The key challenges facing a new Indonesia

In late October, Joko ‘Jokowi’ Widodo will be inaugurated as the seventh President of Indonesia. The island archipelago of 252 million people, spanning the distance of New York to Alaska, is at an economic crossroad and his presidency could well prove to be a defining moment in Indonesia’s economic history.

But the challenges are legion. Indonesia’s GDP growth in 2014 will probably be the slowest since the global financial crisis, graft has become a part of everyday life, costly subsidies now eat up over 20 per cent of government expenditure, and the basic balance deficit means the fickle sentiment of international portfolio investors can drive Indonesian Rupiah (IDR) volatility.

"The social aspects, compared to the purely economic, of Jokowi’s fiscal policy should become readily apparent early in his term."
Daniel Wilson, Economist, Global Markets at ANZ

This task is made even harder as earlier expectations that political allegiances would shift quickly after the constitutional court challenge by opponent Prabowo have proven overly optimistic, and Jokowi will have to abandon earlier promises not to engage in horse trading to forge a majority and progress reforms. This is a question of numbers.

Yet the promise is bountiful. Jokowi’s reform agenda will be anything but easy, yet the wheels are in motion, and ANZ research anticipates improvements in Indonesia’s efficiency and growth rate in the coming years.

Recent growth has lagged

GDP growth has moderated sharply over the past six quarters, led by a cyclical slowdown in investment. There are a number of reasons for this moderation in growth: election uncertainty, a tightening of monetary policy, and mining regulation capping the private sector’s contribution.

Infrastructure development has been lacking, with the misallocation of funds to temporary consumption subsidies straining fiscal accounts. However, ANZ Research sees this slowdown in investment coming to an end this year, rebounding, and becoming a key driver of growth next year.

That said, monetary policy is likely to remain on a tightening bias which will dampen the strength of the investment upswing.

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Re-allocation of expenditure crucial

The Indonesian government’s growing contribution to investment next year will be conditional on the reallocation of expenditure. However, we believe the bulk of the increase will be in 2016-17 rather than 2015.

The most important, and also the most painful reallocation over the short run will be the rationalisation of fuel subsidies. The fuel subsidy bill has ballooned over the past five years with a budget of IDR276.1trn ($US24bn) tabled in 2015.

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Jokowi and his team have been vocal about their desire to cut fuel subsidies. Fuel price rationalisation may come as soon as November this year, with his advisors signalling the resulting fuel price hike to be as high as IDR3,000.

The reduced subsidies will be offset partially by an assistance package for the poor, limiting fiscal savings and reallocation efficiencies in the first year. However we estimate that for every IDR1,000 increase in retail fuel prices, the government will save roughly IDR31trn in subsidy expenditures per annum.

The social aspects, compared to the purely economic, of Jokowi’s fiscal policy should become readily apparent early in his term.

Navigating around the political impasse

Undoubtedly the current political situation places many of Jokowi’s reform plans on shaky foundation. That said, there are a number of key reforms that he will not need to go through parliament to implement.

Reforms such as the moderate rationalisation of fuel prices, the creation of a technocratic cabinet, changing the energy mix in Indonesia away from imported oil towards coal and gas, and increased transparency and improved tax collection efficiency will all go some way in advancing the reforms needed in Indonesia and will not require the approval of the parliament.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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