Is Indonesia about to shed the ‘fragile five’ label?

WATARU SUZUKI, Nikkei staff writer

JAKARTA — Indonesia is gearing up for a presidential election in July, and investors are betting on an economic resurgence. The Jakarta Composite Index has jumped more than 10% since the end of last year, making it one of the world’s best-performing stock benchmarks. The nation’s currency has also been steadily strengthening.

     Indonesia has been grouped with Brazil, India, Turkey and South Africa as one of the so-called fragile five — economies that are considered unstable. Is the Southeast Asian country about to leave the group behind and regain its status as the region’s rising star?

     Destry Dimistry is the chief economist at Bank Mandiri, Indonesia’s largest bank by assets. In a recent interview, she offered her thoughts on the country’s economic prospects.

Q: Indonesia’s gross domestic product in 2013 grew at the slowest pace in four years. The nation’s current-account deficit widened. Have you seen any signs of a recovery so far this year?

A: It is true that Indonesia’s economy still carries imbalances in both the external and domestic sectors. The current-account deficit reached 4.4% of GDP in the second quarter of 2013, caused mainly by higher imports. The domestic economy is strong, reflected by the rapid growth of the automotive and property sectors. But this puts more pressure on the trade balance, because Indonesia imports raw materials and builds the final products here.

     The policies of the central bank and government are gradually showing signs of improvement. Bank Indonesia imposed a tight monetary policy by raising interest rates and cutting the loan-to-value ratio for the automotive and property sectors. At the same time, the government cut its fuel subsidies, closing the gap between the domestic and market prices. As a result, the current-account deficit narrowed to 2% of GDP in the fourth quarter.

     I believe that although imbalances remain, improvement will continue in 2014, with the deficit narrowing to around 2.7% of GDP compared to 3.3% last year.

Q: Indonesia’s financial markets, especially stocks, have outperformed most neighbors so far this year. Do you think the strong performance is sustainable?

A: I believe the market is overreacting to recent economic indicators showing signs of a recovery. It is true the inflation rate remained low in February, foreign exchange reserves went up and the trade balance swung to a surplus in the last three months of 2013. The strong performance in the stock market is also due to its attractive valuation.

     But there are still uncertainties about domestic and global conditions, especially political risks, as the country faces its first presidential election in a decade. This is why the market might undergo a correction before the election in July. Assuming the election goes smoothly, I expect the rupiah to stabilize at around 11,400 to the dollar by the end of this year. 

Q: What economic policies will the next government need to implement?

A: The main focus will be on fuel subsidies. The government cut its fuel subsidy last year, causing the domestic price to rise more than 40%, but it is still much lower than the market price. The government will eventually need to adjust the fuel price further in order to cut spending. This will most likely happen in 2015, after a new government is established. But the decision will not be easy, as the price hike will trigger higher inflation and draw anger from the public.

Q: The government imposed an export ban on mineral ores in January. What consequences might this have in the short and long terms?

A: In the short term, it will definitely put pressure on the export sector. It already caused the trade balance to dip into deficit in January. Raw minerals, excluding coal and oil, are among Indonesia’s key exports. Strict implementation of the rules has the potential for losses of $6.5 billion worth of annual exports.

     On the other hand, the government’s aim to develop local industry is on the right track for the medium to long term. It will encourage intermediate industries to develop, to build smelters, and the country can expect investment to flow in. It will also reduce illegal mining, which is currently widespread throughout the country and is harming the environment.

     Now that the government has implemented the policy, its homework is to plan a strategy to make it work. An industry cannot develop in one to two years.

     The initial plan for the export ban was laid out in 2009, but the government failed to provide subsidies — perhaps in the form of investment or tax breaks — and support the infrastructure. Incentives are needed to ensure investors that they can benefit.



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