President Jokowi in DC

President Jokowi's visit to the US October 26 and 27, although shortened by the forest fire issue, included a longer than expected bilateral with President Obama, progress on security relations, a substantive unexpected announcement by President Jokowi on TPP ("Indonesia intends to join"), successful sessions with potential and current investors, and roll backs of unnecessary rules for foreign workers as well as possible changes to the negative investment list.  Although the ongoing issues of criminalization and incarceration of employees for civil infractions as well as nettlesome energy and mining contract extensions may have been discussed, no follow on announcements were made.  The comments of ministers who joined the visit were full of reform rhetoric and combined with the TPP statement one might conclude that Indonesia is moving towards a RBE (rules-based economy).  The President did discuss foreign affairs and the economy at Brookings but turned to his ministers repeatedly to answer nettlesome questions.   This young President has the strengt

h to delegate but he could send no stronger signal than resolving the case of the Chevron employees that remain incarcerated after courts have decided in their favor as well as making the necessary regulatory changes so international energy and mining companies can safely extend their contracts in a timely fashion facilitating $20-30 billion of potential investments.  Such moves would resonate well beyond the extractive sector.  But kudos must be given to the overall strong signals the visit generated.  I had met Jokowi when he was mayor of Surakarta but he did remember me and our visit to his furniture factory.

New Deregulation Package

Indonesia has released the second of three deregulation/stimulus packages designed to boost a flagging economy and strengthen the exchange rate. The first (released September 10) was primarily an exercise in reducing red tape and regulatory confusion in the trade arena and did not garner a lot of attention and praise, perhaps because its hard to immediately see benefits when you are looking in the regulatory weeds. Darmin Nasution, the Coordinating Economic Affairs Minister admitted,  "We issued too many deregulations in the first package and it made us seem to lose focus. Our explanation turned into numbers and people did not get the substance". 

However, the package announced Wednesday is more focused and could perk up the ears of investors who --as a whole-- have been moving assets out of Indonesia's capital markets. "We are making (investing in Indonesia) as attractive as possible," said Chief Economics Minister Darmin Nasution, announcing the latest measures along with several other ministers. "We must fix, simplify, make it cheaper."  

Here is what you should know about "Installment 2":

• Permit processing times slashed- New measures announced Tuesday included slashing the time taken to process investment permits from at least 8 days to just 3 hours, with processing for permits in mining and geothermal projects in forested areas to be cut from up to 4 years to about 15 days.  The 3-hour time frame, however, is for investments over $6.8 million located in designated industrial parks employing over 1,000 people.  Although when announced the facility was to be available immediately, officials have backtracked and say it will be launched in mid-October. The number of permits needed for mining exploration and for establishing a business in an industrial economic zone have been cut. 
• Tax Reductions- Exporters who deposit foreign exchange revenue in Indonesia or convert it to rupiah will have withholding taxes from the current rate of 20% to 0% depending on maturity. The interest earnings of a one-month dollar-denominated deposit account would now incur a 10 percent income tax; six-month deposits would incur 2.5 percent and for deposit accounts over six months there would be no income tax. The government will remove value-added taxes for ships, planes and trains made in Indonesia.  The VAT is also removed for imported aircraft and spare parts. 
• Certificates of Deposit- Indonesia's central bank, Bank Indonesia, will reissue three month certificates of deposit and two week repo agreements.    "We want to drive [liquidity] from short-term instruments towards longer-term instruments because we're afraid excessive [liquidity] in short-term will create speculation. So we reopen these instruments," said Mirza Adityaswara, BI's senior deputy governor.
• Intervention- Bank Indonesia signaled it will intervene in forward markets for rupiah where it is currently valued above 16,000 to the dollar. The rate as of September 30 was 14,717.
• Import bans on cloves and tires were eliminated. The new trade minister, Thomas Lembong, said "The regulation on tire imports was wrongly targeted as it was aimed at protecting the local wheel industry, while our local tire industry is already world-class as Indonesia is a net exporter.

We will need to see the implementing regulations before a final judgement can be rendered on these policies.  But they are a welcome sign of the Jokowi's government intention to make reforms and other changes. It will be interesting to see what will be covered in the next package.  There are rumors that Indonesia may bring down corporate tax rates from the current 25% to a level more in line with its ASEAN neighbors or lower.  Also, the government may alter the Negative Investment List to allow for more foreign equity.   However, other, more wide-reaching  reforms to open the economy, change restrictive labor laws, or back away from the mandated value-added (local content requirements) nature of many laws and policies are not yet being talked about.   In the end, these deregulation packages may end up being characterized as more minor than major, and Indonesia needs to be performing in the major key.  But combined with an earnest approach to building infrastructure-- and getting the allocated budget into the system--the packages should push growth back towards 5% or above.

The Meaning of Banggai

August 7, 2015

President Jokowi traveled to the Banggai Regency in central Sulawesi this week to inaugurate the $5.8 billion "Pertamina Mega Integrated Project", which is planned to match the upstream production of natural gas with downstream users. The visit follows other forays of the President around the country to jump start other infrastructure projects including: parts of the Trans-Java - a 1,000 kilometer proposed toll road across Java from Merak in Banten, West Java, to Banyuwangi in East Java; the Trans-Sumatran Highway, a 2,508 km north-south road in Sumatra, from Banda Aceh to Bandar Lampung; new power plants that are part the 35,000 gigawatts expected within the next five years; and a 433-km Holtekamp Bridge in Papua. 

 

At Banggai, the President cautioned: "It must be integrated not only on paper but also in its real implementation in the field. This must be truly integrated, incorporating upstream and downstream industrial sectors and connecting gas producers and users. This must be implemented in the petrochemical and LNG business sectors and power plants," said Jokowi.

 

The huge project symbolizes the dreams of Indonesia's policymakers: for every raw material, there must be integrated downstream uses in the country. One hears the term "integrated" often in discussions and I suppose its natural. We like to think that everything is connected to everything else. When I lived in Indonesia in the 1970's I was always surprised by the natural way many of my Indonesian friends integrated the micro and macro aspects of life. An accident on a road could be instantly connected to a cosmic pattern that had been detected. Integration is harmony, steady-state, stable, values that resonate strongly in Indonesia rather than the dynamic, inherent conflicts of markets.

 

The meaning of Banggai is not just harmonius upstream and downstream integration, its also about self sufficiency and independence. The gas can be turned into LNG for power as well as ammonia for fertilizer and other uses, lowering the need to import. But in an increasingly interdependent world is this type of integration planning sufficient ? Could it not turn into an ideological imperative, locking Indonesia into policies that isolate rather than integrate it with the region and beyond ?

 

I think we are at a critical juncture in Jokowi's Presidency. If infrastructure of the kind that lowers logistics costs and helps supply chain integration cannot be accelerated we will only see more nationalist and protectionist policies, further isolating Indonesia's economy, especially given the weaknesses in the rupiah. We rarely hear the voices of Indonesian economists who know their way around international economics, even though some remain in the government. This week two Indonesian economists based in Australia--Arianto A. Patunru and Sjamsu Rahardja-- released an important report via the Lowey Institute, "Trade Protectionism in Indonesia". They observed that in past times bad economic circumstances led to good economic policies but today we are seeing "bad times leading to bad policies". Whether their cautionary voices and those of us outside Indonesia who are her closest friends, alarmed by the protectionist trend, will be heard remains to be seen. Indonesia's needs more "Banggais" and more industrial integration but not at the expense of regional and global intergration. Indonesia's future is not just supply chain connections within its borders but outside them as well.  The former will not happen without the latter.

Idul Fitri Reshuffle

June 30, 2105

The serious Cabinet reshuffle rumors began in June: in Indonesia, they are part of the air one breaths. An underwhelming economic performance would prompt President Jokowi to reshuffle his Cabinet after Lebaran (end of the Muslim fasting month on July 18), especially his economic team. The economy is, given Indonesia's potential, standing still, even though GDP growth hovers at close to 5%. Very little of the dividend from the elimination of energy subsidies has found its way into infrastructure projects, even though the government now has more authority to settle nettlesome land issues. The question is whether the implementation problems are due to incompetent management at the top of ministries-hence the need for a Cabinet change-or something more structural. I am persuaded by the latter. Changing the Cabinet will not necessarily quicken the pace unless the President is persuaded to use more of the power that is vested in his office to bring a greater policy coherence throughout the government and the regions. The import and export ban and value added thesis along with a rupiah-only currency policy are overcompensations for a bureaucracy that has difficulty efficiently delivering the services it was created to deliver. One of the co-chairman of PECC (Pacific Economic Cooperation Council), Jusuf Wanandi, (who since the 1960's has been an influential thought leader) recently said some very important things at a regional economic conference worth repeating here:

"There has been widespread disappointment with the Jokowi government, with economic growth falling to 4.7 percent in the first quarter, a lack of policy coherence keeping investors on the sidelines and bureaucratic inertia causing repeated delays to budget implementation. Investors have been waiting for the right signal to enter Indonesia, but the President should not convey mixed signals. He should do away with the inordinate nationalistic sentiment of the Indonesian Democratic Party of Struggle (PDIP)".

  

You will read further in this issue of Outlook/Indonesia that the President intends to move quickly in the second half of the year to start spending. You can see moves in this direction by observing the statements of the state-owned construction companies who have announced toll road projects they have won as well as the progress in negotiations over a high speed rail project between Jakarta and Bandung. The stimulus achieved by getting projects underway will certainly help move Indonesia's growth forward as most of it has been from consumption which has been slacking off. But the continuance of populist and protectionist policies (Indonesia just boosted tariffs on a range of food and consumer items), some designed to expand the role of the state in the economy, will likely yield mixed results or worse.

President Jokowi, unlike his fellow political mavericks such as the Governor of Jakarta and the Mayor of Bandung, has chosen to stick by the political party that chose him, PDI-P, a party that remains wedded to a 1950's ideology of state interventionism and a patronage culture (return of favors ) that has been largely eschewed by Indonesia's people. Cabinet changes could make a difference but only if accompanied by more open and transparent economic policies unfettered by the impulse to reward political parties and their benefactors. At least there has been the beneficial influence of the watchdog KPK (anti-corruption commission), press, and NGOs. However, their necessary vigilance has a side effect of paralyzing project implementation by fearful bureaucrats. Let's hope that with or without a Cabinet shuffle the President and his team can reduce the transactional politics that underlies too much of the government's decision-making and get the bureaucracy moving more swiftly. Only then will Indonesia get close to the 6% or higher growth that it is highly capable of achieving.

Soekarno's Echo

Indonesia's first President became so frustrated with the "West" that he famously declared " go to hell with your aid".  A combination of the Cold War and misjudgments of Soekarno's complex ideology (mixing capitalism and socialism) led the US and other countries down several dead ends that almost capsized relations completely.  The late 1950's and early 60's were tough for Indonesia's relations with the US: late to implement economic development aid the US lost critical influence.  The US State Department was also obsessed  with keeping Indonesia out of the orbit of the Soviet Union and China. Soekarno continuously fought against Western imperialism as well as aid with "strings attached".   I heard an echo of Soekarno's rhetoric at two recent events (and their aftermath) that occurred in Indonesia almost simultaneously: The World Economic Forum- East Asia (WEF) and the 60th Anniversary of the Asian African Conference Commemoration (AACC) in Bandung. In his opening address before the AACC President Jokowi said:  "Views stating the world's economy can only be resolved by the World Bank, IMF and ADB are outdated and need to be thrown away. . .When the rich nations, which comprise a mere 20 percent of world's population, consume 70 percent of world resources, then global injustice becomes real."  These and other similar remarks led to headlines in Jakarta papers such as "West-led Order Obsolete- Jokowi".  The immediate background to these statements is, of course, the China-backed Asian Infrastructure Investment Bank (AIIB), an institution that Indonesia's backs wholeheartedly, and America, less so.  The US took a direct hit from Finance Minister Bambang Brodjonegoro who commented to reporters right after the WEF: "The US has been very critical, very harsh, about the AIIB and it is unfair . . . The US itself has consistently refused to boost its capital in both the World Bank and the ADB. This has made the situation difficult for us".    Jokowi's less direct --but just as clear-- formulation was: "We've urged reform in the global financial architecture to eliminate the domination of a few. The world now needs collective leadership that is just and responsible".  The last time I looked Indonesia's own Sri Mulyani, former Finance Minister, held one of the highest positions in the World Bank. 

The elevated rhetoric is unfortunate but perhaps to be expected given that most Indonesian Presidents are driven by domestic politics to eschew "western influence and dominance".  And perhaps President Jokowi felt it necessary --given the nature of the occasion-- to channel his predecessor's and his party's nationalist viewpoint in Bandung. Both Jokowi and Brodjonegoro are probably right that Asia needs another multilateral lender (especially one focused on infrastructure) but they are wrong to denigrate the institutions --developed at Bretton Woods out of the ashes of the Depression and WWII-- that have helped to lift so much of Indonesia out of poverty.  Do these institutions make mistakes and do some of them have their own internal governance issues, yes.  But they are not part of some conspiracy to keep countries "down" as Jokowi's comments imply. The US (along with the IMF, World Bank, and Asian Development Bank) should be actively engaged with the AIIB as it develops with the eventual goal of joining. Indeed, contrary to what Minister Brodjonegoro has said, President Obama has already made supportive statements regarding the AIIB.  "We're all for it if incorporates strong financial, social and environmental safeguards", he said.    However, reforming the world's "financial architecture" seems less important than reforming the bureaucracies in Indonesia and other developing countries that have had severe problems with leakages, "white elephant projects", and other implementation difficulties.  These will remain and need to be dealt with as the China-led AIIB gets going. 

Indonesia's growth has dropped to below 5%, the rate of foreign investment has dropped, and commodity exports prices have weakened.  The President should prioritize economic reform and openness rather than focusing on an untested new institution (AIIB) whose benefits (building infrastructure) will take many years to achieve.   Rather than sewing seeds of divisiveness, echoing the nationalism of his predecessor, one might have expected more from Indonesia at these forums.  After all Indonesia is a member of the G20 now, it has a seat at the table.  It should use its position wisely, not provocatively.

Backing Away From the Dollar

We are starting to see the glimmer of a new strategy for how Indonesia wants to do business and it may have less to with the US dollar. 

Foreign exchange ratios have been a hot topic among Indonesia's policy makers ever since June of 2014 when the first news of the end of Fed easing caused financiers to pull money from emerging markets such as Indonesia and the rupiah suffered. After years of trading in the 9,000 range, its been in the 12,500-13,000 for several months now.  Even though Finance Minister Brodjonegoro said in January "12,500 is already a good rate to maintain our competitiveness," many companies would disagree.   For exporters selling goods priced in dollars who don't need to source components a weaker currency is great news, but for those who need dollars to buy inputs, its been tough going.   Increased prices for electricity and higher costs for inputs have forced some exporters out of business.

Concerned over an ongoing current account and trade deficit, policy makers have pursued fiscal programs that -short of currency controls-try to limit foreign exchange transactions.   Among these are:

• Mineral export bans, required local smelting and downstream processing
• Beef import bans
• Crude palm oil export tax levied to build a biodiesel industry. The same policy may eventually be applied to coffee and rubber. 
• Regulation requiring 50% of reinsurance policies to be paid to a state owned reinsurance company rather than offshore providers. 
• Planned tax amnesty to attract offshore funds
• Investment policies promoting "value-added" manufacturing as a priority such as a regulation to ban sale of cell phones not made in Indonesia. 

Along with the fiscal import substitution policies we are also seeing other monetary moves to be less dependent on the US dollar for transactions.  Although the idea has died, there were rumors that Indonesia would price its energy exports in other currencies not dollars.  Bank Indonesia announced last week that as of July 1 all domestic transactions have to be in rupiah.  (cash transactions in foreign currencies have been banned since 2011).  Eko Yulianto, acting director of money management at Bank Indonesia, said there was demand for at least $6 billion each month for domestic transactions, which the bank hopes to cut once the new regulations are in force. "There are still a lot of transactions using foreign exchange and that has added to pressure on our exchange rate," Yulianto told a briefing on Thursday, adding that companies in textiles, pharmaceuticals, chemicals and the oil and gas sector often used the dollar for domestic payments. "We don't want a dollarized economy so we need to uphold the sovereignty of the rupiah," he said. 

Countries that share Indonesia's problems with a strong dollar such as Russia are already aligning themselves accordingly.   In a recent bilateral economic meeting Russian Minister of Industry Denis Manturov indicated that the Russian government hopes to localize more fertilizer production in Indonesia and start making payments in rupiah for products it buys from Indonesia. "We have experience in switching to contract payments in national currencies with India, China" said Manturov. 

The China-led Asian Infrastructure Investment Bank (AIIB) is slated to bring tens of billions in investment and project finance to Indonesia. Although the bank has yet to launch, 50 countries have agreed to join, including all of Indonesia's major trading partners except the US and Japan.   Given China's huge balance of dollars, estimated to be $8 trillion, its unlikely China will be as quick as Russia to meet Indonesia's terms.  Thus, we can probably expect that PLN, Indonesia's electricity monopoly, will continue to write power purchase agreements (PPA) with foreign investors in dollars.  But that could change, especially China is agreeable to rupiah PPA's. 

I personally think Indonesia is overly concerned by a strong dollar and the end of Fed easing.   Given the rosy reports from BKPM (the Investment Coordinating Board) Indonesia is attracting large amounts of foreign investments.  So its negative current accountpositions may have more to do with the importation of capital goods than US Fed policy. (In fact there was a trade surplus in March due to the drop in oil imports. ) The best path to a stronger rupiah is to promote an open investment regime with fewer strings attached (meaning less nationalism), strengthen the rule of law, and fully implement an infrastructure investment program. If that can be achieved the momentum of the country's economy and youthful population will win out over fluctuations in exchange rates.  But meanwhile, US companies should expect Indonesia to make more use of policies that maximize the use of rupiah for transactions. 

The Value Added State

President Jokowi is likely to travel to the US for his first official visit to Washington in early June.  President Obama no doubt wants to hear Indonesia's President describe his country, his plans for its economic future and how the US fits in.   What might Jokowi tell President Obama about today's Indonesia? He will no doubt discuss plans for achieving 7-8% growth and creating jobs. He may not say so in so many words but Indonesia's paradigm has become the VAS, Value-Added State.   

What are its characteristics?

(Apologies for over simplification of a topic that is actually much more complex than what I set out below.) 

1.  A VAS welcomes FDI BUT

A VAS welcomes foreign direct investment but wants it to meet priorities established by either its government or legislature.  Indonesia does not want foreign investment to create raw materials if there is not the addition of processing or if it believes a local company should be doing it. Indonesia desires to be more than a big market but part of the global supply chain of manufactured goods, producing for other markets, especially within ASEAN.

2. A VAS crafts policies to keep as much currency within the country without going as far as establishing formal currency controls.  Indonesia is drafting regulations that will keep insurance premiums within the country.  It already has other regulations in place that limit offshore borrowing and prevent Indonesian private equity firms from investing more than 20% of its capital offshore. A VAS finances its debt in local currency when possible. 

3. A VAS expands rather than contracts its state-owned sector.

To build the VAS Indonesia's leaders do not fully trust market forces and rely on a large state sector. SOE's (state-owned enterprises)  were very important in Indonesia's early years as the private sector was still small. By the late 1990's many SOE's become redundant and unprofitable and some lost their monopoly positions. A wave of privatizations occurred but today they are again being given an out-sized role. For example, four small state-owned reinsurance companies are being merged and given a quasi-monopoly position to receive mandated premiums from companies that previously went offshore.   Although the regulation is still under review insurers are highly concerned there may be a loss of capacity and risk leverage which could negatively effect future big ticket investments. Similarly, the 2015 budget includes massive increases to many SOE's who will be tasked with building critical infrastructure. 

4. A VAS is paternalist; it desires to be a player not just a referee. 

Reform exists and will continue but only as a sidebar to pervasive patronage networks that limit transparency and the rule of law.  These networks are stubborn and extend from the private sector to the large bureaucratic state through political parties.   Preferences may be given to state-owned firms rather than private companies to import and distribute products.   Foreign companies and employees may be singled out for selective prosecution or blamed for holding back the development of local capacity.  A non-VAS would see the "other side of the coin"; foreign companies are true partners and are catalysts for the development of local players. 

5. A VAS pursues import substitution policies through a combination of import and export bans.  A ban on various kinds of beef imports is now employed to boost local cattle production. Raw and semi processed mining products cannot be exported or if so, they have very high duties attached.  It has been reported that only cell phones made in Indonesia will be allowed to be sold in the future.  The goal is to legislate what the market has not created, more local manufacturing. 

6.  A VAS intensively credentials foreign workers.

Even though businesses acknowledge a shortage of qualified middle managers, Indonesian officials and some professional associations believe local labor needs protection.  Labor certification is reported to be getting more difficult and a new regulation will soon be implemented to require all expatriates employed in the country to pass a basic test of the Indonesian language. Even Indonesian doctors who have earned medical diplomas overseas cannot get these credentials recognized and thus cannot practice if they want to return. 

President Obama should ask President Jokowi the following questions:  How does the vision of a VAS fit in with regional economic agreements such as APEC, WTO, and the ASEAN Economic Community that lower barriers between the movement of goods, capital, and people?  Are there not some internal contradictions?