Country Report
- Indonesia 2003
William R.
Thomson
Chairman of Momentum Asia Ltd
26 August, 2003
Political developments
After
thirty years of stability under President Suharto, Indonesia
underwent a period of revolving door presidencies. Since the
elevation of Megawati Sukarnoputri from the vice presidency in
2001, Indonesia has enjoyed something resembling stability -
in the sense that are no credible threats to remove he from office
- after the turbulence of the previous three years with it four
presidents.
The President
came to office on a wave of popularity since she enjoyed her
father's name - the founder of modern Indonesia. But her character
could not be more different than that of her charismatic father.
By nature, she is a retiring individual, untrained for the job
with only a high school education, who delegates her authority,
and so has performed more of a ceremonial rather than an executive
role.
The Bali bombings
in October, in which over 200 people were killed, the majority
of them tourists has been a wake up call, however. The act, perpetrated
by home grown Islamic fundamentalists, exploded the myth that
South East Asian Islam represented a less aggressive threat than
that of the Middle East. The reality is that the links between
extremists in the Middle East and elsewhere are stronger that
previously believed, but the telltale signs of the linkages had
been conveniently ignored. Bali, however, created a crisis within
the government with the US and Australian authorities demanding
action.
The President
found herself in the middle, between foreign powers demanding
action and an anti-Western populist lobby resentful of perceived
western bullying. Despite being accused of being a western puppet,
she acted to tighten up security legislation and a number of
the Bali suspects were picked up and tried quickly. In August
2003 the first suspect was convicted and received a death sentence.
The increasing
willingness of the US and Australia to intervene extra-territorially
undoubtedly contributed to the unaccustomed urgency on the part
of the Indonesian authorities. There is a widespread belief that
the American forces based in Mindanao on continued operations
are, in reality, an expeditionary force available to use in Indonesia,
if major trouble developed there.
At year-end,
the Government signed a peace deal with the Aceh independence
movement granting the Achenese elections and a high degree of
autonomy from 2004. This agreement came in the shadow of threats
from Megawati to unleash the full force of the military against
them. The Achenese probably agreed to the deal in part because
they knew the US in its present frame of mind would not countenance
independence of a conservative Muslim state sitting on large
oil and gas reserves at a vital, strategic point in the Molluca
Straits. The US, Japan and the World Bank all sweetened the deal
by offering substantial aid to Aceh in return for signing. Whether
the deal will hold in the long run is unsure since the independence
movement has deep roots.
Presidential elections
The
first direct Presidential elections will be held in 2004 as well
as elections for the Legislature. It seems likely that Megawati
will run again and, despite polls showing more support for the
Sultan of Yogyakarta and Coordinating Minister Yudhoyono, it
is far too soon to count her out.
International relations
Indonesia's
traditionally close relations with the United States broke down
in the late 1990s over the human rights abuses of the Indonesian
Armed Forces against the largely Roman Catholic citizenry of
East Timor. The US Armed Forces were forced to sever their links
with the Indonesian forces. But following East Timor's full independence,
and awareness of the full scale of the security threat within
Indonesia, the US is close to normalising relations between the
two countries armed forces again. Relations with the Howard government
have been particularly tricky but the Australian armed forces
are looking to do the same. It is a mark of extreme cynicism
on the part of the western powers since the Indonesian Armed
Forces are as unreformed and brutal as ever. They are seen, however,
as largely secular and an insurance policy against religious
extremism.
Economic developments
The
economy grew by 3.7 percent in 2002, its best year since the
onset of the crisis. The result would have been even better but
for the reaction to the bombings. The growth was supported by
strong public spending, which grew by 13 percent, and private
spending, which had its best year since 1997 growing by 4.7 percent.
However, investment had a poor year reflecting continued over
capacity, a loss of competitiveness in manufacturing to China
and Vietnam in some labour intensive manufacturing areas and
generally weak governance by in both the public and private sectors.
Private consumption
was facilitated by sharp increases in wages in manufacturing
- accounting for some of the loss of competitiveness already
noted - as a catch up from the declines in real incomes suffered
during the crisis, and by a substantial increase in bank lending
as the bank's situation continued its improvement. At year-end,
non-performing loans were reported to be only 10.2 percent reflecting
success at recapitalisation and transference of existing bad
loans to the asset management companies.
Exports and
imports were almost flat in 2002 growing by 1.1 percent and 0.4
percent respectively. However, the breakdown of exports changed
significantly with oil and gas exports soaring on the back of
higher prices whilst non-oil and gas exports declined by 5.6
percent. The current account remained comfortably in surplus
at 4.3 percent GDP facilitating a build-up in the exchange reserves
to USD 31.6 billion.
The budget
deficit was halved to 1.6 percent GDP and total external debt
was stable at USD 130 billion, a substantial reduction from the
post crisis peak of USD 151 billion in 1998. More importantly,
the debt service ratio has declined from a crushing peak over
40 percent of exports to 31 percent - a figure that is still
too high for comfort. In addition, the external debt still has
a substantial short-term component, leaving the country much
more exposed to shifts in market perceptions compared with its
neighbours.
Economic prospects
for 2003
Growth
in 2003 is expected to dip slightly from last year's 3.7 percent
to about 3.4 percent caused by the uncertainties surrounding
the Iraqi war and the depressed tourism figures. If those clouds
are lifted then an expected revival in global trade should lift
the growth rate in 2004 to between 4 and 5 percent. If terrorism
can be contained then there should also be an improvement in
tourism. Firm oil and gas prices are also helping the economy.
Inflation,
which has grown at double digit levels since the onset of the
crisis, is expected to moderate in 2003 and 2004 to around 5
percent helped by a table of moderately appreciating Rupiah which
is expected to trade around 8,000 compared with 9,000 in 2002.
Tighter monetary policy will be assist the local currency and
the policy will be facilitated by a declining budget deficit
to around 1.5 percent GDP. As the government demands on the economy's
savings are reduced there will be scope for private sector borrowing
to expand and expand consumption.
The elections
due in mid 2004 are likely to hinder Government's efforts to
address sensitive issues such as privatisation with the required
vigour to effect change.
The Government
seems determined to exit from its IMF programme in 2003 for political
reasons. This would allow the Government to demonstrate some
necessary independence from a western organisation before the
2004 elections. However, that action is likely to engender concerns
about the country's ability to finance itself at a reasonable
price and some donor programmes might be delayed. But. Japan,
on the other hand, with its great need for Indonesian oil and
gas, and a desire for a greater regional role, might be willing
to increase its aid and become the country's lead donor. This
would be more acceptable to nationalist sentiment within Indonesia.
Japan, however, is also susceptible to pressure from the US,
and. the latter will be reluctant to see Indonesia exit the IMF
programme. Additional terror attacks would make things financing
considerably more difficult and more expensive and would probably
require an eventual return to the IMF.
Economic issues
Foreign direct investment
In
the boom years, foreign direct investment was the economy's driver
bringing technology and finance to a broad range of industries,
from natural resources to infrastructure, property and consumer
industries including tourism. That all ended with the Asian crisis
of 1997-8. Since then FDI has been negative every year. Originally,
there had been some hope that 2003 would see a reversal of these
trends with the re-emergence of small positive FDI flows in the
oil and gas sector. The situation in the wake of the Bali and
the Marriott Hotel bombings has delayed expectations somewhat
of an FDI revival of FDI until 2004.
There are some
signs of renewed interest in the oil and gas sector. A 20-year
liquefied natural agreement was signed on 24 July with a consortium
of energy companies led by the US firm Marathon Oil to supply
6-10 million tons LNG annually beginning in 2007 to the US West
Coast and Mexico. Significantly, the project has been won against
severe competition from Latin America, despite the latter's proximity
to the United States and the related transportation cost advantages.
Outside the
natural resources sector the country needs to address perceptions
of corruption within the legal system for FDI to flourish once
again. A greater willingness to allow foreigners to purchase
state owned enterprises would increase revenues and enhance productivity
and management quality. Privatisation has been proceeding at
about half the levels required under the IMF programme. In 2002
they were only about USD 300 million with the Bank of Central
Asia and Niaga Bank being successfully privatised - but to local
investors. Prejudice against foreigners was also shown in the
Manulife case.
Stock Market:
Stock
markets are supposed to cut through the surface noise and blaring
headlines and by assembling all available intelligence discount
the future as or more accurately than any other mechanism. Whilst
their record is far from perfect, their long-term forecasting
track record has almost certainly been better than any other.
If this continues to be the case, then the Jakarta stock exchange
is signalling better times ahead, despite all the other gloom.
The Jakarta
stock exchange remains the smallest and least developed of the
South East Asian emerging markets: the so-called Mango markets
of Thailand, Indonesia and the Philippines. These markets have
the advantage of not being strongly correlated with Wall Street
since their economies still have a substantial commodity or natural
resource base. Natural resources (oil, gas, minerals and food)
are all experiencing a revival in demand and a firming of prices
after almost two decades when they were declining or stagnant.
In this particular respect, they are the beneficiaries of China's
voracious appetite for raw materials. From an ownership standpoint,
European and US investors are still significantly underweight
these markets, so a positive performance generated by local investors
could eventually begat further capital inflows and even better
performance.
There is still
plenty of upside room since the market was the hardest hit in
the Asian crisis along with Thailand. At its worst it lost over
90 percent in USD terms. However, a stabilised and improved exchange
rate and economy have led to some recovery in values. In the
wake of the Bali bombings last year the market retreated to a
level around 350 from which it has since rebounded to around
500 on the Jakarta Stock Exchange Index. At these levels, the
market is still about 35 percent off its all time highs in Rupiah
terms and 80 percent down in USD terms.
Jakarta's corporate
governance remains quite opaque and off the screen of eligible
investments of the giant California State Pension Fund (CALPERS),
which is often seen as a market leader in this field. That fact,
plus the negative headlines on the war on terror, will undoubtedly
make reflows slow but will also create opportunities for intrepid
contrarians willing to enter the lion's den. Since the economy
is continuing to grow and, as noted, it produces natural resources
the region and the world needs, and values are attractive, careful
investors may be pleasantly surprised since most of the negatives
are already heavily discounted in the prices.
The sophisticated
investor who ventures here would be well rewarded if prices challenge
their old highs in Rupiah terms over the next 2-3 years. The
difficulty for smaller investors is that the pure Indonesian
mutual funds have largely been liquidated because their size
became uneconomic with the decline in prices and redemptions.
Country risk:
Ratings
Economic:
Improving (but fragile)
Political: Poor (but better than it looks)
Regional stability: Fragile
Stock Market: Satisfactory
William R. Thomson
wrthomson@btconnect.com
Tel: 44 1483 440825
Bill
Thomson is Chairman of the Siam Recovery Fund and advises governments
and several asset management companies and institutions in Asia.
He was formerly Vice President of a major international bank
in Asia and is a former US Treasury official. He writes widely
and we really appreciate his words of wisdom at 321gold.
321gold Inc
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