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Economy

The economic imperative of the next Indonesian president

It was already clear from the preliminary count that the results of Indonesia's April 9 parliamentary election hold crucial implications for the country's future.

     First, no single party gained sufficient votes to name its own candidate for the presidential election in July. That means the key parties will have to form coalitions and negotiate in order to name their candidates. Second, regardless of national leadership, without a clear majority, Indonesia's national parliament will remain fragmented.

     The numerous divisions in parliament from 2004 to 2014 resulted in a coalition cabinet and a weakened presidency. This helps explain why the government lacked the political will -- and strength -- to push ahead with crucial economic reforms. The result has been delayed infrastructure development, no reforms in labor market policy, and growing uncertainty surrounding investment policy.

     As Indonesia's economy chugs along, it seems to be choosing the path of least resistance. Until 2012, the country relied mainly on commodity exports in the real economy and capital inflows in the financial sphere. At the same time, the manufacturing sector went into a steady decline.

 

Feeling the squeeze

The recent global economic slowdown and impact of the U.S. Federal Reserve's decision to scale back its monetary easing program put strain on the Indonesian economy from early 2013. It became clear that it would become impossible to finance the country's current-account deficit with capital inflows. Hence there was a sharp drop in the stock market index and a sudden rise in government bond yields.

     At the same time, investment flows also dwindled. The Jakarta stock index fell from 5,200 in May 2013 to 3,900 in August 2013. The rupiah, which strengthened to 9,700 per dollar in February 2013, fell to 12,100 by December, while the benchmark 10-year government bond yield rose 3% between January and December 2013, according to government data.

     These pressures resulted in weakened market sentiment and a decline in gross domestic product growth from 6.5% in 2011 and 6.2% in 2012 to 5.8% in 2013. It also put pressure on the government budget. On the expenditure side, the government adjusted fuel subsidies in July 2013, driving up prices at gas stations and boosting the annual 2013 inflation rate to 8.4% from the previous two-year average of 4%, according to the government's Central Statistics Bureau.

     So far in 2014, however, amid increased demand for subsidized fuel and higher prices for Indonesian oil exports, subsidies have jumped back to pre-July 2013 levels. On the revenue side, in previous years the government relied heavily on natural resource extraction and mineral export taxes. With the decline in coal and crude palm oil prices, income from these sources has also dwindled. In 2008, income from natural resources accounted for 23% of all Indonesia's revenues. But by 2014, that figure had almost halved to 12%, according to Indonesia's Ministry of Finance.

     Other emerging-market economies facing the same global pressures have fallen back on their manufactured exports. Indonesia, with its relatively underdeveloped manufacturing base, cannot immediately do so. It clearly must revamp this sector in coming years.

     The nation's manufacturing sector has suffered from lack of investment and labor market rigidities. Government data shows that from 2008, the manufacturing sector grew at an annual rate of 4.7%, 1.3 percentage points below the GDP growth average of 6%, while growth in the trade sector was 6.7%. Meanwhile, finance and real estate grew at an annual 6.8% clip, and transport and communications expanded by nearly 13%.

 

The "commodities curse"

Another victim of the country's over-reliance on commodity exports has been the labor market. Indonesia has among the most rigid labor regulations of emerging economies. The high costs and difficulty of laying off workers have driven employers toward outsourcing, short-term labor contracts and underemployment. All the while, Indonesia's minimum wage has been raised repeatedly in the past few years. In 2013, for example, the minimum wage was raised 19%, much faster than inflation, which grew at 8.4%. In the past five years, the average rise in Indonesia's real minimum wage, after accounting for inflation, was 7.2%, among the largest in emerging-market economies.

     The rise in the minimum wage occurred without a commensurate rise in productivity. The result is an inefficient and anachronistic labor market and an outsize "informal" labor sector. A labor market survey by the Central Statistics Bureau in August 2013 showed that over 63% of the country's 110 million jobs in 2013 were informal, with no wage contracts or minimum conditions. The same survey showed that alongside 6.3% direct unemployment, 33% of adult workers were classified as underemployed -- that is, working less than 35 hours a week.

     To improve the livelihood of millions of Indonesians, the country needs sweeping labor reforms along with training programs to move workers into the formal sector.

     On the demand side, the country urgently needs a massive job-creation program, most of all in the manufacturing sector. This could begin with simple, agriculture-based processing and progress to larger-scale activities employing more capital with more complex technology. Exporting more manufactured goods would also help solve the current-account deficit problem.

     There are three main conditions necessary for drawing manufacturing investment: a more reliable legal framework with more streamlined regulatory requirements for manufacturing investment; an improved and simplified bank credit process to enable startups and small enterprises to acquire loans more easily and cheaply; and massive infrastructure investment, especially in transportation, energy and information technology.

 

Strong leadership required

The task of implementing widespread economic reform with a fragmented parliament requires strong executive-branch leadership. While a coalition cabinet may be inevitable under a presidential system, direction from the top should be clear and action readily taken.

     Ahead of the July presidential poll, all candidates should propose a detailed reform plan they would implement once in office. Given the limited time and resources, priorities must be established, and the focus should be on how urgent problems can be solved within a five-year presidential term. Some issues will certainly take longer, but a strong start to tackle them would boost confidence.

     Hopefully, by widely distributing such plans, the candidates will be able to shift voters' focus toward issues and possible solutions rather than the personal popularity of any given candidate.

     At the moment, Golkar, Indonesia's most established party, may be the only mainstream party with a fully developed, long-term economic framework that includes detailed policy targets. This is understandable given its experience and cadre of seasoned politicians.

     The Great Indonesia Movement Party (Gerindra), led by Prabowo Subianto, a presidential aspirant and former general, has published a comprehensive economic policy platform that emphasizes domestic production. But its relatively narrow focus on the domestic economy could be to the detriment of foreign investment and other pressing issues. Indonesia should be trying to achieve a balance between domestic and foreign investment, especially because the country has made binding international trade commitments, not least to the World Trade Organization.

     The Indonesian Democratic Party of Struggle (PDI-P), the third -- and until recently regarded as the most popular -- party has the least-clear program, emphasizing domestic economic sufficiency but at the same time unrealistically pledging to create a surplus government budget.

 

Personalities yield insights

The background and nature of the presidential candidates from these three leading parties also give important insight.

     Golkar's Aburizal Bakrie was previously a cabinet minister with economy and welfare portfolios. He is also a seasoned businessman who turned around the Bakrie Brothers Group empire, one of Indonesia's largest conglomerates, from near bankruptcy to a dominant position in several sectors. A key liability is his link through family companies to the Sidoarjo mud disaster, which has displaced local communities around the mud volcano in East Java since 2006. He has been repeatedly accused of not fulfilling promises to compensate all the victims.

     Prabowo Subianto, leader of Gerindra and a former special-forces commander, heads several businesses, mainly in mining and agriculture. His main disadvantage is persistent accusations of human-rights abuses that occurred under his watch in the military, particularly in the last few years of his military career.

     Jakarta Gov. Joko "Jokowi" Widodo is the PDI-P's presidential candidate. A former mayor of Solo, a city in Central Java, he has the least experience among the three leading candidates but is the most popular. Jokowi's particular handicap is his lack of experience at the national level, let alone on the international stage.

     Among the most complex domestic challenges are serious issues over the role of such provinces as Papua and Aceh. Also, stalled negotiations over rights to natural resources and the government's recent controversial ban on raw mineral exports will require a seasoned leader to navigate between the country's best interests and conflicting whims of the market and global investors.

     To nominate their presidential candidates, the three main parties will need to form a coalition, either among themselves or with smaller parties. But as the elites play their games, the process of formulating and then selling their programs to the people will be important for two reasons. The first is to show readiness and ability to act quickly when the winner gets into office. The second is to educate Indonesians to demand good and implementable plans, instead of picking candidates merely on popularity.

 

Kahlil Rowter is an economics lecturer at the University of Indonesia and chief economist at Bakrie Global Ventura. He is also an adviser at Indonesia's Ministry of Finance.

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