What Indonesia needs now

A shift underway

Hopes for breakthrough reforms to be passed in the period already dubbed ‘Jokowi 2.0’ are high. Jokowi’s speech on July 14 outlined five policy focus areas – investment, bureaucratic reform, infrastructure, quality of human capital and budget appropriation.

“We will accelerate and connect the infrastructure projects, such as toll roads, railways, seaports and airports,” Jokowi said during the speech.

There is an understanding, in ANZ’s view, among the private sector and Jokowi’s administration that fiscal and monetary policy frameworks have strengthened in recent years, playing a major role in supporting economic growth.

Bank Indonesia’s inflation-targeting framework, complemented by market development and improving communication with market participants, has restored confidence in times of stress. The Ministry of Finance’s fiscal prudence has contained the budget deficit while supporting infrastructure projects (even as tax revenues disappointed), arguably helping avert a deeper bond market correction in 2018 as investment flows diverted back to the US and away from local currency and bond markets.

The fiscal and monetary space is nonetheless much reduced. The Ministry’s role going forward would be limited to ensuring stability and facilitating other engines of economic growth.

Reforms to watch

Looking ahead, Chatib Basri (who led the Ministry of Finance from 2013-2014) has identified bureaucratic reform and investments as most binding conditions for increasing the economic growth rate.

Jokowi’s 16 economic packages announced in his first term and recently announced tax incentives for research and development activities (‘super deductibles’) need supporting implementation measures to be effective. Two areas in policy development are worth watching for.

To solve the persistent problem of aligning local governments’ performance to the central government’s development and efficiency targets, the central government could consider a system of incentives and disincentives for local governments to encourage bureaucratic reforms.

To increase investments from both foreign and domestic investors, labour law reform is the next big step to consider. Investments are the make-or-break condition for Indonesia to not only reach the 7 per cent annual growth target but to maintain the current rate of just about 5 per cent.

In June ANZ Research said Indonesia’s near-term growth is likely to remain stuck at around 5 per cent. At the current rate, considering the domestic savings pool, Indonesia still needs foreign financing - and a more stable funding source than portfolio flows.

A key objective will therefore be to increase Foreign Direct Investment, more specifically into export-oriented sectors that entail research, development and training as supporting activities.

Indonesia’s effective isolation from the global supply chain, as suggested by its low global-value participation rate and manufacturing-to-GDP rate compared to its regional peers, is a blessing at times like now but a key disadvantage for long-term development.

Not taken for granted

Elsewhere in the economy, infrastructure development - a key economic growth driver and policy focus in Jokowi’s first term - appears to have taken a back seat, at least at face value.

Under the surface, it’s just that shape which has shifted - from headline-grabbing projects at centralised strategic locations to smaller projects aimed at supporting the development of human capital and small-to-medium businesses.

Improving the quality of both human capital and productivity is no easy feat and often means long-term program commitment.

The Indonesian government wants to focus on providing vocational training, improving health and nutrition and incentivizing knowledge and skill transfer among private companies. The private sector has not stood still and has found means to boosting productivity in shorter periods of time.

Technological advancement is playing a growing role in Indonesia’s expansion, particularly in financial services. Fintech is at the forefront of ‘disruption’ in the country’s economy, with many players in the sector carrying an explicit social mandate to raise the digital and financial literacy of Indonesia’s people.

Budi Gandasoebrata, Managing Director of Go-Pay, says such tech is enlarging not just the market reach (and productivity) of street-side food vendors but also insurance and investment products of large financial institutions.

These combined forces of the private and government sectors leave Indonesia well placed to achieve what it needs to reach its growth goals.

Jennifer Kusuma is Senior Asia Rates Strategist, Institutional at ANZ

This story is an edited version of a recent ANZ Economic Outlook seminar conducted in Indonesia.