Investment in Indonesia: What is holding back recovery?<\/p>\n
David Jay Green
\nCountry Director
\nAsian Development Bank
\nJakarta
\ndgreen@adb.org<\/p>\n
Indonesia is having tremendous difficulties convincing
\ninvestors, either foreign or Indonesian, to commit their funds
\nfor the long-term. A host of problems, ranging from political
\nuncertainty and insecurity to a still weak banking sector
\ndiscourage people from building new plants and buying new
\nequipment. Some change is occurring -- a messy process of reform
\nis producing some progress that, if sustained, could lure
\ninvestors back to this huge, sprawling country.<\/p>\n
Most adult Indonesians grew up in an economy very different
\nfrom the one they face today. Most importantly, they were
\naccustomed to an economy that grew substantially each year. There
\nwere difficult periods, but for decades average gross domestic
\nproduct and average income rose, and the incidence of poverty
\nfell. For most Indonesians, this world came to an end in 1997
\nwith the East Asian Financial Crisis.<\/p>\n
True, the Indonesian economy is still growing about 3 percent-
\n4 percent each year and that is better than in many countries.
\nBut it isn't like the old days. Importantly, it won't rescue many
\nfamilies from poverty. At 3-4 percent growth, with the population
\ngrowing 1-2 percent each year, average incomes are rising only 1-
\n3 percent annually. This is better than nothing, but not always
\nnoticeable in a country where much of the population lives so
\nclose to the poverty line that illness or bad weather can push
\nthem under.<\/p>\n
One reason growth is sluggish is that investment is running
\nfar below levels in the mid-1990s. From 1988 to 1997 investment
\ngrew 168 percent, helping GDP nearly double. In 2002, while GDP
\nhad recovered to within 2 percent of its 1997 peak, real
\ninvestment was nearly one-third below the 1997 value. While one
\nshould not be overly nostalgic for the late 1990s -- growth then
\nhad many of the characteristics of an unsustainable speculative
\ninvestment bubble. However, current purchases of new business
\nequipment and the building of new plants by private or state-
\nowned firms are too small to generate income, jobs, or higher
\ngrowth.<\/p>\n
Why are investors so cautious? Three broad sets of problems
\nare hindering commitments by local and foreign investors:
\nConcerns over peace and security, weak banking and financial
\nsectors, and the cost of poor governance -- especially
\ncorruption.<\/p>\n
First, there are the headline grabbing problems of peace and
\nsecurity. The financial crisis in Indonesia was not just a period
\nof economic difficulties. The crisis was a trigger for wide-
\nranging political changes that moved to reverse decades of
\nauthoritarian rule. Understandably these changes are not smooth.
\nThe recent terrorist attacks in Bali have heightened the
\ninternational impression that personal security is an issue in
\nIndonesia and have surely discouraged foreign business interests
\nin the country. But security is not just an issue for foreigners.
\nLong-running conflicts in Aceh, the Moluccas, and other areas
\nhave kept Indonesians from making long-term investments in their
\nown country.<\/p>\n
The second set of problems rests in the weak banking and
\nfinancial sectors. The financial crisis was partly a failure of
\nthe banking system to operate on commercial principles. Before
\n1997, investment in Indonesia was typically financed by bank
\nloans -- often supplied by institutions that were little more
\nthan captives to larger industrial groups. The decision to loan
\nwas often made on the basis of non-economic considerations,
\nsometimes simply on the assumption that politically well-
\nconnected investors or contractors would not lose money.<\/p>\n
But now firms that blithely bought into projects touted for
\ntheir political connectivity are looking for robust returns and
\nexamining project-related risk. This new environment requires a
\nstrong financial system. But in Indonesia the banking system is
\nstill quite weak. Rescue efforts effectively nationalized the
\nmajor part of the banking sector. Fragile balance sheets continue
\nto discourage aggressive loan expansion.<\/p>\n
The third obstacle blocking investment is a new appreciation
\nof the costs of poor governance, especially corruption and
\nweaknesses in the legal and judicial system. International
\nsurveys rank Indonesia as facing one of the world's most severe
\ncorruption problems. Any reader of this newspaper has seen
\nstories of judicial shakedowns in Indonesia and anyone currently
\noperating in the country knows how difficult it is to avoid
\ncompromising oneself to get things done. Though often discussed
\npurely in moral terms, corruption in Indonesia is systemic,
\nreflecting problems with courts and the police and the need for
\ncivil service reform.<\/p>\n
Before the crisis it was common to excuse corruption and
\nassociated problems as a cost of business, one that bought the
\naccess to power and privilege that ensured success. But there has
\nbeen a reassessment. Across East Asia, especially in those
\neconomies hit by the crisis, investment has held up better where
\ncorruption is not seen as a massive problem. Corruption now
\nappears to be one of the more serious barriers to business
\noperations, particularly new businesses.<\/p>\n
All these problems require solutions. Restoring business
\nconfidence is likely to be a long-term process. But business
\nshould not disregard the real progress being made in Indonesia.
\nThe government has had signal success in bringing down inflation,
\nstabilizing the currency, meeting budget targets, and curbing the
\nimpact of the large public sector debt that is a legacy of the
\ncrisis. Without these efforts, the economy would still be in
\nrecession.<\/p>\n
Improving security, strengthening the financial system,
\ncleaning up the courts, revamping the police forces, and reducing
\nthe perception of corruption will take years. In each area
\nefforts are under way that can contribute to longer-term
\nprogress. There has been a recent peace accord in Aceh and banks
\nare being privatized. Anti-money laundering legislation was
\npassed. If these efforts can continue, if some dent can be made
\nin the perception that corruption is pervasive, then we will see
\npeople again willing to commit their funds to Indonesia's future.<\/p>\n
The opinions expressed are those of the author and do not
\nnecessarily represent those of the ADB.<\/p>",
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