Asia Sentinel
23 September 2008
Indonesia's Poverty Trap
LISA MURRAY
It's an economic cliché, but as the rich get richer, this country's poor keep
getting poorer
The tragic loss of 21 Indonesians who were trampled to death as they jostled
outside a house in East Java to receive a cash handout of just 30,000 rupiah
(US$3.20) has shocked the nation and exposed the plight of its poorest
citizens.
Politicians were quick to dismiss any link between the country’s chronic
poverty problem and last week’s tragedy, citing a drop in the official poverty
rate last year to 16.6 per cent from 17.8 per cent the previous year.
But that is a fairly meaningless statistical improvement to the more than 19
million Indonesians who still live on less than US$1 a day. Moreover, almost
half of the country’s 225 million people live on less than US$2 a day.
Rising food and fuel prices this year have hit hard for the bottom third of
households, which spend 65 per cent of their income on food and drink.
If Indonesia wants to significantly reduce its poverty rate, the Organisation
for Economic Cooperation and Development says that its economy needs to grow at
least 8 per cent a year.
But that is looking virtually impossible for the next few years. Rising
inflation, a sliding rupiah and the breakdown in world financial markets are
already threatening this year’s expected growth rate of 6 per cent.
And some economists are predicting a significant slowing next year, with HSBC
forecasting growth of just 4.9 per cent.
While that’s below most analysts' expectations it is a real possibility given
that Indonesia’s economy is driven by domestic spending and interest rates have
risen by 1.25 percentage points since May to 9.25 per cent, with more rate
rises to come.
"That [forecast] is really reflecting our feeling that the rate increases will
feed into the economy at that time," says HSBC senior economist Robert
Prior-Wandesforde.
"It’s a double-whammy of weaker exports and higher interest rates."
The man with his hands on the lever, new central bank governor Boediono, is
confident Indonesia can overcome current challenges.
"It’s as if we are on a boat amidst stormy seas," he told reporters last week.
"We have to stay calm, controlling the boat as best we can until the swings
subside and we can see a better direction. The point is our boat is in good
shape."
He does have a point. Indonesia’s economy grew at a surprisingly robust 6.4 per
cent in the first half of the year as companies raked in profits from selling
coal, gas and crude palm oil to China, India and Japan, amid record spending by
local consumers on everything from mobile phones to cars. Foreign investment
also surged as high commodity prices tipped the risk-reward ratio in investors’
favour and followed positive government reforms including an easing in rules
for expats and a new regulation that will cut the corporate tax rate from 30
per cent to 25 per cent by 2010.
But in the last few months commodity prices have been dropping from their
highs, hurting investor sentiment and leaving Indonesia even more vulnerable to
a fall in domestic spending.
"In the last two months, commodity prices have fallen and the hot money has
left the country," presidential candidate and former finance minister Rizal
Ramli told foreign journalists in a panel discussion this month.
"There will be a correction. And the only adjustments that can be done are on
domestic interest rates. If you want to stabilise the macro-economy you need to
raise rates. But that will have a significant impact on investment and job
creation."
The problem for Indonesia is that when financial markets are in turmoil,
investors look to lower their risk profile and emerging markets bear the brunt
of that swing in sentiment.
"If you look at global money flow, it’s not only Indonesia which is doing
badly, other emerging markets in Asia and South America are also being hit,"
says Adrian Rusmana, an analyst at HD Capital.
Ramli believes that any slowing in the economy will hit small to medium sized
businesses the hardest.
"Ten years ago, big business overheated because of the financial crisis," he
said.
"The small to mid-size companies were not great, but doing ok. Now, big
business has recovered but the small to medium-sized businesses are the hardest
hit in 40 years.
"Over the last five years, the Indonesian economy has been going very well
thanks to commodity prices. The improvement in the macro-economy has been
export driven. But there’s a missing link in what happens at the macro and
micro level."
Standard Chartered economist Fauzi Ichsan agrees.
"When you look at the big corporates that the banks are lending to, they are
Crude Palm Oil companies, coal companies and service companies like shipping so
that when commodity prices rise they benefit and can absorb rate rises because
their revenue is up," he says.
"The smaller companies, like manufacturers, don’t have the same revenue boost
and so the rate rises have a bigger impact for them."
Even if Boediono does steer the economy through the current market turmoil, a
lack of adequate infrastructure is still holding the economy back from growth
rates anywhere near 8 per cent.
"Infrastructure bottlenecks are the biggest challenge for the country," says
Ichsan.
"If Indonesia can tackle this issue, GDP could be more than 7 per cent."
Before the last election four years ago, the government promised to build a
1,100 kilometre trans-java toll-road by 2009. But up until now, just 109km is
close to being built.
There is also concern that that the government’s plan to build new power plants
that will add 10,000 megawatts to the system is falling well behind schedule.
The power shortage has become so bad that the government recently introduced a
hasty regulation, forcing factories to shift two working days each month to a
Saturday or Sunday. The move is designed to take the pressure off during peak
electricity periods.
Apart from a lack of infrastructure, investors complain that Indonesia’s labour
laws are too rigid and its judicial system was recently voted the worst in
Asia, according to a survey by research group Political and Economic Risk
Consultancy (PERC).
There is some concern that none of these problems will be properly addressed
until after the elections next year, with the parliamentary vote in April and
the presidential poll three months later.
"Up to October 2009, we are in a holding pattern," says Umar Juoro, an
economist at the Habibie Center.
"We will have to wait until after the election but the pressure to move on
issues like labour laws and a lack of infrastructure will be stronger then."
Political parties are likely to spend money during the campaign and that could
provide some relief to poor families. But general government spending on
health, education and social programs has been falling.
It’s a vicious circle. As oil and commodity prices rose boosting the price of
food and fuel, government subsidies also jumped putting pressure on the budget
and cutting spending in other areas. The cost of government subsidies for food,
fuel, fertiliser and electricity is expected to be equal to 7 per cent of gross
domestic product this year up from 3.8 per cent in 2007, according to a recent
report by the Asian Development Bank. As a result, planned spending on
education was cut by 9.5 per cent from the original budget and the health
budget dropped by 7.4 per cent.
Meanwhile, economic growth of around 6 per cent has been generating jobs, but
not nearly enough to fix the chronic problem of underemployment. Slightly less
than 28 per cent of the labour force is underemployed, or works less than 35
hours a week, and 70 per cent of total employment is in the informal sector,
where there is no minimum wage and very little supervision.
The ADB is forecasting growth of 6.2 per cent next year, depending on the
central bank’s handling of the current inflation threat and the cost of
subsidies.
Ichsan also predicts the economy will be resilient.
"There is little reason to be pessimistic," he says. "The economy is more or
less driven by domestic issues, the government expects a budget deficit of 1.8
to 1.9 per cent of GDP and we are expecting less than that, growth has been
robust in the first half, business indicators – like motor sales and credit
growth – are robust and oil is likely to come down. And among its neighbours,
Indonesia is looking like the most politically stable."
All of this may be true but the people who are deciding whether or not they can
afford to go home this year to celebrate the main religious holiday of Idul
Fitri are pessimistic.
And the photos of last week’s tragic stampede outside the home of a wealthy
Indonesian, who distributes cash handouts every year as part of Ramadan, has
shone the light on the country’s uneven distribution of wealth.
The poorest fifth account for just 8 per cent of consumption, while the top 20
per cent of income earners account for 45 per cent.
It is a telling statistic.
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