reflections

The Indonesian Conundrum

5 MINS READOct 27, 2015 | 01:37 GMT
(Stratfor)
It can be difficult to separate the important from unimportant on any given day. Reflections mean to do exactly that — by thinking about what happened today, we can consider what might happen tomorrow.

Indonesian President Joko "Jokowi" Widodo is in Washington for a state visit and a meeting with U.S. President Barack Obama. Jokowi hopes to secure greater investment into Indonesia's infrastructure and industrial bases.

Jokowi, who finished the first year of his presidency on Oct. 20, campaigned on the promise of significant fiscal, regulatory and economic reform designed to help facilitate Indonesia's transition from an economy based on raw commodity exports toward one more dependent on manufacturing and industry. However, as is the case with all candidates who take office, Jokowi's actions thus far reflect the limitations he faces rather than his campaign promises. Jokowi is contending with the challenge of balancing long-term economic plans with short-term domestic economic needs. This means that his reforms are often contradictory — sometimes offering incentives for foreign investors and other times closing doors to investment in certain sectors.

Jakarta is reacting to a world that is undergoing a major transition. China's economy is slowing down, and Indonesia — like all commodity-reliant emerging markets — is in financial turmoil as commodity demand slows and the U.S. Federal Reserve contemplates raising interest rates, affecting the values of their currencies, among other things. At the same time, China and Japan are becoming more assertive regionally, especially in security matters. This presents Indonesia with both problems and opportunities.

Indonesia's massive population base, location and large cache of domestic natural resources make the country a possible destination for low-end manufacturing leaving coastal China and other regions of East Asia where labor costs are rising. Indonesia's fragmented and harsh geography, cumbersome regulatory processes, rampant corruption and underdeveloped infrastructure have all hampered Indonesia's efforts to attract foreign investment into manufacturing and industry beyond the main island of Java to other parts of the archipelago.

To insulate Indonesia from big swings in commodity prices, many of Jokowi's plans have been designed to transform the country's economy into one rooted in value-added manufacturing. This initiative carries both benefits and costs for an investor eyeing Indonesia. For example, Jakarta has been working to end price controls and slash fuel subsidies as well as streamline and centralize the regulatory and permitting process — all measures designed to increase potential returns on investment for international investors and make Indonesia an easier place to implement projects.

At the same time, however, Jakarta has been growing state control and regulations in specific sectors. In the oil and natural gas industry, Indonesia has increased domestic content regulations and is considering shifting the control of the oil and natural gas industry to state-owned corporations, allowing investors to provide only capital and technology. Jakarta has done the same thing with the mining industry; it has banned the export of raw unprocessed minerals, forcing international companies to invest in more value-added processing plants. 

Indonesia's foreign ownership rules, even outside of the extractive industry, remain high. For example, global conglomerate company Maersk has been hoping to invest $3 billion in Indonesia's maritime infrastructure, but only companies that are majority owned by Indonesians can do so. Although the regulations and efforts to streamline investment processes oppose Jokowi's other efforts to incentivize investment, they all have the same goal: move Indonesia up the value chain, and do it with a high level of Indonesian ownership.

This is the long-term agenda that Jokowi has attempted to implement, but there is another part of the picture. Jokowi's short-term situation is rooted in the near-term fallout of a slowing Chinese economy, shifting financial markets and falling Indonesian rupiah. These affect the day-to-day expectations of Indonesians and thus influence his political standing and political support. This has forced Jokowi to venture away from his long-term objectives in some ways and mitigate short-term problems. 

Indonesia's management of the price of fuel and its fuel subsidies is one such contradiction. Amid falling oil prices, Jokowi was able to abolish fuel subsidies on Jan. 1 with minimal social backlash. However, as oil prices began to rise later in the year, Indonesia continued to keep artificially low fuel prices, essentially shifting the burden of subsidized fuel prices from Indonesia to Pertamina, its state-owned oil and natural gas firm. Pertamina has estimated that it has lost $1 billion from the low domestic price of diesel and gasoline. During the last month, Jokowi has looked at reducing fuel prices even more as a way to stimulate the economy.

Although he is putting some of his long-term plans on hold, Jokowi is still trying to push through as many reforms as possible. One major stimulus package that has been approved created a new fixed formula for minimum wage increases that will be based on provincial-level inflation and economic growth rates. It is designed to increase the certainty for foreign investors for labor costs. Currently, minimum wages are dependent on negotiations between local governments and unions. However, one of Jokowi's big pushes has been centralizing economic power away from these regional administrations.

Indonesia is a difficult country for anyone to control. Jokowi has encountered difficulties in meeting his envisioned goals on economic and political reform, but anyone would encounter problems in Indonesia. Jokowi will certainly fail to achieve all of his long-term goals, but the progress toward a more industrialized economy is slow. Bits and pieces of reform and piecemeal progress in industrial development will occur, but progress will be inconsistent as Jokowi — and his successors — struggle to deal with Indonesia's fundamental long-term and short-term problems.

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