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Country Report - Indonesia 2003William R.
Thomson Political developments The President came to office on a wave of popularity since she enjoyed her father's name - the founder of modern Indonesia. But her character could not be more different than that of her charismatic father. By nature, she is a retiring individual, untrained for the job with only a high school education, who delegates her authority, and so has performed more of a ceremonial rather than an executive role. The Bali bombings in October, in which over 200 people were killed, the majority of them tourists has been a wake up call, however. The act, perpetrated by home grown Islamic fundamentalists, exploded the myth that South East Asian Islam represented a less aggressive threat than that of the Middle East. The reality is that the links between extremists in the Middle East and elsewhere are stronger that previously believed, but the telltale signs of the linkages had been conveniently ignored. Bali, however, created a crisis within the government with the US and Australian authorities demanding action. The President found herself in the middle, between foreign powers demanding action and an anti-Western populist lobby resentful of perceived western bullying. Despite being accused of being a western puppet, she acted to tighten up security legislation and a number of the Bali suspects were picked up and tried quickly. In August 2003 the first suspect was convicted and received a death sentence. The increasing willingness of the US and Australia to intervene extra-territorially undoubtedly contributed to the unaccustomed urgency on the part of the Indonesian authorities. There is a widespread belief that the American forces based in Mindanao on continued operations are, in reality, an expeditionary force available to use in Indonesia, if major trouble developed there. At year-end, the Government signed a peace deal with the Aceh independence movement granting the Achenese elections and a high degree of autonomy from 2004. This agreement came in the shadow of threats from Megawati to unleash the full force of the military against them. The Achenese probably agreed to the deal in part because they knew the US in its present frame of mind would not countenance independence of a conservative Muslim state sitting on large oil and gas reserves at a vital, strategic point in the Molluca Straits. The US, Japan and the World Bank all sweetened the deal by offering substantial aid to Aceh in return for signing. Whether the deal will hold in the long run is unsure since the independence movement has deep roots. Presidential elections International relations Economic developments Private consumption was facilitated by sharp increases in wages in manufacturing - accounting for some of the loss of competitiveness already noted - as a catch up from the declines in real incomes suffered during the crisis, and by a substantial increase in bank lending as the bank's situation continued its improvement. At year-end, non-performing loans were reported to be only 10.2 percent reflecting success at recapitalisation and transference of existing bad loans to the asset management companies. Exports and imports were almost flat in 2002 growing by 1.1 percent and 0.4 percent respectively. However, the breakdown of exports changed significantly with oil and gas exports soaring on the back of higher prices whilst non-oil and gas exports declined by 5.6 percent. The current account remained comfortably in surplus at 4.3 percent GDP facilitating a build-up in the exchange reserves to USD 31.6 billion. The budget deficit was halved to 1.6 percent GDP and total external debt was stable at USD 130 billion, a substantial reduction from the post crisis peak of USD 151 billion in 1998. More importantly, the debt service ratio has declined from a crushing peak over 40 percent of exports to 31 percent - a figure that is still too high for comfort. In addition, the external debt still has a substantial short-term component, leaving the country much more exposed to shifts in market perceptions compared with its neighbours. Economic prospects
for 2003 Inflation, which has grown at double digit levels since the onset of the crisis, is expected to moderate in 2003 and 2004 to around 5 percent helped by a table of moderately appreciating Rupiah which is expected to trade around 8,000 compared with 9,000 in 2002. Tighter monetary policy will be assist the local currency and the policy will be facilitated by a declining budget deficit to around 1.5 percent GDP. As the government demands on the economy's savings are reduced there will be scope for private sector borrowing to expand and expand consumption. The elections due in mid 2004 are likely to hinder Government's efforts to address sensitive issues such as privatisation with the required vigour to effect change. The Government seems determined to exit from its IMF programme in 2003 for political reasons. This would allow the Government to demonstrate some necessary independence from a western organisation before the 2004 elections. However, that action is likely to engender concerns about the country's ability to finance itself at a reasonable price and some donor programmes might be delayed. But. Japan, on the other hand, with its great need for Indonesian oil and gas, and a desire for a greater regional role, might be willing to increase its aid and become the country's lead donor. This would be more acceptable to nationalist sentiment within Indonesia. Japan, however, is also susceptible to pressure from the US, and. the latter will be reluctant to see Indonesia exit the IMF programme. Additional terror attacks would make things financing considerably more difficult and more expensive and would probably require an eventual return to the IMF. Economic issues There are some signs of renewed interest in the oil and gas sector. A 20-year liquefied natural agreement was signed on 24 July with a consortium of energy companies led by the US firm Marathon Oil to supply 6-10 million tons LNG annually beginning in 2007 to the US West Coast and Mexico. Significantly, the project has been won against severe competition from Latin America, despite the latter's proximity to the United States and the related transportation cost advantages. Outside the natural resources sector the country needs to address perceptions of corruption within the legal system for FDI to flourish once again. A greater willingness to allow foreigners to purchase state owned enterprises would increase revenues and enhance productivity and management quality. Privatisation has been proceeding at about half the levels required under the IMF programme. In 2002 they were only about USD 300 million with the Bank of Central Asia and Niaga Bank being successfully privatised - but to local investors. Prejudice against foreigners was also shown in the Manulife case. Stock Market: The Jakarta stock exchange remains the smallest and least developed of the South East Asian emerging markets: the so-called Mango markets of Thailand, Indonesia and the Philippines. These markets have the advantage of not being strongly correlated with Wall Street since their economies still have a substantial commodity or natural resource base. Natural resources (oil, gas, minerals and food) are all experiencing a revival in demand and a firming of prices after almost two decades when they were declining or stagnant. In this particular respect, they are the beneficiaries of China's voracious appetite for raw materials. From an ownership standpoint, European and US investors are still significantly underweight these markets, so a positive performance generated by local investors could eventually begat further capital inflows and even better performance. There is still plenty of upside room since the market was the hardest hit in the Asian crisis along with Thailand. At its worst it lost over 90 percent in USD terms. However, a stabilised and improved exchange rate and economy have led to some recovery in values. In the wake of the Bali bombings last year the market retreated to a level around 350 from which it has since rebounded to around 500 on the Jakarta Stock Exchange Index. At these levels, the market is still about 35 percent off its all time highs in Rupiah terms and 80 percent down in USD terms. Jakarta's corporate governance remains quite opaque and off the screen of eligible investments of the giant California State Pension Fund (CALPERS), which is often seen as a market leader in this field. That fact, plus the negative headlines on the war on terror, will undoubtedly make reflows slow but will also create opportunities for intrepid contrarians willing to enter the lion's den. Since the economy is continuing to grow and, as noted, it produces natural resources the region and the world needs, and values are attractive, careful investors may be pleasantly surprised since most of the negatives are already heavily discounted in the prices. The sophisticated investor who ventures here would be well rewarded if prices challenge their old highs in Rupiah terms over the next 2-3 years. The difficulty for smaller investors is that the pure Indonesian mutual funds have largely been liquidated because their size became uneconomic with the decline in prices and redemptions. Country risk: Ratings William R. Thomson |