Basri: Indonesia stalled because we wanted it to

Asiamoney, June 2014

Received wisdom has it that Indonesia was the most badly hit of all southeast Asian economies when Ben Bernanke’s unexpected comments about tapering set off an emerging market sell-off last May. Vulnerable because of its twin budget and current account deficits, and hostage to flighty foreign capital, it was anointed one of the Fragile Five – an unhappy collective term for particularly vulnerable emerging economies – and its economy stalled while its currency tumbled.

But we’ve got it all wrong. According to finance minister Muhamad Chatib Basri, it was all part of a cunning plan.

Not the first bit, the current account deficit: that was unavoidable, a side-effect of Indonesia’s own success, Basri says.

“We are a country with a young population. Most of our population are workers aged less than 30,” he says. This has led to a consumption boom. “People in their initial career will start to buy cars, motorcycles; that’s why the growth of motorcycles in Indonesia is one of the highest in the world.”

The growth of wealth amongst this sector sounds mild in world terms, but in fact a pivotal level has been reached. In 2003, he says, the proportion of people who would spend $4 per day or more was about 5%; by 2010 it was 18%. “In a country of 240 million people, the additional number is about 40 million people, larger than the populations of Malaysia, Singapore and Australia combined,” he says.

This has been fertile ground for foreign consumer companies: Toyota, Unilever and L’Oreal are examples of multinationals with large production bases in Indonesia.

But the problem is, this sudden new army of young consumers wanted goods at a rate that Indonesia just could not meet domestically. “This big young middle class population had huge demands. We became a victim of our own success: the economy grew 6.5% and people demanded things that couldn’t be entirely supported from the supply side. And if a product is not available, they are going to buy imports.” 92% of Indonesia’s imports are capital goods and raw materials; when the economy does well, Indonesia imports more of these things, and inevitably the current account deficit climbs. Early last year it reached 4.4% of GDP, or $10 billion, and this is what markets identified as weakness when the tapering sell-off took hold.

What to do? “As a minister of finance, I have two choices,” Basri says. “The ideal one would be to expand the supply side, increase productivity, improve infrastructure, and improve the quality of human resources. But I completely understand it takes time to get there.

“If I cannot handle this from the supply side, my only option is to slow down demand.

“The slowdown of the economy,” he says firmly, holding eye contact, “was by design.”

This version of events does have some merit. By Basri’s telling, two things did the job: a 44% reduction in the fuel subsidy, and the central bank’s decision to raise rates by 175 basis points, causing the currency to depreciate. “It’s a standard model for handling a current account deficit,” he says. “Within four months, we were able to manage this issue, from 4.4% to 1.9%, or $4 billion. I don’t think this will be a major issue in the future.”

With that done, Basri – who will step down as finance minister when a new government comes into power later this year – wants foreign investors to focus instead on long term business opportunities, and to trust that macroeconomic stability is underway. But is that message getting through? What are capital flows telling him?

On the portfolio side – which, at 40% of the Indonesian capital account, is significant and vulnerable to volatility – he says: “The risk is still there. I don’t know but maybe the Fed will expedite the process of tapering and, later on, increase long term interest rates in the US. If emerging markets do not prepare for this, there will be turbulence.” In his view, bringing the current account deficit under control was crucial to ensuring that when US rate rises happen, Indonesia will not be targeted as it was last time. “If we have been able to consolidate the current account deficit at less than 3%, this will make the market less nervous.”

Asiamoney is talking with Basri in a side room at a sprawling conference centre in Astana, Kazakhstan, where the Asian Development Bank meeting has been taking place, and in the previous days he has been one of many people complaining about the Fed’s behaviour last year, when its comments not only roiled markets but came as something of a surprise to the emerging countries themselves. There has been widespread request, from Basri among others, for better communication.

Putting this to him now, he steps back a little and says that things have improved since concerns were aired at least year’s G20 meetings in Russia, but restates the point. “Of course, I understand it is impossible for the Fed to provide a roadmap for this, but better communication would be very useful for us.”

Basri has also been pointing out that when the US recovery moves from tapering (which, after all, is now well underway, with relatively little impact on markets) to rate rises, a different set of countries will be in the firing line – and certainly not Indonesia, which has not gorged itself on cheap debt during the low interest rate environment. A consensus seems to be emerging that Malaysia, Thailand, China, Hong Kong and Singapore have more to worry about when that happens. “I agree, this may affect countries with relatively high debt”, he says. “And don’t forget sometimes the market over-reacts. That is why it is important to ensure that macrostability is in place.”

And is it, in Indonesia? He points to foreign exchange reserves to support his point: they fell from US$102 billion to $92 billion last year as markets reeled, but he says they are now back to US$103 billion plus about $60 billion in bilateral lines, “because capital is flowing back to Indonesia.”

Our interview takes place as Indonesia is captivated by the pending general election, something that has been bothering analysts for about 18 months now, firstly because Indonesia has thrived under the political stability of Susilo Bambang Yudhoyono and any change is unpredictable, and secondly because of a fear of policy paralysis in an election year at a time when continued reform has been needed.

“Let me put it this way,” he says. “Whoever becomes president, he or she needs to maintain his or her political support by producing jobs, in order to reduce poverty,” he says. “If you want to create jobs, you need to ensure the economy grows by 7%.” This is not a number plucked from thin air: he calculates that 1% growth absorbs about 300,000-400,000 new entrants into the labour market, and that since new entrants are actually running at about 2.4 million, “you need to grow by 6% just to break even. If you want to reduce unemployment, you need to grow more than that. And there is no way Indonesian can achieve 7% growth without being an open economy.”

He therefore thinks any winner will have to do the same thing. “On the campaign trail some of the presidential candidates come up with nationalistic views. I can completely understand that, because it’s a political gimme. But once they are in power, they are constrained by the economic reality. So I don’t think there will be a major change of policy because whoever becomes president, the main concerns will be the same.”

“Let me give you an example,” he says, of the difference between populist remarks and political reality. “All the presidential candidates in the past, before they assumed power, disagreed strongly with fuel price adjustments. All, once they became president, adjusted the fuel price: Habibie, Wahid, Megawati, Yudhuyono.”

Aside from growth, Basri believes that any new leader has to grapple with a more complex task: reinventing Indonesia’s economy. “Indonesia cannot continue to rely on natural resources,” he says. “And we cannot continue to rely on cheap labour. Somehow we have to move to new stages of development.” He wants to see professions, design, a knowledge economy, investment in human capital. And alongside it, a better environment for business. “I believe this country will be discriminated against by investors, not on physical assets but intangibles, meaning policy and the investment climate: ease of doing business, combating corruption.”

No interview with an Indonesian minister ever gets far without turning to infrastructure: it remains the most obvious impediment to growth. Basri claims that a new law on land acquisition, the single biggest problem in infrastructure development because claims over land ownership can be lost in courts for a decade at a time, is about to be passed, which would ensure any dispute about land price would be resolved through court within 90 days.

Asiamoney informs Basri that he is the fifth finance minister we have heard say this. How certain is it this law will go through? “It has been passed by the parliament and will be enacted by January 1 2015. You cannot amend the law unless you come back to parliament.”

To get a sense of the difference it would make, it’s worth looking at the new toll road that was created in just 11 months ahead of last year’s APEC meeting in Bali. That happened, Basri says, because the road went over the sea, so there were no land issues. “I said: in Indonesia it’s easier to create miracles like Moses than to procure land.” If the law does finally prove to be the transformative moment so many have promised, the priorities will be land transportation and ports as well as a double-track railway that is already underway. “Let me put it this way,” he says. He says that a lot, with a strident directness that is quite convincing in person. “I believe the future of world trade will be based on supply chain logistics.”

Indonesia’s numbers are, by and large, looking pretty good now, but Basri is aware of two considerable threats to them, and neither one is US tapering. They are related issues: commodity prices, and China.

“Maybe I’m too pessimistic,” he says, “but I will say the resources boom is over.” Declines in commodity prices last year destroyed export revenues, and also tax income, since so much of taxation revenue is based around mining and plantations. This underpins his reasoning for diversifying sources of income away from resources.

“This is why I emphasize the risks coming from a slowdown in China,” he says. “First, most of the products we export are primary products,” so a Chinese decline affects demand for exports. “Secondly, if China slows down, the demand for commodities will decline and the commodity price will decline with it. It is a double blow for us: 65% of our exports are energy and commodity-related.”

So China is the biggest threat? He nods slowly. “Sure.”