Jokowi's Economic Policy: What will it take to reach sustainable development?

I would like to discuss Indonesia's economic policy, starting with recent economic conditions and moving on to some of the keys to economic policy in the country.

Indonesia has performed well in recent years, despite the economic slowdown. Last year, it grew at 4.8%. The main driver for growth has been household and investment consumption. The government has said that the economic slowdown will continue this year, making this the main driver of growth in 2016. Direct and indirect investment increased last year. Account balances are net positive for the first time in four years. However, the absolute import and export figures actually decreased. Lower commodity prices, particularly lower oil prices, contributed to this. Indonesia is currently a net oil importer and has been since 2004. The cost performance index (CPI) was 4.14% last year. Investment increased: 19% from foreign direct investment (FDI) and 15% from domestic investment. The fiscal deficit is capped at almost 2.6% under an Indonesian law which prohibits deficits to be larger than 3% of the gross domestic product (GDP). If the government were to exceed this budget cap, the president's position would be jeopardized.

Government policies are trying to encourage consumption by 250 million people—a large population and one that is more than adequate to become a growth-stimulating source of consumption. The dependency ratio is 49%. Inflation is stable, direct investment levels are good, and the country is well-regarded as a destination for investment by several rating agencies.

Reforms began to be made last year. The current president, Joko Widodo (Jokowi), took office in 2014. At that time, he had no say in the 2014 budget. The Indonesian fiscal year runs from January to December. When President Jokowi took office, the budget for 2015 had already been decided and approved by the previous president and parliament. Under the law, he could not deviate from this budget without officially revising it with the approval of parliament. They began revising it in March 2015, and the revised budget was approved in April 2015. He only had approximately eight months to work out his own budget policy. The government would like to formulate a new budget policy which moves from a heavy subsidy to a targeted subsidy intended to maintain welfare. The president would also like to break from the past by spending more on developing new assets rather than on disposable spending such as officials' salaries, business trips, etc.

The new government wants to change the fundamental economic structure of Indonesia from a community-based model to an industrialized, resource-based economy. As such, the government is trying to boost manufacturing, and envisions a shift from consumption-led to investment-led growth, and a policy to maintain purchasing power. A sufficient market is needed for these new investments.

Bear in mind that the 2015 budget reforms have changed twice in accordance with changes in the internal and external economic factors. There has been a significant decrease in revenue because tax revenue decreased quite significantly from the target, but spending didn't increase on a percentage basis. Indonesia has a problem with spending capacity. Nearly all agencies are unable to spend as much as they plan. The government calls this an absorption problem: the agencies push to spend more to reach the numbers in their plans, and could potentially lead to inefficient spending.

The significant increase may be both good and bad. Indonesia has embraced centralization since 2001, and transfers to local governments increase annually. Approximately one-third of the budget is directly transferred to local governments at present, while another one-third spent by national agencies for the regions.

The government claims some improvement in budget implementation last year. This is most important. The energy subsidy was dramatically reduced from 250 trillion rupiahs in 2014 to 138 trillion in 2015 and will be reduced again in this year's budget. These funds will be shifted to the education budget, housing budget, and infrastructure development. This is a clear attempt by the government to commit to a policy of increasing investment and productivity. Capital spending increased quite significantly and spending on goods also increased. Of course, not all goods are assets, but the government is trying to shift more from the categories of goods made by government spending to asset accumulation.

With regard to 2016 economic policies, the government is considering how to respond to the ongoing global economic slowdown and persistently low commodity prices. Indonesia has abundant natural resources, both mineral and agricultural. It has managed volatility and a lack of supply for infrastructure. At the same time, a new universal healthcare system will still require government support.

What additional tax revenue sources are available that would enable the deficit to be kept below 3% of GDP? We should look at spending capacity. The instrumentality of executive power is the same: same directors, same technical staff. It's very challenging to boost the capacity of the same personnel and mechanisms, but they are speeding up the capacity to spend through some deregulations and timely targets.

The government has identified three key pillars in its plan to achieve sustainable economic growth. The first is optimizing revenue: shift from commodity-based revenue to investment-based revenue, to broad tax coverage, improve and strengthen tax compliance, etc. The second pillar is enhancing the quality of spending: spend more on goods that boost productivity, enhance the subsidy scheme from a simple subsidy to a targeted subsidy, and empower local governments to participate in this new style of government. The third pillar is sustainable financing: finding additional government revenue sources and effectively utilize international and domestic funding sources, including new schemes coming from development policy loans (DPL) like deferred debt options (DDO).

With regard to strategies related to the first pillar—revenue optimization—the current numbers are a significant increase from that of last year. They are said to be impossible to reach, but the government knows that it is imperative that it does so. It will revise them in the mid-year parliamentary hearings to broaden the tax base and improve administration, with additional policies such as tax amnesty. On the expenditure side, attempts must be made to increase spending efficiency. It has not been unusual in recent years for hotels in Indonesia to be booked full in October and November by government agencies for meetings. The government is trying to reduce that kind of wasteful spending and focus on productivity. With regard to financing, the budget deficit must be kept under 3% of GDP and contain a mix of financing instruments and currencies, using bilateral loans, DDO, government bonds, etc.

With regard to economic strategy, the government has promulgated some policies to accelerate infrastructure development, incentivize the business sector, and maintain purchasing power.

The 2016 budget is not impossible given the percentages, growth expectations, inflation, etc. Tax administration is still a challenging weakness, along with the economic slowdown. The budget numbers are likely to be revised. Estimated oil and gas income tax will be revised downward because of the continuing low price of oil. The international trade tax will also be lower because of changes in exports.

Indonesia now has more than 500 autonomous regions with subnational governments, some of which are really good, while others are very poor in terms of management, capacity, and resources. One-third of the budget is directly transferred to these governments and is therefore indirectly spent. The problem is that the current regulations on the fiscal relationship between national and subnational governments are non-discriminatory, and are applied to all regions despite vast differences.

One of Jokowi's key policy goals is to achieve an east-to-west maritime nexus. I have just completed a research study on the role of maritime connectivity in Asia. Indonesia lies outside the major international shipping lines. Most shipping originates in Japan, China, Taiwan, Hong Kong, etc. and passes through the Malacca Straits rather than through Indonesia and the Philippines. There is a need to strengthen domestic maritime connectivity due to the very high, inefficient logistics costs in Indonesia. These reached 28% of GDP last year, higher than that of Malaysia and Thailand.

Last year, the president became upset about the dwelling time in Indonesian ports—eight days—compared to only a day or two in Thailand and Malaysia. He even changed the responsible ministers. However, dwelling time is not the only problem. It should be seen as part of the overall logistics and supply chains nationally. It will not be effective to only reduce dwelling time while failing to improve the poor tracking system and while connectivity remains poor with very high shipping costs. Last year, sending a box of containers from Dumai to Jakarta was more expensive than sending it from Singapore to Jakarta because of economies of scale. In the eastern part of Indonesia, economic productivity is very small in scale. When a ship visits an eastern port, it brings goods demanded by the local area, but it returns empty.

To move faster and improve the quality of spending, the government has tried to encourage ministers and local governments to begin procurement at an early time. Not many local governments are ready to do that. Also, priorities may differ between governments. The challenges are to minimize red tape, corruption, and political intervention.

Infrastructure construction plans include national toll roads, the one million house project, water infrastructure for urban areas, intercity railways, airports, and seaport development (new port construction and expansion of existing ports).

The estimated amount needed for infrastructure financing is quite high: more than 6,000 trillion rupiah in total for the period 2015-2019. The government can only provide 20% of that, resulting in a need for state-owned-enterprise and public-private partnership (PPP) participation.

The package of economic measures is still new. Some are already having an impact, while others will need more time before their effects can be assessed. The government eliminated the foreign ownership cap for 35 business types while simultaneously trying to protect small and medium-sized enterprises (SMEs).

I think the government needs to make major comprehensive reforms. What has been done is fragmented and discrete. The capacities of local governments and domestic private companies are particularly in need of improvement. Coordination problems are occurring which point to a need for prioritization and appropriate timelines. The government on some occasions has tried to tackle one problem, but then moves on to another before finishing. A comprehensive roadmap is needed for maritime connectivity.

I expect the government to try to change the spending pattern to enable faster spending and faster construction to promote asset accumulation and improved connectivity. We expect the government to try to induce new economic production centers outside Java, create special economic zones, and reduce logistics costs. The government is still very new so more time will be needed before these efforts can be assessed.

The government has said that its current policy is designed to lay the groundwork for sustainable development. However, there are issues with its approach. The long-term goals are less visible. The industrialization vision remains unclear; the trade policy is amorphous and ambiguous; and the education sector remains detached from the rest of the development agenda. The government needs to know what skills labor needs and coordinate education sector initiatives to ensure that people possess them. Many SMEs still have no access to financial resources. Financial illiteracy and inclusion are a big problem. The government is trying to formulate policy, but we do not see strong connections linking all of it together. No systematic efforts have been made toward network economies. Why not make a cluster out of places with small economies of scale? The government efforts have been too separate and not sufficiently intertwined.

I have four broad points I would like to ask about the issues. First, on the current status of the Indonesian economy, given the slowdown globally and in the Chinese economy, the Indonesian economy has slowed but not as much as other more trade-dependent countries. Relatively speaking, I think Indonesia is doing quite well. The question is how much of this relatively favorable performance by Indonesia is attributable to President Jokowi's policy. As you already pointed out, the budget he had was basically decided by the previous government, but I am sure he had some say in last year's and this year's budgets.

Second, regarding the strategy of the current government, the shift from a consumption-led to an investment-led approach and a greater focus on assets is not new. Many previous governments were also interested in developing the manufacturing sector and so on. Knowing this, how optimistically do you view the prospects of these goals being achieved by the current president? Do you think it is more likely that these objectives will be achieved by this president and, if so, why? What is different about the implementation of economic policies by the current government compared to earlier governments? On a related point, how do you view 5.5% or 6% economic growth? Do you think this is below Indonesia's potential? In my view, it is below potential. If so, how can the gap be reduced to unlock unrealized and potentially much higher economic growth? What would the challenges be?

The third issue is FDI, which plays a very important role in achieving economic growth for any country. As you may know, Japanese companies see Indonesia as a very attractive FDI destination. According to the most recent Japan Bank for International Cooperation (JBIC) survey that came out late last year, Indonesia is ranked second, behind only India, among the most promising FDI destinations for Japanese companies. Indonesia is very attractive for reasons such as its enormous growth potential, a growing and potentially huge local market, and abundant inexpensive labor. Some clusters are already being built there. At the same time, however, Japanese companies are experiencing several problems with operating in Indonesia. The first problem is increasing labor costs: wages. The second problem is the lack of an effective legal system. I guess this has to do with corruption and so on. The third problem is underdeveloped infrastructure, which you emphasized. The fourth problem is intense competition with other companies. Finally, a shortage of highly-skilled middle management human resources exists in Indonesia. If I understand the situation correctly, labor unions have increased their influence in setting wages. How are wages now? How do you view the prospects of rising wages in Indonesia? On infrastructure, I would like to see how PPP may be helpful and how it may contribute to the building of infrastructure in Indonesia. What are the possible problems for Indonesia in carrying this out? I would also like to ask about the high-speed train project which the Japanese government lost to the Chinese. What is the current status of the project?

Finally, I'd like to ask about trade policies. President Jokowi told U.S. President Barack Obama that Indonesia is interested in joining the Trans-Pacific Partnership (TPP). Is there an active debate in Indonesia about this? What is your analysis of possible participation? What would it take for Indonesia to join the TPP? There is also the Regional Comprehensive Economic Partnership (RCEP) which involves 16 countries. I would like to see the Association of Southeast Asian Nations (ASEAN) take the initiative in these negotiations, but I have an impression that they are not. I think Indonesia has to take the lead. What are your views on Indonesia's participation in the RCEP negotiations?

We have to give credit to Jokowi for his breakthrough. The previous presidencies had some implementation problems. The plans and the documents were there, but they couldn't make it happen for various reasons, mainly conflicting regulations. The new government has tried to break through these problems, and it has succeeded to some extent. The amount of infrastructure is increasing very significantly through the eight months of the budget year. Jokowi had a hand in both the 2015 policy and the current one.

The government is trying to spend more on infrastructure and give more to investors. Again, though, we cannot detach this from external factors: exchange rates, imports, exports, etc. Many Indonesian companies rely on imported materials. When the government tries to boost the manufacturing sector, we have to expect more imported goods and more pressure on the rupiah. We suggest that the government not promise to lower the exchange rate against the U.S. dollar, but rather that it stabilizes the rate. I haven't seen a long-term roadmap on manufacturing.

I agree that growth is still below potential. Given how hard many politicians, including those of Jokowi's own party, attacked him last year, I think it's quite an achievement. One thing that can be done is utilizing idle assets. There are many cases because property ownership is low in Indonesia due to strict laws which also make it difficult for state-owned banks to sell properties. This is an inefficient way of managing assets.

Labor unions have become stronger. This is because Indonesia is a young democracy, and anyone can say anything. Last year, the government created an index to inflation. We expect no further prolonged wage negotiation disputes. Still, the labor unions are against this.

Turning to the PPP prospects for infrastructure, the first challenge is how to improve the government's capacity to understand PPP. The high-speed train is related to this. The Japan International Cooperation Agency (JICA) conducted a feasibility study and issued a report under the previous minister. It was put in the plan of the previous government. However, the new government has the authority to set its own development plan. The current five-year development plan is owned by Jokowi, and it removed the high-speed train from the priority list and spent more of the budget on building road and infrastructure outside Java. When Japan came to ask for this project, because it is not called by the government, it fell under the category of unsolicited projects such as that of PPP. When such proposal is received, the government has to hold a beauty contest. That's when China came. Both proposals were originally rejected for budget reasons. Then China made a new proposal, a business-to-business scheme, not using loans. Japan came with a revised version which still propose a loan for budget state, and that's why the government chose China.

The Minister of Transportation has stated that he does not support this project. Then, fiscal support or exclusive rights was requested. The minister's response is bad for the whole investment situation. He lacks understanding on how the private sector works. Some risks are better borne by the government. The most challenging issue is how to educate the key people.

I could say the same thing about the TPP and the RCEP. I haven't seen a debate on this. Some non-government organizations (NGOs) say everything is bad for open trade. The government has recently conducted a study on key areas to assess the advantages and disadvantages of participation. This will need maybe two years to be completed. Political decisions may also delay this.

Q&A

*This summary was compiled by RIETI Editorial staff.