Blog Indonesia’s policy balancing act

Indonesia’s policy balancing act
Given its large, youthful population and commitment to improving the investment environment, Indonesia is one of Asia’s most exciting investment prospects. But the government faces a number of policymaking tests in balancing the structural reforms fundamental to its long-term growth prospects, and the stability issues sometimes prompted by shorter-term capital flows. 

Sri Mulyani Indrawati, Minister of Finance, Indonesia, delivers a keynote address at the AIC.

Sri Mulyani Indrawati, Indonesia’s finance minister (in her second stint in the role, and winner of the “Best Minister” award at the World Government Summit in 2018), articulated the challenge in a keynote address on the first day of the 2019 Credit Suisse Asian Investment Conference (AIC). 

Minister Indrawati admitted that 2018 had been tough, given the need to respond to global headwinds including rising interest rates in the US – leading to capital outflows from Indonesia and other emerging markets, and a 6 percent depreciation in the Rupiah – trade conflict between the US and China, and other geopolitical tensions. Nonetheless, Indonesia’s economy grew 5.17 percent last year, the strongest growth seen in the past three years, and the government made progress in improving tax revenues and reducing the budget deficit.

This resilience is something Minister Indrawati said would remain a focus beyond the upcoming landmark presidential and legislative elections (scheduled for mid-April).  “Regardless of the election result, Indonesia has the reputation to be able to maintain the resiliency of our economy, pragmatism in policy and a prudent policy framework."

Stability and pragmatism are the watchwords in Indonesia’s bid to strengthen the mix of fiscal, monetary and real-sector policies, in addition to incentives to improve the investment environment – of which there have been many in recent years, including 365 import-export incentives (as of October 2018), the establishment of special economic and free trade zones, and a range of tax holidays. 

We firmly believe investment cannot be attractive only through incentives but needs to be addressed in a fundamental way through improvement in infrastructure, policy and bureaucratic and institutional policy. Sri Mulyani Indrawati, Minister of Finance, Indonesia

At the same time, faced with external pressures and volatility of the kind seen last year, the policy mix will shift from growth to stability. "We don’t want high growth at all costs, it has to be sustainable,” she explained. “Within the policymaking process we’re always pragmatic. If in 2018 there was more anxiety because of the changing direction of policy at the global level, we will address that anxiety…[to indicate] that we understand [investors'] thinking about us and the world. But it doesn't mean we will give up our policy direction as we want to build the right foundations for the economy."

Long-term outlook

Those foundations rely on addressing long-term development challenges to eliminate an output gap and supply-side constraints, including upgrading Indonesia’s physical infrastructure and human capital – in part to ensure that the massive labour force can adapt to the disruption caused by technological change. 

“For us to be able to continue improving our standard of living from a lower-middle to an upper-middle income country and avoiding the middle income trap, we need to address issues that are critical, such as those related to skills, innovation and technology as well as institutional capacity,” Minister Indrawati said.

The issue of institutional capacity is one that has been a persistent challenge in effecting change across Indonesia’s massive archipelago; it is not so much coming up with new development policies but consolidating those already in place and coordinating between national and local governments, Minister Indrawati said. Take upskilling the massive workforce: the government is mandated by the constitution to spend 20 percent of the budget on education, the largest spending item. “The challenge is not about the allocation [of budget] but how to spend the money,” Minister Indrawati said. “That requires a lot of delivery capacity at the local level.”

One thing is certain: Indonesia does not lack for entrepreneurial spirit, or evidence that it is meeting the challenge of technological disruption. "Indonesia enjoys the reputation of being the country that has produced four out of the seven unicorns in ASEAN. That is a good start despite the fact that we are still at an early stage in addressing issues fundamentally important for [the economy],” Minister Indrawati told the audience.

Regardless, some investors are still liable to focus on structural issues that attend a growing, opening economy, such as a current account deficit. Whether short-term concerns around such issues will jeopardise the capital inflows the country needs to help realise its long-term potential comes back to the issue of policy balance:

“This combination of policy is the most important thing. If you need to push the brake, you have to do it. But at the same time, be selective to use the right instruments to continue maintaining the momentum of growth while addressing the issues of fundamentals.” 

It is a policy balancing act that, if achieved, will make Indonesia the kind of long-term investment prospect the government has long been keen to create.