Sunday, January 10, 2016

Ra Residence | A Foreign Investor’s View: Will Indonesia’s Economy Recover?

By James Castle | After five years of steadily deteriorating economic performance, the Indonesian economy may be in the process of turning around. After reaching a 21st-century high of 6.4 percent in 2010, the country’s GDP growth rate has been lower every year since. It is unlikely to be higher than 4.7 percent this year, the lowest level since the 2009 global crisis.

There are now some signs that the slump may be ending, however, and 2016 growth may exceed five percent. What caused the last five years of decline? What is causing the fledgling recovery and what are its prospects for success?

Changing Directions
The cause of this new, albeit modest, optimism are more efficient government spending on infrastructure after a very slow start in the fiscal year and President Jokowi’s clear determination to improve all government efficiency and reduce red tape. The government is also trying to provide some modest additional stimulation beyond infrastructure spending, especially through tax incentives.

After more than a decade of increasingly inward-looking legal and regulatory reforms that have steadily narrowed the space for private-sector activity, restricted economic freedom, discouraged investment and increased costs, several key government policymakers have started publicly challenging the protectionist orthodoxy of previous governments and acknowledge the need for a change in direction.

They are saying in public what only a few intrepid officials dared whisper in the past decade: Indonesia must embrace the global economy as a competitive and constructive player or it will be left behind by more dynamic emerging market countries, particularly neighboring Vietnam, but also the Philippines and India. This change in perception is very recent and very fragile.

Although easy to miss at the time, the first public signal of this new attitude came just four months ago with the August cabinet reshuffle. While the changes in economic portfolios appeared modest on the surface, it is now clear that President Jokowi is seeking to change the direction of the economy.

The appointments of veteran warhorses Darmin Nasution and Rizal Ramli to coordinating positions initially stirred little optimism because both are closely linked to some of the more restrictive economic policies of previous administrations, including currency controls and limitations on foreign investments.

But apparently the President is not primarily seeking policy advice from them. Insiders say the President has grown increasingly frustrated and angered by the behavior of many career bureaucrats who have consistently ignored his instructions and embraced regulatory complexity as a means to increase their power vis-a-vis the private citizens they are supposed to serve. Rather, what he sees in Nasution and Ramli is two tough, wily bureaucratic infighters who can help him corral obstreperous apparatchiks and start to bend the country’s recalcitrant administrative apparatus more to his will.

The appointment of a new trade minister was equally significant. The trade ministry has traditionally adopted an inward-looking, defensive posture, and this attitude hardened significantly in the past five years, encouraging protectionist sentiments in the legislature.

The new minister, Thomas Lembong, is perhaps the most global personality in the current cabinet. He is as comfortable in New York boardrooms as he is in the backrooms of Jakarta policymaking. He does not fear foreign investors. He frequently stuns the vast platoons of Jakarta’s rent-seeking legionnaires disguised as economic nationalists by bluntly saying things like it’s better to have foreign hospitals, schools, doctors and teachers operating in Indonesia. It is better that they are accessible to the general Indonesian public rather than having Indonesians spending billions abroad and quality services only being available to the wealthy few.

He has called the notorious Negative Investment List (DNI) the “Import Encouragement List”, arguing that discouraging foreign companies from manufacturing products locally just encourages the importation of the same products or condemns Indonesian manufacturers and consumers to pay more for lower quality products.

What Went Wrong: Denial
Indonesian policymakers have been slow to accept any responsibility for the slowdown started in 2011. For the first few years after the global crisis, the official mantra was “our policies are not to blame”. Yes, growth is slowing, the leadership said, but global conditions are bad and we’re still growing faster than our ASEAN neighbors and most other emerging market economies.

The denial was, in fact, just rhetoric covering increasing contractionary policies that discouraged private-sector trade and investment. As a result, Indonesia’s growth now lags that of Vietnam, the Philippines and India – all countries that have historically experienced much slower growth than Indonesia, but have been undertaking significant pro-market reforms over the past several years and are now reaping the benefits.

Complacency
The first five years of the Yudhoyono administration was a period of high commodity prices and heady growth. This lulled policymakers into a sense of complacency. Growth was easy. Credit was loose. Profits were high. Incomes grew.

Even as global growth contracted sharply in the wake of the 2008 Lehman crisis that brought many of the world’s largest economies to a standstill, Indonesian growth continued to accelerate, reaching its 21st-century peak of 6.4 percent in 2010.

But Indonesia’s economic chalice was poisoned by the rapidly expanding role of state-owned enterprises and steadily increasing antipathy to the private sector within the bureaucracy and the legislature, as reflected by a virtual flood of economic restrictions. According to the World Bank, Indonesia instituted over 225 laws and regulations restricting trade and investment since 2009. Vietnam, by comparison promulgated about 60 and the Philippines less than 10 in the same period.

The building list of policy failures of the previous administration actually began with an ill-fated attempt to bring transparency to the government’s negative investment list: the notorious DNI.

The DNI itself is a relic from the Suharto era that was originally established with good intentions. Foreign investors seeking approval via the national Investment Board (BKPM) frequently found themselves shunted from pillar to post within the bureaucracy trying to find out exactly what was allowed and what was forbidden. The first DNI was published in 1989. This was a welcome improvement at the time and served the country and potential investors well for many years, despite its unfortunate name.

But a series of short-lived, weak governments followed the fall of Suharto in 1998 resulting in frequent cabinet changes. Policy discipline vanished. In an eight-year span from 1998 to 2005, the government had six different finance ministers, five economic coordinating ministers, four trade and industry ministers and three energy ministers. Indeed, Indonesia, a country that had been led by only two presidents in its first 53 years existence, suddenly experienced four more presidents in six years from 1998 to 2004.

Given the lack of sustained leadership from the top, de facto economic policymaking was often left in the hands of second and third-tier bureaucrats, many of whom were repressed socialists who resented the modest, neo-liberal reforms of the Suharto era and were genuinely suspicious of, if not overtly hostile to, the private sector.

Many eagerly took advantage of the confusion at the top and more policy initiatives flowed up from careerists seeking to expand their power rather than downwards from technocrats interested in reducing bureaucratic interventions and increasing administrative efficiency.

In 2005, the government wisely decided to try bring some order to its increasingly opaque and chaotic investment regulatory process. The trade minister was tasked to collect all restrictions on foreign investment into one authoritative document that potential investors could consult quickly.

The instructions were simply for each department to report all restriction on foreign investment in their sections so they could be compiled into a single document, a comprehensive DNI. This would make restrictions on investment transparent and potential investors would not have to spend weeks canvassing relevant departments just to find out if they could invest in Indonesia.

As part of the exercise, it was stated that no changes were to be made and that the government would establish a new protocol for enacting restrictions on investment. A key change was to be a requirement that any new restrictions on foreign investment be supported by an analysis of the benefit of any proposed restrictions to Indonesia or the harm that would be done if the investment were not restricted.

In the event, the departments resisted sharing information and authority with the trade ministry and the President backed down. The result was that effort took longer than intended, new restrictions were added and the requirement to provide justification for changes was ignored.

The lack of impact analysis of regulatory changes was to become a hallmark of economic policymaking of that era and was to have its most devastating effect with the imposition of on-shore smelting requirements for virtually all mineral exports in 2014. The loss of export and tax revenue that ensued contributed greatly to the continuation of the country’s growth slowdown.

Whither Indonesia?
Extreme bureaucratic intervention and strong support for a privileged public sector are deeply ingrained in the Indonesian psyche, especially the establishment elites. These attitudes have proven to be difficult to change. Unfortunately, they lead to the view that the private sector should function as a tool of public policy rather than an independent engine of growth. Much of Indonesia’s leadership elite actually fears independent, undirected economic activity.

Since the turn of the century, Indonesia has increasingly reverted to the dead-end policies of autarchy. Reflected in protectionist trade policies and import substitution investment policies. These are the policies that have failed many developing countries. They failed Indonesia in the 1950s and 1960s, and they will fail Indonesia today.

As a small businessman, President Jokowi instinctively mistrusts bureaucratic micromanagement. It hurts all businesses, but it is the particular bane of small businesses everywhere. Let us hope his reform efforts succeed.

James Castle is the founder of CastleAsia and a Board Member of the Australia-Indonesia Centre.

This article originally appeared in Tempo magazine.

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