Part 1 of 2: When will investors give RI a break

Part 1 of 2: When will investors give RI a break

Sisira Jayasuriya and Chris Manning, Canberra

The recent announcement by the Investment Coordinating Board
Chairman that foreign direct investment (FDI) was down by one-
third in the first half of 2004 is hardly news these days (The
Jakarta Post, July 15). It is just further confirmation that
investors continue to shun Indonesia, one of Asia's proud,
"tiger" economies until the 1997 Asian Economic Crisis.

There is a widespread misconception that while the neighboring
Asian countries have successfully pulled themselves out of the
1997 crisis, Indonesia remains in a perilous state, both
politically and economically.

Both domestic and foreign investment is depressed. Gross
domestic investment -- at less than 20 percent of GDP - is among
the lowest in Asia, and capital outflows continue to
significantly outweigh inflows, as they have for every year since
the fall of Soeharto in 1998. Consequently, Indonesia is mired in
a low investment -- low growth trap.

Without underestimating the major challenges and problems
confronting Indonesia, we believe that widespread perceptions
about its political and economic conditions are based on a
superficial understanding of the political economy of
development. Unfortunately misplaced international perceptions
seem to have permeated the psyche of the domestic business and
policy elite, discouraging both investment and bold initiatives.

In terms of most indicators of political and economic
stability, Indonesia actually compares quite well with its
neighbors, or with India, with which it shares many important
similarities. When considered in the context of the economic and
political problems it faced after the 1997 crisis, from an
international perspective much has been achieved.

The casual outside observer, informed mainly by the
international media, could hardly be blamed for assuming that
Indonesian news has been almost entirely a story of internal (and
international) strife since the downfall of Soeharto.

This dismal picture has been bolstered by reports of about the
ineffectiveness of President Megawati Soekarnoputri, the lack of
central authority and instances of policy indecisiveness.
Jakarta, it would seem, has lost control over the far flung
provinces and districts, particularly after the decentralization
law brought in January 2001.

But a focus on these issues misses the bigger picture. First,
lets consider political reform. From decades of authoritarian
rule under the Soeharto, Indonesia achieved an almost bloodless
transition to a functioning democracy, confounding most analysts
who had predicted widespread violence.

And, it is no mean feat for a country of around 220 million,
most of whom have no experience of ever voting in a free
election, to have maintained a climate of open debate and a
functioning democratic regime for 5 years, and hold a largely
peaceful and, by developing country standards, relatively clean
presidential election which has seen the incumbent president
accept a situation where she has been beaten into second place in
the first round.

The Indonesians have demonstrated a political maturity and a
commitment to democratic processes and institutions that compare
favorably with countries with much longer histories of democratic
rule.

Second, what about economic recovery? On the economic front,
too, Indonesia's steady but unmistakable recovery from the depths
of the financial and economic crisis has received less credit
than it deserves.

The exchange rate has been stabilized at around Rp 9,000 to
the U.S. dollar, from Rp 10,000 in 2001; indeed the currency has
appreciated by some 10 percent relative to its neighbors in the
last 3 years.

On the domestic front, public debt has been drastically
reduced, to less than 70 percent of GDP from 140 percent in
1998/99; on the external front, overall foreign debt -- of which
public debt is around half -- is down to around 60 percent of
GDP. Inflation has been brought down to 5 percent - figures in
June suggested it may be as low as 3.3 percent, and interest
rates have also fallen.

Of course major problems remain, with weaknesses in financial
systems, and concerns about corruption high on the list. But
perhaps the one essential difference between Indonesia and its
neighbors is in their growth performance.

Indonesia's GDP growth (according to IMF sources) was 4.1
percent in 2003 and likely to reach 4.8 percent this year. It is
certainly below what its crisis affected neighbors have managed
to achieve in recent years (like Thailand, which returned to its
pre-crisis per capita income in 2002).

But even here the differences can be easily overstated.
Contrary to common perception, the average GDP growth rate of
Indonesia over the three years 2000-2002 at 4 percent actually
exceeded, though marginally, that of Thailand.

Thailand has really only pulled ahead only since last year,
when it grew at 4.8 percent compared with Indonesia's 4.1
percent, while Thailand's 2004 growth is projected to be as high
as 7 percent. The key to this difference in growth performance is
investment: Thailand has started to attract investment while
Indonesia has not.

Similar comparisons can be made with other countries, such as
India or Vietnam. There are no persuasive reasons for arguing
that short or even longer term prospects for investment in
Indonesia are significantly worse than in India, or Thailand or
Vietnam. On most counts Indonesia offers an investment climate
that is at least as good, if not better.

Take the overall level of policy liberalization. Indonesia had
achieved quite significant economic reform by the time of
Soeharto fell in 1998, and these reforms have remained in place
in the post-Soeharto era.

Despite the widespread application of minimum wages and the
dinosauric, new labor law, labor markets remain more deregulated
in Indonesia, compared to India where restrictions on firing and
bankruptcies are significantly stronger. And, Indonesia has no
equivalent to the entry barriers placed on many key industries,
such as garments, which are reserved for small scale enterprises
in India.

When it comes to government interventions in industry,
Indonesia is surely no worse than India, Vietnam, or even
Thailand, where Prime Minister Thaksin's government has a well
earned reputation for frequent interference in economic affairs,
to the detriment of competition and at the expense of independent
private investors.

What about political stability and institutions? Again,
Indonesia is not a "basket case" by any means. It is true that
India, for example, has had a much longer history of democracy, a
seemingly better functioning legal system and a more established
bureaucracy inherited from the British. But is the government
more stable or is the general "law and order" situation much
better in India?

Today's Indian government is an unstable alliance of 12
parties, and depends on Communist parties that remain outside the
government for a parliamentary majority. True investors
recognize that policy stability has stronger roots, given broad
consensus within the mainstream parties about the economic policy
agenda.

Similarly, it is also not obvious that India is safer haven
from "terrorist" threat, given India's history of frequent
regional, ethnic and religious conflicts and terrorist incidents,
including almost daily reports of bombs and deaths in Kashmir.
With regard to legal institutions India probably has a clear
advantage over Indonesia. But Indonesia's legal institutions are
hardly much worse than in China until recently or in today's
Vietnam.

Sisira Jayasuriya is Director of the Asian Economics Center,
Department of Economics, University of Melbourne, and Chris
Manning is Head of the Indonesia Project, The Division of
Economics, Research School of Pacific and Asian Studies, the
Australian National University).