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Indonesia’s commitment
tofree marketsis looking
After the Asian currency cris...
At a time when many south-east Asian economies have seen
their growth rates rise and fall in line with global economic
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Indonesia - a consistent performer but opportunities go begging


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Indonesia’s commitment to free markets on shaky grounds

Our new report ‘Indonesia – a consistent performer but opportunities go begging’ finds that

Indonesia stands out as an economy that is delivering consistently rapid growth. Last year the economy expanded by 6.2%, and real GDP growth is expected to reach 6.5% by 2014.

However, Indonesia’s outsized domestic economy – a strength during the global slowdown - also underscores one of the country’s main weaknesses: the absence of a competitive export-led manufacturing sector. Will that lack, along with the high cost of doing business in Indonesia, rapidly rising wages and increasingly protectionist trade measures mean that the country will struggle to compete with its more flexible neighbours in the future?

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Indonesia - a consistent performer but opportunities go begging

  1. 1. RETREAT FROM FREE MARKETS Indonesia’s commitment tofree marketsis looking increasinglyshaky. After the Asian currency crisis of the late 1990s, Indonesia reformed its near-bankrupt economy, under pressure from the IMF and other creditors. However, now that those reforms have delivered a more stable economic environment—and Indonesia is starting to be seen by foreign investors as a market they cannot neglect—there seems to be a degree of hubris on the part of policymakers. In the past 18 months, the government has passed a series of measures that have heightened concerns of trade protectionism and even economic nationalism. The natural resources sector has been on the frontline. In February 2012 the president, Susilo Bambang Yudhoyono, signed a decree requiring that all mines be at least 51% owned by Indonesians by their tenth year of operation. Previously, mines had to be at least 20% locally owned by their fifth year of operation. In May the government imposed a 20% export tax on 21 different categories of metal ore, including copper, nickel and gold, ahead of a moratorium on all such shipments scheduled for 2014. The aim was to encourage mining firms to build smelters and export only finished metals. Miners operating under old work contracts are protected from these regulatory changes, but their contracts are being renegotiated on less favourable terms, as they come up for renewal to bring them into line with the new rules. The government is also tightening import restrictions. New licensing rules on imports of fruit and vegetables, along with long- standing restrictions on meat shipments, have raised the ire of the US government, which in January filed a complaint against Indonesia at the World Trade Organisation (WTO), claiming that such measures represented a “serious impediment” for its exporters of farm products. The government also tried to restrict imports of finished goods, but later watered down its proposals amid protests by foreign chambers of commerce. This challenge to free-market principles coincides with the sidelining of leading reformists. The first to go was Sri Mulyani Indrawati, who resigned as minister of finance in 2010 to become a managing director at the World Bank, after a series of high-profile disagreements with Aburizal Bakrie, the chairman of the Golkar party (part of the ruling coalition) and one of the country’s richest pribumi (native) businessmen. The protectionist push began at about the time that Mari Pangestu was demoted from minister of trade to minister of tourism in September 2011. She has now entered the race to succeed Pascal Lamy as chairman of the WTO, after alienating many of her cabinet colleagues with her commitment to free trade. In the latest move, Mr Yudhoyono has appointed Agus Martowardojo, the current finance minister, as governor of Bank Indonesia (BI, the central bank). Although Mr Martowardojo is well qualified for the role, his departure represents the loss of yet another reformist minister. Foreign investors have taken notice of Indonesia because of its reforms, but it would be wrong to assume that they will flock to the country come what may. With presidential and legislative elections to be held next year, protectionism and nationalism will continue to influence policy, but it is hoped that there are still reformists among the government that will keep the country from backtracking. Sponsored by: Inthe past18 months, the governmenthas passeda series of measuresthathave heightened concerns oftradeprotectionism and even economic nationalism. About Aberdeen Asset Management Aberdeen Asset Management is a global investment group, managing assets for both private clients and institutional clients from offices around the world. Aberdeen manages eight Asia-Pacific closed-end funds for U.S. investors including Aberdeen Indonesia Fund, Inc. For more information, including up-to-date performance and pricing information, please visit the Fund on the web at Important Information Closed-end funds are traded on the secondary market through one of the stock exchanges. The Fund’s investment return and principal value will fluctuate so that an investor’s shares may be worth more or less than the original cost. Shares of closed-end funds may trade above (a premium) or below (a discount) the net asset value (NAV) of the fund’s portfolio. There is no assurance that the Fund will achieve its investment objective. Past performance does not guarantee future results. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments. There are also risks associated with investing in Indonesia, including the risk of investing in a single-country fund. Concentrating investments in the Indonesia region subjects the Fund to more volatility and greater risk of loss than geographically diverse funds. Equity stocks of small and mid-cap companies carry greater risk, and more volatility than equity stocks of larger, more established companies. Aberdeen Asset Management (AAM) is the marketing name in the U.S. for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Managers Ltd, Aberdeen Asset Management Ltd and Aberdeen Asset Management Asia Ltd, each of which is wholly owned by Aberdeen Asset Management PLC. “Aberdeen” is a U.S. registered service mark of Aberdeen Asset Management PLC. The information in this report is accurate as of May 2013. About the Economist Intelligence Unit The Economist Intelligence Unit (EIU) is the world's leading resource for economic and business research, forecasting and analysis. It provides accurate and impartial intelligence for companies, government agencies, financial institutions and academic organisations around the globe, inspiring business leaders to act with confidence since 1946. EIU products include its flagship Country Reports service, providing political and economic analysis for 195 countries, and a portfolio of subscription-based data and forecasting services. The company also undertakes bespoke research and analysis projects on individual markets and business sectors. More information is available at or follow us on Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in the report.
  2. 2. At a time when many south-east Asian economies have seen their growth rates rise and fall in line with global economic demand, Indonesia stands out as one economy that is delivering consistently rapid growth. Even in 2009, when many of the region’s export-led economies saw their GDP shrink in real terms in the aftermath of the global financial crisis, Indonesia’s economy still grew by 4.6%. Last year the economy expanded by 6.2%, and the Economist Intelligence Unit (EIU) expects real GDP growth of 6.4% in 2013 and 6.5% in 2014. Indonesia has, of course, benefited from the relatively large size of its domestic economy. Domestic demand, particularly private consumption, has propped up overall GDP growth, even as exports have slowed amid depressed global economic conditions and a collapse in demand for the natural resources the country sells to the rest of the world. The economy’s domestic components (private and government consumption, fixed investment and changes in stocks) are equivalent to 90% of GDP. Exports of goods and services are equivalent to only about 50%. In 2012 personal consumption expenditure rose by 5.3% in real terms and contributed 2.9 percentage points to the economy’s overall expansion—more than any other expenditure account. Last year fixed investment expanded by 9.8% and contributed 2.4 percentage points to growth. Meanwhile, net exports of goods and services subtracted 1.5 percentage points from GDP growth. At a time of weak global growth, it is not surprising that many observers see Indonesia’s outsized domestic economy as a sign of strength. But it also underscores one of the country’s main weaknesses: the absence of a competitive export-led manufacturing sector. The high cost of doing business in Indonesia means that the country struggles to compete with its more flexible neighbours. Although manufacturing accounts for 23.9% of GDP, which is in line with the region’s other main economies (Thailand, Malaysia, the Philippines and Singapore), Indonesia’s merchandise exports comprise mostly natural resources—such as coal, palm oil, natural gas and crude oil. These four commodities account for about 40% of its export earnings. The country has developed no equivalent of Malaysia’s world-class electronics sector, or of Thailand’s automotive factories. This reliance on natural resources makes the economy vulnerable to swings in commodity prices and deprives it of what could be an export-orientated, employment-creating manufacturing sector. A high-cost economy Weak infrastructure is one of the main reasons why Indonesia has not developed a competitive manufacturing sector—the cost of moving goods within the country is extremely high. The government still spends more on market-distorting subsidies than it does on capital projects. Indonesia’s restrictive labour laws and rapidly rising wages are another factor. Since the advent of direct elections for provincial governors in 2005, local politicians have figured out that the surest route to office is to promise voters hefty rises in minimum wages. In Jakarta, the capital, the minimum wage rose by 43.8% this year, at a time when unemployment and under-employment remain high, at 6.3% and 12.3%, respectively. Then there are the perennial uncertainties of the business environment, with frequent changes to laws and regulations. Late last year, for example, the Supreme Court dissolved the upstream oil-and-gas regulator overnight, in response to a petition from a group of religious nationalists. The government soon established a successor agency, but External pressures Meanwhile, external pressures are becoming apparent. In 2012 Indonesia recorded a current-account deficit of US$24.2bn, equivalent to 2.8% of GDP, the first annual deficit since 1997. The merchandise trade balance swung into deficit for the first time since at least the 1960s. This has put pressure on the rupiah, which depreciated by about 6% against the US dollar last year, making it one of Asia’s worst- performing currencies. In Indonesia’s case, current-account deficits are not necessarily a bad thing. They are a consequence of a recent revival in fixed investment (the current-account balance represents the difference between domestic saving and investment). Fixed investment shrank to about 20% of GDP after the Asian crisis in 1997, as the country’s corporate sector collapsed under the weight of its foreign-currency liabilities, but after almost 15 years of painful restructuring, firms are beginning to invest again. Fixed investment now stands at about 33% of GDP and exceeds domestic savings. But the country needs to attract foreign capital in the form of direct and portfolio investment, in order to prevent a steady decline in foreign reserves that could eventually lead to a balance-of-payments crisis. With foreign reserves (excluding gold) of about US$105bn, Indonesia is a long way from facing any such crisis. The trouble is that protectionist and nationalistic economic policies risk scaring off foreign investors at a time when the country needs their capital to support the external accounts. The government should be attracting more foreign investors to Indonesia, so that it can sustain high levels of fixed investment and a current-account deficit that doesn’t risk running down the country’s foreign reserves. © The Economist Intelligence Unit Limited 2013 © The Economist Intelligence Unit Limited 2013 the damage to the country’s reputation as a stable place to do business had already been done. The government of the president, Susilo Bambang Yudhoyono, has shown little willingness to make the tough decisions needed to turn things around. In 2006 it proposed far-reaching changes to make labour laws more flexible, only to abandon them in response to large protests by trade unions. Subsidies represent a wasteful misallocation of resources, yet the government has repeatedly run away from any rises in fuel prices for fear of protests. According to the 2013 budget, subsidies this year are expected to cost Rp316trn (US$32.4bn). But only four months into the year everyone expects this target to be exceeded, with consumption of subsidised petrol already well ahead of official forecasts. The EIU expects Indonesia’s economy to grow by 6.5% a year on average in 2013-17, and personal disposable income to rise from US$287bn in 2012 to US$495bn by 2017. That represents a huge opportunity for foreign retailers and other firms looking to sell their goods and services abroad. Yet at a time when the country is benefitting from its demographic dividend, with its youthful, economically productive people outnumbering its elderly, dependent population, it could be growing at an even faster pace. Further reforms would lower business costs and allow the country to develop an export-orientated manufacturing sector that would propel growth and create employment when the world economy begins to recover. INDONESIAA consistent performer, but opportunities go begging Macroeconomic overview 2 0 1 2 Population: 248.8 m GDP: US$ 878 bn Real GDP growth: 6.2% Consumer price inflation: 4.3% Current-account balance: -2.7% Petroleum production: 993,000 b/d Petroleum consumption: 1,203,000 b/d Median household income: US$3,640 Retail sales: US$342.6 bn Passenger car sales: 780,785 Commercial car sales: 335,445 Motorcycle sales: 7,064,457 TheEIUexpects Indonesia’s economytogrow by6.5%ayearon averagein2013- 17,andpersonal disposableincome torisefrom US$287bnin 2012toUS$495bn by2017. Current-account balance (% of GDP) US$ bn (Left scale) % change; real terms (Right scale) External balance Gross fixed investment Government consumption Private consumption Source: Economist Intelligence Unit Contribution to real GDP growth (percentage points) Source: Economist Intelligence Unit 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 International reserves (minus gold; US$ bn) Gross domestic productSource: Economist Intelligence Unit Source: Economist Intelligence Unit 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Jan-10Mar-10May-10Jul-10 Sep-10Nov-10Jan-11Mar-11May-11Jul-11 Sep-11Nov-11Jan-12Mar-12May-12Jul-12 Sep-12Nov-12Jan-13 120 130 110 100 90 70 60 80