2006 - Building for the future

2006 - Building for the future

David O'Brien
Jakarta

Next year should mark a period of consolidation for the
Indonesian economy. In the wake of the tough decision to reduce
fuel subsidies and subsequent price increases, domestic demand is
likely to remain somewhat weaker. This is not necessarily a bad
thing.

The economy was exceedingly dependent upon the consumer, with
estimates of this sector driving 80 percent of economic growth.
Malls have been constructed at a pace that outstripped demand and
consumer debt has been increasing at an unsustainable rate. In an
era of easy credit, consumers remain poorly educated about the
true cost of "paying with plastic". With monthly interest rates
in the region of 3 percent, one may be better off borrowing from
Tony Soprano.

There has been recent central bank intervention requiring a
minimum 10 percent repayment of monthly outstanding balances.
While companies remain driven by market share, it may be too easy
for a card holder to obtain another card to pay the 10 percent
balance and so on.

This is the scenario which occurred in Korea. Consumers tired
of the austerity since the 1997 crisis went on a spending spree
when interest rates fell around 2000. This lasted until late 2003
when the bubble burst and there was a subsequent huge contraction
in consumer spending. Thailand has recently instituted measures
to curb some marketing "over enthusiasm" in relation to less well
educated consumers. In Indonesia it may be the less expansive
bubble is gently deflated as rates rise to middle of 2006 and
people are reminded about "easy" money.

In a broader economic context, too many uncertainties remain
in the global economy to refocus the spotlight on Indonesia in
the forthcoming year. Global opinion remains obsessed with the so
called "Chindia" phenomenon at the moment. With an average 9
percent and 7 percent annual growth rate for China and India
respectively for the past four years, they are likely to remain
the at the top of the global investment radar for the moment.

Eyes will also remain focused upon the ongoing record current
account deficit in the U.S. and how it is sustained. Will foreign
investors continue their demand for U.S. assets and thus keep the
dollar strong (and their currencies weak to foster
competitiveness) or will interest rates have to rise to continue
to attract investment to cover the deficit. Such interest rate
rise will have a major impact on consumer sentiment that has been
fueled by asset inflation rather than price inflation over the
last several years.

With all this going on in the world, Indonesia has an
opportunity to work out of the spotlight in executing micro
economic reforms. A number of commentators wrote in The Jakarta
Post in November of the necessity for ongoing implementation and
successful execution of reforms in regulation to match the
President's vision.

This is where things can be put right to make a difference to
the investment climate. The broad brush epithets, global road
shows and infrastructure summits will not work unless the
underpinning rules and regulations are in place.

The outline of the vision of where the country will be
economically in three to five years could be better articulated
in parallel with the steps necessary to get there. These steps
can be delegated to ministers in order that there are clear
indicators which they can be measured against.

Such an allocation of responsibility may also allow for a re-
assessment of the number and type of ministries and allow for a
lesser number of better directed ministries. The present number
of ministries often seems to be at cross purposes and often act
as a counter weight to reform measures.

To improve the investment climate the aim should be
transparency, equality and simplicity. This needs to be the case
for both foreign and local investors. The small business sector
which remains engine of growth through innovation should not be
forgotten. It often seems that reform measures being undertaken
remain focused upon the "top end of town".

There seems to be an emphasis paid to foreign direct
investment (FDI) as a panacea. However Indonesia does not lack
for domestic capital. For example the last year has seen
predominately family companies in Sampoerna and Risjadson reap
billions of dollars in selling their domestic businesses at very
full prices.

These cash rich companies are struggling to find appropriate
new projects for their capital. Legal uncertainties, rent seekers
and the high cost economy remain serious impediments to be
overcome to promote Indonesian investment locally as well as
globally.

From the FDI perspective, Western countries are unlikely to
rush back next year. The herd mentality associated with other
investment destinations will dominate. FDI will continue to be
dominated by Asian investors.

Chinese demand for resources and particularly resource
companies to mitigate their price risk exposure will remain
strong. Japan and Korea are likely to remain active investors in
the manufacturing sector. Malaysian and Singapore investments are
likely to continue in infrastructure and service based industries
where they feel they have outgrown their domestic market.

The Asian tiger economies were built on speculative capital
inflows and lacked an associated reform program to address the
deeper competitive issues of operating in the global economy. If
such reform can be instituted there is a bright future for
Indonesia, building upon its inherent competitive advantages with
a mixture of wealth in both natural resources and its human
resources.

The extent to which business is deterred from innovation is
highlighted in charges for broadband access. Where it is
available, the charges for a 2 Mbps connection are 48 times more
expensive than India. International connection to the internet is
at a level 3.5 times the Indian price. For innovation to thrive
and meet world markets, communications are too important to be
subject to non competitive tariffs.

For a country so blessed with natural resources, a sustainable
approach based on developing skills at the local land owner level
could be better promoted. The agribusiness sector seems sadly
neglected in Indonesia, unless discussing palm oil or pulp and
paper with their questionable credentials for sustainability.

By way of example the Post of Nov. 29 reports that there is a
large potential for salt production in East Nusa Tenggara which
could offset imports of nearly 2 million tonnes a year. The same
edition of the paper detailed that fishery exports were likely to
be 50 percent below the level forecast for 2005, somewhat
attributable to quality control issues. Indonesia severely lags
Thailand as an exporter of fresh fruit. In most cases the
limiting factor in innovation seems to be getting market
information to producers.

Earlier in the year I wrote about the potential to adapt the
Indian success in installing internet access at village level in
an Indonesian context. Access is provided by solar power and
satellite and a member of the community is trained to operate and
teach. The web access includes a portal that shares information
for farmers on pricing along with sourcing raw materials,
maximizing yields and other technical matters.

With the Community Service Obligation (CSO) now being
collected by the telecommunications operator, it would be an
excellent time to establish a broader program with content
applications. Modern wireless technology is ensuring the costs to
serve remote areas are falling rapidly and a mix of CDMA coverage
and satellite is an option to develop a program similar to
India's.

In the immediate term there are a number of implementing steps
to be undertaken at ministry levels to improve the investment
process by ensuring transparency, equality and simplicity.
Accountability needs to be instilled to aid the execution. In the
longer term thought needs to be given to further reforms
promoting innovation to leverage the country's wealth. This
includes reform of inefficient industries to optimize new
infrastructure developed.

The writer is a technical advisor at CSA Strategic Advisory.
CSA helps businesses through a combination of "soft" behavioral
and "hard" financial advice. He can be reached at
dobrien@csadvisory.com.