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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
Stephen Howes & Robin Davies
To cite this article: Stephen Howes & Robin Davies (2014) Survey of Recent Developments, Bulletin of Indonesian Economic Studies, 50:2, 157-183, DOI: 10.1080/00074918.2014.938403 To link to this article: http://dx.doi.org/10.1080/00074918.2014.938403
Published online: 30 Jul 2014.
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* The authors thank Armida Alisjahbana, Haryo Aswicahyono, Chatib Basri, Faisal Basri, Bambang Brodjonegoro, Pieter Gero, Edimon Ginting, Scott Guggenheim, Anton Gunawan, David Hawes, Mohammad Ikhsan, Noke Kiroyan, Neil McCulloch, David Nellor, Ninuk Pambudy, Raden Pardede, Isa Rachmatawarta, Douglas Ramage, Steven Scott, Alex Sien-aert, Jerry Strudwick, Sudarno Sumarto, Wismana Adi Suryabrata, Peter van Diermen, Bill Wallace, Maria Monica Wihardja, Lucky Eko Wuryanto, staff of the political and economic and development cooperation sections of the Australian embassy in Jakarta, and numer-ous faculty members and associates of the ANU College of Asia and the Paciic. They bear no responsibility for any errors. We also acknowledge excellent research assistance from Ashlee Betteridge and Jonathan Pryke.
SURVEY OF RECENT DEVELOPMENTS
Stephen Howes and Robin Davies*
The Australian National University
SUMMARY
Outgoing Indonesian president Susilo Bambang Yudhoyono’s second-term record is creditable, measured against the targets he set himself in 2010, but deicient in key areas: economic reform, infrastructure investment, and anti-corruption. Indonesia’s 2009–14 par-liament has been active in economic policymaking, and will leave as its legacy a raft of protectionist legislation. Both presidential candidates, Joko ‘Jokowi’ Widodo and Prabowo Subianto, have appealed to nationalism in their campaigns, calling for Indonesia to assert its sovereignty and increase its self-suficiency, but Jokowi’s economic platform is more moderate and economically literate than Prabowo’s. The incoming president will inherit an economy that continues to slow. Growth is now not expected to approach 6% until 2015 at the earliest. Having engineered a reduction in the current account deicit, Indonesian policymakers now face the more dificult problem of structural iscal adjustment. Energy subsidies are the most immediate problem, but iscal reform more generally will emerge as an overriding and unpleasant imperative for whoever wins the presidential election on 9 July. Unless dificult iscal policy measures are taken, Indonesia will face major trade-offs between deicit control and investment in social programs and economic infrastructure. The new president will struggle to restrict the deicit to the cap of 3% of GDP: a balanced budget will likely not be feasible for several years. He will need to increase the ratio of rev-enue to GDP and eliminate fuel subsidies—through a more systematic approach than the infrequent price increases of the past. He will need to choose carefully between competing expenditure priorities, such as infrastructure and defence. The new president would also be well advised to tread cautiously in implementing the legal mandates he will inherit, and to work with parliament to avoid further and unwind current earmarking of public expenditure.
Keywords: iscal reform, energy subsidies, economic reform, trade policies
JEL classiication: D72, E62, O11, O53
This survey begins with a retrospective on the outgoing president and parliament. It then turns to recent political, economic, and policy developments. It concludes
with a discussion of the iscal policy challenges that will confront Indonesia’s new
executive and legislature.
REVIEW OF THE 2009–14 PRESIDENTIAL AND PARLIAMENTARY TERM
Table 1 shows Indonesia’s performance against the key targets set out in the 2010–
2014 National Medium-Term Development Plan, inalised after Susilo Bambang Yudhoyono assumed ofice for his second term. These are, therefore, the presi -dent’s targets.
As was the case with his irst term (Kuncoro, Widodo, and McLeod 2009),
Yudhoyono cannot report that his targets have been fully achieved, but he can certainly point to considerable progress in important areas. Indonesia looks
espe-cially good in an international perspective: its economic growth over the last ive
years was the fourth highest in the G20, though it was helped more than most
countries by China’s demand for energy and mineral resources. Poverty in Indo
-nesia has fallen consistently and signiicantly, though it would have fallen more
had the same rate of growth been achieved with a smaller increase in the level of inequality. As table 2 shows, the share of Indonesia’s richest 20% in total
house-hold expenditure rose from 42% at the start of Yudhoyono’s irst term to 49% at
the end of his second.1
Yudhoyono is the irst president in Indonesia’s brief democratic era to serve
out a full term, let alone two. It was not so long ago that a democratically elected president, Abdurrahman Wahid, was impeached by parliament in questionable
circumstances and removed from ofice under threat of action by the Indone
-sian military. A major positive legacy of Yudhoyono’s two terms in ofice is the
entrenchment of a vibrant, open, and pluralistic democracy, notwithstanding the drop in the Indonesian Democracy Index score (table 1),2 and, related to this, a perceived rise in, and inadequate response to, religious intolerance (McRae 2013, 301).
Yudhoyono’s second-term economic reform record is not impressive, especially given the strong mandate given to him. Protectionism and economic nationalism reasserted themselves during this term, particularly in agriculture and mining. Despite some progress, infrastructure is still a major problem, and the growth of
1. See also De Silva and Sumarto’s (2014) and Yusuf, Sumner, and Rum’s (2014) studies, in this issue.
2. Yudhoyono stated the following at the 2014 World Economic Forum meeting in Manila: ‘We have proved … that we do not have to choose between democracy and development … We have achieved the often elusive connection between democracy and stability … We have become an example that democracy, Islam, modernity can go hand-in-hand’ (Philstar. com, 25 May 2014). The decline in the Indonesian Democracy Index score (table 1) is due largely to a perceived diminution in civil liberties with respect to freedom of speech and the rights of religious minorities. The occurrence of violence in connection with political protests in some provinces also reduced scores in the political-rights component of the in-dex. However, scores for the performance of democratic institutions have improved since 2009. See also Bappenas’s (2014) report and ‘Indeks demokrasi Indonesia turun, ini pe-nyebabnya’ (Indonesian Democracy Index down, the cause) (Kabar24.com, 11 Dec 2013).
TABLE 1 2010–2014 National Medium-Term Development Plan Achievements and Targets
Target Assessment Comments
Economic
Average economic growth to reach 6.3%–6.8% Mainly achieved 6.2% in 2010, 6.5% in 2011, 6.2% in 2012, 5.8% in 2013 (average of 6.2%)
Average inlation to stabilise at 4%–6% per year Mainly achieved 7.0% in 2010, 3.8% in 2011, 4.3% in 2012, 8.4% in 2013 (average of 5.9%) Unemployment to decrease to 5%–6% by 2014 Mainly achieved Decreased from 7.9% in 2009 to 6.1% in 2012, increasing to 6.3% in 2013 Poverty to decrease to 8%–10% by 2014 Mainly achieved Decreased from 14.2% in 2009 to 11.3% in 2014
Production growth: rice, 3.2%; maize, 10.0%;
soybean, 20.1%; sugar, 12.6%; beef, 7.3% Not achieved
2009–13 averages: rice, 2.9%; maize, 1.2%; soybean, –5.4%; sugar, 0.3%; beef, 5.7%
Social
Infant mortality to fall from 34 per 1,000 live
births in 2008 to 24 by 2014 Mainly achieved Decreased from 34 per 1,000 live births in 2008 to 26 per 1,000 by 2012 Life expectancy to increase from 70.7 years in
2008 to 72.0 by 2014 Partly achieved Increased from 69.7 in 2008 to 70.6 in 2012 Illiteracy in the over-15 population to fall from
6.0% in 2008 to 4.2% by 2014 Partly achieved Decreased from 7.8% in 2008 to 6.7% in 2012
Governance
Corruption Perceptions Index to reach 5.0 by 2014 Not achieved Increased from 2.8 in 2009 to 3.0 in 2011 and to 3.2 in 2012 and 2013 Indonesian Democracy Index score to reach
73 by 2014 Not achieved Decreased from 67.3 in 2009 to 63.7 in 2013
Source: Data on economic growth, inlation, unemployment, illiteracy, and the Corruption Perceptions Index from Bappenas (2014); on poverty from Bappenas (2014)
and BPS (press release, 1 Jul 2014); on the Indonesian Democracy Index from Bappenas (2014) and BPS (press release, 4 Jul 2014); on production growth from Kemen-terian Pertanian (2014a, 2014b, 2014c, 2014d, 2014e); on infant mortality and life expectancy from the World Bank (2014b, 2014c).
non-residential capital stock, though it has risen, still lags signiicantly behind
rates seen in the 1990s.3 As discussed later, the iscal position has deteriorated. Earlier in his second term, Yudhoyono’s failure to prosecute an anti-corruption agenda was much commented on.4 With Indonesia’s Corruption Eradication
Commission increasingly going after very high-proile accused,5 progress in this area now looks more encouraging. However, Indonesia’s rating in the
inter-national Corruption Perceptions Index has improved only marginally and by
nowhere near enough to hit the president’s target (table 1). Its relative ranking
has actually slightly declined. For a radical reduction in corruption, more politi -cal leadership will be required to complement the enhanced investigatory effort (McRae 2013, 297–99).
During 2009–14, Indonesia’s parliament passed ive important pieces of legis -lation governing agriculture, industry, and trade: Law 13/2010 on Horticulture,
Law 18/2012 on Food, Law 19/2013 on the Protection and Empowerment of Farmers, Law 3/2014 on Industry, and Law 7/2014 on Trade. They all either man -date or authorise a protectionist approach to economic policymaking.
3. Van der Eng’s (2008, updated to 2013) study shows that Indonesia’s non-residential capi-tal stock grew, on average, at 12% during 1990–97 but at 6.5% during 2010–13.
4. Emmerson (2012, 72) writes of Yudhoyono’s ‘lagging campaign against corruption’. 5. For example, former trafic chief of the national police Djoko Susilo; Bank Indonesia deputy senior governor Miranda Goeltom; former youth and sports minister Andi Mal-larangeng (the irst minister to resign in connection with the commission’s investigations); Constitutional Court judge Akil Mochtar; former head of oil and gas regulator SKK Migas Rudi Rubiandini; former Democratic Party chairman Anas Urbaningrum and treasurer Muhammad Nazaruddin; and former religious affairs minister Suryadharma Ali.
TABLE 2 Welfare and Distributional Indicators, 2002–13
Megawati–Haz Yudhoyono–Kalla Yudhoyono–Boediono
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Aggregate welfare indicators
GDP growth (%) 4.5 4.8 5.0 5.7 5.5 6.3 6 4.6 6.2 6.5 6.2 5.8 Poverty (%) 18.2 17.4 16.7 16.0 17.8 16.6 15.4 14.2 13.3 12.5 12.0 11.4 Unemployment (%) 9.1 9.5 9.9 11.2 10.3 9.1 8.4 7.9 7.1 6.6 6.1 6.3 Gini coeficient 0.33 0.32 0.32 0.36 0.33 0.37 0.35 0.37 0.38 0.41 0.41 0.41
Shares of household consumption expenditure (%)
Highest 20% 42.2 42.3 42.1 44.8 42.2 44.8 44.8 44.9 45.5 48.4 48.6 49.0 Middle 40% 36.9 37.1 37.1 36.4 38.1 36.1 35.7 36.1 36.5 34.7 34.4 34.1 Lowest 40% 20.9 20.6 20.8 18.8 19.8 19.1 19.6 19.0 18.1 16.9 17.0 16.9
Source: Data from Bappenas (2014); BPS (2014e, 2014g); Kuncoro, Widodo, and McLeod (2009).
Note: Poverty rates, Gini coeficients, and expenditure shares calculated using data from the National Socio-economic Survey (Susenas).
The horticulture law places a 30% cap on foreign ownership, and at the time of writing was the subject of a court challenge. It commits the government to
supporting horticulture by providing tax concessions, infrastructure, inance, and
training. It requires that permission for horticultural imports be obtained from both the Ministry of Trade and the Ministry of Agriculture.
The food law deines three important concepts: food self-suficiency, food sov
-ereignty (the state’s right to deine food policy), and food security (the individ -ual’s ability to secure food). It stipulates that food policy should be based on all three. Under the law, food imports are allowed only if domestic production is
insuficient or infeasible. The suficiency of staple foods is to be determined by the relevant minister. Food imports are not to harm sustainable farming or the
welfare of farmers. The government is obliged to balance the interests of farmers
and consumers by stabilising staple food prices, whether by ixing producer and
consumer prices, managing food reserves, or regulating exports and imports. The farmers law requires the government to prioritise domestic agricultural production and to protect farmers. To this end, ‘The government is obligated to create conditions that produce favourable agricultural commodity prices for farmers’ (article 25).6 This can be done by setting tariffs on agricultural
commodi-ties, stipulating their points of entry, and stabilising food prices. Commodities
that are particularly important are to have their own tariff policy. As with the food
law, agricultural imports are prohibited if domestic production is suficient, and
this is to be determined by the relevant minister.
As Nehru (2013) explains, the industry law gives the ministry the power to
promote industry by, for example, procuring products from domestic irms; con -trolling strategic industries; and arranging the selection, procurement, and use of industrial technology. The law decrees that nationals are to be given preference over foreigners, including in access to natural resources. The trade law, also cov-ered by Nehru (2013), is similarly wide-ranging. It authorises the relevant minis-ter to restrict imports to protect domestic industries and ‘to maintain the balance of payments’ (article 54).7
All ive laws have varying degrees of lexibility, but all provide a basis on
which any trade, industry, or agriculture minister so inclined could build a policy package of high tariffs, quotas, or both. The food and farmers laws are the most
clearly protectionist: the former makes self-suficiency the objective of govern -ment, and the latter requires the government to prop up agricultural prices. The European Union, the United States, and New Zealand have complained that the horticulture law violates Indonesia’s WTO commitments (WTO 2013, 2014) and the European Union has suggested that the trade and industry laws do the same
(European Commission 2014). The Indonesian government will continue to be
constrained by international commitments and public outcries against high food prices, but it will also be under pressure—not least from the parliament itself—to implement what is now the law of the land.
6. See http://usdaindonesia.org/wp-content/uploads/2013/07/Indonesian-Farmers-Bill-Translated.pdf.
7. See http://usdaindonesia.org/wp-content/uploads/2014/04/Bill-Trade-Law-ENGLISH- FINAL-140219.pdf.
More generally, the enactment of these and many other pieces of legislation
(including Law 5/2014 on Civil Administration and Law 6/2014 on Villages, dis -cussed below) suggests that Indonesia’s parliament has become a key player in
policymaking. Law 4/2009 on Mineral and Coal Mining, passed at the end of the
previous parliament’s term, is the basis of the current ban on the export of unpro-cessed minerals, and the parliament also recently passed laws on deforestation,
land acquisition, microinance, higher education, and inancial sector regulation.
No doubt some of this legislation will languish for lack of implementing regula-tions or because there is no political will to implement it, but much of it could be
inluential.
We are not in a position to evaluate the relative roles of the president and the parliament in initiating and shaping recent legislation. Most bills are proposed by the president (Sherlock 2007, 28). There is no right of presidential veto, but the president’s approval is required before the parliament can vote on a bill (Sherlock 2007, 7–8). Though Indonesia’s parliament is typically represented as ‘divided [and] fractious’ (Evans 2012, xvii), in fact bills are usually passed unanimously, after extensive negotiations (Sherlock 2007, 3). The legislative program of the
cur-rent parliament appears to relect views shared across parties (as do, to a large
extent, the political party manifestos discussed later).
Not all the legislation passed in the last ive years is detrimental to good policy.
Law 2/2012 on the Acquisition of Land for Development in the Public Interest, in
particular, might help speed up infrastructure projects, and the Financial Services Authority, established under Law 21/2011, might help improve inancial sector
regulation (Allford and Soejachmoen 2013). There is no doubt, though, that the 2009–14 parliament, acting in collaboration with the president and his adminis-tration, has bequeathed to Indonesia a raft of protectionist legislation. There is a risk, but fortunately not a guarantee, that this will become its most important economic legacy.
POLITICAL DEVELOPMENTS Parliamentary Elections
In the legislative elections held on 9 April 2014, just under three-quarters of
Indo-nesia’s 186 million eligible voters cast their ballots to ill 560 seats in the Peo
-ple’s Representative Council (Dewan Perwakilan Rakyat [DPR]), 132 seats in the Regional Representative Council, and almost 20,000 seats in assemblies at the pro -vincial and city or district level. The election was orderly, peaceful, and, allega-tions of attempted vote-buying aside, gave observers no cause to doubt that it was substantially free and fair.
Twelve political parties contested the elections, down from forty-eight in the 1999 elections, and ten secured seats in the DPR, Indonesia’s primary legislative chamber. The bar for party eligibility was raised in 2011 (by Law 2/2011 on Politi-cal Parties) so that now only the largest parties, with chapters across the nation,
can ield candidates (an exception is made for Aceh) (Freedom House 2012, 2).
As a result, and as table 3 shows, the proportion of votes that went to parties that did not meet the threshold for DPR representation fell from 18.3% in 2009 to only 2.4% in 2014 (despite an increase in the threshold itself from 2.5% to 3.5%). Table 3 also shows that votes in both elections were fairly evenly distributed among the parties, and that no party was, at either election, able to gain more than about 20% of the vote.
TABLE 3 Votes and Seats Won in the Indonesian DPR Elections, 2009 and 2014
2009 2014
Votes Seats Votes Seats
Parties gaining seats
No.
(m) % No. %
No.
(m) % No. %
New secular parties
Gerindraa 4.6 4.5 26 4.6 14.8 11.8 73 13.0
Hanurab 3.9 3.8 17 3.0 6.6 5.3 16 2.9
NasDem Partyb 8.4 6.7 35 6.3
Established secular parties
Democratic Partyc 21.7 20.8 148 26.4 12.7 10.2 61 10.9
Golkar Partya 15.0 14.5 106 18.9 18.4 14.8 91 16.3
PDI–Pb 14.6 14.1 94 16.8 23.7 19.0 109 19.5
Islamic parties
Prosperous Justice Party (PKS)a 8.2 7.9 57 10.2 8.5 6.8 40 7.1
National Mandate Party (PAN)a 6.3 6.0 46 8.2 9.5 7.6 49 8.8
United Development Party (PPP)a 5.5 5.3 38 6.8 8.2 6.5 37 7.0
National Awakening Party (PKB)b 5.1 4.9 28 5.0 11.3 9.0 47 8.4 Totals
Total for parties gaining seats 84.9 81.7 560 122.1 97.6 560 Total for parties not gaining seats 19.0 18.3 2.9 2.4
Total valid votes 104.0 125.0
Parties supporting Prabowo–Hatta 61.2 49.0 292 52.1
Parties supporting Jokowi–Kalla 51.1 40.9 207 37.0
Source: Data from KPU (2013, 2014a, 2014b); Kuncoro, Widodo, and McLeod (2009).
Note: DPR = Dewan Perwakilan Rakyat (People’s Representative Council). Gerindra = Great Indone-sia Movement Party. Hanura = People’s Conscience Party. PDI–P = IndoneIndone-sian Democratic Party of Struggle. New parties are deined here as those founded after 2005. The NasDem Party was founded only in 2011. Of the two parties not gaining legislative seats in 2014, the Indonesian Justice and Unity Party (PKPI) supported Jokowi–Kalla in the 2014 presidential election and the Crescent Star Party (PBB) supported Prabowo–Hatta. Around 14.6 million votes were spoilt or null in the 2014 elections.
aSupporting Prabowo–Hatta. b Supporting Jokowi–Kalla. c Announced support for Prabowo–Hatta at
the end of June 2014. Not counted in supporting parties’ total.
The Presidential Election
Only two candidates were nominated for Indonesia’s 2014 presidential election on 9 July: Joko ‘Jokowi’ Widodo, of the Indonesian Democratic Party of Strug-gle (PDI–P), and Prabowo Subianto, of the Great Indonesia Movement Party (Gerindra). In the lead-up to the parliamentary elections in April, Jokowi, gov-ernor of Jakarta and formerly mayor of Surakarta (or Solo), was widely favoured to win the presidency. Yet PDI–P’s share of the vote, at 19%, fell well short of expectations, and the party was forced into a coalition to marshal the 25% of votes required to be able to nominate Jokowi. Moreover, the Golkar party, which
received the second-highest share (15%) of the national vote, opted not to pur-sue a candidacy for its unelectable chair, Aburizal Bakrie, and instead entered into a coalition with Prabowo’s Gerindra. So did three of the four Islamic parties, which collectively accounted for some 21% of the vote. One of these parties, the National Mandate Party, supplied its chair, Hatta Rajasa, as Prabowo’s running mate. Rajasa brings a business perspective and government experience, having been transport minister and, most recently, coordinating minister for economic affairs. Prabowo himself is a former general and businessman, a former son-in-law of Soeharto, and was an unsuccessful vice-presidential candidate in 2009.
Although Jokowi’s party’s share of the DPR vote disappointed his supporters and surprised observers, it was not much smaller than that of Yudhoyono’s Dem-ocratic Party in 2009 (21%), and Yudhoyono won that election decisively. Jokowi
and PDI–P have assembled a usefully diverse coalition—the People’s Conscience
Party (Hanura) is headed by a former general; the National Awakening Party (PKB) is the most popular of the four Islamic parties; and the more youth-oriented National Democratic Party (NasDem) brings access to the extensive media empire of its chair, Surya Paloh. In Jusuf Kalla, Jokowi has a running mate with a broad base of support (including outside of Java), previous vice-presidential experience (2004–9), a reputation for getting things done, and a capacity to engage effectively in political debate. It does no harm that Kalla is a former chair of Golkar.
In Indonesian politics, coalition structures, parties’ shares of the vote, and running mates do not necessarily mean much. Voters have demonstrated a pro-pensity to direct their votes to individuals rather than to the parties or party groupings they represent. Most notably, the Democratic Party rose and then fell with the popularity of its leader and founder, Yudhoyono. Viewed as individuals, Jokowi and Prabowo have very different strengths and weaknesses. Jokowi has wide public support owing to his novelty, clean reputation, and common touch. He also has strong backing from the business community, which is not normally aligned with PDI–P but which sees him as likely to push forward in at least some areas of economic reform, not least because he has expressed a disposition to appoint people to key economic ministries on the basis of technical merit. Jokowi is also perceived, perhaps optimistically, as the candidate more likely to resolve long-standing infrastructure bottlenecks, because he has demonstrated a capacity to build consensus and to negotiate to make things happen. Prabowo’s popular appeal speaks to people who believe that Indonesia lacks decisive, clear-sighted, and perhaps even aggressive leadership. Prabowo carries baggage, including allegations that he was involved in human rights abuses as a senior military com-mander. He, far more than Jokowi, evokes the leadership archetype of the past— but it is a past of which the youngest third of the population of Indonesia has no direct experience.
Jokowi performed unremarkably during the early stages of the presidential campaign by tending to overwork his ordinariness. Prabowo, despite notable
stumbles, better projected a capacity for national leadership and made up signii -cant ground in the polls.
Parties’ and Candidates’ Positions on Economic Policy
A review of the major parties’ platforms going into the presidential election reveals a range of positions and emphases, few disagreements, and many areas of
consensus. In general, the parties’ platforms stress economic ‘independence’ and ‘sovereignty’, the development of infrastructure and the rural economy, and the eradication of corruption. None promises to liberalise the economy, or to under-take what might be termed structural reform. Some, however, call for an increase in the tax-to-GDP ratio—both PDI–P and Gerindra target an increase in this ratio from its current 12% to 16%.
PDI–P’s economic platform (PDI–P 2014) begins with the claim that Indone-sia is losing its economic, food, and energy sovereignty. It promises to reverse these trends by developing ‘skilled national human resources’, promoting infra-structure, and improving the social security system. At the level of strategy, its nationalism is more limited: PDI–P wants to restrain the foreign ownership of banks and manage energy resources in favour of national industry and domes-tic investors. While the platform commits to increasing agricultural exports and reducing imports, it does not advocate an overtly protectionist approach. Rather, it promises more support to Indonesia’s farmers by establishing a farmers’ bank, developing rural infrastructure, and limiting the conversion of land in Java.
In a long op-ed in Kompas (10 May 2014), Jokowi calls for nothing less than a ‘mental revolution’ in Indonesia to end old, corrupt ways. He also calls for meas-ures to increase food and energy security, saying that achieving these aims is ‘not negotiable’. He suggests, however, that in other sectors he is prepared to allow trade to ‘drive the economy’. He is critical of relying too heavily on foreign invest-ment. In separate comments, Jokowi committed to phasing out fuel subsidies over
four to ive years (Teraspos.com, 30 Apr 2014).
Gerindra’s election manifesto (Gerindra Party 2014) begins, as might be expected, with a heavy emphasis on the need for strong leadership: ‘Weak national leadership is a decisive factor causing deterioration in the nation’s life’. Its economic section begins with a wide-ranging critique of Indonesia’s ‘liberal-capitalistic’ system, which, it alleges, has allowed foreigners to dominate the economy and failed to ensure the welfare of the people. The manifesto advances a cooperative model with a heavy emphasis on state ownership and control. It speaks out against foreign borrowing, and for the restriction of foreign direct investment. It rejects liberalisation and deregulation and favours trade
protec-tion, as well as other policies (improved infrastructure, better access to inance) to
help farmers and small businesses. The manifesto also includes a strongly worded attack on corruption.
Prabowo and Hatta have also released an economic platform (Prabowo–Hatta 2014) as part of their campaign. It focuses on building infrastructure and providing government support for agriculture and other sectors, and also on state-owned-enterprise-led development and on the development of a national manufacturing capability to build motor vehicles, ships, and aeroplanes. Prabowo has in the past spoken out against fuel subsidies, but his most recent public remarks call for their maintenance with better targeting (Jakarta Globe, 21 May 2014).
Overall, Jokowi goes into the election with a more moderate and economically literate platform than Prabowo.8
8. For a broader overview of the key commitments of the Jokowi–Kalla and Prabowo– Hatta teams, see ‘What Is on the Political Agenda of Joko Widodo and Prabowo Subianto?’ (Indonesia-Investments.com, 22 May 2014).
ECONOMIC DEVELOPMENTS Economic Growth
Economic growth slowed in Indonesia from 6.5% in 2011 to 6.2% in 2012 and to 5.8% in 2013 (table 2). It seemed to have stabilised in the second, third, and fourth quarters of 2013, with rates of 5.8%, 5.6%, and 5.7%, respectively (table 4), but in
fact growth in the last quarter was artiicially high as companies rushed to pro -duce and export their unprocessed minerals before the ban on such exports in
January 2014. In turn, this ban pushed growth down to 5.2% in the irst quarter of
2014. Table 4 shows that fourth-quarter growth for mining and quarrying in 2013
was 3.9% (the highest in several years) but irst-quarter growth in 2014 was –0.4%.
Exports of the affected commodities—copper ore, nickel ore, and bauxite—were
0.6% of GDP in the irst quarter of 2013 (valued in current prices), and 0.0% a year
later (BI 2014). This also explains the high export growth in the former quarter and the negative growth in the latter.
Some commentators, and the Indonesian government itself, had predicted growth of 5.5%–6.0% for 2014. This now seems unlikely. In May the government conceded that its growth target of 6.0% for the 2014 calendar year was unachiev-able, and revised it down to 5.5%. Bank Indonesia (BI) adjusted its forecast from between 5.5% and 5.9%—and it had earlier been between 5.8% and 6.2%—to between 5.1% and 5.5% (Jakarta Post, 8 May 2014). This forecast is in line with
those of the World Bank and the IMF of 5.3% growth in 2014.
The ban on unprocessed mineral exports will continue to dampen growth for the remainder of 2014. There are also risks in agriculture: a press report (Kompas, 3 May 2014) suggests that rice farmers in West Java face the prospect of particularly low harvests in 2014, owing to pest infestation worsened by indiscriminate use
of pesticides (Fox 2014; Manning and Purnagunawan 2011). The harvested rice
area in January–April decreased relative to the same period in 2013 by more than 97,000 hectares, and production decreased by close to 1 million tonnes of paddy, largely in Java (BPS, press release, 1 Jul 2014). If the El Niño climatic event were to arrive in mid-2014, as predicted, it would reduce rainfall and most likely damage the year’s second rice crop (Reuters, 27 May 2014). BPS predicts that the harvested area during the second rice crop in 2014 will decrease by 168,000 hectares, and that total rice production in 2014 will be 1.4 million tonnes of paddy lower than in 2013.
Figure 1 shows recent quarterly year-on-year growth igures for both private
consumption and investment. It demonstrates the slowly but steadily rising growth of private consumption, which makes up 55% of total expenditure, but also the fall in investment growth which has been behind the slowdown in GDP growth, and which has reduced demand for imports (World Bank 2014a). On the
positive side, the igure suggests that investment growth has at least stabilised.
Other positives are the record level of foreign direct investment, and Indonesia’s strategic, political, and social stability, especially given the volatile times that some of its neighbours are enduring.
Growth should recover in 2015. The World Bank (2014a) predicts a rebound in
2015 to 5.6%; the IMF (2013, 38) 5.8%. However, some commentators suggest that,
until major progress is made in reducing infrastructure bottlenecks, growth will stay closer to 5.0%—even in the medium term.
Balance of Payments
Indonesia’s current account balance has been falling since 2009. It turned nega-tive in the fourth quarter of 2011 and reached –4.4% of GDP in the second quarter
of 2013 (igure 2). In response, the government introduced policies to reduce the current account deicit (CAD) to below 3% to counter international perceptions of
excessive risk. Policymakers achieved their sought-after adjustment by allowing a large depreciation in the exchange rate (of 25% during 2013); by raising
inter-est rates (BI increased the overnight deposit facility rate ive times between May
and December 2013, from 3.75% to 5.75%); and by increasing fuel prices by 33% in April 2013.
In the fourth quarter of 2013 and the irst quarter of 2014, the CAD was about 2% of GDP. Exports were lat through most of 2013 but artiicially inlated in the
TABLE 4 Components of GDP Growth (2000 prices; % year-on-year)
Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014
GDP 6.0 5.8 5.6 5.7 5.2
Excluding oil & gas 6.7 6.3 6.1 6.0 5.6
By expenditure
Private consumption 5.2 5.1 5.5 5.3 5.6
Government consumption 0.4 2.2 8.9 6.4 3.6
Investment 5.5 4.5 4.5 4.4 5.1
Construction 6.8 6.6 6.2 6.7 6.5
Machinery & equipment 0.8 –0.7 0.8 0.2 5.1
Transport 2.1 –6.3 –4.4 –12.1 –9.6
Other 11.3 12.4 8.3 12.4 4.8
Exports 3.6 4.8 5.2 7.4 –0.8
Imports 0.0 0.7 5.1 –0.6 –0.7
By sector
Tradables 4.4 4.2 4.1 4.7 3.8
Agriculture, livestock, forestry &
isheries 3.7 3.3 3.3 3.8 3.3
Mining & quarrying 0.1 –0.6 2.0 3.9 –0.4
Manufacturing 6.0 6.0 5.0 5.3 5.2
Excluding oil & gas 6.9 6.6 5.5 5.4 5.6
Non-tradables 7.4 7.1 7.0 6.5 6.4
Electricity, gas, & water supply 7.9 4.0 3.8 6.6 6.5
Construction 6.8 6.6 6.2 6.7 6.5
Trade, hotels, & restaurants 6.5 6.4 6.1 4.8 4.6
Transport 6.0 7.7 6.7 7.8 8.2
Communications 11.7 12.8 11.8 11.7 11.3
Financial, rental, & business services 8.2 7.7 7.6 6.8 6.2
Other services 6.5 4.5 5.6 5.3 5.8
Source: Data from BPS (press release, 5 May 2014; 2014d, 2014f); BI (2014).
FIGURE 2 Current Account Balance as a Share of GDP, Current Prices, 2009–14 (%)
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
-5 -4 -3 -2 -1 0 1 2 3 4 5
2009
2014 2013
2011
2012
2010
Source: Data from BI (2014; press release, 9 May 2014).
(2000 prices; % year-on-year)
Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 0
3 6 9 12 15
Private consumption
Investment
Source: Data from BPS (2014d); BI (2014).
TABLE 5 Balance of Payments ($ billion)
2013 2014
Q1 Q2 Q3 Q4 Q1
Current account –6.0 –10.1 –8.6 –4.3 –4.2
Exports 45.2 45.6 44.2 48.4 44.4
Non–oil & gas 36.8 37.6 35.6 39.8 36.7
Oil & gas 8.5 7.9 8.5 8.7 7.7
Imports 43.6 46.1 44.0 43.7 40.9
Non–oil & gas 32.3 36.1 32.8 32.9 30.5
Oil & gas 11.3 10.0 11.2 10.8 10.3
Merchandise trade balance 1.6 –0.5 0.1 4.8 3.5
Non–oil & gas 4.5 1.6 2.8 6.9 6.2
Oil & gas –2.9 –2.1 –2.6 –2.1 –2.6
Services –2.6 –3.5 –2.8 –3.1 –2.2
Income –6.1 –7.1 –6.8 –7.0 –6.5
Current transfers 1.1 1.0 0.9 1.0 1.0
Capital & inancial accounts –0.5 8.6 5.5 8.8 7.8
Capital account 0.0 0.0 0.0 0.0 0.0
Financial account –0.5 8.6 5.5 8.8 7.8
Direct investment 3.6 3.7 5.8 0.5 2.9
Portfolio investment 2.8 3.4 1.9 1.8 9.0
Other investment –6.9 1.6 –2.3 6.5 –4.1
Errors & omissions –0.1 –1.0 0.5 –0.1 –1.6
Overall balance (change in reserves) –6.6 –2.5 –2.6 4.4 2.1
Foreign reserves 104.8 98.1 95.7 99.4 102.6
Source: Data from BI (2014).
fourth quarter—and subsequently suppressed in the irst quarter of 2014—by the 2014 ban on the export of unprocessed minerals (table 5). The CAD might have
been expected to rise as a result, but the fall in exports was offset by a reduction
in imports. In fact, both exports and imports fell in the irst quarter of 2014 com
-pared with both the previous quarter and the irst quarter of 2013.
The lower-than-expected CAD for the irst quarter of 2014 suggests that the CAD for the full year should remain below 3%, but not necessarily by much. Data for April showed a trade deicit of $2 billion, on the back of rising imports, and in June BI warned that the CAD would exceed 3% in the second quarter of 2014 (BI,
press release, 2 Jun 2014; Jakarta Post, 6 Jun 2014 ). The May trade balance showed a very marginal surplus, as imports fell that month (BPS, press release, 1 Jul 2014).
The World Bank (2014a) predicts a CAD of 2.9% of GDP for 2014, and 2.1% for
2015.
On the capital account, portfolio investments surged in the irst quarter of 2014,
to $9.0 billion—almost as high as the total for 2013. Net foreign investment in
Indonesian stocks amounted to $3.6 billion during January–May, but the June
igure fell to just $0.1 billion as foreign portfolio investors began to await the
results of the presidential election.9 Foreign-exchange reserves continued their
climb, which had resumed in the fourth quarter of 2013, and in February 2014 they exceeded $100 billion for the irst time in eight months.
Other macroeconomic indicators are mainly positive. The stock exchange, after
falling in the second half of 2013, more than recovered its lost ground in the irst half of 2014, rising 14.8% in the calendar year to 3 July. Inlation peaked at 8.8% in
August 2013 (year on year) as a result of the fuel price increases, and was still at that level in December 2013. It has since fallen, however, and was at 6.7% in June 2014 (BI 2014). Growth in both broad and narrow monetary aggregates (M2 and M1, respectively) has fallen since mid-2012, and remains at relatively low levels, according to the latest (April) data. Year-on-year growth in M2 (M1) was 20.3% (23.3%) in April 2012, 14.7% (15.4%) in April 2013 and 11.0% (6.5%) in April 2014 (BI 2014). Growth in cash in circulation, which is more volatile, has in general
been higher. It grew at 15.3% for the irst four months of 2014, compared with 14.0% for the irst four months of 2013 and 16.0% for the irst four months of 2012
(BI 2014). The ratio of external debt service to exports has continued to rise (BI 2014).10 The government continues to express concern about this, but has
lim-ited scope for action, since most of the debt is private (Ministry of Finance, press
release, 22 May 2014).
The government has achieved much by stabilising the external balance. Some observers feared that exchange-rate depreciation would accelerate out of control,
as it had in 1998. It did not. Although the size of the CAD remains a concern for
policymakers, the Indonesian economy is certainly perceived to be less risky in 2014 than it was in 2013.
POLICY DEVELOPMENTS
Law 5/2014 on Civil Administration
President Yudhoyono enacted a new civil service law on 15 January 2014, some two and a half years after it was passed by parliament. According to press reports,
the law establishes a new independent Indonesian Civil Service Commission of
seven members, with representatives of academia and civil society as well as the government (Jakarta Post, 3 Feb 2014). It moves towards open, merit-based recruitment and performance-based promotion and remuneration. It increases the retirement age of public servants and introduces a new service-wide salary system, which seeks to provide ‘fair and decent wages’ (article 79, own transla-tion), and abolish most allowances, thereby bringing to an end the long-standing practice whereby those in ‘wet’ positions—that is, positions with more access to project funding and/or more prone to corruption—receive more by way of allow-ances than those in ‘dry’ positions. Indonesia’s salary bill has grown at an average
rate of 9% a year (after inlation) during Yudhoyono’s second term (table 7), and
observers expect the civil service law to add to it, as it will tend to push up remu-neration for ‘dry’ positions to bring them into line with ‘wet’ ones.
9. See http://www.idx.co.id/en-us/home/publication/statistic.aspx. 10. See also Nehru’s (2013) survey for further discussion of this issue.
Law 6/2014 on Villages
Indonesia’s new village law, enacted on 15 January 2014, gives villages the right to regulate and manage local government affairs, community interests, and
custom-ary and traditional rights. The law provides villages with signiicant new fund -ing, much of it from the national government. It entitles villages collectively to an amount equivalent to 10% of central government transfers to lower levels of government (provinces, districts, and municipalities), to be transferred directly from the national budget. The law stipulates that this component of funding for villages should be additional to existing transfers. Villages are further entitled to 10% of the funds received by districts and municipalities from the national gov-ernment, after subtracting special allocation funds. All funds provided under the
law are for development purposes, as deined by villages themselves.
The irst entitlement, worth Rp 59 trillion if paid in 2014, is new. The second, worth Rp 45 trillion, relects existing practice (under the Alokasi Dana Desa [vil -lage fund allocation] program). If divided equally among Indonesia’s approxi-mately 73,000 villages, these entitlements would deliver Rp 1.4 billion each year to each village, on top of which would be added the relatively small amounts (in most cases) of own-source revenues and 10% of regional funds. It is not clear when direct payments will begin—implementing regulations will be needed, as usual—but it may be as early as 2015, given the law’s strong support (Jakarta Post, 21 Dec 2013).
In many ways, the new village law builds on Program Nasional Pemberdayaan
Masyarakat Mandiri (National Program for Community Empowerment [PNPM
Mandiri]), which was once the Kecamatan Development Program (KDP), Indo-nesia’s well-known community-driven development program. Having started in 1998 as a World Bank project, the KDP was converted into an Indonesia-wide program by President Yudhoyono in 2006. PNPM Mandiri has an annual budget of about Rp 17.5 trillion.11 The new funding provided under the village law, of around Rp 60 trillion each year, as above, will be more than three times as much. A
recent review of PNPM Mandiri (PNPM Support Facility 2012) points to achieve -ments and challenges, but nowhere suggests that it lacks funds. Direct transfers to villages on the scale envisaged could do much to meet local infrastructure
short-falls, but absorptive capacity may be a problem. For one thing, however lexible it is, the village law is designed to inance projects. It will enable villages to build
things, not to run them.
The village law will also shift the balance of power in village development. The success of PNPM Mandiri relies on multiple checks and balances, such as the use of facilitators to ensure that program guidelines are being met and to
mitigate the risks of elite capture, corruption, and waste (PNPM Support Facil -ity 2012). But PNPM Mandiri is an executive-run program without any basis in legislation. Empowering villages, as the village law does, will make mitigation of these risks harder. The village law, then, may continue the successful expansion of community-driven development in Indonesia, or it may undermine the founda-tions on which it builds. Time will tell.
11. Using an exchange rate of 11,675 rupiah per dollar, as at the end of May 2014, and an annual igure of $1.5 billion (PNPM Support Facility 2012).
Ban on Unprocessed Mineral Exports
Indonesia’s ban on unprocessed mineral exports began in January 2014 as a result
of Law 4/2009 on Mineral and Coal Mining. Allford and Soejachmoen (2013),
Armstrong and Rahardja (2014), and the World Bank (2014a) all provide extensive coverage. What follows is only a brief overview and update.
The ban affects about $5.5–$6.0 billion of Indonesia’s exports, or about 3% of total exports (BI 2014)—principally copper ore, nickel ore (of which Indonesia is responsible for half of global production), and bauxite. Unprocessed exports of nickel and bauxite have been banned altogether; copper concentrate can be exported up to 2017, but companies are required to pay a prohibitive 20% (and increasing) export tax. Exports of these commodities, which traditionally have not been processed on a large scale in Indonesia, have therefore stopped. There has been talk that if companies commit to building smelters they will be allowed to export provided they pay a bond and show progress in construction (Monitor
Global Outlook, 13 Mar 2014). Yet there are no conirmed cases of concluded deals
or the resumption of ore exports.
A challenge to the law is, at the time of writing, before the Constitutional Court.
The appellants make the case that articles 102 and 103 of the law require only that ores contain minimum contents (for example, that exports of copper ore contain a certain amount of copper), not that the ores have to be processed to be eligible for export (Jakarta Post, 13 Mar 2014). Japan, which relies on Indonesia for its nickel, has told Indonesia that it intends to challenge the law at the WTO (Indonesia-Investments.com, 4 Apr 2014).
Fiscal Policy
If the CAD was the most pressing policy problem last year, then this year it is the iscal deicit, or, more broadly, the budget. This problem is more dificult and will
take longer to solve. Indonesia’s debt has fallen drastically over the last decade but is now starting to inch up. The debt-to-GDP ratio fell from 76.4% of GDP
in 2001 to 24.5% in 2012 (IMF 2005, 2013), but IMF (2013) estimates values for this ratio of 26.2% for 2013 and 26.8% for 2014. This relects the fact that the pri
-mary balance (the iscal balance before interest payments), which determines debt dynamics, has been on the decline since 2002 (igure 3). For the irst time since its iscal rule was put in place (in 2003), the iscal deicit is close to its mandated
limit of 3% of GDP.12 The 2014 budget target for the iscal deicit was 1.7%, but the revised budget presented to the parliament in May targets 2.5%.
Table 6 shows the budgeted and revised budget estimates and assumptions for 2014.13 Uncontrolled fuel subsidy costs are an immediate and familiar prob-lem. The fuel subsidy was originally budgeted at Rp 211 trillion but is now esti-mated to hit Rp 285 trillion, 36% higher than its level in 2013, despite the 33% fuel price increases introduced in July 2013. The subsidy blowout is due to a higher
12. For discussions of iscal rules and budgeting in Indonesia, see Blöndal, Hawkesworth, and Choi’s (2009) and Budina et al.’s (2012) studies. The rule is contained in Government Regulation 23/2003 and pertains to Law 17/2003 on State Finance.
13. A mid-year revised budget is a standard part of the annual budgetary cycle in Indone-sia. These igures are the ones presented by the government to the parliament. At the time of writing, the parliament had yet to vote on the budget.
FIGURE 3 Primary and Fiscal Balance, 2000–14 (% of GDP)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 -5
-4 -3 -2 -1 0 1 2 3 4 5
Fiscal balance Primary balance
Source: Data from BPS (2014a, 2014b); BI (2014); Republic of Indonesia (2014).
Note: The primary balance is the iscal balance plus interest payments. Data for 2013 are actuals. Data for 2014 are the revised budget estimates in table 6.
exchange rate than that assumed in the draft budget, as well as lower domestic oil production and higher domestic consumption.
The government also faces revenue problems. Revenue actuals in 2013 were lower than expected, and although revenue growth of 11% is still planned for 2014 it starts from a 4% lower base. With weaker revenue and a ballooning fuel subsidy, the revised budget cuts expenditure harshly wherever possible: it axes capital spending by 18% (relative to the budget) and material (operations and maintenance) by 29% (table 6). Without major policy reform, this sort of com-pression of potentially productive expenditure will characterise future budgets, as elaborated on in the next section.
Other recent economic policy developments include the long-awaited announcement of a new negative list for investment, perceived to reduce open-ness, especially in the energy sector (Jakarta Globe, 13 May 2014); a ruling by the
Constitutional Court that customary forests should not be classiied as state for -ests, that is, as under state control (Mongabay.com, 17 May 2013); and another ruling limiting the ability of the legislature to modify line-item budget allocations (Jakarta Post, 23 May 2014).
Fiscal Policy Challenges for the Next Administration and Parliament
Given the low stock of government debt, there is certainly no iscal emergency in Indonesia. Yet the trend of rising deicits (igure 3) is concerning for three reasons. First, it is symptomatic of strong underlying upward pressure on expenditure not
being matched by commensurate revenue growth. This poses a long-term threat to sustainability and a shorter-term risk to the macroeconomy, especially if the
CAD remains stubbornly high. Second, the deicit cap combined with the govern -ment’s inability to control energy subsidies will crowd out more productive and
(Rp trillion)
2012 2013 2014
Actual Revised Actual Budget Revised
Change (%)
REVENUES & GRANTS 1,338.1 1,502.0 1,437.0 1,667.1 1,597.7 –4.2
Domestic revenue 1,332.3 1,497.5 1,431.5 1,665.8 1,595.4 –4.2
Tax 980.5 1,148.4 1,077.3 1,280.4 1,232.1 –3.8
Domestic 930.9 1,099.9 1,029.8 1,226.5 1,176.9 –4.0
Income tax 465.1 538.8 506.4 586.3 562.5 –4.1
Value-added tax 337.6 423.7 384.7 493.0 475.6 –3.5
Other 128.2 137.5 138.7 147.2 138.8 –5.7
International trade taxes 49.7 48.4 47.4 53.9 55.2 2.3
Non-tax 351.8 349.2 354.2 385.4 363.3 –5.7
Natural resource revenues 225.8 203.7 226.8 226.0 221.2 –2.1 Proits of state-owned
enterprises 30.8 36.5 34.0 40.0 38.0 –5.1
Other 95.2 109.0 93.5 119.4 104.1 –12.8
Grants 5.8 4.5 5.5 1.4 2.3 71.0
EXPENDITURE 1,491.2 1,726.2 1,639.8 1,842.5 1,849.4 0.4
Personnel 197.9 233.0 221.7 263.0 263.0 0.0
Material 140.9 206.5 168.5 215.6 153.1 –29.0
Capital 145.1 192.6 172.4 184.2 151.3 –17.9
Interest 100.5 112.5 113.0 121.3 135.9 12.0
Subsidies 346.4 348.1 355.0 333.7 444.9 33.3
Energy 306.5 299.8 310.0 282.1 392.1 39.0
Fuel 211.9 199.9 210.0 210.7 285.0 35.2
Electricity 94.6 100.0 100.0 71.4 107.1 50.1
Transfers to regions 480.6 529.4 513.3 592.6 583.7 –1.5
Other 79.8 104.1 96.2 132.3 117.6 –11.1
BALANCE –153 –224 –203 –175 –252 44.0
(% of GDP) –1.9 –2.6 –2.2 –1.7 –2.5
BUDGET ASSUMPTIONS (AND ACTUALS)
GDP growth (%) 6.3 6.2 5.8 6.0 5.5
Inlation (%) 4.3 7.2 8.4 5.5 5.3
Exchange rate (avg Rp/$) 9,384 9,600 10,460 10,500 11,700
SBI exchange rate (avg %) 3.2 5.0 4.5 5.5 6.0
Crude oil price (avg $/barrel) 112.7 108 106 105 105 Oil production
(avg ’000 barrels/day) 861 840 825 870 818
Source: Data from BI (2014); BPS (2014a, 2014b); Republic of Indonesia (2014).
Note: SBI = Bank Indonesia Certiicate.
FIGURE 4 Fuel and Non-fuel Subsidies as a Share of GDP and Government Expenditure, 1990–2014
(%)
Non-fuel (lhs) Fuel (lhs)
Subsidies/expenditure (rhs)
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 0
1 2 3 4 5 6
0 5 10 15 20 25 30
Source: Data from BI (2014); Republic of Indonesia (2014).
Note: Non-fuel subsidies are mainly electricity subsidies. Revised budget igures are used for 2014, as in table 6.
equitable expenditures. Third, the preference of the Indonesian legislature to set ambitious sectoral and other spending targets not only adds to these concerns but
also increasingly limits spending lexibility.
Energy Subsidies
Indonesia’s irst (and oldest) iscal policy challenge is, arguably, to tackle energy
subsidies. Indonesia has subsidised energy prices since the Sukarno era, but did
so only moderately until the late 1990s. During the 1997–98 Asian inancial crisis,
neither fuel prices nor electricity prices were adjusted to pass through the sub-stantial depreciation in the exchange rate. Since then, energy subsidies, covering
both electricity and fuel, have claimed an increasing share of the budget (igure 4). We focus here on fuel subsidies—speciically, for concreteness, the petrol sub
-sidy. Figure 5 shows actual (regulated) monthly petrol prices alongside what
they would have been without any subsidy, from January 2005 to April 2014. The
prices are all adjusted for monthly inlation.
The government increased fuel prices a number of times in the early 2000s, but in 2003 President Megawati reversed an earlier decision to do so. (She also removed an indexation rule, which had automatically linked domestic to inter-national diesel prices.) In 2005, President Yudhoyono, not long after his election, raised the petrol price by 150% (in two stages) and accompanied it with a com-pensation package to cover this and other large fuel price increases (Sen and Steer 2005). Since the compensation package required legislative approval, in essence so did the fuel price increase.
There was another signiicant price increase in 2008 (33% in the petrol price),
accompanied by a similar compensation package. This increase did not last,
FIGURE 5 Petrol Subsidy and Regulated and Unsubsidised Petrol Prices, 2005–14 (Rp ’000/litre; 2002 prices)
Unsubsidised petrol price
Regulated petrol price
Per-litre subsidy
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
-1 0 1 2 3 4 5 6
Source: Petrol price data from Mohammad Ikhsan. Monthly inlation data from BPS (2014c).
however. Though the compensation package was left in place, the price increase
itself was reversed by three price reductions between December 2008 and February 2009, motivated in part by the need for iscal stimulus and the fall in global oil
prices and in part by impending elections.
Fuel prices were set to increase again in 2011, but the president abandoned
the plan at the last minute. The government made another attempt in 2012, this time with the agreement that any increase would have parliamentary approval. But such approval was not forthcoming: the parliament authorised an increase in fuel prices only if international oil prices rose by 15% above that year’s budget assumption for the oil price, which they did not (Burke and Resosudarmo 2012).
Fuel prices inally increased in July 2013 (by 44% in the petrol price), as part of that
year’s revised budget (Nehru 2013). This again required parliamentary approval on account of the accompanying compensation package.
The government has recognised the need for further fuel price increases.
Indo-nesia’s inance minister, Chatib Basri, has loated the idea of replacing a ixed price per litre with a ixed subsidy per litre, falling over time, to reduce budget volatility and accustom consumers to a lexible fuel price. The president could in
principle implement any such reform—whether of the amount of the subsidy or of its design—without parliamentary approval, provided that existing budget ceil-ings covered any compensation measures (since it is such measures that require
parliamentary approval, not the price increase itself). However, any signiicant
price increase will give rise to the expectation of additional compensation and thus, in practice, require parliamentary approval.14
14. There was some expectation that the revised budget would include an increased fuel price, but it did not. All electricity tariff adjustments have to be approved by parliament, which at the time of writing was considering a large such adjustment for July 2014 (Indonesia-Investments.com, 7 Jun 2014).
The 2015 budget is already being prepared—the outgoing president will present it to the outgoing parliament on 16 August 2014. Some observers argue
that Yudhoyono will not want to leave a legacy of iscal proligacy. While it is
possible that the president will propose to increase fuel prices as part of the 2015 budget, in the run-up to the 2009 election the same president reduced fuel prices. Moreover, it would be unusual, and perhaps undesirable, for a lame-duck presi-dent to introduce a highly controversial proposal into the political fray after his successor has been announced.
Another possibility is that the new president will amend the 2015 budget prior to its approval in order to incorporate fuel price increases. The new parliament will commence on 1 October and the president will be inaugurated shortly there-after, but the budget is not due to be passed until the end of October. Alterna-tively, the new president could introduce such increases in the course of 2015, or later, either as part of the revised budget or as a stand-alone measure—or he could decide not to increase fuel prices for several years, which would keep the subsidy bill above 4% of GDP and 20% of total expenditure. As noted earlier, Jokowi has spoken in favour of reducing fuel subsidies over time, but it remains to be seen whether the new president, whoever he is, will be any more successful than his
two predecessors in tackling this enduring and politically dificult problem.
One lesson from Indonesia’s experience with fuel subsidies is that one-off increases, however large and admirable, are ultimately ineffectual. While Indone-sia’s packages of price increases and compensation have been hailed worldwide (for example, Financial Times, 23 Sep 2009), they have not stopped the energy
sub-sidy bill from rising over time. They are so dificult to engineer that they can occur
only infrequently. Nor can an approach based on off increases rule out one-off decreases: between 2003 and 2013, the petrol price was reduced (four times)
almost as often as it was increased (ive times).
Figure 5 suggests that the enemy of fuel subsidy containment is not so much a rising international oil price, or even a depreciating rupiah, as simply inlation. After inlation, the subsidised or regulated petrol price is today 22% lower than it
was immediately after the large price hikes in 2005. The unsubsidised price is just 6% lower, and the per-litre subsidy 43% larger. Huge political capital has had to be consumed merely to make up for the erosion in the real value of the subsidised price.
Given the dificulty of the problem, many ways have been suggested to better
target and limit the fuel price subsidy. The tendency has been to look for technical solutions, such as selling petrol only in certain locations (poor areas), or at certain times (not at weekends), or only to certain cars equipped to receive it (to exclude
subsidised fuel-eficient cars [Jakarta Globe, 2 Apr 2014]). It is easier to segment the electricity market than the fuel market, and cross-subsidisation has been heavily
prosecuted in the former. For example, not only do commercial users pay more
than residential, and large commercial pay more than small commercial users, but, now, due to the most recent round of price increases, large commercial com-panies listed on the stock exchange pay more for their electricity than those not listed. In the fuel market, segmentation is also used as a strategy—industrial users no longer receive subsidised diesel—but none of the many technical proposals has been adopted, and nor are they likely to be, given how easy it would be to evade them.
FIGURE 6 Government Expenditure and Revenue as a Share of GDP, 1990–2014 (annual and average; %)
Expenditure
Revenue
1990 1992 2000 2002 2004 2006 2008 2010 2012 2014
14 15 16 17 18 19 20 21 22
Source: Data from BI (2014); Republic of Indonesia (2014).
More radical reform is clearly needed, such as a time-bound program with an upfront agreement that the end result would be the elimination of energy subsi-dies within, say, three or four years.15 Given the political dificulty involved, it may be necessary for the president to seek parliamentary support for such a plan, though history shows that that itself would be a Herculean task.
Other Fiscal Policy Challenges
If all energy subsidies were eliminated immediately, the government would free
up some 4.5% of GDP for deicit reduction or other spending. This would on its own solve Indonesia’s iscal problems, at least for several years. But it would be naive to propound a iscal adjustment strategy based only on fuel price reform. A
broader approach is needed.
Both revenue and expenditure fell, as a percentage of GDP, after the 2008 global
inancial crisis, but expenditure has since recovered to just over 18% of GDP, the
average for the last 25 years, whereas revenue has not, and remains at under 16%,
below the historical average of 17% (igure 6). Indeed, expenditure growth has
been rapid across the board. Table 7 shows the average growth rates of
expendi-ture during 2009–14, after inlation, for a number of major expendiexpendi-ture items. All
have grown faster than GDP, except for interest payments.
In addition, a growing proportion of government revenue is earmarked by legislation or Indonesia’s constitution:
• The constitution requires that 20% of government spending be on education. While much of this is by subnational governments, in practice this provision pre-commits about 7% of central government expenditure.
15. Jokowi is reported to have committed to something similar: ‘In four years, the fuel sub-sidy should be eliminated gradually, step by step, until it’s gone’ (Jakarta Post, 2 May 2014).
TABLE 7 Selected Categories of Central Government Expenditure, Annual Average Growth, 2009–14, and Share in Total Expenditure, 2014
(2005 prices, %)
Annual average growth rate Share in total expenditure
2009–14 2014
Total expenditure 8.4 100.0
Personnel 9.3 14.2
Material 7.5 8.3
Capital 8.6 8.2
Interest 1.9 7.3
Subsidies 19.5 24.1
Social assistance 11.4 4.8
Transfers to regions 7.4 31.6
Source: Data from Republic of Indonesia (2014); BPS (2014c); BI (2014).
Note: Revised budget igures are used for 2014, as in table 6.
• Indonesia’s complex decentralisation legislation translates in practice to a mandate on the central government to transfer at least 29% of its total revenue to subnational governments.
• The new village law requires the central government to transfer 10% of its transfers to subnational governments to villages. This comes to about 3% of total expenditure.
• Law 36/2009 on Health requires the non-salary health national budget to be 5% of total expenditure (article 171), much more than currently.
If the budget were in balance, these requirements would altogether earmark about 45% of expenditure.
A second category of expenditures are inlexible ones, in which we include subsidies and interest payments. Although very different, both are dificult to avoid or reduce. At current levels, inlexible expenditures are just more than a third of revenue, meaning that, in the absence of a deicit, legislated and inlexible
expenditure commitments amount to about 80% of expenditure. But, in 2014, sal-aries, capital, and material (excluding education and health) alone take up more than a quarter of revenue, even after the cuts associated with the revised budget. Social assistance spending is another government priority (5% of revenue); other transfers to regions (on top of what is mandated by law) constitute about 8%. Unless fuel subsidies are quickly and largely eliminated, Indonesia will have to
live with deicits for some time—otherwise the quality of spending will deterio
-rate greatly. Indeed, it will be dificult to limit the deicit to 3% of GDP.
To provide a more rigorous, but still illustrative, analysis, we assume that in
2015 Indonesia has a 3% deicit (that is, the maximum possible given existing iscal legislation), and that the revenue-to-GDP ratio stays at its current level, of
16.7% of GDP. We assume that all expenditures required by legislation (and the
constitution) are incurred in full, that the subsidy ratio stays ixed as a percentage
TABLE 8 Simulation of 2015 Budget Challenges
Share of expenditure
(%)
Share of GDP
(%)
A. Total revenue 84.1 15.8
B. Deicit 15.9 3.0
C. Total expenditure 100.0 18.8
D. Legislated expenditure 39.4 7.4
Education 7.0 1.3
Health (non-salary) 5.0 0.9
Mandated transfers to regions 24.4 4.6
Village funds 3.0 0.6
E. Inlexible expenditure 30.4 5.7
Subsidies 23.4 4.4
Interest 6.9 1.3
F. Available funds for discretionary expenditure (C–D–E) 30.2 5.7
G. Policy-compliant discretionary expenditure 39.2 7.4
Defence 4.5 0.9
Other salaries 6.8 1.3
Infrastructure 16.2 3.1
Social assistance 4.1 0.8
Discretionary grants & other 7.5 1.4
H. Discretionary spending gap (G–F) 9.0 1.7
Source: Indonesian budget documents; authors’ calculations and estimates.
Note: See text for explanations. The 2014 base for defence, capital, material, and salaries uses budget rather than revised budget igures (table 6), since these avoid any forced cuts. Revised budget igures are used for interest and subsidy payments. Infrastructure is deined as capital and material exclud-ing estimated defence, education, and health non-salary spendexclud-ing. Other salaries exclude estimated defence and education salaries. Nominal GDP growth for 2015 of 12% is assumed, with inlation of 6%.
of GDP, and that the interest burden grows at historical rates (table 7). Under
these assumptions, as table 8 shows, legislated and inlexible expenditure takes up 70% of total expenditure, leaving 30% for discretionary expenditure. Current
policy settings favour large increases in defence spending (as described in sev-eral defence policy pronouncements, which include a spending target of 1.5% of GDP); the salary bill (as shown by past trends, and in line with the new civil ser-vice law); infrastructure spending; and social assistance. We simulate policy com-pliance in these areas by requiring them to grow in line with GDP (we assume a nominal growth rate of 12% for 2015). Other expenditures, mainly non-mandated
regional transfers and grants, are merely increased in line with inlation. Under this simulation, even with a 3% deicit, the expenditure envelope is unable to meet
spending requirements (table 8). On the contrary, the total available funding for discretionary spending falls short by some 1.7% of GDP or 9% of total available spending.
In practice, the Indonesian government will square this circle in several ways, including by delaying the full implementation of both the health law and the village law. But note that we are being conservative in our estimates of what pol-icy requires when it comes to our category of discretionary spending. Indonesia needs to spend much more than 3% of GDP on infrastructure, especially when that amount includes maintenance. And, owing to a lack of data, we have not costed Law 40/2004 on Social Security, which obliges the government to establish health and labour insurance programs. As Armstrong and Rahardja (2014) explain, both these programs began in 2014 through the introduction of the National Social Security System (Sistem Jaminan Sosial Nasional), whose costs are expected to grow considerably.
For these reasons, the new president will, for several years, ind it dificult to restrict the deicit to 3% of GDP. Adhering to the 3% cap (which is important
for macroeconomic reasons) is a more realistic short-term goal than eliminating
the deicit. The president will need to increase the revenue-to-GDP ratio—at least
back to the average of the last 20 years, and then some: Indonesia’s ratio is low
compared with those of other lower-middle-income countries (IMF 2011, igure
2). He will need to implement a plan that will result in the elimination of fuel sub-sidies. He will have to decide which among a number of expenditure priorities are the most important (infrastructure, social assistance, or defence?). He would also be well advised to tread cautiously in implementing the legislated spending man-dates he will inherit, and to work with parliament to unwind current earmarking and avoid it in the future.
Indonesia has done well over the last ive or even ten years. But many chal
-lenges lie ahead. Fiscal reform is not an election issue, but it will no doubt emerge
as an overriding and unpleasant imperative for the new president.
REFERENCES
Allford, Jason, and Moekti P. Soejachmoen. 2013. ‘Survey of Recent Developments’. Bulletin of Indonesian Economic Studies 49 (3): 267–88.
Armstrong, Shiro, and Sjamsu Rahardja. 2014. ‘Survey of Recent Developments’. Bulletin of Indonesian Economic Studies 50 (1): 3–28.
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