It was just 12 years ago that the Asian financial crisis
brought the Indonesian banking system to its knees, sent the
rupiah tumbling and sparked the messy downfall of President
Suharto after 32 years of dictatorial rule. This time round the
country has surprised many by emerging from the recent global
crisis almost completely unscathed.
With the banking system on a much sounder footing, a huge
domestic market of more than 230 million people to protect
against external demand shocks, and a stable, adept government,
Indonesia has been able to ride out the global storm in
Indonesia was the third-fastest growing economy in the Group
of 20 nations last year after China and India, growing by 4.5%,
compared to 6.1% in 2008 and 6.3% in 2007. The government
forecasts growth of 5.56% this year, a view shared by
This resilience, and the potential for further rapid growth
that it implies, have not gone unnoticed.
Starved of attractive opportunities in sickly western
markets, international investors have piled into Indonesia,
which became the emerging market story of the last year.
Investment bank Morgan Stanley encapsulated the buzz in a
research report released last June, which suggested that
Indonesia should be seen as the fifth member of the Bric
nations, the emerging market powerhouses of Brazil, Russia,
India and China.
Indonesias macroeconomic stability, large and
expanding consumer market and its wealth of natural resources
are likely to drive robust growth in the years ahead. But the
country still suffers from widespread corruption, burdensome
red tape, creaking infrastructure and a lingering hostility to
The key challenge, in President Yudhoyonos
scandal-ridden second term, is whether he can push the reform
agenda hard enough to ensure that these roadblocks to growth
Indonesias remarkable recovery over the last decade is
all about the return of political and macroeconomic
The combination of low inflation, shrinking external debt,
growing foreign exchange reserves and sustained economic growth
has led to a structural decline in the cost of capital, says
Chetan Ahya, an economist at Morgan Stanley in Singapore and
one of the authors of last years influential report.
Indonesia is experiencing a virtuous cycle of rising
savings and investment, he says. When the cost of
capital is high, business is about who can get a licence from
the government or who has a relationship with a particular
politician. But when the cost of capital is low you can see new
guys emerge, and you will see a transition from a country being
run by five or six main entrepreneurs to many more businesses
emerging in the private sector.
This is the best momentum weve seen for 10
years, says Faisal Basri, an economist at the University
of Indonesia. Weve seen more and more hot money
coming into the capital markets, but the trend for foreign
direct investment is also increasing.
Boosted by the inflow of foreign money, the benchmark
Jakarta Composite Index has been one of Asias
best-performing stock market indices over the last year or so,
hitting record highs in April after more than doubling in value
since its trough in March 2009.
The rupiah was Asias best-performing currency last
year, rising 16% against the US dollar, a trend that has
continued into the second quarter of this year. Since the start
of the year, Fitch Ratings and Standard & Poors have
lifted Indonesias sovereign credit ratings, with Fitch
rating Indonesias debt at BB+, just one level below
The government sees this optimism as a vindication of
its sound economic management. Growth is picking up,
consumption is picking up, exports are robust, and investment
will hopefully be picking up as well, Mari Elka Pangestu,
the trade minister, tells Emerging Markets.
But despite her enthusiasm, the US trained economist
acknowledges that there are serious challenges ahead. The
big question is how we are progressing on developing policy to
ensure that we can sustain growth, she says.
Another concern, raised recently by the IMF and the ADB, is
that the large inflows could destabilize emerging Asian markets
like Indonesia when the flow inevitably starts to turn.
Perry Warjiyo, a senior official at Bank Indonesia, the
central bank, warned in April that Indonesian stocks have
entered bubble territory and that the bank may need
to consider some form of capital controls further down the
line. Bank Indonesia subsequently played down the probability
of capital controls being imposed, and analysts agree that,
despite the real risks of concerted outflows when the bubble
bursts, such moves are unlikely.
One of the biggest risks to Indonesia is likely to be
capital flow, wrote Arief Wana, head of research at
Credit Suisse in Jakarta, in a recent note. The risk of
capital control is low, given that Indonesia is opting for an
open market system.
The re-election of Indonesias cautiously progressive
president Yudhoyono with a strong personal mandate last July
fuelled expectations that his administration would forge ahead
with the economic and bureaucratic reforms that began after he
was elected in 2004. But the robust nature of Indonesias
political system and the fact that Yudhoyonos Democrat
Party only won 21% of the vote in the April 2009 elections has
dashed hopes for rapid reform.
The House of Representatives, the main legislative body, has
yet to pass a bill since it was re-elected. That is largely
because it has been pre-occupied with investigating the 6.7
trillion rupiah ($740 million) bail-out of a small but troubled
lender called Bank Century in 2008.
Most economists believe the rescue of the bank, led by
Finance Minister Sri Mulyani Indrawati and Vice-President
Boediono, who was then head of the central bank, was necessary
to ward off the threat of financial contagion. But political
opponents of Sri Mulyani and Boediono, both well respected
technocratic reformers, have criticized the manner of the
bail-out and made unsubstantiated allegations that the
president and his ministers benefited financially from the
An official House of Representatives probe concluded in
March that the bail-out was illegal but failed to provide
convincing evidence of wrongdoing. The conclusion of that
inquiry has partially drawn a line under the issue, although
lawmakers are pushing for further probes, and the powerful
Corruption Eradication Commission is conducting its own
In its recent quarterly emerging markets review, investment
bank Credit Suisse said the affair has politically
weakened the government and warned that Indonesia may be
entering a period of policy paralysis that could
expose Indonesia to external financial and commodity
price shocks in the medium term.
One peculiar result of the political turbulence has been
that Bank Indonesia has been without a governor since May last
year, when Boediono stepped down to run for vice-president. Sri
Mulyani was originally believed to have been lined up to
replace Boediono but, facing the gathering storm over Bank
Century, Yudhoyono decided it would be impolitic to reshuffle
his pack at this stage.
Its certainly a strange situation, says
James van Zorge, a business consultant in Jakarta. But it
hasnt caused too much concern among investors yet as
monetary policy has remained solid.
Despite such concerns, Kevin ORourke, a Jakarta-based
political risk analyst and author of the Reformasi Weekly
Review, believes it is increasingly likely that Boediono and
Sri Mulyani who have spearheaded vital reforms of
Indonesias notoriously corrupt tax and customs
directorates will not be forced out.
The battle over Bank Century represents the
fundamental tensions between reformers and vested
interests, he says. Indonesia was an extreme
example of a patronage state for 500 years, with public
officials focused on gaining economic rents to buy support. It
was only with the fall of Suharto and the 2004 election of
Yudhoyono as president that reforms got underway.
With Indonesia persistently ranked as one of the more
corrupt countries in the world by organizations such as
Transparency International, it is vital that key reformers such
as Sri Mulyani and Boediono are allowed to continue their good
work, says Basri, who is a leading campaigner for further
A raft of high-profile corruption cases has hit the
headlines in Indonesia recently, including that of a mid-level
tax official called Gayus Tambunan, who allegedly collected
more than $3 million from businessmen in exchange for fiddling
The seemingly endless stream of graft cases may look bad at
first sight, says Van Zorge, a business consultant in Jakarta,
but it shows the governments determination to root out
corruption and is testament to the fact that Indonesia has an
unshackled press that is free to expose official abuses.
Foreign investors can try to side-step corruption by picking
their local partners carefully, van Zorge and ORourke
say, but the profusion of red tape is a hurdle that is less
With significant power devolved to Indonesias 33
provinces and government ministries often overlapping in remit,
it can take years for companies (both domestic and foreign) to
get approval for infrastructure and mining projects. US mining
giant Freeport McMoRan Copper & Gold and Indonesian coal
producer PT Indo Tambangraya Megah are among those that have
been caught in disputes with the government because of
uncertainty over their permit status.
Countless infrastructure and tourism projects
including an ambitious Dubai-led plan to transform the sleepy
island of Lombok into the next Bali have been delayed or
cancelled because of the problematic land acquisition
And yet infrastructure investment is the key to
Indonesias future growth prospects. Investment in
infrastructure has dropped to the equivalent of about 3.5% of
GDP in the past three years, from 7% before the Asian crisis,
lagging such investment in faster-expanding economies,
the ADB said in April in its development outlook report for
This country needs infrastructure investment
desperately, says ORourke. It will create
jobs and bring down poverty: 14% of the population is still
living below the poverty line of 6,500 rupiah per
Gita Wirjawan, head of the countrys inward investment
agency, says Indonesia needs $100150 billion over the
next five years to upgrade its ageing infrastructure, if it is
to reach the governments goal of 7% annual economic
growth. Two-thirds of that investment will have to come from
the private sector, he says.
Juan José Daboub, managing director of the World
Bank, thinks Indonesia requires something more like $250
billion over the next five years, while some economists believe
the country needs as much as $100 billion a year if it is to
attain China-style economic growth of 7% a year and above.
But the flow of hot money into Indonesian stocks and bonds
has yet to be matched by a surge in foreign direct investment.
Given the long gestation period of road, rail and other
infrastructure projects, it will take a year or more before it
becomes apparent whether talk of renewed FDI has turned into
concrete investments, says van Zorge.
The government, which hosted a large international
infrastructure conference this April, is trying hard to drum up
interest, particularly from China.
Trade minister Mari Pangestu hopes that US president Barack
Obamas eagerly-awaited return to Indonesia, where he
lived for four years as a child, will help increase awareness
among US investors after his visit in June.
Were open for business, and if you dont
come now, youre going to miss the boat, she tells