Reflections on the near-term economic outlook in Indonesia

David Jay Green, Jakarta

National elections and a change in government are a wonderful time for reflection and stocktaking and Indonesia's recent set is no exception. It is a useful, as well as a fun undertaking to try and identify the most important lessons of yesterday and guess the problems we'll face tomorrow. From the standpoint of the economy, one clear picture emerges: Indonesia has shown both stability and moderate growth for the past few years and most forecasts suggest more of the same.

This picture contains both good and bad news. Stability has meant that Indonesia has weathered a number of shocks over the past several years. The country has had to endure terrorist attacks in Jakarta, its financial and political capital; and also in Bali its center for tourism.

The country faced a fall-off in trade and travel due to international strife and also regional problems such as SARS and Avian Flu. The elections themselves, until fairly recently were a source of concern -- not all elections in such a large, developing country as Indonesia have gone as smoothly or as peacefully.

The robust performance with respect to these and other shocks has allowed Indonesia to put the 1997 Economic Crisis and the political upheaval of the end of the Soeharto regime firmly behind itself. Since 2001 the annual growth rate in GDP has risen from less than 4 percent to between 4.5-5 percent. This has allowed per capita income to rise and the incidence of poverty to fall. Millions of people have been made better off -- at least a little. This growth has come on the back of strong household and public sector spending.

It has not come alongside strong investment spending -- year after year, firms have failed to spend to open new plants or even to maintain old facilities. Currently, the investment-to-GDP ratio is nearly two full percentage points below its level in 2001.

Indeed, perversely this is one of the reasons the economy has been relatively stable: There have been so few investors that there has been no one to scare when shocks hit. While stability has been welcome, it has meant on average lower growth. More worrisome, potential growth is lower: Failure to invest in new plants, to buy new equipment, and to maintain existing facilities means that the economy will be limited in its ability to grow in the future. A lack of investment today, stunts growth possibilities tomorrow.

The reason for a lack of foreign investment is well known. Foreign investors, in particular, have been reluctant to risk new funds in view of the well-publicized problems in governance, in protecting their rights amid a corrupt and poorly functioning legal and judicial system. Any firm contemplating new investments is going to think of the experiences of Manulife and Prudential. Indonesian firms similarly have severely limited their new commitments over the past few years. They too worry about ensuring the safety of their investments.

The picture of a relatively stable economy with low investment has been quite clear for several years. During the election it has made for focused discussion on the need to encourage investment by improving governance. Arguably, it was the image of Susilo Bambang Yudhoyono as the candidate more likely to attack corruption that helped give him the victory.

Ironically, it may also be the election that makes it harder to see the economy in this fashion. It would not be unusual for an election such as this, bringing in a reform-minded candidate, after a long period of little investment that sparks a mini-boom in business spending. It would not take too much for many firms to increase their capital spending -- many businesses are likely to need to spend something just to keep their production facilities going.

The Asian Development Bank's 2004 Asian Development Outlook projected only a very modest increase in investment expenditures, supporting an overall 4.8 percent rise in GDP. If that investment spending increased to 10 percent, it would boost GDP growth by more than one full percentage point. A 10 percent increase in investment spending sounds large by recent standards, but it would still put business spending 20 percent below the levels seen in 1996 and 1997, before the Economic Crisis.

I am not saying we will definitely have this pickup in business spending; many things can combine to frustrate this. (Although if it does occur, remember where you heard about it first.) We can all dream up external or internal shocks that combine to lower growth. Missteps in monetary or fiscal policy, if they occur, could also be costly.

But if the "boomlet" does come, let us be clear that it does not reflect a resolution to the many problems Indonesia has been struggling with for the last few years. An economic boomlet that stands on a cyclical upswing in investment, encouraged by a calm election and prospects for reform, will be short-lived unless these reforms actually come about. When firms have accomplished their priority spending targets, when this higher spending works its way through higher household income and expenditures, growth will again slacken.

Only when palpable changes in the investment climate emerge will there be sustainable higher levels of spending and sustainable higher growth. A boomlet will give the Government some breathing room, but the longer-term reforms will still be needed to turn a boomlet into a period of prosperity.

David Jay Green is Country Director at the Indonesia Resident Mission in Jakarta of the Manila-based Asian Development Bank. The opinions expressed are those of the author and do not necessarily represent those of the ADB.