Indonesia as contrary indicator

With panic spreading through United States and European markets, Southeast Asia’s largest economy appears poised to ride out the shockwaves. As Asia’s more export-dependent economies brace for the impact of a possible double-dip global recession, Indonesia’s domestic demand-driven growth is expected to sustain its momentum.

That is a stark contrast to the country’s financial position 13 years ago, when the Asian financial crisis demolished Indonesia’s economy, drained the national coffers and spoiled its reputation among investors. It has now leveraged into high global commodity prices and ever-rising local consumption that together account for around 70% of gross domestic product (GDP).

“Indonesia is really a domestic markets story and a commodities story,” said Fawzi Ichsan, an economist at Standard Chartered Bank. He notes that robust domestic markets helped to cushion Indonesia against the global economic crisis in 2008 that dramatically affected many of its regional neighbors, including Singapore and Thailand.

Many Asian markets have been hit by the global free fall caused after Standard & Poor’s downgraded the US’s sovereign credit rating to AA+ from its top-tier AAA due to US politicians’ inability to manage the country’s huge fiscal deficit.

Even Jakarta’s Composite, one of Asia’s best-performing stock markets this year, was down by close to 2% on Monday. But analysts here say the US crisis should have little impact on an economy that has, to some surprise, bucked the negative trends elsewhere.

“The impact is immediately being felt in financial markets, but it is not Indonesia-specific,” said Ichsan. “In the long run, the US is experiencing a ratings downgrade, while Indonesia is seeing upgrades.”

Indeed, the big three ratings agencies – S&P, Moody’s and Fitch Ratings – have all upgraded Indonesia’s sovereign credit rating to BB+ or its equivalent and analysts expect the country to achieve investment-grade status within the year.

Indonesia’s GDP rose by 6.5% in the second quarter of this year on the back of high commodity prices, strong consumer demand and rising investment. As regional heavyweights China and India struggle with persistently high inflation, Indonesia has seen previous inflationary pressures ease. Economists predict that the central bank will hold the benchmark interest rate at 6.75% for a sixth consecutive month.

One reason for Indonesia’s comparatively lower inflation stems from a government decision to increase budget allocations for fuel subsides, a policy the World Bank and International Monetary Fund have criticized. Jakarta has also allowed in more imports of vital food supplies, such as rice, to meet production shortfalls. That could prove particularly prudent during the Islamic fasting month of Ramadan, when demand and prices rise as families prepare elaborate fast-breaking meals.

High yields on government treasuries have also brought more money into the bond market. Ten-year Indonesian bonds currently yield at 6.8%, carrying a higher risk but significantly higher potential returns than 10-year US government bonds, which carry a rate of around 2.6%.

With government debt comprising less than 30% of Indonesia’s GDP, investment levels are up near record highs. Foreign direct investment in the second quarter rose 21% over the same period last year. Those funds, analysts say, will serve as a cushion to short-term portfolio capital flows – or so-called hot money – that are usually the first to flee during times of crisis.

In the domestic market, meanwhile, the property, telecommunications and automotive sectors all booked double-digit profit growth in the second quarter compared to last year, while manufacturing rose to its highest level since the 2008 economic downturn.

Economists say there is the potential for some instability caused by legal uncertainties over land use rights and contract sanctity, as well as rampant corruption and infrastructure failings seen in a lack of toll roads, ports and power plants.

For now, however, investors drawn by the high potential returns and stable inflation environment appear willing to navigate those risks. But some financial analysts worry that a fall in global commodity prices or unforeseen political instability could yet spark a reversal.

Indeed, the upbeat forecasts do not reflect ongoing problems caused by a weak government, including endemic corruption, political infighting and peripheral sectarian conflicts.

Faint cracks
Recent violence in remote Papua, where a low-level separatist movement has been brewing for decades, strikes at mining companies by workers demanding higher pay and a growing number of scandals that have rocked the Democrat Party led by President Susilo Bambang Yudhoyono are all risk factors.

On Tuesday, Indonesian officials confirmed that Interpol had captured fugitive lawmaker Muhammad Nazaruddin, who escaped the country on May 23 one day before he was scheduled to appear before court on corruption charges. The former Democrat Party treasurer had eluded arrest and launched accusations from an undisclosed hideout that fellow party members, including chairman Anas Urbaningrum, had accepted millions of dollars in influence money.

Nazaruddin also accused the respected Corruption Eradication Commission, which boasts a 100% conviction rate, of unethical behavior by colluding with Democrats to shield high-ranking officials from graft investigations. A poll released on Monday by the independent Indonesian Survey Circle revealed that trust in the anti-graft body had hit an all-time low while the agency’s deputy chairman Mochammad Jasin told journalists recently that corruption in Indonesia was at its worst.

Whether these accusations and revelations will cause enough political turbulence to derail the economy and foreign investor confidence, for now, seems doubtful. “It’s like airing your dirty laundry,” said Yohanes Sulaiman, a political consultant and lecturer at Indonesia’s National Defense University. “Maybe it’s embarrassing to some, but it won’t cause problems on a wide scale.”

However, some argue Nazaruddin’s case has again revealed the lack of control Yudhoyono has over his administration and political party. Sulaiman says Nazaruddin is merely a loose cannon who has caught the government off guard and that investors who know the country are prepared to roll with such risks.

“As an investor you already know there are bribes to pay, commissions to pay, so it’s really just business as usual,” he said. “You have to have connections, and you factor this into your analysis when you invest in Indonesia.”

While Indonesia’s political wheeling and dealing may not register much investor attention, other domestic conflicts are drawing international scrutiny. Global human-rights groups have called on Yudhoyono to stem the recent political violence in Papua that has killed 22 people.

They have also condemned the light sentences given to those who killed three members of the Ahmadiyah minority sect last February. In late July, a court sentenced 12 religious hardliners to no more than six months in jail for leading a stick-wielding and stone-throwing mob attack against the sect, which they considered heretical to Islamic beliefs. None of the suspects was found guilty of murder.

The Foreign Ministry defended the verdicts last week when it told reporters that people should not “oversimplify” where Indonesia stands on religious tolerance based on just one case. But as such cases add up, questions will rise about the quality of Indonesia’s governance and how poor oversight could eventually impact on its fast and impressive growth.

Sara Schonhardt is a freelance writer based in Jakarta, Indonesia. She has lived and worked in Southeast Asia for six years and has a master’s degree in international affairs from Columbia University.