http://www.atimes.com/atimes/South_Asia/LI02Df05.html
Sep 2, 2010
BRIC ambitions for Indonesia
By Sara Schonhardta
JAKARTA - With Indonesia's economic growth among the strongest in Southeast
Asia and brightening future prospects for the resource-rich country, economists
are weighing whether it should be the next country added to the BRIC grouping
of fast-growing emerging economies comprising Brazil, Russia, India and China.
When US investment bank Goldman Sachs came up with the BRIC acronym in 2001, it
projected that the combined economic size of the four countries would be bigger
than all Group of 7 countries except the United States by 2050, according to
Milan Zavadjil, country director at the International Monetary Fund's (IMF)
Indonesia office. (The other G-7 countries being Japan, Germany, the United
Kingdom, France, Italy and Canada.)
Sticking to that definition, Indonesia is arguably ripe for inclusion to the
club. For some financial analysts, Indonesia's BRIC designation would be
symbolic of the gathering global shift in economic power away from the
developed G-7 economies and towards faster-growing emerging ones. It would also
give a boost to President Susilo Bambang Yudhoyono's economic management
credentials.
Indonesia still lacks certain BRIC indicators, including large-scale foreign
capital inflows, which until now has allowed the government to maintain a
relatively hands-off approach to rising inflationary pressures. If capital
inflows were to rise significantly above current levels, Bank Indonesia, the
central bank, would be put to an important test, economists say.
There are limits to building up foreign reserves and allowing the exchange rate
to appreciate, said Zavadjil, who believes sustained investor interest in
Indonesia will depend more on achieving investment grade credit ratings than
BRIC admission. In January, Fitch Ratings upgraded Indonesia's sovereign credit
rating to BB+, based on improvements in the country's public finances and the
economy's resilience to the global crisis. Fitch research estimates that
Indonesian banks enjoy some of the strongest lending margins in Asia, and
limited competition means that yields should remain strong over the medium
term.
The stable rating is still one level below investment grade. Ai Ling Ngiam, the
lead analyst covering Indonesia at Fitch in Singapore, said reservations remain
about upgrading Indonesia to the coveted A rating, which would signal to
investors that Indonesia is capable of meeting its financial commitments even
in adverse economic conditions.
"The growth side has been acknowledged," said Ngiam. "But what has been lacking
is infrastructure improvements and cooperation from local governments to get
projects underway." She says the government often says the right things, but
then fails to act.
Indonesia's past crisis responses may justify the need for caution. By not
factoring in the risk of rising inflation, the government would have to move
quickly if sudden vulnerabilities arise that would call for strong policy
adjustments, said Ngiam. She argues that more pre-emptive measures are needed
to hedge against fast fluctuating foreign capital flows in and out of the
country's illiquid financial markets.
That said, many economists believe that Indonesia is now in an economic sweet
spot, with economic growth poised to hit 6% this year after gross domestic
product (GDP) rose 6.2% year on year in the second quarter. President Yudhoyono
is even more bullish, predicting that economic growth will reach 6.6% by year's
end.
The Jakarta Composite Index, Asia's second-best performing stock exchange so
far this year after Japan, has reflected the bullishness, hitting a record high
on July 29 following the appointment of Darmin Nasution as Bank Indonesia's new
head, ending a 14-month impasse over the central bank's leadership and
signaling to the market a move towards prudent macro-economic management.
Foreign direct investment (FDI), meanwhile, hit $7.8 billion in the first half
of the year, a 49% gain over the same period in 2009. Indonesia's investment
coordinating board now predicts FDI could reach $13.1 billion by the end of the
year.
Resilient in crisis
When the global economy started to unravel in early 2008, some economists and
investors worried that Indonesia would repeat the tailspin that devastated its
economy and emptied the national coffers during the 1997-98 Asian financial
crisis.
The government responded to that crisis by raising interest rates and
tightening fiscal policy, but those interventions failed to stop the rupiah
from plunging 85% against the US dollar. The subsequent double-digit inflation
triggered steep gains in the prices of key staples such as rice and cooking
oil, and sparked the riots that eventually forced then president Suharto to
resign.
When the 2008 global recession hit, Indonesia was better prepared. The central
bank had built up adequate foreign exchange reserves to cushion against foreign
fund outflows and expansionary fiscal policies stoked strong domestic demand.
Abundant natural resources, such as palm oil, coal and timber, have also
allowed Indonesia to manage the downturn with only a moderate slowdown in
economic growth thanks to steady demand from places like China, which is
increasingly relying on Indonesia to help meet its growing energy needs.
Investors have since watched Indonesia's recovery with interest. Rapid
population growth, a growing middle class, abundant natural resources and low
levels of government and household debt give the $690 billion economy -
Southeast Asia's largest - an advantage as an investment destination over
mature economies such as the United States and Europe, said Zavadjil. "In a not
very bright global economic story, Indonesia stands out," he said.
Yet short-term risks remain, namely rising inflation, which has accelerated to
6.98% year on year after an unexpected jump to 6.22% in July. While most of
Asia's major economies have raised interest rates to stem inflationary
pressures - India has raised its rate four times since the start of 2010 -
Indonesia has taken a different tack, holding its benchmark interest rate at a
record-low of 6.5% for the 12th month in a row.
Some economists say Bank Indonesia will need to raise rates to 7% before the
end of the year to keep inflation within its targeted 4-6% band and to
strengthen its own credibility in international markets. BI governor Nasution
says that for now, the government prefers to emphasize economic growth over
stability.
Last month, he blamed the up-tick in inflation on unseasonably wet weather that
has hurt harvests and forced up the cost of vegetables and spices. That means
an increase in interest rates would have little impact on the price of these
goods, which Nasution predicts will fall after the Muslim fasting month of
Ramadan. The cost of goods typically rises during Ramadan when food consumption
increases due to the fast-breaking events and charity that mark the holiday.
In the longer term, analysts say income inequality could prove more problematic
since Indonesia still trails far behind the BRICs on per capita investment in
major infrastructure and human capital.
"The government has failed to perform the most basic functions to support
economic growth," economist Jonathan Pincus wrote in an e-mail to Asia Times
Online. "Infrastructure development is slow, particularly in power and
transport; the education system is failing to provide people with basic skills
and to prepare them to acquire more advanced technological skills; the legal
and judicial system are dysfunctional."
Pincus, dean of the Fulbright Economic Teaching Program in Ho Chi Minh City,
Vietnam, recently co-authored a report, "From Reformasi to Institutional
Transition" that argued Indonesia's economic strategy relies too heavily on
natural resource exploitation and is lagging behind competitors in the region
in manufacturing exports and employment growth.
"Negative [Suharto era] New Order legacies have left Indonesia with a political
and administrative system that creates obstacles to enterprise and innovation,"
Pincus wrote. He also argued that overcoming entrenched nepotism and corruption
will require much deeper reform and investment, and warned that investor
sentiment is not a good indicator of the country's long-term growth prospects.
Still Indonesia's relatively cheap labor force and perceived political
stability under Yudhoyono is attracting multinational companies that are
looking to establish production bases in Southeast Asia. Indonesian authorities
expect to lure more foreign funds as manufacturers expand their existing
operations to take advantage of the rising purchasing power of Indonesia's
growing middle class.
Zavadjil says companies that do not have a presence in Indonesia are taking a
look for the first time and some small companies are looking to upgrade their
activities. Indeed, corporate giants from Japan, China and South Korea are all
making new investments in the country. For instance, Panasonic has started to
redesign certain of its products to appeal to the Indonesian market and Nissan
has outlined plans to more than quadruple its local sales by 2013.
There is no denying the strong fundamentals offered by Indonesia's market of
240 million people, and economists say the foundations are largely in place for
the country to continue down the path to sustained growth regardless of
short-term inflationary pressures. But at least for now, those building blocks
may not be solid enough to be considered among the BRIC countries.
Sara Schonhardt is a freelance writer based in Jakarta, Indonesia. She has
lived and worked in Southeast Asia for six years and has a master's degree in
international affairs from Columbia University.
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