World Risk Developments - July 2014


Indonesia — New president will struggle to meet expectations

As the more moderate and pro-reform of the two presidential candidates, president-elect Joko Widodo has high expectations riding upon him. He hasn’t indicated he will retreat from any of the major policy benchmarks set by outgoing president Susilo Bambang Yudhoyono (SBY). But neither is he likely to achieve any big reform breakthroughs.

The Election Commission declared Jakarta governor Joko ‘Jokowi’ Widodo Indonesia’s president-elect on July 22, after he beat Gerindra party chairman Prabowo Subianto 53% to 47% in the July 9 presidential election. Jokowi will take office on October 20.

This is assuming — as most commentators do — that Prabowo fails in an appeal of the result to the constitutional court. He has threatened to question 30 million votes. Jokowi’s winning margin was 8.4 million ballots.

Market reaction

Financial markets greeted news of the Jokowi victory with a rally of stocks, bonds and the rupiah, and seemed to overlook or dismiss the Prabowo challenge.


Ratings agency Standard & Poor’s issued a statement on election day saying that the result would have little impact on Indonesia’s sovereign credit rating of BB+/stable/B. It said it expects slow reform progress no matter who is elected, which will continue to improve fiscal and debt indicators.

Political uncertainty

Since Prabowo would need to get at least another 4.2 million votes to supplant Widodo, and since there have been no reports of systematic ballot-rigging in favour of Widodo, his chances of succeeding with his appeal look poor. Still, the appeal will create uncertainty in the short term while the constitutional court deliberates. The court must hand down its decision by August 21. Its decision will be final.

SBY legacy

Under the 10-year presidency of SBY, Indonesia performed quite well macroeconomically, but less well microeconomically.

Annual real GDP growth averaged 5.9% over 2005-13 — a respectable performance if below that of regional peers. Real per capita GDP over the period climbed more than 40%. Average annual inflation was 7%. Public and external finances strengthened, with public debt falling to 26% of GDP from 47%, and external debt to 30% from 47%.

When setbacks came along, the economy coped well. In 2009 during the global financial crisis, it grew at 4.6% even as the world economy contracted by 2.1%. During the emerging market sell-off induced by talk of QE taper last year, the country’s financial markets came under heavy selling pressure. In fact, Indonesia came to be called one of the ‘Fragile Five’— along with Brazil, India, Turkey and South Africa. Still, the government managed to contain the pressures through monetary and fiscal policy tightening.

In recognition of its increased resilience, ratings agencies Moody’s and Fitch each gave Indonesia an investment grade sovereign credit rating in 2012.

Much of the credit for these results can be taken by policies that fostered macroeconomic stability and strengthened external and fiscal solvency — a fiscal policy that capped the dExport Finance Australiait at 3% of GDP, a monetary policy that targeted inflation, and a flexible exchange rate.

Social and industry policies were less well-managed. Despite two attempts to increase the subsidised fuel price, one of which was reversed, the government never managed to contain a mammoth fuel subsidy bill. At 2.6% of GDP and 21% of the central government budget (after transfers to the regions and interest payments), these subsidies are almost double the spending on infrastructure.

Industry policy, meanwhile, was marred by resource nationalism. In January, the government imposed a ban on exports of some unprocessed minerals, including nickel, copper and bauxite. The ban is part of a policy designed to encourage mining companies to build local smelters and refineries. The government has also passed regulations requiring foreign mining companies to divest at least 51% of their mining ventures to local companies after 10 years of operation.

According to the World Bank, the export ban could reduce the trade balance by US$12½b and cut fiscal revenues by US$6½b over 2014-17. Meanwhile, the export tax has prompted some mining companies to talk about going to international arbitration on the grounds that they are liable only for those taxes included in their contracts.

Populism vs nationalism

During the election campaign, both candidates advanced policies that were populist and nationalist. Each supported the ban introduced by SBY on unprocessed mineral ore exports, and both have spoken against the influx of foreign resource companies. Prabowo also talked of allocating new contracts to local companies and giving a greater role to state-owned enterprises. Jokowi emphasised instead land reform to help the poor.

Macroeconomic policy

In macroeconomic policy, the biggest news has come from the Prabowo camp, where Prabowo’s brother and financial backer, Hashim Djojohadikusumo, said that Indonesia is ‘underleveraged’ and should double its debt-to-GDP ratio to achieve 10% growth.

Standard & Poor’s dismissed this as ‘a grandiose campaign statement rather than an actual policy goal’. But it made other commentators nervous, because it seemed to downplay the risks of ambitious borrowing and implicitly rejected the prudent macroeconomic envelope accepted by previous governments going back to Suharto. Some analysts went so far as to suggest that Prabowo’s debt-fuelled nationalistic agenda could spark a market sell-off if it showed any signs of getting up.

In contrast, Jokowi is more likely to respect the existing policy framework, including the dExport Finance Australiait cap and relatively independent central bank. He has set no growth target, but has instead emphasised easing impediments to growth so it can climb above 7%.

Among the ways he hopes to do this are simplifying investment laws, introducing a law on settling industrial disputes, taking steps to ensure legal certainty, and developing a nationwide transport system with support from a new infrastructure development bank. Markets find this more comforting.


Neither candidate has indicated any wish to lift the ban on raw ore exports, though Jokowi is thought to be more pragmatic on the issue — interested in achieving a balance between the interests of investors and the public. Encouragingly for foreign investors, he has indicated that he will honour existing contracts.

Prabowo, in contrast, has said he would renegotiate existing mining contracts considered to be unfair, including those of the biggest operators in the country, such as Freeport, Newmont and Chevron. He has long been an advocate of more local processing and ownership of Indonesia’s natural resources.


Infrastructure developers are cautiously optimistic about Widodo for three reasons — first, his strong emphasis on the importance of eliminating infrastructure dExport Finance Australiaits; second, his proven ability while Jakarta governor to streamline bureaucratic processes and improve tax collection; and third, hope that his pursuit of prudent macroeconomic policy will create ‘fiscal space’ for more projects.

Fuel subsidies

Though Widodo has promised to raise fuel prices by about IDR 1,500 (14c) a litre a year to free up US$30b for additional infrastructure spending, it remains to be seen whether he can convince his party, which has consistently opposed all efforts by the SBY government to cut subsidies.

This is an issue to watch. If the new president fails, the budget will remain sensitive to currency depreciations and international oil price increases that swell the subsidy bill and possibly deny funds to infrastructure and social programs. If he succeeds, both macroeconomic stability and infrastructure spending will be winners.

Food self-sufficiency

After Indonesia experienced food shortages and price shocks in 2008 and 2011, the outgoing government set a policy of achieving self-sufficiency in rice, soybeans, sugar, beef and maize by 2014. This policy guarantees a minimum price for products, and subsidises the price of inputs such as fertiliser. Although the policy failed to hit its targets for rice, soybeans and sugar, and created many market distortions, it has proved popular, and both candidates supported it while campaigning.

This is not good news for Australian food exporters hoping for better market access.


Jokowi looks to be the stronger of the two candidates on fighting corruption. He has pledged to support the popular KPK, or Corruption Eradication Commission. This body has been successful in prosecuting many prominent figures. This has enabled Indonesia to improve its ranking for corruption in international surveys (first chart below). But it remains a poor performer with much room for further improvement (second chart below).


Reform obstacles

Apart from Jokowi’s platform, there is another issue to consider – policy execution. Here he will face a variety of political obstacles.

First, he has promised to appoint the professional, the technocrat and only the best’ to his cabinet. But he may also have to reward with cabinet posts party loyalists within the PDI-P for their support.

Second, he may face opposition in the 560-member lower house of the legislature. There the PDI-P managed to gain only 109 seats, while a 353-seat grouping made up of Gerindra, Golkar, the Democratic Party, the Crescent Star Party and three Islamic parties has coalesced to oppose him. (This obstacle will, however, subside if Prabowo’s
election partners start to work with Jokowi’s side – something they have said they are open to do. Coalitions formed for the presidential election seldom survive beyond election day.)

Third, while Jokowi’s outsider status and success as a self-made man might have been pluses for voters, they will be handicaps in his dealings with the political, military and bureaucratic establishments.

Finally, it needs to be remembered that political and fiscal devolution since 1999 has transferred important powers to provincial and district governments. Some have engaged in arbitrary regulation and imposed predatory fees. His leverage over them will be limited.

Roger Donnelly, Chief Economist

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