The Gold Standard | Back to Indonesia – guest post

I was reading this Bloomberg News story on Indonesia today:

Under the old regime, corruption was highly organized and predictable, and now it’s highly disorganized and unpredictable,” said Hill. “You knew who to pay, how much and what the payoff would be. Now, none of those are clear.

Of course, this should be a lot familiar to Indian readers.  The full story is worth reading.

In this context, this blog had a discussion on Indonesia some time ago. My good friend Manu Bhaskaran of the Centennial Group who has followed the Southeast Asia region and its economies closely for more than two decades, kindly agreed to send his comments below to be posted as a guest-post.  In fact, he had sent me this almost two weeks ago. My travels (I am now at Madurai in Tamil Nadu as I am posting this) have caused a delay in posting this.

Over to Manu:

Indonesia has many things going for it and even with few reforms, there are probably enough positives – young and cheap work force, commodities, large consumer market, less trade dependence on the US and Europe – to keep the economy on a reasonable growth track of around 5% on average for the next few years.

However, in order to match the expectations built into the valuation of its equities, bonds, currency and assets which foreigners are buying, Indonesia should be doing a lot better and its failings could well make it a lot more vulnerable to downside risks than expected:

First, the political economy is moving in an unfortunate direction. It is a weak democracy that is proving too easily captured by vested interests.

Parliament’s efforts to weaken the Constitutional Court and the anti-corruption agency are just the most recent examples of this, there are so many other outrageous examples. This produces a country that is run for the benefit of certain private interests and against those of the country and people at large.

A country known for its extraordinary religious tolerance is also increasingly seeing extremist intolerance which the current government has shown no backbone in confronting – the brutal videotaped murders of Ahmadis saw the murderers given light prison sentences while one of the Ahmadis who fought back was jailed!

Second, the financial dimension of Indonesia’s economy remains a concern – even recognising the improvements such as the strong rise in FX reserves, the sharp fall in the fiscal debt/GDP ratio and the better capitalisation of

the banking sector. Indonesia has been borrowing on a large scale from European banks in the last 2 years, as they cut back on lending, Indonesian entities will have to find other sources of loans.

Indonesia has a history of devaluations and inflationary spikes which means that inflation and exchange rate expectations of economic agents can change very quickly and destabilise. The recent financial travails of a very large Indonesian company is a reflection of how quickly the financial position of key entities can deteriorate.

Third, growth has been driven in recent years by (a) the fall in risk premium (as political and macro-economic stability improved after the dislocations in 1997-2002) driving down cost of capital and spurring investment; and (b) surging commodity prices driving incomes and demand as well as inflows of FDI. The first driver has been in operation for nearly a decade and probably does not have long to go. As for the second, if the global economy slows as will surely happen, commodity prices and volumes will be hurt. Indonesian growth is far more susceptible to global events than many assume.

In short, Indonesia is not a bad story in the long term but there are increasing vulnerabilities which investors may have under-estimated.

DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.