Clogged Reforms a Speed Bump for Indonesia’s Economy

By Neil Chatterjee

Commuters standing in the doorways of a train and sitting on its roof, are seen as they travel to work in the capital Jakarta November 10, 2011. Indonesia’s economy has shown strong growth this year, but failure to improve a stifling bureaucracy, to end wasteful subsidies and to systematically curb graft, could derail a growth story that has made resource-rich Indonesia into Southeast Asian’s sweet spot. Doubts are growing that President Susilo Bambang Yudhoyono can deliver on promised reforms that improve creaky infrastructure and creating higher-value jobs for the young in the world’s fourth most populous country. Picture taken November 10, 2011.         REUTERS/Supri

JAKARTA, Nov 22 (Reuters) – At a time when many countries are slipping off investors’ radar screens, Indonesia is a beacon with stable finances and the fastest growth rate in Asia outside China and India.

Yet its failure to improve a stifling bureaucracy, to end wasteful subsidies and to systematically curb graft could derail a growth story that has made resource-rich Indonesia into Southeast Asian’s sweet spot.

Doubts are growing that President Susilo Bambang Yudhoyono, who’s been in office seven years and has three left, can deliver on promised reforms that would improve creaky infrastructure and creating higher-value jobs for the young in the world’s fourth most populous country.

While Indonesia has had solid growth rates during Yudhoyono’s tenure, much of that is rooted in demand from overseas for the country’s coal and other commodities.

If there’s a major global slump that depresses demand, Indonesia could fail to get needed investment because it remains a difficult place to do business and one where personalities matter, not process.

There has been no real reform of the inefficient civil service – where bribery remains rife — and no sustained progress in building institutions that enhance the business climate such as credible courts.
“The political elite in the parliament and the government are busy with politicking, ignoring an urgent and important economic agenda that needs to be dealt with,” said Syamsudin Haris, senior political analyst at the government-funded Science Research Institute.

After getting improved grades in recent years as a place for business, Indonesia’s position has slipped. In the World Bank’s 2012 rankings for ease of doing business, Indonesia was 129 out of 183 countries, down from 126 a year earlier.

Re-elected by a landslide in 2009, Yudhoyono has so far squandered a mandate to drive reforms and, according to polls, has lost popularity. His long-awaited cabinet reshuffle last month reflected a desire to shore up political support more than to initiate real change before a presidential election in 2014 which he cannot contest.

“We haven’t seen any headline reforms done, which has led to some market disappointment and also to disappointment among voters,” said Prakriti Sofat, an economist at Barclays Capital in Singapore.

“If Yudhoyono and company don’t put things in order, and there’s not a good candidate coming through in 2014, then the risk will go up.”

Having solid GDP growth by itself does not mean trends are good. Just look at India: Although growth is still relatively strong, its image as an emerging market star is losing its shine as corruption scandals, high inflation and a flagging reform agenda have dented investor confidence. Business leaders openly fret that the government may be squandering India’s chance at the big time.

Azim Premji, billionaire chairman of outsourcing giant Wipro , summed up a sense of policy paralysis in India when he recently attacked a “complete absence of decision-making among leaders in government.”

The result has been investors fleeing from Mumbai stocks , making it one of the world’s worst performing major markets in 2011.

While Indonesia has been drawing investors, “long-term, if there are better opportunities elsewhere, money will go somewhere else,” said Sofat.

Yudhoyono’s government has been often commended for good macroeconomic policies. It has maintained fiscal discipline, steadily cutting the debt-to-GDP ratio and boosting foreign reserves, while lifting its budget for infrastructure by 28 percent this year.

But the government’s administrative mechanism is often clogged. Lifting budgets is not translating into spending in the real economy. Overall, government spending grew just 2.5 percent in the third quarter from a year earlier, a slower pace than in the second quarter.

“The government has never shown any reliable track record of efficient budget spending and I don’t think that will change in the foreseeable future,” said Lanang Trihardian, investment analyst at Jakarta-based Syailendra Capital, which manages around $460 million. “The impact of that is I don’t believe Indonesia can grow above the 8 percent level as seen in China and India.”

Officials often rush to spend some of a budget overhang in the fourth quarter. A much-needed project to improve woeful drainage in Jakarta recently started on the main thoroughfare — just as the torrential rainy season began, causing gridlock terrible even by the capital’s traffic standards.

“You know what the bureaucracy is like for government projects — long and complicated,” the head of Jakarta’s public works office, Ery Basworo, told a press conference called to address complaints. “For us to even get the project started in September was an achievement.”

At one time, many Indonesians felt Yudhoyono was making good gains to combat the old, damaging problem of graft, but it remains entrenched. To some citizens, corruption has worsened, in part because of decentralisation since the era of strongman Suharto.

In the remote provinces of the scattered archipelago, greater regional autonomy has sometimes resulted in corrupt local authorities to siphon off resource wealth meant for development.

Yudhoyono has declared eradicating corruption a top priority and said no official is above the law. But his recent cabinet shuffle did not signal a tougher or more effective approach. Two ministers whom the Indonesian media alleged to be tainted retained their seats.

Meanwhile, political squabbles led to a demotion of the trade minister and the narrow survival of the finance minister, both well-respected internationally.

The reshuffle “was an opportunity for Yudhoyono to have a stronger team and he missed it,” said Erman Rahman, director of economic programs in Indonesia at The Asia Foundation, a San-Francisco-headquartered nongovernmental organisation.

Another longtime impediment to business, the bloated and inefficient bureaucracy, remains a source of big frustration. “It will take more than very strong leadership to change this,” Rahman said.
So far, there are no signs of planned reforms for the police department or justice system, which are often the source of complaints.

TRACKING SPENDING FLOWS

Polls show that many Indonesians, used to Suharto’s 32-year rule, want another military man to run the country from 2014. Yudhoyono, the first directly elected president, is a retired army general but is seen by many as unable to make bold decisions to promote institutional change.

Analysts say Vice-President Boediono, a former central bank governor, is trying to improve efficiency and governance by steps such as putting into ministries computer systems that track spending flows.

In the important area of infrastructure, investors have been waiting for a long-mooted land reform bill that would speed up the acquisition of land for state-backed projects, such as $150 billion of public-private partnerships the government wants to see.

But as the end of another year approaches, it has still not been passed by a cantankerous parliament, and Yudhoyono has been silent on the issue.

Another issue that needs addressing is subsidies. With inflation significantly easing this year, the government has missed an opportunity to phase out fuel subsidies for private cars, backtracking on a planned April move and delaying it indefinitely.

The government fears hiking gasoline costing just half the price of the market rate could dampen the domestic economy or spur the kind of riots that contributed to Suharto’s fall in 1998.

Yet not ending subsidies only stores up inflationary problems for the longer-term. The “ruinous middle-class subsidies”, as one economist has dubbed them, could instead go to building roads and ports, argue economists and rating agencies who see weak infrastructure and high inflation as key risks.

“Progress on structural reforms appears to have slowed in the past year. In particular, there has been limited progress in reforming the composition of spending,” said Andrew Colquhoun, head of Asia-Pacific sovereign ratings at Fitch.

($1 = 9050 Rupiah)

(Additional reporting by Andjarsari Paramaditha in JAKARTA and Matthias Williams in NEW DELHI; Editing by Richard Borsuk)

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