Walter Molano | Indonesia: Fighting the tide

After enjoying almost three years of relative stability, the Indonesian rupiah, the IDR, devalued sharply last month.

The tightening of United States monetary policy, which sent the yield on the 10-year Treasury bond above three per cent, also led to billions of dollars of outflows across the emerging markets spectrum.

Like many other developing countries, particularly those heavily dependent on foreign capital to finance their large current account imbalances, Indonesia was forced to respond with higher interest rates.

In late May, the Bank of Indonesia tightened monetary policy for the first time in four years. This will probably slow the economy. GDP growth, which was 5.07 per cent year-on-year in 2017, slowed slightly to 5.06 per cent year-on-year growth during the first quarter of this year. This was well below President Joko Widodo's campaign promise to raise the pace of economic activity to seven per cent year-on-year during his mandate. Furthermore, it was slightly below the 5.4

per cent year-on-year target established by the government earlier this year.

President Widodo has introduced measures to modernise infrastructure. He promised to increase infrastructure spending by US$350 billion. He reduced some government regulations and attracted foreign direct investors. The central bank also cut interest rates by 200 bps.

Unfortunately, private consumption remains subdued. Low wage growth, relatively high unemployment and an abundance of foreign workers are some of the reasons why analysts argue that consumption remains weak. Moreover, conservative banks have kept a tight rein on consumer credit.

With the consumer in check, it is no wonder the economy is stuck at five per cent year-on-year growth. Yet, it would not be prudent to accelerate the pace of economic activity without much more investment into the export sector.

Indonesia's current account deficit during the first quarter of 2018 was 2.15 per cent of GDP. This was slightly better than the 2.3 per cent shortfall that was reported in the fourth quarter of 2017. Unfortunately, capital account inflows were not enough to offset the current account deficit, and this was the reason why international reserves fell and the IDR devalued.

One of the silver linings to the Indonesian story is that foreign direct investment is on the rise. FDI increased 12.4 per cent year-on-year during the first quarter of this year. This was led by Singapore and followed by Japan. Both countries are taking advantage of the recovery in international commodity prices and Indonesia's cornucopia of natural resources.

FDI from South Korea, Hong Kong and China comprised a distant third, fourth and fifth places. The fact that China was in last place was surprising, given its Belt & Road Initiative. Indonesia sits in a strategic crossroads between the Indian and Pacific Oceans.

However, Singaporeans and Japanese multinationals have a long tradition of working in Indonesia, and have become more adept at working through the bureaucracy, red tape and other impediments. Nevertheless, it is imperative that Jakarta take steps to expand foreign investment to improve the productive capacity of the country, thus averting an overheating of the economy and a balance of payments crisis.

Unfortunately, some local analysts are questioning whether President Widodo will stay the course. Presidential elections are scheduled for April 19, 2019, and he will surely run again. Ahead of the elections, he reprogrammed US$20 billion of infrastructure projects into social spending, thus moving on to a more populist approach. These measures will help consolidate the double-digit lead he enjoys against his traditional rival, former General Prabowo Subianto - who he narrowly defeated in 2014.

Like other emerging market countries, Indonesians have grown tired of corruption. Fortunately, President Widodo has averted being entangled in any major scandal. At the same time, his government has worked hard to clean up the government.

The general election commission, the KPU, is trying to bar convicted lawmakers from holding office. This was done, despite a law that was passed in February providing members of congress with immunity from corruption charges.

President Widodo's quest to clean up the country is one of the reasons why he continues to receive widespread support, despite not being able to deliver on some of his campaign promises.

Still, Indonesia has a tough row to hoe. The ongoing rise in global interest rates is siphoning capital out of the emerging markets, forcing central banks to intervene to stabilise their currencies and raise interest rates.

This will surely lead to higher inflation and a weaker economy. Unfortunately, there is little that governments can do to stem the tide of global monetary movements.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com