Indonesia needs new development strategy

Indonesia needs new development strategy

David E. Sumual, Jakarta

In the past one-month, many economic discussions have focused
on two major external risks facing the Indonesian economy, namely
the possibility of aggressive interest rate hikes by the Fed and
the impact of higher oil prices on the government budget.
Meanwhile, a possible hard landing for China's economy might not
affect the country so much since the 4.7 percent share of
Indonesia's exports to China (in April 2004) could be deemed
insignificant.

These external threats coupled with excess liquidity and
political uncertainty in relation to the upcoming presidential
elections have put pressures on the rupiah and inflation,
prompting Bank Indonesia (BI) to take measures to absorb banks'
excess liquidity in the market.

Nevertheless, Indonesia might now breathe a sigh of relief as
oil prices have cooled off to around US$36 per barrel in recent
weeks.

The risk of U.S. inflation in May also appears to be in check.
As such, the transition to higher U.S. interest rates may also
happen at a measured pace with interest rates possibly only
rising by a quarter-point at the Fed's next meeting on June 30th.
Thus, business concerns over the possibility of higher interest
rates would also recede accordingly.

What is not well understood is why the rupiah does not seem to
be boosted by these encouraging developments given that it had
mainly depreciated on concerns relating to external risks. It
appears that the rupiah exchange rate in the short run is
influenced by market sentiment on political issues rather than
for economic reasons.

In other words, whatever happens, the political developments
surrounding the July 5 presidential elections would be the best
leading indicator of the rupiah, at least in the short run. As
such, concerns on the rupiah are overdone, as its value will soon
move back to its fundamental level as soon as the political
uncertainty recedes.

As macro stability alone is not sufficient, what is more
important is to give attention to some domestic structural
problems that may affect Indonesia's economic outlook in the
middle to long-term. As such, sustainable growth needs a policy
that is unreservedly committed to both domestic and foreign
direct investment (FDI).

The political leaders and the soon-to-be-elected president
thus should become aware of how to increase Indonesia's
investment competitiveness.

Developing an action program to improve Indonesia's
competitiveness should be the first priority of the next
government. Time is ticking given that Indonesia's competitors
such as China, India, Vietnam and Thailand are now developing
import-substitution industries, thus threatening the outlook for
Indonesia's exports. It would be no surprise then if Indonesia's
manufacturing exports fell in the years ahead as those countries
will no longer need the goods they now import from Indonesia.

According to the World Investment Report published by the
Economist magazine, world FDI will rebound by 31.2 percent to
$754.8 billion in 2004 after three consecutive years of declines.
Meanwhile, it is predicted that the global FDI inflows to
developing countries will increase 22.8 percent from $186.9
billion in 2003 to $229.6 billion in 2004.

Citing data from the Investment Coordinating Board (BKPM),
confidence in the investment climate continued to deteriorate in
the first four months of this year as FDI approvals plummeted by
30.6 percent compared to the same period last year to only $2.30
billion.

Foreigners have regrettably lost their appetite to invest in
Indonesia. Some of the problems include: Less-friendly government
policies, corruption, and rigidity in the labor market. The
rigidity in the labor market is caused, for example, by the
regional minimum wages that are hiked each year, outpacing gains
in productivity thus reducing the country's competitiveness. The
country's corrupt and unpredictable judicial system also remains
as a main obstacle to higher investment in Indonesia.

The latest example is an unfair ruling against the foreign
investor, Rowe Evans Plc, which had to return a $2.3 million palm
oil plantation because the executive who signed the contract in
2002 did not have the correct work permit. Despite the small sum
of money involved, the case will surely have a negative impact on
investor perceptions.

To tackle the investment problems, Indonesia should think a
strategy well beyond just the security, political and
macroeconomic stability. The main priority is to kick-start the
development of domestic infrastructure to improve national
productivity. Besides productivity, infrastructure investment
would also be important to improve national efficiency and reduce
the cost-push inflationary pressure by eliminating structural
bottlenecks as a result of the dilapidating infrastructure.

There is already evidence of severe infrastructure
deterioration in Indonesia. The decrepit road network that cannot
cope with the rise in traffic volumes, and the electric power
shortages are two main infrastructure problems in the country.
And according to the National Development Planning Agency, the
funds needed to upgrade the infrastructure network in 2005-2009
are huge (slightly more than $72 billion). As such, breakthrough
ideas -- for example, by creating infrastructure funds in the
stock market to attract new investment in infrastructure projects
-- are needed.

The soon-to-be-elected president should also identify the
country's indigenous strengths and adopt a dual-track development
strategy. In other words, besides enhancing the investment
climate by offering manageable levels of risk, the next
government should also focus on the development of skill and
resource driven SMEs (small and medium enterprises).

Such an initiative would strengthen Indonesia's microeconomic
structure, one of the essential factors to boost growth
sustainability. However, the real results of good strategy will
only come from strong political leadership that insists on
reforms and on meeting investor expectations in as many areas as
possible.

The writer is an analyst of Danareksa Research Institute. This
article is a personal view.