Is Indonesia Bound for the BRICs?Ho

Is Indonesia Bound for the BRICs?
How Stalling Reform Could Hold Jakarta Back
By Karen Brooks


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Indonesia is in the midst of a yearlong debut on the world stage. This past spring and summer, it hosted a series of high-profile summits, including for the Overseas Private Investment Corporation in May, the World Economic Forum on East Asia the same month, and the Association of Southeast Asian Nations (ASEAN) in July. With each event, Indonesia received broad praise for its leadership and achievements. This coming-out party will culminate in November, when the country hosts the East Asia Summit, which U.S. President Barack Obama and world leaders from 17 other countries will attend. As attention turns to Indonesia, the time is ripe to assess whether Jakarta can live up to all the hype.

A little over ten years ago, during the height of the Asian financial crisis, Indonesia looked like a state on the brink of collapse. The rupiah was in a death spiral, protests against President Suharto's regime had turned into riots, and violence had erupted against Indonesia's ethnic Chinese community. The chaos left the country -- the fourth largest in the world, a sprawling archipelago including more than 17,000 islands, 200 million people, and the world's largest Muslim population -- without a clear leader.

Today, Indonesia is hailed as a model democracy and is a darling of the international financial community. The Jakarta Stock Exchange has been among the world's top performers in recent years, and some analysts have even called for adding Indonesia to the ranks of the BRIC countries (Brazil, Russia, India, and China). More recent efforts to identify the economic superstars of the future -- Goldman Sachs' "Next 11," PricewaterhouseCoopers' "E-7" (emerging 7), The Economist's "CIVETS" (Colombia, Indonesia, Vietnam, Egypt, Turkey, and South Africa), and Citigroup's "3G" -- all include Indonesia.

To be sure, Indonesia's track record has been impressive. In just a few short years following Suharto's 1998 fall from power, Indonesia transformed from a tightly controlled authoritarian system to one of the most vibrant democracies on earth. The elections in 1999 were widely praised as a triumph of democracy; the military stayed on the sidelines, and independent civil-society groups and the media blossomed in the run-up to the polls. With sweeping political and fiscal decentralization, Jakarta devolved real power and resources to the country's hundreds of districts and municipalities. The government created new, independent political institutions to provide for additional checks and balances, including a constitutional court, a judicial commission, and a corruption eradication commission (known by its Indonesian acronym, KPK). An ambitious constitutional reform formalized a presidential system and established a one-man, one-vote process. With no mechanism to filter the results (as the Electoral College does in the United States), Indonesia's voting system is among the most democratic in the world.

The country's economic turnaround has been no less dramatic. In 1998, Indonesia's economy suffered a contraction of more than 13 percent. Since then, it has grown at an average rate of more than five percent per year, including 4.5 percent in 2009, when GDPs in much of the rest of the world shrank. This year, the Indonesian economy is expected to grow 6.5 percent. Indonesia's debt-to-GDP ratio has declined from a high of 100.3 percent in 2000 to 26 percent today, which compares favorably to those of the country's neighbors: Malaysia's is 54 percent, Vietnam's is 53 percent, the Philippines' is 47 percent, and Thailand's is 44 percent. Inflation, which spiked to 77 percent in 1998, now hovers just under five percent. The rupiah, which lost over four-fifths of its value that same year, is the strongest it has been since 2004 and is up 31 percent since 2008 alone. Other ASEAN currencies generally appreciated by between 15 and 20 percent in the same period.

Indonesia has also made great strides in improving its security. In 2004, the government negotiated a peace settlement with separatists in the province of Aceh, ending a three-decade-long conflict that claimed thousands of lives. Elsewhere, Indonesian security forces have killed or captured hundreds of Islamist militants and have uncovered and shut down major terrorist hideouts and training camps, including one in Aceh in February 2010 that led to a number of high-profile arrests. The government has also implemented important structural reforms, including the creation of a national counterterrorism agency, tasked with forming and enforcing new domestic security laws.

Against this backdrop, Indonesia has started to play a larger role on the international stage. When the G-20 was established in 2008, Indonesia was the only Southeast Asian nation offered membership. That same year, Indonesia launched the Bali Democracy Forum, a yearly regional conference to promote democracy in Asia. In recent months, the forum has become a platform for Indonesia to share lessons from its own democratic transition with some of Egypt's aspiring democrats.

LOOMING CONSTRAINTS

Yet despite all the fanfare, the Indonesian score contains some decidedly discordant notes. Indonesia's ports are overstretched, its electrical grid is inadequate, and its road system is one of the least developed in the region. These conditions make the Indonesian economy inefficient and will stifle its future growth. In some regions, the price of basic commodities is up to three times as high as on the main island of Java. Meanwhile, manufacturers are squeezed by exorbitant transportation costs, which are higher in Indonesia than in almost every other ASEAN nation. On the World Bank's 2010 Logistics Performance Index, which is based on a worldwide survey of shippers and carriers combined with data on the performance of each country's supply chain, Indonesia ranked 75 out of 155, well below its neighbors.

Jakarta is well aware of these problems, yet it currently spends only half as much on infrastructure development as it did in the 1990s. Seeking to address almost constant criticism on this issue, in May, Indonesian President Susilo Bambang Yudhoyono issued a new economic "master plan" with an emphasis on infrastructure projects. He also called for higher infrastructure spending in the 2012 budget. But even this budget would cover only about half of the administration's planned development through 2014. Without the new development, Indonesia will not meet its target of 7-8 percent GDP growth by the same year.

Much of the burden of paving roads and providing power and water nationwide will thus fall to the private sector. However, Indonesia's inadequate regulatory framework and weak enforcement of existing regulations have muted private-sector interest. The absence of meaningful eminent domain regulations has proved particularly problematic; the inability to acquire land has prevented many projects from ever getting off the ground. Bureaucratic chaos at the National Land Agency, where plots are often recorded as being owned by multiple parties, has not helped. Yudhoyono has pledged to tackle these problems, but his credibility on the issue is fading.

Endemic corruption further adds to Indonesia's high-cost economy. At the beginning of his first term, Yudhoyono named combating corruption a top priority. Since then, the KPK has sent dozens of politicians and former government officials to jail. Still, corruption runs deep at all levels of government, since the devolution of power after Suharto's fall brought with it the decentralization of graft. Now, officials from Jakarta down to the village level demand bribes and kickbacks, and such payments no longer ensure that things get done.

A number of high-profile scandals during Yudhoyono's second term have showcased the breadth and depth of the problem. Investigations into the 2008 collapse and subsequent $700 million government bailout of Bank Century, a midsize bank with politically connected depositors, revealed that individuals from all elements of law enforcement -- senior police officers, officials from the attorney general's office, lawyers, judges -- had attempted to profit from the government bailout.

Since then, the police and others have tried to weaken the KPK, including by attempting to frame two sitting members of the commission for, of all things, corruption. The episode paralyzed the KPK for months and made a mockery of Indonesia's judicial system. Although the commission emerged from this episode intact, it has since been focused on lower-profile cases.

Perhaps most damning, the president's own political party has been at the center of an escalating series of corruption scandals in recent months. Muhammad Nazaruddin, the party's former treasurer, and other senior party members stand accused of rigging bids to fulfill government contracts worth more than $1 billion. Nazaruddin fled the country in May and spent three months on the lam before he was arrested in Colombia. Such public drama has undermined domestic and international confidence in the administration's supposed fight against corruption. Perhaps more important, no major political party now credibly carries the anticorruption mantle.

The Yudhoyono administration's promotion of Indonesia as an open, investor-friendly economy is another area in which the gap between rhetoric and reality is particularly large. The government's most recent Investment Negative List, which lays out limitations on foreign investment, is more restrictive than in the past. Indonesia has also backslid on some of its international commitments. The ASEAN-China Free-Trade Area, which came into effect in January 2010, is one such case. As part of the pact, Indonesia and China agreed to reduce or eliminate tariffs on thousands of goods. But since the agreement came into force, Indonesia's domestic industries ha