Monday, 5 May 2014

Indonesia's Election and Economic Prospects

Arisyi Fariza Raz
The Jakarta Post
5 May 2014

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The unofficial quick count results of the April 9 election showed that the Indonesian Democratic Party of Struggle (PDI-P) led with 19 percent of the vote, below the initial predictions of 25 percent or higher in various polls prior to the election.

The failure of the “Jokowi-effect” (the announcement of Jakarta Governor Joko “Jokowi” Widodo as the PDI-P’s presidential candidate) to boost the party’s vote means the party may need to form a coalition. 

As a consequence, the presidential election that will be held on July 9, will be much more competitive and less predictable than initially expected. Political bargaining is expected to occur and thus the new government may lack solidity if too much give and take occurs.

Whoever wins the election, the new president must be aware of the country’s economic potential and the challenges it faces. 

He, with his new government, must be visionary in terms of the implementation of economic policies and addressing economic challenges.

As suggested by a report published by McKinsey in 2012, Indonesia has the potential to be one of the biggest economies in the world by 2030, surpassing Germany and the UK. However, Indonesia also faces internal and external challenges that may affect its economic development and growth sustainability.

One of the challenges is related to the establishment of the ASEAN Economic Community (AEC) later in 2015 or early 2016. The objective of the AEC is to create an ASEAN single market and production base, which consists of the freer flow of goods and services, investment, capital and skilled labor.

When the AEC becomes effective, Indonesia must fully open its market to other ASEAN economies and thus intra-regional competition will become fiercer. 

The inability to compete in this free market atmosphere may harm the existence of local businesses, since more competitive overseas businesses might be able to replace them easily.

Another challenge comes from uncertainty in the global economy. The US Federal Reserve has been constantly reducing its quantitative easing in line with economic improvements in the US. 

Even though the Fed’s chief, Janet Yellen, has signaled to the market that the US interest rate will remain unchanged in the short term, in the longer term, it may increase the interest rate if the unemployment rate has already hit the Fed’s appropriate level (between 5.2 and 5.6 percent).

When this happens, global liquidity will once again tighten and Indonesia may face another external shock like the one that happened in 2013. 

Hence, the government must be prepared to anticipate this shock by preventing it from spreading to the real sector.

Fiscal sustainability is another issue that will be faced by the new government. Even though the government has reduced its fuel subsidy by raising the subsidized fuel price from Rp 4,500 (39 US cents)to Rp 6,500 per liter last June, this is still not sufficient to maintain its fiscal sustainability.

Indonesia’s strengthened purchasing power and increased consumption has caused the demand for fuel to be relatively less elastic to price changes. If this trend continues, the fuel subsidy is expected to surpass the government’s budget allocation this year, threatening a widening fiscal deficit.

To address these challenges, the new government has to be alert to these issues and needs to implement clear policy stances to deal with them. 

One of the most important policies is to improve Indonesia’s export competitiveness. Export competitiveness can be improved by promoting the manufacturing sectors that have been experienced a downturn in recent years. 

Potential export-oriented industries have to be closely supported by the government through policy incentives.

It also has to spend more on infrastructure. Adequate infrastructure will improve export competitiveness through the reduction of business costs and an increase in production efficiency.

As suggested by Gustav Papanek, an economist, during an interview with Tempo magazine in March 2014, the government should spend at least around 5 percent of its revenues on infrastructure projects to have an effective impact on the economy. This figure is far above current spending, which is only 1 percent of total revenues.

Human capital improvement is also necessary to support Indonesia’s competitiveness in international trade. Capable human capital will attract more technologically advanced investments from overseas. This will create huge employment and ameliorate industry competitiveness through knowledge transfer.

In addition, sufficient human capital capability will provide positive externalities to the economy through the creation of accumulated knowledge, thus creating more rapid economic growth.

The new government will also need to review its fuel subsidy policy. As mentioned earlier, spiking fuel consumption undermines Indonesia’s fiscal and trade balances. 

One method to deal with this issue is by introducing a fixed fuel subsidy instead of a price-based fuel subsidy.

Through this scheme, the subsidized oil price will fluctuate according to the market mechanism, and the government will not need to incur additional costs when subsidized fuel consumption surges.

Another method, suggested by Papanek during his interview, is to convert fuel consumption from oil to gas. He further argues that this could be done effectively by providing incentives to every stakeholder, including banks and infrastructure providers.

In short, political power should not interfere too much in Indonesia’s economic development process. Despite the political bargaining for power among the parties, the new government must be fully aware of the challenges facing the economy. 

By addressing these challenges effectively, Indonesia will be better able to improve its export competitiveness and reduce its energy imports. As a consequence, its trade and fiscal balances will become more sustainable. 

Indonesia’s economy will be more resilient to external shocks and will able to grow more rapidly and sustainably.


The writer is an economist and is a graduate of the University of Manchester, the UK.

1 comment:

  1. nice inspiring blog :)