Indonesia's Transition to Growth and Stability

Date: June 23, 2014

Indonesia's Transition to Growth and Stability

It is remarkable to think that roughly 15 years ago, Indonesia was a country convulsed by political upheaval and economic crisis.  Indeed, the conventional wisdom in many quarters at that time was that Indonesia was in effect an “Asian Yugoslavia”, heading inevitably towards a messy disintegration and economic stagnation.

Today, Indonesia has firmly established itself both as an engine of growth in one of the fastest growing regions in the world, and as a stable democracy on the verge of what is expected to be an orderly national election and transfer of power.  How has Indonesia managed to execute such a strikingly successful transition to stability?

The short answer?  Strong economic growth, a favorable set of global strategic circumstances, competent leadership, and a fair amount of good luck.

Start with the basics:  Indonesia is big.  With a population of over 250 million, Indonesia is the fourth most populous nation in the world, and the largest economy in Southeast Asia.  Indonesia’s large population provides both an abundant pool of cost-completive labor to help drive exports, as well as a substantial source of local demand.

 An aggressive reform agenda enacted during President Yudhoyono’s first term (2004-09) – including significant reforms to the finance sector, and tax and customs regimes, along with enhanced capital market development and supervision – are generally credited with setting the stage for growth.  The Administration also won plaudits from multilateral agencies for its stringent fiscal management, resulting in a debt to GDP ratio of less than 25%, and a fiscal deficit of less than 3%.

Propelled by prudent macroeconomic management, strong domestic consumption and investment, and rising prices for its commodity exports such as palm oil, copper, and rubber, Indonesian growth rates have been exceptionally strong over the past decade -- generally in the 5 – 6.5 percent range, except during the global financial crisis.   And even during the darkest days of the crisis, while many major economies were contracting, Indonesia managed to grow at a rate of 4.6% in 2009.   Indeed, Indonesia, China, and India were the only G-20 members to maintain positive growth that year.

Indonesia’s credit rating returned to investment-grade status in 2011, and the Boston Consulting Group estimates that the number of middle class and affluent consumers could double to 141 million by 2020 – a figure which is higher than the entire population of Thailand.

 Importantly, the population of Indonesia is not only large and becoming wealthier, it is also young.  While the two largest economies in Asia, China and Japan, will inevitably wrestle with severe demographic challenges in the decades to come as a result of aging populations, more than half of Indonesia’s citizens under the age of thirty.

By virtue of its extremely large domestic market, low labor costs, impressive growth, expanding middle class, and preferential access to ASEAN and China, Indonesia has become a highly significant market in its own right, a logical springboard into China, and a leader amongst it ASEAN brethren.  A growing chorus of economists and analysts have made the case that Indonesia’s economic success story makes it a legitimate candidate for inclusion in the BRICS club of leading emerging economic powers.   

In fairness however, it should be pointed out that some have begun to wonder if the Indonesian growth story might soon be hitting a few road-blocks.  The IMF recently downgraded its growth estimates from 6.3% to 5.25%, citing weakening demand for commodity exports, dropping commodity prices, and potential capital outflows associated with the onset of the US Federal Reserve’s tapering policy.  Indonesia’s widening current account deficit will become even more difficult to finance as access to capital grows less abundant. And the Indonesian currency has suffered sharp decreases – especially after the US Federal Reserve dropped hints over the summer about the likelihood of tapering.

Glaring deficiencies in the infrastructure will become even more evident, and unless addressed in a meaningful way, could create a progressively greater obstacle to continued growth.  And years of super-charged growth are beginning to put upward pressure on wages, which could serve to undercut one of the strongest assets the nation possesses.  Finally, although Indonesia is certainly not alone in this regard, corruption is still an all-too-frequent fact of life.  

So while a continuation of the Indonesian success story seems likely, no one should assume that the economic road ahead will be free from pot holes or challenges.   On balance however, there is ample reason to expect that Indonesia will remain an anchor of stability and economic dynamism in the fast growing ASEAN region. 

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