Indonesia: Indonesia Promotes Economic Reform: What Results So Far?


Chris Manning

It is now almost a year since the Indonesian President Susilo Bambang Yudhoyono (SBY) reshuffled his cabinet and appointed a new team under Coordinating Minister for Economic Affairs, Dr Boediono, to direct financial affairs. At the time Indonesia was suffering macroeconomic instability and there were concerns regarding investment levels. How successful has the move been and are there any signs of a turnaround in growth and investment? These questions are pertinent in assessing the economic performance of the Susilo Bambang Yudhoyono (SBY) and Yusuf Kalla leadership 'duumvirate', which had been strongly supported by the domestic business lobby in the Presidential elections of 2004. The team is now two years into its five-year term, scheduled to end in 2009.

The cabinet reshuffle of November 2005 and appointment of a new economics team - including shifting of no-nonsense technocrat Sri Mulyani to the important Finance portfolio - took place at a time when inflation and interest rates had risen sharply in the wake of fuel price increases. Economic growth rates, which had recovered a year earlier, fell sharply to just below 5 per cent in the last quarter of 2005. The government had made little progress towards overcoming communications bottlenecks, after a disappointing infrastructure investment summit early in its term of office. The World Bank had highlighted various dimensions of Indonesia's relatively poor investment climate: tax and customs procedures unfavourable to business, new labour laws (2003) which had raised the cost of hiring and firing quite significantly, and pervasive bureaucratic obstacles for would-be investors (on average it was taking around 150 days to process new investment applications).

The new economics team under Boediono moved quickly. New initiatives signalled a more systematic, longer-term approach to solving problems, in contrast to the more ad hoc style of his predecessor, Aburizal Bakrie. In February 2006 the government announced a new package for improvement of the investment climate, covering five major areas: a new investment law, customs, taxation, labour, and small and medium enterprises and cooperatives. A new set of initiatives for infrastructure development was also announced, to be followed up by another summit later this year. In July 2006, a package of financial sector reforms was introduced, especially aimed at stimulating credit through domestically owned banks. Besides having the direct backing of SBY in the form of a Presidential Decree, these and other reforms have included a time-line for action specifying the ministries responsible, and have been accompanied by detailed monthly progress reports.

Several aspects of the draft investment law, if passed by parliament, should create a more favourable environment, focusing on both the principle of equal treatment for domestic and foreign investors, and calls for a transparent 'negative list' of activities closed to foreign firms. In addition, the Vice President announced that Indonesia would create eight new special economic zones (SEZs) within 12 months, in an attempt to sidestep pervasive bureaucratic and infrastructure bottlenecks.

How has the economy fared as a result of these reform efforts? First, sounder macroeconomic policies have stabilised the economy, resulting in a more stable rupiah and much reduced inflationary pressure in the first eight months of 2006. Output growth has showed a better than expected recovery in the second quarter of 2005 (GDP growth 5.2 per cent). Exports - both oil and gas, and non-oil - had also grown quite rapidly (16 per cent in the first seven months of 2006), although imports were down, as business struggled to expand operations under the burden of rising real interest rates.

There have been also some encouraging signs with regard to investment. In March, the longstanding dispute over exploitation of the valuable Cepu oil blocks in Central and East Java was resolved in favour of ExxonMobil. Some foreign (mainly Asian) investors in labour-intensive activities (such as oil palm, fisheries and footwear) have begun to show renewed interest in Indonesia. In mid 2006, Nissan announced that it intended to expand operations in Indonesia. Foreign and especially domestic investment approvals (the latter rising several fold) had improved in the first half of 2006 compared with the previous year.

However, a general recovery in investment has still remained elusive. A turnabout is proving difficult, perhaps not least because of lingering security concerns in the wake of the bombings in 2004 and 2005, respectively. Despite government efforts to cut red tape - with some success (investment processing time had been reduced by around one-third in 2005) - foreign investment realisations were 24 per cent lower in the first seven months of 2006 compared with 2005. Another factor has been slow decision-making mainly due to delays in passing the tax, customs and investment laws in parliament.

Related to these difficulties, the government's performance in delivering on promises in areas of poverty alleviation and unemployment came under greater public scrutiny following the President's 17th of August speech. Critics focused on little recent improvement in the poverty figures in the past few years. Unemployment, which the government had pledged to halve by 2009, was recorded to have actually increased to over 10.4 per cent in early 2006.

New initiatives have been counterbalanced by conflicting policy substance and signals from some cabinet ministers, especially in Agriculture (of critical importance for livelihoods of close to half the population) and State Enterprises, where privatisation has stalled. The resolve of the President to back his reform-minded ministers has been questioned. In both the above-mentioned areas, the President himself has been reluctant to intervene in favour of more market-oriented solutions. He also backed down on labour law reform, regarded as important for creating more jobs, in the face of concerted labour union opposition in April-May 2006.

While the foundations for reform have been put in place, and there are some encouraging signs, Boediono and his team still face major challenges, not least equivocal support from top political leadership, in turning around the investment climate.

WATCHPOINT: Despite some major achievements, Boediono and his team face major challenges in turning the investment climate around.


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