Tue, 24 Nov 2009
From: Asia Times
By Fabio Scarpello
JAKARTA - Indonesian President Susilo Bambang Yudhoyono is widely expected to use his strong electoral mandate to push reforms in his second term to attract foreign investment. But the re-elected leader's first 100-day plan is already raising concerns that much-needed liberalization measures may be slow in coming.

Greater foreign direct investment (FDI) will be pivotal to Yudhoyono's stated goals of achieving 7% gross domestic product (GDP) growth and substantially reduced poverty and unemployment rates by the end of his term in 2014. World Bank data shows that over half of the country's 240 million people live on less than US$2 a day and that roughly 40 million people are unemployed or underemployed.

Indonesia will need at least $200 billion in spending each year to accomplish Yudhoyono's vision of faster growth, lower poverty and higher employment, according to government estimates. The government's budget as currently designed will contribute only 15% of that total, meaning that the rest will have to be raised from local and foreign investors.

Last year, Indonesia attracted FDI worth almost $15 billion, representing over 80% of the country's overall 154 trillion rupiah ($17.1 billion) in total investment, according to the government's Investment Coordinating Board (BKPM). That marked a significant rise over the previous year, when foreign inflows amounted to $10 billion.

Some analysts believe the past two years of relatively robust foreign capital flows have marked a positive turning point for the economy, which a decade later still faces lingering effects from the 1997-98 Asian financial crisis. At its height, that crisis saw GDP contract by 13%, the local currency plummet to 17,000 rupiah to the US dollar from around 2,000, and ratings agencies downgrade sovereign long-term debt to junk bond status.

Recapitalization of the banking system has deprived budgetary outlays of badly needed investment in infrastructure as well as health and education. The cautious recovery in foreign investment has been widely attributed to Yudhoyono's reform agenda, but doubts about his new government's direction are already emerging.

During his first term, Yudhoyono was credited for restoring political stability to the often volatile archipelago, which some feared would disintegrate after the 1998 downfall of former strongman Suharto. Under Yudhoyono, Indonesia's democratization process has surged ahead, including through decentralization of power to provincial administrations.

Moreover, his economic managers have presided over sound fiscal policies, which have contributed largely to the country's improved economic and financial indicators. Jakarta has been running a budget deficit of around 1% of GDP over the past three to four years, well below the legally mandated limit of 3%.

In 2008, the deficit was a mere 0.1% of GDP, while in 2009, in fiscal response to the global crisis, the deficit was in line with global trends raised to 2.5% of GDP. With clear signs of economic recovery, the deficit is expected to be pared back to around 1.6% in 2010. This all means that total government debt is now down to around 30% of GDP, a massive improvement from over a decade ago when the country was technically insolvent.

Sound macroeconomic management has stabilized the national finances and fostered growth of 6.2% in 2008, despite the global crisis that has driven many regional economies into negative growth territory. GDP growth is expected to hit 4% this year and 5.5% in 2010, according to government estimates. The International Monetary Fund has more conservatively projected Indonesia's growth will hit 4.5% next year.

Stability and growth have contributed to Indonesia's improved FDI prospects, despite the slow pace of actual reforms and lingering concerns about corruption and governance. Yudhoyono's stated commitment to fight corruption had won investor plaudits, though a recent controversy surrounding an alleged official plot involving senior police and the attorney general's office officials to undermine the quasi-independent anti-corruption commission has brought his intentions under new scrutiny.

Indonesia's ranking in Transparency International's Corruption Perception Index has improved to 111th out of 180 countries this year from 126th place last year and 143rd out of 179 countries in 2007.

Meanwhile investors often cite the 2003 Labor Law as an impediment to their operations, due in part to difficulties in laying off redundant workers. The lack of labor market flexibility has driven many investors to China, India and Vietnam.


Reform resistance

Yudhoyono has demonstrated a strong grasp of what needs to be done to attract more foreign capital, including substantive legal reforms. But his sometimes over-cautious approach and until now a resistant parliament has mitigated against the passage of relevant reforms during his first five-year term.

For instance, strong opposition from the Megawati Sukarnoputri's PDI-P and Islamic parties contributed to a watering down of provisions in the crucial 2007 Investment Law, including the maintenance of the Negative Investment List of business sectors closed to foreigners. Reform proponents complained after the law's passage that its provisions were too vague and lacked specific benefits for foreign investors.

Similar complaints attended the 2009 Mining Law, which included several nationalistic measures, including mandatory divestments over set periods of time and the legal obligation for foreigners to use national companies as contractors unless a clear need existed for hiring a foreign one. Yudhoyono's attempts to amend the 2003 Labor Law, which includes measures that make it difficult and costly to fire redundant workers, met strong opposition in the form of street protests from labor unions that forced him to backtrack on proposed reforms.

Meanwhile opposition from both the PDI-P and Golkar parties meant that badly needed institutional reforms, including over the civil service and judiciary, perennial areas of complaint among investors, saw little, if any, change. Yudhoyono had promised to achieve fundamental reform of the bureaucracy by 2011, but of five relevant bills up for discussion, only the Public Service Law has been endorsed by the House of Representatives.

Yudhoyono's Democratic Party notched a strong victory at the April legislative elections and with his coalition partners now commands a near 70% majority in parliament. Yet his recently announced 100-day plan was notable for its numerous political concessions to anti-reform elements, both inside and outside his coalition.

Conspicuous in their absence were any major reform plans for the notoriously corrupt and inefficient bureaucracy and judiciary, both strongly resisted by Golkar, as well as the urgent need to make the labor market more investor-friendly, which is opposed by Islamic parties and unions.

The fast-track plan includes 15 priorities, the first elements of a longer list of 45 priority areas to be announced later as part of his five-year plan. The top three priorities of the 100-day plan include taking on a so-called "court mafia", revitalizing the defense industry and bolstering counter-terrorism measures.

In terms of measures that would improve the investment climate, Yudhoyono placed to "develop infrastructure" at number eight on his list and the vaguely worded "financing investment and development" at number 10. No details were provided about how the government would pursue either objective.

Investors are thus expected to take a wait-and-see approach before ramping up new commitments to Indonesia's vast internal markets and huge store of untapped natural resources. Many remain wary of the economy's structural flaws and poor governance that often make doing business here a high-stakes gamble.

Yet the domestic market prospects are promising. According to the United Nations' World Population Prospects 2008, Indonesia's population will by 2050 reach 288 million, with as much as 64% of the population of working age. The country is also quickly urbanizing, with 54% of the population already living in cities and towns, a trend that is expected to accelerate.

Indonesia's per capita GDP stands at around $2,000 - twice as high as India - and is expected to reach $6,200 by 2018, according to Business Monitor International, a private outfit that provides business intelligence, analysis and forecasts. Despite these low levels, private consumption already accounts for 65% of GDP and is the country's main economic growth driver.

Indonesia is the world's second-largest producer of tin, the fourth-largest producer of copper, the fifth-largest producer of nickel, the seventh-largest producer of gold and the eighth-largest producer of coal, according to the the country's Investment Coordinating Board. The country also is believed to have a significant amount of underexploited or untapped reserves of oil and gas.

This production potential is greatly undermined by frequent power outages, transportation failures and inadequate water supplies in nearly every Indonesian city and province. Much of the blame lies with the government: according to a 2007 World Bank estimate, Indonesia's investment in infrastructure amounts to only 3% of GDP, while competitors in the region for FDI, such as China and Vietnam, are investing around 10%.

Despite being recognized as Asia's most active business regulation reformers in 2008/2009, Indonesia remains a "difficult" place to do business, according the recently published "Doing Business 2010: Reforming through Difficult Times", the seventh in a series of annual reports published by the International Financial Corporation.

The report ranked Indonesia at 129 out of 181 countries in terms of the overall "ease of doing business" - below the ranking of regional competitors Vietnam, Thailand, China and India. Turning those negative investor perceptions positive will be crucial to the success of Yudhoyono's second term.

Fabio Scarpello is the Southeast Asia correspondent for Adnkronos International. He may be contacted at fscarpello@gmail.com



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