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Indonesia: pitfalls along the path to prosperity
Indonesia’s investment story remains compelling, but infrastructure development continues to be a challenge while inflation and volatile capital flows could derail the Indonesia story, attendees at the Credit Suisse Asian Investment Conference heard today.
There are many reasons to be positive about Indonesia’s economy, including a rapidly-expanding middle class said Muhammad Chatib Basri, Vice Chairman of the Indonesian President’s National Economic Committee and Senior Lecturer at the University of Indonesia’s Faculty of Economics. He pointed out that the proportion of the population in Indonesia’s middle income bracket had increased from 37.7% in 2003 to 56.5% in 2010.
Dr. Basri said he expected Indonesia’s strong growth path would continue in 2011, forecasting Gross Domestic Product growth of 6.2%-6.5% this year. He also noted that leading indicators suggested investment in the economy was accelerating. These indicators included cement sales, which Dr. Basri said were a reliable proxy for construction activity. “When you buy cement, you have to build a house,” he said.
Indonesia’s economic growth has helped attract global investors. Dr. Basri observed that while foreign portfolio investment had risen by nearly 500%in 2009, Foreign Direct Investment (FDI) had then risen by more than 250% in 2010. “Interest in Indonesia has not been limited to portfolio investment, it has also gone to FDI”, said Dr. Basri. “It shows that the Indonesian economy [is] really in good shape.”
Dr. Basri admitted that surging capital inflows along with higher inflation – he forecasts 7%-7.5% this year – presents a “dilemma” for policymakers. “I call it a good problem,” said Dr. Basri. “Managing capital inflows is better than managing capital outflows.” But he pointed out that the government and central bank risked hurting low income households in Indonesia, who spend more than 60% of income on food, if they did not tighten monetary policy to combat inflation. At the same time, raising interest rates could attract even larger capital inflows, driving the exchange rate higher.
Dr. Basri said he doubted that the Indonesian government wanted to maintain the exchange rate against the US dollar at around IDR9,000, pointing out that Indonesia had spent approximately US$3bn last year managing exchange rates. He argued that Indonesia should capitalize on the popularity of its currency to raise long term financing through rupiah-denominated bonds. “You can use this to finance infrastructure,” he said. “There’s a lot of appetite because of the appreciating rupiah.”
He added that it was essential that capital inflows found their way into infrastructure, which he said was the top economic priority if Indonesia wanted to achieve growth of 7% or more without fueling inflation. “The only way to transform paper money into real money is by building infrastructure,” he said. “But unfortunately progress on infrastructure has been very slow.”
Indonesia’s fuel subsidies were not a problem at current oil prices, said Dr. Basri, but could become one if oil rose to US$120 a barrel. He also said that it was important for the government to act before price pressure on the supply side translated into higher price and salary expectations on the demand side, making inflation worse.
Joining Dr. Basri on the panel, Wishnu Wardhana, Co-CEO, of Indika Energy, which controls Indonesia’s third-largest coal producer, argued that the country also needed to address the depletion of natural resources reserves. “This must be overcome by investing more to unlock unexplored resources,” he said.
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Day 2: Photo Album
