Last May, when Ben Bernanke made unexpected comments about tapering and set off a brutal sell-off in emerging market assets, nowhere in southeast Asia was more badly affected than Indonesia. Named as a member of the so-called Fragile Five – a group of countries that had both budget and current account deficits, and were therefore especially vulnerable – Indonesia suffered foreign capital flight, a slowdown in economic growth, a falling currency and plunging foreign exchange reserves.
But in an interview I conducted with finance minister Muhamad Chatib Basri, featured in full in this month’s edition ofAsiamoney magazine, we hear a version of events that may seem surprising: it was all part of a cunning plan.
“The slowdown of the economy,” he says firmly, holding eye contact, “was by design.”
Not the first bit, the current account deficit: that was unavoidable, a side-effect of Indonesia’s own success, Basri says.”We are a country with a young population. Most of our population are workers aged less than 30,” he says. This has led to a consumption boom. “People in their initial career will start to buy cars, motorcycles; that’s why the growth of motorcycles in Indonesia is one of the highest in the world.”
The growth of wealth amongst this sector sounds mild in world terms, but in fact a pivotal level has been reached. In 2003, he says, the proportion of people who would spend $4 per day or more was about 5%; by 2010 it was 18%. “In a country of 240 million people, the additional number is about 40 million people, larger than the populations of Malaysia, Singapore and Australia combined,” he says.
This has been fertile ground for foreign consumer companies: Toyota, Unilever and L’Oreal are examples of multinationals with large production bases in Indonesia.But the problem is, this sudden new army of young consumers wanted goods at a rate that Indonesia just could not meet domestically. “This big young middle class population had huge demands. We became a victim of our own success: the economy grew 6.5% and people demanded things that couldn’t be entirely supported from the supply side. And if a product is not available, they are going to buy imports.” 92% of Indonesia’s imports are capital goods and raw materials; when the economy does well, Indonesia imports more of these things, and inevitably the current account deficit climbs. Early last year it reached 4.4% of GDP, or $10 billion, and this is what markets identified as weakness when the tapering sell-off took hold.
What to do? “As a minister of finance, I have two choices,” Basri says. “The ideal one would be to expand the supply side, increase productivity, improve infrastructure, and improve the quality of human resources. But I completely understand it takes time to get there.
“If I cannot handle this from the supply side, my only option is to slow down demand.”
This version of events does have some merit. By Basri’s telling, two things did the job: a 44% reduction in the fuel subsidy, and the central bank’s decision to raise rates by 175 basis points, causing the currency to depreciate. “It’s a standard model for handling a current account deficit,” he says. “Within four months, we were able to manage this issue, from 4.4% to 1.9%, or $4 billion. I don’t think this will be a major issue in the future.”
In the interview, Basri also talks about improvements in capital flows, a full recovery in foreign exchange reserves, and the need for greater clarity from the Federal Reserve on tapering and, subsequently, interest rate hikes. He calls for a reinvention of Indonesia’s economic base away from natural resources, and says that the biggest single threat to the Indonesian economy is a slowdown in China. He also says, as many of his predecessors have, that a new land acquisition law will open the bottleneck in Indonesian infrastructure development. Click the link above for the full article.
Basri will soon step down as finance minister when a new president is elected on July 9. It is a mighty piece of democracy, with 186 million voters going to the polls, and is a closer race than it at first appeared: front runner Joko Widodo, governor of Jakarta, still leads from former general Prabowo Subianto, but the gap has narrowed in recent weeks. The election, and the possible impact of its outcome on investors, will be discussed in a later post.