Tue, 15 Dec 2009
From: Reuters
JAKARTA, Dec 15 (Reuters) - Indonesia has emerged
remarkably strongly from the global economic crisis, but hopes
among investors that the government would quickly push through
reforms have been dented by controversy over corruption.

Following is a summary of key Indonesia risks to watch:

* CORRUPTION AND GOVERNANCE

Corruption has emerged as the defining issue for Indonesia
at the start of the second term of President Susilo Bambang
Yudhoyono, with popular anger mounting over a power struggle
between the respected Corruption Eradication Commission (KPK)
and the police and attorney-general's office. The KPK has made
significant progress in investigating corrupt officials, but
this has stirred powerful opposition. The state prosecutor has
dropped a case against two top anti-graft officials who were
apparently framed by officials in the police and
attorney-general's office, removing one flashpoint for tension,
but Yudhoyono has so far appeared cautious about taking more
decisive action to end the feud and press ahead with decisive
reforms.

Key issue to watch:

-- Pace of reform of Indonesia's civil service, police and
courts. Yudhoyono's cautious response to the power struggle
over the KPK suggests he will move much slower than markets had
hoped, confirming his reputation for preferring gradual change
to bold, sweeping reform. Investors betting on more decisive
reform during Yudhoyono's second term have had to adjust their
expectations.

-- Investor perceptions of progress in tacking corruption.
In Transparency International's 2009 Corruption Perceptions
Index, released last month, Indonesia's ranking improved to
111th out of 180 countries from 126th the previous year. But
recent events may cause investors to re-evaluate their
optimism.

* GOVERNMENT EFFECTIVENESS IN DRIVING REFORM

Yudhoyono, returned to a second term after a decisive
election win in July, is widely regarded as a progressive,
market-friendly reformer. Many investors hoped that his second
term would see a faster pace of reform, and hopes were raised
when he announced a cabinet in October that included top
technocrats Sri Mulyani Indrawati and Mari Pangestu in the key
economic posts, with a new presidential delivery unit headed by
Kuntoro Mangkusubroto and another technocrat, Boediono, as vice
president. But so far, the evidence suggests his second term
will, like the first, move slowly in implementing reform.

Controversy over the bailout of a small bank last year may
also damage reform prospects. Parliament said last week it
would investigate the bailout of Bank Century, which had been
backed by Indrawati and Boediono. Local media have reported
that among the bank's depositors were several wealthy
businessmen who later donated money to Yudhoyono's re-election
campaign. The president, vice president and finance minister
have all denied wrongdoing, saying that the bailout was crucial
to maintain confidence in the financial system as the global
credit crisis struck.

Key issues to watch:

-- Developments in Bank Century case. The main risk at this
stage is that the case will distract the government from
policymaking, and damage the reputations of Indrawati and
Boediono, key pro-market members of the government. Analysts
say that for the moment, there appears little risk that they
could be forced to resign, or that Yudhoyono could face
impeachment. But powerful vested interests could try to use the
issue to force the government to go slower on economic reforms.

* HOT MONEY AND CAPITAL CONTROLS

The rupiah IDR=, Asia's best performing currency, has
appreciated by around 16 percent this year and the central bank
is concerned about destabilising "hot money" inflows. Last
month the senior deputy governor said Bank Indonesia was
studying the possibility of curbing foreign ownership of its
short-term debt. Signs that capital controls are becoming more
likely could spur some investors to take profits after the
year's strong rally in Indonesian assets.

Key issues to watch:

-- Comments from officials on the threat from hot money.
Officials have played down the prospect of curbs in the short
run, but if they change their tone, some investors will be
scared off. Analysts say that Indonesia's pro-market officials
are unlikely to introduce any drastic measures, however, and
any tightening of capital controls would most likely be mild.

* SECURITY

Suicide bombings at two luxury hotels in Jakarta in July
were the first major terror attacks in Indonesia since 2005 and
raised concerns that the threat from militants was again on the
rise. The killing of Noordin Mohammad Top and other key figures
-- including the man who recruited the two suicide bombers for
the attacks in July -- may significantly reduce that threat.
Analysts warn, however, that other dangerous militants remain
at large and further attacks cannot be ruled out.

Key issues to watch:

-- Ability of the militants to regroup and launch more
attacks. Opinions vary on whether Top was leading a beleaguered
and shrinking team or whether he had managed to attract
considerable new manpower, funding and weaponry over recent
years. Police say there are signs some of Top's funding was
coming from overseas. If the group managed to establish firm
enough links with al Qaeda to secure sustained funding,
expertise and recruits, the threat may be far from over.

* OVER-RELIANCE ON YUDHOYONO

Many analysts worry that Indonesia's recent progress
towards greater political and economic stability has been very
reliant on the personal popularity and power of Yudhoyono. If
anything were to happen to him, much of Indonesia's recent
gains could unravel. He has no obvious successor with the
support base and drive to continue the reform process. And if
popular anger over corruption and the Bank Century issue
significantly undermine his popularity, the perception among
investors that Indonesia's political stability has greatly
improved would be threatened.

(Compiled by Andrew Marshall and Sara Webb)



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