Indonesia has the largest economy in ASEAN, and new reforms will help attract further investment from the US. Image: ASEAN Matters for America, 2014.

Indonesia Gets Serious About Economic Reforms

ASEAN Indonesia

Indonesia’s manufacturing sector, including food & beverages, consumer goods, information technology and automotive, have in recent years increasingly benefitted from US investments. This is partly due to the higher disposable income of the Indonesian middle class, and signals a significant change.

A 2013 study commissioned by the US Agency for International Development, in confirming that Indonesia has been a key destination for US investors, also showed that most US investments in the Southeast Asian country had traditionally gone to extractive sectors such as mining, oil, and gas.

The study found that between 2004 and 2012, US investments in Indonesia reached as high as $65 billion. It also revealed major plans by US based-companies to increase their investment in the country by $61 billion over the next five years, assuming that the investment climate is conducive.

US-Indonesia economic ties are therefore expected to strengthen, given the serious economic reforms that the new government in Jakarta is currently undertaking. Less than one month into his presidency, Joko Widodo, or “Jokowi,” made a bold and potentially unpopular decision to increase fuel prices. Despite some politicians questioning his decision, to many observers his move shows strong commitment about reforming the economy. The fuel-price hike may save the 2015 state budget by around Rp 120 trillion (US$9.8 billion). With that money in hand, President Jokowi promises to improve the country’s poor infrastructure, enhance its irrigation system, increase health spending and better social protection measures. The President has also promised to continue revitalizing Indonesia’s naval capability in order to improve the country’s poor maritime capacity. He plans to increase the defense budget to 1.5 percent of GDP by 2019 and attract foreign investments towards developing the country’s maritime infrastructure and modernizing its defense industries. All these developmental initiatives, if properly carried out, will have a long-lasting positive effect to the Indonesian economy.

Jokowi’s decision to gradually remove fuel subsidies is an important first step towards a structural reform of the Indonesian economy, and will help convince the international community and regional governments that he means business. In fact, the move did send a strong positive signal to the financial market. At the same time, the government needs swift policy responses if it is to mitigate expected negative effects. The fuel-price hike will raise inflation, and the biggest victims will be poorer households. The government will have to implement measures to ease consumer prices, especially in the eastern part of the country. Even before the fuel-price hike, the price disparity between the western and the eastern parts of Indonesia has been astronomically high (e.g. the price of one liter of petrol was 10 times higher and one sack of cement was 20 times higher in the remote east as compared to western Indonesia).

In the short term, the government needs to ensure smooth implementation of various social protection programmes to minimise the detrimental effects on the poor. In the medium term, the government must prioritize major infrastructure programmes. Better infrastructure will further boost investor confidence and create job opportunities. In addition, Indonesia needs to seriously deal with its regulatory uncertainty towards foreign investment, which is needed to support its long-term economic growth. The country is running against time as the ASEAN economic community is knocking at the door. Removing fuel subsidies is only just the beginning.

Economic reforms will most likely improve economic ties with the US and open up more investment opportunities for many American investors. For the reform to continue, Indonesia will need to ensure strong coordination within the cabinet and also strong support from parliament. For the US, it is now the right time for it to be more alert about Indonesia’s economic reform and to seize the opportunity to increase its investment in the biggest economy in Southeast Asia.

Siwage Dharma Negara is a visiting fellow at Singapore’s Institute of Southeast Asian Studies. He is presently on leave from the Indonesian Institute of Sciences (LIPI).