottlenecks and regulatory uncertainties overshadow growth prospects in non-commodity sectors. At a time of subdued growth in domestic demand, Indonesia could consider ways to use this momen-tum to grow its non-commodity exports. After all, it is home to 55% of labour in
3. Article 9 in Law 42/2008 on Presidential Elections states that presidential and vice-pres-idential candidates can be nominated only by a political party or a coalition of political parties that secure 20% of seats in the parliament or obtain 25% of votes in the parliamen-tary election preceding the presidential election.
4. Interviewees for this ‘Survey’ noted that PDI–P is known as a nationalist party but that Megawati’s 2001–4 presidency was characterised by pragmatism in economic policy.
the big four ASEAN countries (Indonesia, Malaysia, Philippines, and Thailand) yet contributes just 17% of the non-commodity manufacturing exports of these countries.5
GDP in 2013 grew by 5.6% and 5.7% (year-on-year) in the third and fourth quarters, respectively, a decline from 6.2% and 6.1% in 2012. Slower growth in the last two quarters made total GDP in 2013 grow by 5.8%, a noticeable decrease from 6.3% in 2012. On the expenditure side, the main drag on growth in the last six months has been the continued weakening of investment. Gross ixed capital formation (GFCF) continued to weaken throughout 2013, as shown in table 1. Investment spending increased by only 3.8% in the fourth quarter of 2013, com-pared with 7.3% in the same period of 2012. In 2013, GFCF grew by 4.2%, less than half of the growth in 2012. The decline in investment growth was led by large decreases in the construction, machinery and equipment, and transport sectors. Rising interest rates and a depreciating rupiah are likely to be behind the continu-ing slowdown in investment in construction, which contributed 70% of total real investment in 2013.6
Aggregate consumption spending has been relatively stable. Growth in real private consumption in the third and fourth quarters has stood up at 5.5% and 5.3%, respectively, and resulted in annual growth at 5.3%, the same as in 2012. The relative strength of private consumption is surprising, given that the food CPI increased by 14% and 12% (year-on-year) in the third and fourth quarters, respectively—higher than in 2012—which would have affected the real purchas-ing power of consumption of non-staple foods. Indeed, growth of non-food con-sumption remained relatively strong, at 6.2% and 5.9%, in the last two quarters, consistent with BI’s Retail Sales Survey, which indicated strong growth (BI 2013b). Growth in real government consumption spending has also picked up consid-erably, reaching 8.8% in the third quarter and 6.5% in the fourth. This surge in the third quarter is likely to have been driven by the government’s temporary cash-transfer program (Bantuan Langsung Sementara Masyarakat), used to offset higher fuel prices, which ran until September 2013. This was an unusually high disbursement from the government budget; its implementation involved a large outlay on electronic ID cards and related equipment, as well as paying PT Pos, the state-owned postal service, to administer the distribution of the transfers.
Indonesia’s strong export growth in the fourth quarter of 2013 was unexpected, given the declining trade surplus. Real exports of goods grew by 7.4% (year-on-year), an increase from 5.3% in the third quarter. Badan Pusat Statistik (BPS) recently revealed that nominal non-oil exports increased by 9.3% in December (year-on-year), a contrast to the 8.4% decline in December 2012 (year-on-year) (BPS, press release, 3 Feb 2014). The increase in exports in December created a $1.5 billion surplus in trade, the highest since November 2011. This increase was driven mainly by strong growth in exports of mineral ores, which suggests that mining companies were rushing to export unprocessed ores in anticipation of
5. See the World Bank’s World Development Indicators (speciically, industry of employ-ment for those aged 15 and over): http://data.worldbank.org/data-catalog/world-devel-opment-indicators. Export data are available at http://wits.worldbank.org/wits/. Non-commodity manufacturing is deined as Standard International Trade Classiication 5–8. 6. See World Bank (2013) for a discussion of the decline in nominal credit growth and con-struction investment.
Survey of Recent Developments 7
export restrictions on such minerals coming into effect in January 2014. Import volumes contracted in the fourth quarter, most likely because of the slowing econ-omy and, again, the depreciating rupiah.
A relatively strong performance in the tradable sectors was the main contribu-tor to GDP growth in 2013, with the trend in the second half the year follow -ing that in the irst half of the year (Allford and Soejachmoen 2013). Meanwhile, the growth slowdown was noticeable in the non-tradable sectors, particularly in construction, and trade, hotels, and restaurants, which together contributed 24% of nominal GDP.
Monetary and Fiscal Policies
BI has demonstrated its determination to boost the credibility of its monetary policy. It surprised many observers by hiking its policy rate ive times between
TABLE 1 Components of GDP Growth (2000 prices; % year-on-year)
Dec 2012 2013Mar
Jun 2013
Sep
2013 2013Dec 2012 2013
GDP 6.1 6.0 5.8 5.6 5.7 6.3 5.8
Excluding oil & gas 10.5 6.2 5.9 5.8 5.8 10.8 5.9
By expenditure
Private consumption 5.4 5.2 5.1 5.5 5.3 5.3 5.3
Government consumption –3.3 0.4 2.1 8.8 6.5 1.2 4.9
Investment 7.3 5.5 4.5 4.5 3.8 9.8 4.2
Construction 7.8 6.8 6.6 6.2 6.0 7.5 5.9
Machinery & equipment 4.3 0.8 –0.8 0.6 0.2 12.7 0.3
Transport 10.1 1.8 –6.6 –5.1 –13.0 27.3 –6.0
Other 6.5 11.4 12.5 9.6 12.4 11.6 11.1
Exports 0.5 3.6 4.8 5.3 7.4 2.0 5.3
Imports 6.8 0.0 0.5 3.8 –0.6 6.6 1.2
By sector
Tradables
Agriculture, livestock,
forestry, & isheries 2.1 3.7 3.3 3.3 3.8 4.2 3.5
Mining & quarrying 0.6 0.1 –0.6 2.0 3.9 1.8 1.3
Manufacturing 6.3 6.0 6.0 5.0 5.3 5.7 5.6
Excluding oil & gas 7.0 6.9 6.6 5.5 5.4 6.4 6.1
Non-tradables
Electricity, gas, & water supply 6.9 7.9 4.0 3.8 6.6 6.1 5.6
Construction 7.1 6.8 6.6 6.2 6.7 6.8 6.6
Trade, hotels, & restaurants 7.9 6.5 6.4 6.1 4.8 8.2 5.9
Transport 6.8 6.0 7.7 6.7 7.8 6.6 7.1
Communication 11.3 11.7 12.8 11.8 11.7 12.1 12.0
Financial, rental, & business
services 7.7 8.2 7.7 7.6 6.8 7.1 7.8
Other services 5.3 6.5 4.5 5.6 5.3 5.3 5.5
Source: CEIC Asia Database.
May and December 2013, by a total of 175 basis points.7 It did so by raising the
overnight deposit facility rate incrementally, from 3.75% to 5.75%, over the seven months. These small increases seem to have slowed growth in real money supply, which was growing at 8.5% in May but only 4.0% in November (igure 1). These measures have also dampened nominal credit growth—particularly outstanding working capital, which increased by 11% between May and December 2013, com -pared with 13% in the same months of 2012, while outstanding consumer credit slowed to 9% from 13% (BI 2013a, tables 1.8 and 1.10). Together, these decreases may have lowered expectations about rising inlation in the near future. BI’s meas -ures, coupled with the exchange rate, which was allowed to depreciate, helped to cut the current-account deicit to 3.9% and 2.0% of GDP in the third and fourth quarters, respectively, down from 4.5% of GDP in the second quarter. On average, the rupiah depreciated by 21.5% in the fourth quarter against the US dollar (year-on-year), while the real effective exchange rate (REER) depreciated by 7.9%. The depreciation in the exchange rate encouraged exports and helped to reduce non– oil and gas imports. BI also sought to dampen growth in property loans, from 30 September, by introducing a regulation requiring larger down-payments from loan applicants for property purchases beyond their irst property (Jakarta Post, 26 Sep 2013). This has already had an effect; the growth of loans outstanding for lats and apartments declined sharply to just 17% in December 2013 (compared with December 2012), down from 60% to 80% monthly growth during January–July 2013 (BI 2013a, table 1.5).
BPS announced that headline inlation, measured as percentage change in the aggregate consumer price index, declined slightly in January 2014 but remained high, at 8.2% on-year). At the same time, food inlation was at 11.4% (year-on-year), and energy, housing, and rent inlation was at 6.6%. Also in January, heavy rain caused looding in major rice-producing areas and along major trans -port routes in northern Java. Yet core inlation, which is directly inluenced by monetary policy, fell to 4.5% (year-on-year) from 5% in December. The eruptions in February of Mount Sinabung, in North Sumatra, and Mount Kelud, in East Java, may make if dificult to distribute food, particularly horticultural products. There is a risk of further inlation in food prices, given the extent of the looding (Kompas, 10 Feb 2014).
There is also risk in the excessive tightening of monetary policy. The impact of the interest-rate hike on dampening growth in real money supply is likely to understate its impact on liquidity in the banking sector. Indonesia’s money market is relatively underdeveloped, and its share of interbank claims as a proportion of the assets of its banks is low compared with those of other countries in Asia (Lore-tan and Wooldridge 2008). Trading in the interbank money market has remained relatively thin, consisting mostly of transactions with a maturity of less than one month. The market is also segmented (IMF 2013).8 As liquidity has tightened,
7. The unexpected monetary tightening under new BI governor Agus Martowardojo is a departure from the loose monetary policy under the previous governor, albeit in different economic circumstances. See, for example, http://www.bloomberg.com/news/2013-11-12/bank-indonesia-surprises-on-rates-in-credibility-boost-to-policy.html.
8. Uncollateralised funds have typically been more accessible to larger banks than to smaller banks, owing to the perception among larger banks that smaller banks carry more counterparty risk.
FIGURE 1 Bank Indonesia Rate, and Growth in Real Money Supply and Exchange Rates, 2013
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
0
Bank Indonesia overnight deposit facility rate (%, lhs) Real money supply (% year-on-year, rhs)
Nominal exchange rate, Rp/$ (% year-on-year, rhs) Real effective exchange rate (% year-on-year, rhs)
Sources: CEIC Asia Database; Bank for International Settlement; authors’ calculations.
Note: Depreciation of the nominal exchange rate is presented by positive growth; that of the real effec -tive exchange rate is presented by nega-tive growth.
FIGURE 2 Loan-to-Deposit Ratio and Seven-Day Interbank Call-Money Rate, 2013 (%)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
60
banks have started to rely more on third-party deposits as their main source of loans, and competition for funds has increased (BI, press release, 18 Dec 2013).
Figure 2 shows that the average loan-to-deposit ratio exceeds 90%, which sug-gests that banks are inding it more dificult to extend loans using less expensive funds. Indonesia’s seven-day interbank money rate increased to 7.5% in Decem -ber, and total interbank money-market transactions shrank by 22% and 38% in November and December, respectively. The Deposit Guarantee Agency (Lembaga Penjamin Simpanan) revealed that by November 2013 Indonesia’s eight largest banks had increased their deposit base by 24%, while the deposit base of the medium and smaller banks remained lat or was shrinking. Smaller banks had already raised time-deposit interest rates, and some were willing to offer 10%– 11% annual interest rates for large customers (much higher than the 6.5%–7.0% annual rate offered by large banks), yet they struggled to attract more deposits. Should this continue, small banks may face an increasingly dificult situation, because cutting credit lines to existing customers may attract non-performing loans. Continuing to sustain loans at a higher cost of funds could reduce proit -ability and increase solvency risk.9
A feature of the recent monetary tightening has been the diminishing relevance of the rupiah’s exchange rate against the US dollar. BI has defended this rate in the past, and some analysts predicted that BI would intervene to keep the nomi -nal exchange rate around a ‘psychological’ level of Rp 10,000–10,500 per dollar, to avoid capital outlows.10 Yet in July 2013 the newly appointed BI governor,
Agus Martowardojo, stated publicly that BI would not try to maintain this level. Focusing on the rupiah’s value against the dollar ignores the importance of other regional currencies that also matter to the Indonesian economy. Instead, BI seems to have focused on containing inlation expectations and restoring its credibil -ity. Its commitment to an inlation target gives BI a transparent and consistent objective.11 It also suggests the bank’s willingness to impose exchange-rate and
interest-rate measures to maintain macroeconomic stability.
Indonesia’s monetary and exchange-rate policies have absorbed some of the burden of adjusting to new external economic conditions, as has its coordinated iscal policy, which has remained thoughtfully conservative. In the middle of 2013, the government undertook politically dificult reforms to reduce the budget deicit by raising subsidised fuel prices by 40%, which was set to save Rp 40 tril -lion (about $3.4 bil-lion) (Allford and Soejachmoen 2013). In October 2013, the par -liament approved the 2014 budget, with a projected deicit of 1.7% of GDP. But the persistently large fuel subsidies and the shortfall in tax revenue could push the deicit beyond the legally mandated maximum of 3%. Economic growth in 2014 is
9. Liquidity is less of a problem for larger banks, because they can attract depositors easily and lend with relatively cheaper costs of funds. This can inluence the outcome of mon-etary tightening (see, for example, Kashyap and Stein 1994).
10. See, for example, http://www.bloomberg.com/news/2013-04-04/bank-indonesia-won-t-let-rupiah-breech-10-000-bca-chief-says.html.
11. Until Indonesia’s current account turned negative in the last quarter of 2012 and the rupiah started to depreciate, BI tended to rely on what the IMF recently called ‘a combi-nation of heavy intervention and moral suasion’ to stabilise the exchange rate (IMF 2013, 13). See Kenward (2013) for an appraisal of Indonesia’s experience with inlation targeting since 1999.
Survey of Recent Developments 11
projected to be around 5.0% to 5.5%, lower than the 6.0% assumed in the budget. Together with other increasingly unrealistic budget assumptions, including the exchange rate, interest rate, and level of oil production, this inaccurate rate of projected growth will soon need to be revised.
On the revenue side, the shortfall in tax revenue in the 2013 budget is a con -cern. Total tax revenue grew at 9% in 2013, down from 12% in the previous year and still 10% below target for 2013. Most noticeable are the shortfalls in income tax and value-added tax, which are, respectively, Rp 36 trillion and Rp 40 trillion short of their 2013 targets. The government would do well to step up its efforts at tax reform by broadening the tax base and, for example, recruiting more tax inspectors. Another looming problem in 2014 is falling revenue from export tax on commodities and non-tax revenues from natural resources (royalties). They comprise up to 19% of total domestic revenues but this likely to decrease during 2014, given the decline in global commodity prices and the uncertainty about the restrictions on exports of unprocessed minerals.
On the spending side, preliminary data suggests that the government disbursed 95% of the 2013 budget, slightly below the 96% of 2012. Nevertheless, there have been spending improvements in several categories, such as capital and social spending, which so far have reached 89% and 96%, respectively, of their targets. An added challenge for the 2014 budget will be the need to cover subsidies of Rp 18 trillion for insurance-premium contributions to the new National Social Safety Program (Sistem Jaminan Sosial Nasional), which commenced this year (box 1).
Despite a relatively high international price for crude oil, a lack of new investment and explorations is depressing oil production far below the budget assumption of 870 thousand barrels per day. Lower revenue from the mining sec-tor is likely to depress total revenue in the current budget. Extrapolating these
BOX 1 Indonesia’s Social-Security Revolution
Indonesia introduced the National Social Security System (Sistem Jaminan Sosial Nasional [SJSN]) in January 2014, as mandated by Law 40/2004 on Social Security. The program consists of two components: public health insurance (Jaminan Keseha-tan Masyarakat [Jamkesmas]), managed by the state’s social-security agency (Badan Penyelenggara Jaminan Sosial [BPJS]) and titled BPJS Health; and employment insur-ance, managed by a new arm of BPJS and titled BPJS Manpower.
All Indonesians must participate in Jamkesmas, and will be entitled to basic health care. Income earners and employers will contribute by paying insurance premiums, while the government will cover these costs for poor households. The government is targeting 176 million people, or 72% of the population, for immediate coverage. To be effective, the program will need to address low levels of access to health services, especially for the poor and for those in remote areas; the quality of these services; the participation of health providers; and high out-of-pocket expenses for participants (see, for example, Simmonds and Hort 2013).
The process of launching SJSN for employment is still underway, with BPJS Man-power set to start in June 2015. The government is transforming the current private-sector social-security provider, PT Jamsostek, into BPS Manpower, which will oversee a program covering both the formal and the informal sectors. It is uncertain whether BPJS Manpower will have the immediate institutional capacity to provide employ-ment insurance, or the ability to set and enforce contribution levels for workers and employers.
developments to 2014 reveals that some of the main assumptions are likely to ren-der the 2014 budget too conservative in its forecast of spending and too optimistic in its forecast of revenue.
With the tighter inancing conditions and perceived higher risk of capital out -lows, owing to fears of a current-account deicit that Indonesia may ind dificult to inance, and the possibility of subsequent depreciating pressure on the rupiah, investors will demand higher yields on government bonds. So far, government bond auctions have been highly oversubscribed, but at a higher coupon rate. Perhaps due in part to the prospect of an increase in interest rates in the United States (and possibly globally) and in part to Indonesia’s parliamentary elections in April, the government seems to have issued bonds earlier than usual in the year. By early February, the government had already raised 21% of the year’s tar -get bond issuance (Jakarta Post, 6 Feb 2014).
The government and parliament may use the current situation as an oppor-tunity to revisit the 2014 budget. This being an election year raises some obsta-cles. For one, there is the practical problem of inding a window of time in which the government can submit a revised budget to parliament, as well as the pos-sible reluctance on all sides of politics to champion the revision as the elections loom. Nevertheless, a deterioration of the current iscal deicit, or other weakened economic conditions, will be an opportunity to propose as a priority a phased adjustment of the fuel subsidy to a lower amount per litre, and also to push for much-needed investment in infrastructure.
Balance of Payments
The current-account deicit moderated in the third quarter of 2013, as the economy slowed. The deicit decreased further in the fourth quarter, as the trade surplus increased and imports fell (because of the weaker rupiah and increased non-oil exports in the second half of 2013). Recent data from BPS show that greater natu -ral-resource exports were the main reason for the increase in exports in December, which created a $1.5 billion surplus in the goods trade balance.12 There was a
surge in exports of raw materials preceding the ban on unprocessed minerals that started in January; ore shipments, for example, were 7.3% higher in December (year-on-year). The deicit in the current account was $4 billion (2% of GDP) in the fourth quarter, down from $10 billion (4.4% of GDP) in the second quarter. Most of the reduction was due to a decline in non–oil and gas imports, particularly those of capital goods and intermediate products, and stronger non–oil and gas exports. The net result was that the balance of non–oil and gas trade increased by 149% in the fourth quarter. But imports of oil and gas remained relatively large, in line with a 12% average increase in international crude prices. This suggests that the volume of oil imports did not decline by much, despite higher domestic retail prices and a slight economic slowdown. The deicit in services trade has adjusted to a decrease in trade more broadly, particularly slower import growth. A large part of the deicit in services trade is due to imports of transport services, which are closely related to trade in goods.
Meanwhile, the deicit in foreign income payments remains fairly steady in the fourth quarter, at $7.1 billion, or 3.5% of GDP. Allowing the rupiah to depreciate
12. The igure for natural-resource exports is listed under the trade classiication Harmo-nized System 26.
Survey of Recent Developments 13
led to fears that investors and multinational companies would repatriate income. This has yet to happen, but it remains something to watch.
Foreign direct investment (FDI) into Indonesia was relatively strong in the third quarter of 2013, at $5.1 billion. Recent data on FDI realisation from Indonesia’s Investment Coordinating Board (Badan Koordinasi Penanaman Modal [BKPM]) suggests an increase of 17.5% in the fourth quarter (year-on-year). Net FDI in 2014 may be lower, owing to tighter external inancing conditions and delays by inves -tors waiting for the results of the elections.
CURRENT POLICY
Intervention, Protectionism, and Distortions
The Indonesian government has not managed to use the opportunities presented by the current economic slowdown to undo some of the protectionist trade policies introduced in recent years.13 It still tends to intervene in markets, for example,
13. Implicit quotas on horticultural and beef imports have been relaxed, but trade policy remains restrictive. Soesastro (1989) describes how declining terms of trade motivated sig-niicant economic deregulation throughout the 1980s.
TABLE 2 Balance of Payments ($ billion)
Dec 2012 Mar 2013 Jun 2013 Sep 2013 Dec 2013
Current account –7.8 –5.9 –10.0 –8.4 –4.0
Exports 47.1 45.2 45.6 44.1 48.6
Non–oil & gas 38.5 36.8 37.6 35.6 40.0
Oil & gas 8.6 8.5 7.9 8.5 8.7
Imports 46.3 43.6 46.3 44.2 43.7
Non–oil & gas 35.3 32.3 36.1 32.8 32.9
Oil & gas 11.0 11.3 10.2 11.4 10.8
Merchandise trade balance 0.8 1.6 –0.7 0.0 4.9
Non–oil & gas 3.2 4.5 1.6 2.8 7.0
Oil & gas –2.4 –2.9 –2.3 –2.8 –2.1
Services –3.2 –2.5 –3.1 –2.6 –2.9
Income –6.7 –6.1 –7.1 –6.7 –7.1
Current transfers 1.3 1.1 1.0 0.9 1.1
Capital & inancial accounts 12.1 –0.3 8.4 4.9 9.2
Capital account 0.0 0.0 0.1 0.0 0.0
Financial account 12.1 –0.3 8.4 4.9 9.2
Direct investment 4.1 3.9 3.8 5.1 1.6
Portfolio investment 0.2 2.8 3.4 1.9 1.8
Other investment 7.7 –6.9 1.2 –2.1 5.9
Errors & omissions –1.1 –0.4 –1.0 0.9 –0.8 Overall balance (change in reserves) 3.2 –6.6 –2.5 –2.6 4.4 Foreign reserves 112.8 104.8 98.1 95.7 99.4
Source: CEIC Asia Database.
and implement policies that protect ineficient irms and industries.14 Constraints
in capacity to develop or implement good economic policy, coupled with populist policies, have produced some economically damaging policies that contribute to the belief that Indonesia is becoming increasingly inward-looking.
As Indonesia enters a politically important year, implementing reforms becomes an even more complex bargaining process. All political interests—not just opposition parties—will weigh economic costs and beneits against outcomes in the upcoming elections. The government has made modest and incremental reforms, but it has muddled through in its approach to sectoral development. Of greatest concern is the slow progress of structural reform and the uncertainty about when numerous new laws will be enacted.
Reform has progressed in areas in which there is clear political consensus. The government, through BKPM, has led agencies in efforts to improve Indonesia’s ranking in the World Bank’s Doing Business indicators.15 Similarly, the
govern-ment has been trying to cut the number of days taken to issue licences and per-mits and to connect electricity to new businesses.16 On domestic connectivity, the
government is turning to external engagement, by building capacity and sharing experience (see ‘APEC Success and Next Steps’, below), to encourage more effec-tive decision-making on priority infrastructure projects by the National Commit-tee for the Acceleration of Infrastructure Provision (Komite Kebijakan Percepatan Penyediaan Infrastruktur), as well as to improve the regulatory environment.17
A series of new interventionist regulations give the impression of being solu-tions in search of market failures. In January 2014, President Yudhoyono enacted Law 3/2014 on Industry, which clariies, in particular, the government’s responsi -bilities in acquiring sites for industrial development and identifying action plans to promote industrialisation. But the industry law also conveys a bureaucracy-knows-best attitude to developing manufacturing. Nehru (2013, 160–61) dis-cusses a few salient provisions in the law, some of which could lead to regulations that allow for unnecessary intervention in the market, create distortions that risk protecting ineficient irms driven by vested interests,18 create more red tape for
businesses,19 and risk channelling public funds for ill-targeted government
pro-jects to support industrialisation.20 For international investors, the detailed
regu-14. Such policies are not new. The development of the automobile sector, for example, has been hampered by highly interventionist policies (Aswicahyono, Basri, and Hill 2000). 15. See http://www.doingbusiness.org/rankings.
16. Such as domicile permits, nuisance permits, and investment licences.
17. The government is currently revising Presidential Decree 42/2005 on the National Committee for the Acceleration of Infrastructure Provision, to streamline the committee’s decision-making process and provide it with a secretariat and funds to conduct pre-feasi-bility work.
18. Article 32 on potential restrictions on the export of raw materials, article 33 on moting domestic value addition, and article 86 on prioritising domestic products in pro-curement of goods and services by government agencies or projects inanced by the state budget.
19. Article 25 on workers’ competency, article 27.2 on the use of foreign experts, and crimi-nal investigations for violating a product’s technical speciications.
20. Article 16 on skills development and article 48 on inancing institutions.
Survey of Recent Developments 15
lations of the industry law may increase uncertainty about the rules under which irms in Indonesia will operate (Castle 2013).
More recently, on 11 February, parliament passed a new trade law. In princi -ple, this law will give the government far-reaching powers to use trade policy to protect domestic producers from imports and restrict exports. The govern-ment already held many of these powers under the old legislation that this law will replace. In addition, it remains to be seen whether the required government regulations and ministerial decrees to implement the law will employ each of the powers without breaking WTO commitments. Nevertheless, the passing of the law and, in particular, the public justiications given by parliamentarians and Deputy Trade Minister Bayu Krisnamurthi appear to underline policies of man -aged rather than free trade, and of protection of domestic producers (Jakarta Globe, 11 Feb 2014; Jakarta Post, 12, 13, 14 Feb 2014).
Also of concern is the abuse of quantitative import restrictions. For example, the high-proile corruption scandal over beef import quotas which surfaced in Janu -ary 2013 led to the KPK’s conviction in December that year of former Prosperous Justice Party (Partai Keadilan Sejahtera) president Luthi Hasan Ishaaq (Jakarta Globe, 28 Nov 2013; Jakarta Post, 10 Dec 2013). This case is just one example of the misuse of quantitative trade restrictions where the economic rent generated by the restrictions does not translate into government revenue but beneits private inter -ests, particularly the holders of import licences. Another example unfolded more recently, when the government was put in a defensive position after the news media reported complaints from local rice traders that 16,000 tonnes of low-cost rice from Vietnam had entered the Indonesian market, allegedly brought in by private importers who abused legal import permits for high-quality rice (Kompas, 28 Jan 2014). The domestic price of rice in Indonesia is estimated to be 25% to 40% higher than that of rice of similar quality produced by other countries in the region
FIGURE 3 Domestic Price of Medium-Quality Rice in Indonesia and Thailand (Rp ’000/kg)
Jan 2013 Mar 2013 May 2013 Jul 2013 Sep 2013 Nov 2013 Jan 2014 4.0
4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0
Thai A-I special rice (import parity)
Indonesia IR-64 III (Cipinang wholesale)
Sources: Cipinang wholesale market; Food and Agriculture Organization of the United Nations; CEIC Asia Database; authors’ calculations.
(igure 3). Households have to pay this higher price, and the difference between the prices of domestic and imported rice, as well as the rent that the licensed pri-vate importers enjoy, is considerable. This problem may get worse for Indonesia, as Thai rice traders continue to rid themselves of Thailand’s record rice stocks and drive down international prices in the process (Jakarta Globe, 20 Feb 2014).
Mineral Export Policies
Prior to the 2009 national elections, Indonesia’s policymakers passed Law 4/2009 on Mineral and Coal Mining, which aims to increase the value of processed natural-resource exports (Baird and Wihardja 2010). This involves adding value to these sectors (at the cost of subtracting value from the economy as a whole) by using very capital-intensive methods of processing raw materials. Instead of creating the necessary infrastructure and environment to foster such activity, and this would in effect be a large subsidy to entice smelting, the government legis-lated for this to occur (Burke and Resosudarmo 2012) and intervened in a market where there is no obvious failure.
As a result, in seeking to develop a minerals processing industry, including try-ing to attract foreign capital for smelttry-ing plants, the government actually passed a law that taxes the exports of some unprocessed minerals, bans the exports of oth-ers (such as unprocessed nickel and bauxite), and stipulates minimum required levels of processing. The global shortage of nickel, in particular, was thought likely to attract foreign investors to build smelters in Indonesia. Some investment in nickel processing has started, such as PT Bintang Delapan’s nickel smelter in Central Sulawesi. Other projects are set to follow, but many are still undergoing feasibility studies or are in the design phase.
The regulations took effect on 12 January 2014. In the lead-up, the international and domestic prices of many of these minerals did not diverge greatly, indicat-ing that expected and actual trade lows were not substantially affected (Financial Times, 8 Jan 2014). Many private mining companies did not invest in process -ing facilities dur-ing the ive-year window, because they assumed that the regula -tions would not be implemented effectively. They were proved right; immediately before the law came into effect, the government was looking for loopholes in its own policy (Jakarta Post, 20 Dec 2013).
Considerable confusion has surrounded the implementation since mid-Janu-ary. President Yudhoyono initially agreed to an exemption for the copper ore of the biggest mining irms in Indonesia, US-owned PT Freeport Indonesia and PT Newmont Nusa Tenggara (Jakarta Globe, 12 Jan 2014). But attempts of both com -panies to bring their lobbying power to bear steeled the government’s resolve. It subsequently clariied that the ban would, until 2016, take the form of an export-tax arrangement, which also covered these two companies (Jakarta Post, 30 Jan 2014). Exports of copper, iron, lead, tin, or zinc ores that are unprocessed or do not meet the minimum processing requirements (ranging from raw materials to concentrates of 15%–62% purity, depending on the mineral) will incur a tax of 20%–25% in 2014, increasing to 60% by the second half of 2016 (Jakarta Post, 1 Feb 2014). Nevertheless, in the course of February the Ministry of Energy and Mineral Resources offered mining irms an opportunity to evade these export taxes by demonstrating that they had advanced plans in place for smelter construction and by committing to a ‘surety bond’ (Jakarta Post, 7 Feb 2014). While some companies were willing to pay the export tax, and subsequently applied for export permits,
Survey of Recent Developments 17
Freeport and Newmont continued to stockpile produce. More recently, Freeport agreed with state-owned PT Aneka Tambang to study the construction of a new copper smelter while arguing the case for reduced export taxes, and both Freeport and Newmont are considering legal action against the Indonesian government for infringing their existing contracts of work (Jakarta Post, 4 Mar 2014). It seems that the wrangling over the mining export ban has yet to end.
Meanwhile, the distortions introduced by the government’s intervention in the mining sector, even if its regulations are not fully implemented, are potentially large and detrimental to non-energy mining. In the short term, the new regulations will decrease exports of unprocessed minerals without offsetting new exports of processed minerals, contributing to the deterioration of the current account and government revenues. They will lead to a discrepancy between the domestic and international prices of certain minerals, when stocks of produce for domestic pro-cessing accumulate as a result of insuficient propro-cessing capacity. This may lower the domestic prices of raw minerals and may create rents for smelting companies to exploit. The regulations have also increased uncertainty for investors, includ-ing in the non-mininclud-ing sectors. Under the current tight international inancinclud-ing con -ditions, the low-on effects of this policy for Indonesia’s balance of trade may add to the depreciating pressure on the exchange rate, and greater exchange risk may increase the costs of inancing operations for investors in Indonesia.
The Fraser Institute’s annual Survey of Mining Companies had already ranked Indonesia as the least attractive country in which to do business in 2012–13 (Sailo 2013). Although these export regulations may have been politically popu-lar domestically, in the eyes of foreign observers they have further damaged the credibility of Indonesia’s economic policymaking and that of the government in implementing its own policies.
Restructuring the Economy
Indonesia, like many other resource-rich economies, enjoyed high terms of trade for almost a decade, from the early 2000s. The domination of commodities in Indo-nesia’s exports meant that the fall in commodity prices has contributed greatly to the current-account deicit. Indonesia is not alone. Other emerging-market econo -mies, some of which are rich in natural resources, such as Brazil, South Africa, Turkey, and India, are also adjusting to more normal global circumstances (that is, without a commodity boom and abnormally loose monetary policy in the United States).
The consequences of this monetary policy helped to keep the rupiah strong until mid-2013. Yet the fall in commodity prices since late 2011 has exposed some weaknesses in the domestic economy. The appreciation of the rupiah during the commodity boom boosted commodity exports and yielded a ballooning trade deicit in manufacturing and other non-commodity trade (Basri and Rahardja 2011). In contrast, the depreciation in the exchange rate since mid-2013 has not expanded exports or reduced the current-account deicit by any great amount, because of Indonesia’s export structure, in which commodities dominate. Aside from mineral exports, crude palm oil contributes 25% of exports, and rubber 14%. Manufacturing exports have not yet beneited from the more competitive cur -rency, and they decreased during December 2013.
The fall in the exchange rate is likely to cause a supply-side response from, for example, labour-intensive operations that can absorb unskilled labour relatively
quickly, such as textiles, clothing, and footwear. There may be a lag before those manufacturing exports pick up, but relying largely on currency depreciation will not change the nature of Indonesia’s manufacturing industry anytime soon. To date, there has been considerable under-investment in manufacturing, particu-larly in non-commodity exports (Lipsey and Sj̈holm 2011). In contrast, much FDI has gone to the natural-resource sectors or been directed at production for domes-tic markets rather than for export. Indonesia’s manufacturing industry, and its volume of manufactured exports, is small compared with those of other countries in East Asia (Aswicahyono, Hill, and Narjoko 2011). Few manufacturing opera-tions in Indonesia can adjust rapidly to changes in global markets and external circumstances as well as absorb the high internal logistics costs (Sandee, Nur-ridzki, and Dipo, forthcoming). If the economy retains its current structure, there will be little response in the short term from non-commodity exports to external demand and exchange-rate depreciation.
Structural change has the potential to create productive jobs and increase growth. Indonesia faces the challenge of creating enough jobs for the 2.3 million mostly young, new entrants to the workforce each year, without forgoing the bene-its of the ‘demographic dividend’ (Kinugasa 2013).21 Manufacturing and services
employment therefore needs to increase substantially—particularly in the high-productivity services sectors such as inancing, insurance, construction, and busi -ness services, if possible (Aswicahyono, Hill, and Narjoko 2011). Figure 4 shows that the share of the workforce in the agricultural sector has fallen steadily, from
21. See also http://www4.bkpm.go.id/contents/general/8/demographics. FIGURE 4 Share of Employment by Broad Sector, 2005, 2009, and 2013
(%)
2005 2009 2013
0 10 20 30 40 50 60
Agriculture, forestry, hunting, & fishery Manufacturing Commercial services Community, social, & personal services
Source: Badan Pusat Statistik (BPS), National Labour Force Survey (Sakernas).
Note: All Sakernas data are from the August round of the surveys. Sectors have been aggregated by
authors, based on BPS categories. Manufacturing also comprises utilities and construction. Commer -cial services includes wholesale trade, retail trade, restaurants, and hotels; transportation, storage, and
communications; and inancing, insurance, real estate, and business services.
Survey of Recent Developments 19
44% in 2005 to 35% in 2013. Labour from agriculture has largely been absorbed by community, social, and personal services, which occupied 11% in 2005 and 16% in 2013, and, to a lesser degree, by commercial services and manufacturing.22
Increasing the capacity of the economy will take time. But Indonesia cannot risk the current slowdown in growth, to 5.0%–5.7%, becoming the new normal, given the relatively young population and the stage of development of the economy. Yet there are few signs of successful structural reform from the current government (Wihardja 2013). Indonesia ranks very low (120th of 189 countries) in the World Bank’s ease-of-doing-business index, and its position has improved little over the past ive years.23
ECONOMIC INTEGRATION The Investment Boom Paradox
In 2012 and 2013, FDI into Indonesia increased to record levels and investment peaked as a proportion of GDP (Allford and Soejachmoen 2013). In November 2013, Indonesia was ranked as the most promising country for overseas business over the medium-term (deined as the next three years or so) in the Japan Bank of International Cooperation (JBIC) survey of Japanese irms (JBIC 2013). It is the irst time in the history of this survey, which started in 1989, that Indonesia has been ranked as the most attractive destination for Japanese investment, overtak-ing China, which has consistently been the highest. In a United Nations Confer-ence on Trade and Development survey of multinational enterprises, Indonesia ranked as the fourth most prospective economy for hosting FDI in 2013–15. In 2012, the country became the 17th largest recipient of FDI, its irst time in the top 20 (UNCTAD 2013).
Yet, in the JBIC survey, Indonesia still ranks behind India and China for over -seas business in the longer term (deined as the next 10 years or so). China’s rela -tive decline as the top destination in the medium term is due largely to rising labour costs, as Japanese irms restructure their investments in adjusting to the new economic circumstances in China (JBIC 2013).
The recent growth in FDI into Indonesia and the country’s improved prospects as an FDI recipient occurred even though there was little improvement in its investment environment or competitiveness. Indonesia ranked fourth among 58 countries in having the most restrictive regulatory regime for FDI in the OECD’s FDI Regulatory Restrictiveness Index of 2013.24 Lipsey and Sjöholm (2011)
explain that Indonesia started from a low base of FDI in East Asia, given its size and characteristics, and that poor infrastructure, a bad investment environment, ineficient government institutions, and low levels of education were to blame. Improvements in these areas have not been signiicant enough to explain their growing attractiveness to FDI. Indeed, FDI growth has occurred even under poli -cies that have cast doubt on Indonesia’s openness to investment and trade, such as the ban on exports of unprocessed minerals (Cornish 2013). Rather, FDI growth appears to have been caused by market-seeking FDI aimed at Indonesia’s large
22. The note to igure 4 lists the BPS categories within these broad sectors. 23. For more, see Thee (2013).
24. See http://www.oecd.org/investment/fdiindex.htm.
domestic economy and FDI aimed at its resources sector, as well as by other FDI destinations becoming less attractive.
Investors had hoped that Indonesia’s new negative investment list (Daftar Negatif Investasi [DNI]), announced by BKPM chair Mahendra Siregar in Decem -ber 2013 (Kompas, 25 Dec 2013), would be more open to, or at least not more restrictive of, foreign entry into more sectors. The revised DNI list has instead accommodated pressures for a less-open regime on logistics and on oil and gas exploration. The DNI has had implementation problems since it was introduced, in 2007; individual ministries have applied their own restrictions, thereby creat-ing uncertainty in areas in which the DNI was supposed to be creatcreat-ing certainty (Magiera 2011). Opening up seaports and airports to foreign management would be a positive development in improving domestic and international connectivity, but its implementation remains uncertain. Foreign nationals are forbidden from participating in management, and state-owned operators PT Angkasa Pura (I and II) and PT Pelindo (I to IV) currently have exclusive rights to manage main air-ports and seaair-ports, respectively (Jakarta Post, 7 Nov 13). Foreign ownership of ports is limited to a minority stake of 49%. Even if the government allows full for-eign management of ports, restrictions will apply to forfor-eign ownership of assets and facilities. This issue is not conined to domestic versus foreign entry into the sector; it also concerns increased competition and openness to domestic competi-tion, and new entrants versus incumbents. Other important proposals for reforms to the DNI include increasing the cap of foreign investment in pharmaceuticals from 75% to 85% and in tourism from 49% to 70%.
Given that FDI has increased without any substantial policy changes or improvements to the investment environment, the question is whether Indone-sia’s ability to attract FDI is sustainable. Major changes will be necessary to make large FDI inlows sustainable and to attract FDI into new sectors, which will boost employment and productivity. The following sections address these changes.
On the Fringes of Supply Chains
Indonesia’s manufacturing exports are much lower than those of Malaysia and Thailand, and, depending on the measure used, those of the Philippines and Vietnam (table 3). In addition, Indonesia has much lower exports of parts and components. Simply put, Indonesia is an outlier in the region, since it has at best achieved partial integration into international and regional supply chains (Lipsey and Sjöholm 2011; Soejachmoen 2012). Indonesia ranks behind its Asian neighbours in the World Investment Report’s global-value-chain participation rate (UNCTAD 2013, 134). Indonesia’s rate is 44%, lower than that of Singapore (82%), Malaysia (68%), the Philippines (56%), Thailand (52%), and Vietnam (48%).
The global fragmentation of production and the resulting supply chains have enabled deeper specialisation across countries and more eficient allocation of resources (Baldwin and Lopez-Gonzalez, 2013). Indonesia is part of the world’s most economically dynamic region, with many of its neighbours beneiting greatly from new market links and technologies (WTO and IDE-JETRO 2011). Production networks in Asia present many new opportunities for economies to specialise, to diversify, and to allocate resources more eficiently. The global growth in trade has been dominated by the growth of such supply chains (UNCTAD 2013; OECD 2013), and there are major growth opportunities in participating more fully in production networks.
Survey of Recent Developments 21
Indonesia is, of course, connected to the lowest-cost suppliers in the region, via multinationals that import from their supply chains to their plants in Indonesia, produce goods, and then sell to the domestic market. But what is absent is a role for Indonesia-based producers as major suppliers to those networks. Table 3 shows that Indonesia is a less signiicant exporter of parts and components relative to the size of its economy. Indonesia has supplied the region with raw materials and inal products, the latter usually from multinationals that were well established in Indonesia’s domestic market. There will be many opportunities in the future in the export of intermediate goods, as China and other large economies come to depend on procurements from lower-cost suppliers of parts and components, as well as tasks, in Asia and beyond.
Being part of production networks allows countries to specialise more and realise their comparative advantages, which is important in generating employ-ment and importing technology, capital, and know-how. Coupled with regulatory reforms that allow more lexibility, it is also important in diversifying industries and improving competitiveness by opening up sectors to more competition. If Indonesia remains at the fringes of regional and global production networks, it forgoes opportunities to build deep specialisation in new industries and take advantage of countless opportunities to supply into the value chains. It could also ind it dificult to increase productivity by relying on exports of natural resources, especially now that resource prices have fallen from their peak of a few years ago.
Supplying production networks requires competitiveness in production and supply. Much of the improved logistics, technology, and know-how can be achieved by attracting new investment—both foreign and domestic—into new or established industries. A more open and business-friendly investment environ-ment may well be helped by a simpliied DNI and by structural reforms, including improvements to Indonesia’s regulatory environment. Opening up and attracting new investment is likely to create resilience in economic activities within and between sectors, and to improve resilience in dealing with the required rapid
TABLE 3 Non-commodity Exports as a Share of Total Exports and GDP, 2012 (%)
Non-commodity exports Parts & components exports
Country Total exports GDP Total exports GDP
China 93.8 23.4 7.1 1.8
Philippines 81.8 17.0 34.4 7.1
Thailand 70.0 43.9 7.6 4.7
Vietnam 64.2 39.9 4.9 3.0
Malaysia 61.6 45.9 9.5 7.1
Indonesia 35.6 7.7 3.1 0.7
Source: Authors’ calculations from the United Nations Comtrade database and the World Bank’s
World Development Indicators.
Note: Classiication for parts and components trade from Athukorala (2003). The classiication under -states participation in parts and components trade, and hence production networks. For a full discus-sion, see Athukorala (2003).
adjustments to changes in economic circumstances. A more diversiied economic structure, with a larger manufacturing base, would help to expand exports as the currency depreciated, which does not appear to be happening at the moment.
In addition to further opening up to investment, fuller participation in global supply chains would require improvements to infrastructure and a more com-petitive labour market (Soejachmoen 2012). The importance of labour quality is related not only to adding value in manufacturing production over time but also to maintaining the importance of services to production networks—service costs are one of the main determinants of a country’s success in production networks. Indonesia is not likely to have a competitive labour force if the recent trend of minimum wage hikes (44% in 2012 and 11% in 2013) continue to exceed growth in productivity and living costs (Aswicahyono and Manning 2011). In order to avoid a skills constraint as Indonesia moves from low-skilled manufacturing to more sophisticated exports, minimum-wage increases need to be tied to productivity and coupled with investment in education.
Indonesia ranked 59th globally in 2012 in the World Bank’s trade-related Logis -tics Performance Index, behind its Southeast Asian neighbours Singapore (which ranked 1st), Malaysia (29th), Thailand (38th), the Philippines (52nd), and Vietnam (53rd). The index ranks performance in infrastructure, customs, tracking and trac-ing shipments, timeliness, logistics competence, and international shipments.
As Chinese wages increase, they create more opportunities to grow the manu-facturing sector in Indonesia and elsewhere. Labour costs in China, and not bilat-eral political tensions, were the primary stated reason why China became much less attractive as an investment destination for Japanese irms (JBIC 2013). If Indo -nesia can improve its domestic business environment and supply regional pro-duction networks, its attractiveness as an investment destination will last beyond the present investment boom.
Infrastructure
A major bottleneck in economic growth has been the insuficient development of infrastructure.25 As an archipelago, Indonesia faces high domestic transport
costs, and chronic under-investment in infrastructure has limited the integration of the domestic economy and the integration of the Indonesian economy into the regional and global economies. Key issues include the sizeable investment that infrastructure requires, the limits to the public budget, and the conditions that would attract private investment in infrastructure.
Infrastructure spending as a proportion of GDP has not returned to pre-Asian inancial crisis levels, of around 9%. It averaged around 4% of GDP after the crisis, with a substantial increase during 2007–9, as igure 5 shows. Under-investment in infrastructure has led to much depreciation and degradation of existing infrastruc-ture, as well as a backlog of nationally important projects. Perhaps most striking in igure 5 is the large fall in the private sector’s contribution. This should be of concern, because the private sector is a major source of funding for infrastructure.
A series of infrastructure summits in Indonesia and the development of regu-lations and incentives to encourage public–private partnerships (PPPs) have not
25. See Narjoko and Jotzo (2007), Manning and Purnagunawan (2011), and Mahi and Naz-ara (2012).
Survey of Recent Developments 23
succeeded in attracting suficient investment from the private sector (Manning and Purnagunawan 2011). Many of the problems are in the project preparation phase, and include the lack of capacity in various ministries to prepare and assess projects; the lack of a inancing environment that secures reasonable returns con -sidering the risks of long-term infrastructure investment; and the lack of a stable and business-friendly regulatory environment that secures private-sector rights in building, owning, and operating facilities.26 Also of concern are the processes
used by private enterprises to tender for public projects, and the degree to which private-sector owners and operators of facilities are able to set prices themselves or be bound by the rulings of a non-independent regulator.
The project preparation phase for infrastructure investment in Indonesia needs to be improved and shortened, and decision-making must be more effective.27
This preparation phase involves those ministries that are directly affected by the project, as well as the Ministry of Finance and the National Development Plan -ning Agency (Bappenas). There is often ambiguity over which priority projects are inanced by state-owned enterprises or the government budget and which are put out to tender for inancing by the private sector or a PPP. Land-acquisition legislation is also a constraint. While the legislation itself contains suficient detail for public agencies to resume land for public purposes, such as for infrastructure projects, it has often been used by vested interests to interfere with the approval of projects, which has created delays and uncertainty for investors.
26. See ‘Annex A—An APEC PPP Experts Advisory Panel and Pilot PPP Centre’, ac-cessed 5 March 2014, http://www.apec.org/Meeting-Papers/Ministerial-Statements/Fi-nance/2013_inance/annexa.aspx.
27. See, for example, Younger (2013) and Bappenas (2013).
FIGURE 5 Infrastructure Spending as a Share of GDP, by Source, 1995–2011 (%)
1995 1997 1999 2001 2003 2005 2007 2009 2011
0 1 2 3 4 5 6 7 8 9 10
State-owned enterprises Private
Subnational Central
Source: World Bank (2012).
The public service has made a considerable effort to reform or strengthen exist-ing institutions by makexist-ing procurement and tenderexist-ing more transparent, pro-viding more regulatory support, and increasing the government’s capacity for preparing projects. A notable innovation is viability gap funding (set out in Presi-dential Decree 56/2011 and Minister of Finance Regulation 223/2013), whereby the government can support and provide guarantees for infrastructure PPPs in order to increase their inancial viability for private partners.
Two state-owned companies have been created to help establish PPPs. The 2005 Indonesia Infrastructure Guarantee Fund (PT Penjaminan Infrastruktur Indone-sia [PII]),28 prepares and provides funding guarantees for a variety of PPPs, and
creates a single window in which to appraise proposals for infrastructure PPPs. In 2009, the Ministry of Finance established PT Sarana Multi Infrastruktur (SMI)29
to help secure long-term inancing of PPPs through mediation between project owners and private investors. Both state-owned irms have been instrumental in implementing new PPPs. Yet of the 21 PPPs that Indonesia has tendered since 2009, by October 2013 just 7 had reached the inal stage of negotiations between the government contracting agency and the winning bidders (Bappenas 2013, xvi–xxi). Six of these projects are toll-road segments in Jakarta, which have been studied since 2005, were proposed in 2008, and then scheduled for construction by PT Jakarta Tollroad Development (JTD), which is owned by the Jakarta gov -ernment (Investor Daily, 17 Oct 2011; Kompas, 21 Feb 2014). Putting the contract out to tender in 2011 yielded just two bids, despite the prospect of a PII guaran-tee. In 2012, JTD eventually won the right to negotiate, but it ran into dificulties in stitching together a consortium of banks to inance the six projects. In 2013, it found that Jokowi wanted to delay the projects until the construction of Jakarta’s Mass Rapid Transit system and monorail had started; Jokowi then put off signing the required environmental permit for the projects (Kompas, 30 Jul 2013; Bisnis Indonesia, 17 Jan 2014). If this experience can be generalised, PPP projects will require sustained commitment from investors, despite the services of PII and SMI.
APEC Success and Next Steps
Indonesia will face dificulties in pursuing economic restructuring policies that are divorced from the regional and global initiatives to which it has committed itself. Indonesia is involved in APEC and ASEAN, and engaged in the ASEAN Economic Community (AEC); the Regional Comprehensive Economic Partner-ship (RCEP) (which includes the ASEAN members plus Australia, China, India, Japan, South Korea, and New Zealand); and trade liberalisation at the multilat-eral level, as part of the WTO. These commitments are the vehicles for effecting much-needed structural changes to Indonesia’s economy, which would help the country participate more fully in regional supply chains and integrate itself into the regional and global economies.
The year 2013 was important for Indonesia’s foreign economic diplomacy. The country hosted the APEC leaders’ summit in October, and a series of APEC meet -ings of senior oficials and ministers throughout the year. It also hosted the WTO
28. See http://www.worldbank.org/projects/P118916/infrastructure-guarantee-fund? lang=en&tab=overview and http://www.iigf.co.id/Website/Home.aspx.
29. For more on the role of PT SMI, see http://www.ptsmi.co.id/content/role-of-pt-smi/.
