Since overcoming the Asian Financial Crisis of 1997/8 which saw the end of the long-running Suharto regime, Indonesia has charted a steady course of political and economic development. As it settles into its new status as a free-market democracy, can Indonesia make a success of the reforms necessary to fulfil its huge potential and take on the mantle of Southeast Asia’s powerhouse?
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Indonesia certainly has a unique profile that hints at its vast potential in the region and beyond. It is the world’s largest archipelagic state with more than 13 000 islands, and has the largest population in Southeast Asia at 258 million, half of whom are under 30. Indonesia is very diverse culturally – there are more than 300 ethnic groups including the Sundanese, Madurese, Malay, and Javanese who are the largest ethnic group forming 40% of the population. The Javanese are also the most politically dominant group; the nation’s capital Jakarta is situated in the island of Java.
Situated in a strategic location along major maritime trade routes between the Indian and Pacific oceans, Indonesia is SEA’s largest economy, amassing US$861 GDP in 2015. It is also the 10th largest economy worldwide in terms of Purchasing Power Parity and a member of the G20 group of major economies. Indonesia’s potential is marked by investors drawn by a large consumer base, rich natural resources and political stability, but often put off by poor infrastructure, widespread corruption and protectionist sentiments.
According to the International Monetary Fund (IMF), Indonesia’s economy continues to register strong growth largely due to solid economic policies and increased household consumption. The country’s GDP growth of 5% in 2016, up from 4.8% in 2015, remains among the highest in large emerging economies. Indonesian exports came up to $150 billion in 2015, with Japan, US, China and Singapore as top destinations. Underlining its economic potential, the World Bank forecasts Indonesia’s growth to come in at 5.3% for 2017, higher than the forecast of 4.4% average economic growth in other emerging economies.
Looking Back: The New Order Era
The state of politics and economics in Indonesia was markedly different two decades ago. Indonesia was run by the authoritarian New Order regime led by former General Suharto who seized power in a coup in 1965, and was in charge until 1998 when he was toppled by the instability wrought on the Indonesian economy by the Asian Financial Crisis. In the New Order, there was no room for political freedom as affairs were dominated by the government and military which played powerful roles in every level of government from national to regional to local. Corruption was rife in the state apparatus and elite business circles, while any dissent against the regime was quashed, often leading to human rights abuses by the military and security forces. The national ideology of Pancasila – comprising five vague principles of belief in God, national unity, humanitarianism, social justice, and democracy – was exploited as an instrument of control.
However, there was remarkable economic growth and development during the New Order era as Suharto embraced Western principles of economic development, and liberalised trade and finance policies to spur foreign investment. Per capital income levels rose from $70 in 1966 to $900 in 1996. Average GDP growth in the last decade of Suharto’s rule was an impressive 8%, while poverty levels dropped from almost 60% of the population in 1968 to 13% by the time of the financial crisis in 1997. Singapore enjoyed excellent bilateral relations with Indonesia under the New Order thanks to warm and close personal relations between Suharto and Lee Kuan Yew.
A New Era: Democracy and Reforms
Indonesia’s political landscape underwent a sea change after the end of Suharto’s rule as it began its journey as a democracy. After a transition period, the first direct presidential elections in 2004 saw Susilo Bambang Yudhoyono (SBY) elected President from 2004 to 2014. There are mixed opinions on the SBY presidency. On the plus side, Indonesia experienced political stability under a democratically-elected presidency that lasted ten years, the longest in its history. Communal violence between ethnic groups and government forces declined, and the 30 year civil war in Aceh ended in 2005. The economy grew at an average of 5% and the economy reached the $1 trillion mark.
However, long-standing structural problems remained as reforms were compromised for stability in a new democracy. There was little progress in fighting corruption, and religious minority rights were eroded as conservative Muslim groups were allowed to push a more narrow religious orthodoxy that pushed out liberal and moderate thought.
In the economy, the benefits of GDP growth were not always distributed to the people as growth was achieved by the capital-intensive commodities sector which generated large profits for companies but did not sufficiently create good jobs or uplift wages. There was also insufficient investment in infrastructure such as roads, ports and electricity networks; less than 4% of GDP was allocated to infrastructure development instead of the recommended 8%.
Indonesia under Jokowi: A New Phase of Growth?
When elected, President Joko Widodo, popularly known as Jokowi, was largely seen as a political outsider with no establishment baggage who could realise the major reforms needed in Indonesia. He was elected on a wave of popular support for his clean reputation and promise of change. Scholars have called for a new approach under Jokowi to lift growth and development beyond current levels by moving Indonesia up the value chain in global production networks through industrialisation and innovation.
The Jokowi government has, since late-2015, announced a host of economic packages to liberalise foreign investment, improve government efficiency and competitiveness, develop human capital, and raise the government’s financial capacity. The most anticipated package for foreign investors was the revision of the Negative Investment List in May 2016 to attract more foreign investment through a liberalisation of the economy. Revisions include the removal of foreign ownership restrictions on business in selected sectors. To encourage inter-Asean cooperation, higher ownership caps were set for Asean investors in selected industries.
To improve government efficiency, there are plans to trim a bloated and inefficient bureaucracy, a legacy of the New Order era, by laying off 300, 000 civil servants from 2017 to 2019, freeing up $13.4 billion of government funds. Another legacy of the New Order, State-owned Enterprises (SOES) comprise 20% of the economy and have been criticised for being oversized and ineffective in competing internationally. Jokowi plans to list several SOEs in the stock market to limit political interference in their operations and compel them to be more competitive.
In the area of human capital, while Indonesia is blessed with an ample and youthful workforce, finding sufficiently skilled workers is difficult for investors. Language and mathematical skills have been identified as areas of improvement especially for the manufacturing and construction sectors.
Raising government revenue for priority areas such as infrastructure development, health and education is another goal. Government strategy in this area has included tax reform to broaden the tax base and strengthen tax collection. The ongoing tax amnesty programme that was launched in July 2016 has raised about $8 billion in revenue. In addition, Jokowi scrapped costly petrol subsidies in 2015, saving about $18.4 billion. These measures notwithstanding, Jokowi’s government will need plenty more financial muscle to implement reforms moving forward.
The Way Ahead to Powerhouse Status
If it is to achieve its powerhouse potential, there are a host of major challenges Indonesia needs to address in areas such as political stability, rule of law, being business-friendly, and infrastructure development. Indonesia’s next presidential elections are due in 2019. Regardless of whether Jokowi or another candidate emerges victorious, it is imperative that Indonesia’s democratic system maintains political and social stability in the face of fundamentalist religious elements and other political elements seeking to destabilise the country. The recently concluded gubernatorial elections in Jakarta were overshadowed by religious tensions thought to be orchestrated behind the scenes by competing political elements engaged in a proxy battle ahead of the presidential elections in 2019. Although it has the world’s largest Muslim population, Indonesia is officially a secular state home to many ethnic and religious groups. Preserving stability and social cohesion is vital to Indonesia’s growth story.
Improving the rule of law especially to eradicate corruption will continue to be a major challenge. The 2015 World Justice Report ranked Indonesia 52 out of 102 countries in measuring the rule of law based on the experiences and perceptions of the public and experts. This was a drop of six places from 2014, indicating that there is a long way to go when it comes to the rule of law in Indonesia. Foreign investors and locals alike need greater assurance that the law can protect them and their business interests.
Simplifying the complex regulatory environment in Indonesia, often described as “a gold mine in a minefield”, will be another long-term undertaking considering the multiple levels of government – national, regional and local – in Indonesia’s now decentralised political system. There are encouraging signs though. Indonesia was among the top 10 improvers globally in the World Bank’s 2017 Doing Business report, climbing from 106 in 2016 to 91 in 2017.
Last but not least, the need for development in Indonesia’s inadequate infrastructure is well-known. A McKinsey study estimated that Indonesia will need at least $600 billion over the next 10 years to address critical infrastructure gaps. Thus far, the government has laid out an ambitious plan targeting $480 billion investment from 2015 to 2019 funded by both public and private sectors. Being a vast archipelago, Indonesia needs the connectivity afforded by ports, roads and utilities serving its citizens and investors.
With its global reputation for political stability, rule of law, ease of doing business, and well-connected and reliable infrastructure, Indonesia’s neighbour Singapore offers Jakarta many opportunities for learning and cooperation. Carrying over from the New Order era, Singapore-Indonesia relations continue to be excellent as the neighbours marked 50 years of diplomatic relations this year. Relations are underpinned by strong economic cooperation in a wide range of sectors including defence, health and the environment. In 2016, Singapore companies invested $7.1 billion in Indonesia for the first nine months, double that of the same period in 2015, maintaining Singapore’s position as one of the largest investors in Indonesia. Going forward, there is a wide range of opportunities for Singapore businesses to capitalise on in Indonesia as it works to realise its potential of becoming a Southeast Asian powerhouse.