Survey of recent developments

By June 2006, the government had largely completed the difficult tasks of stabilising macroeconomic conditions following the October 2005 fuel price increases, and of drawing up a blueprint to improve infrastructure and the investment climate. On the macroeconomic front, the main issues related to how, and how quickly, the economy could return to the growth rates of late 2004 and early 2005, given still low levels of private and public investment. Sound macroeconomic policies had delivered a stronger rupiah and reduced inflationary pressures, albeit with continued decelerating rates of growth. Private consumption and investment having slowed, government spending had become the key driver of growth, but major delays in public spending continued in the first four months of the year.

The reform agenda includes an impressive raft of new laws, or revisions to old ones, in investment, taxation, customs and labour, all of which were covered under a special Presidential Instruction. However, actual reform was slowed by substantial political obstacles. There was growing concern about divisions within the cabinet on the reform package, and about the capacity of the ministerial team to guide reforms quickly through the bureaucracy and the parliament. This included doubts about the resoluteness of President Susilo Bambang Yudhoyono (SBY) on reform initiatives in the face of vocal opposition (as in the case of labour reform), and about Vice President Jusuf Kalla's commitment when political or business interests close to him were opposed to change (as in the case of divestment of shares in Indonesia by the giant cement multinational, Cemex).

Given likely delays in the reform package's impact on output and employment, uncertainty persists about the level of support the ‘duumvirate’ is prepared to offer reformist ministers, and about the political clout of the reformers themselves, as the government moves into the middle period of the electoral cycle. Examples of weak policy making include watered-down investment reforms, the seemingly ‘quick-fix’ approach underlying a proposal to set up special economic zones, and unsatisfactory handling of continuing disputes in the mining sector. A backdown on labour market reforms, at least for the present, has probably been the biggest setback to date in the SBY–Kalla team's attempt to promote investment: a poorly managed reform effort in terms of both substance and political strategy.

Two other events shook Indonesia during the Survey period. A massive earthquake hit the Yogyakarta region on 27 May, killing nearly 6,000 people and leaving thousands homeless. And on the political front, the attorney general controversially dropped corruption charges against the ailing former president, Soeharto.     

Survey of recent developments

The Indonesian economy is maintaining its momentum at a time of ongoing uncertainty in the global economy and slowing economic growth in China. Strong domestic demand saw output grow by 6.4% over the year to June, despite a steep fall in net exports. Inflation is safely within Bank Indonesia's target range, although food prices have increased relatively quickly. The current account deficit widened to 3.1% of GDP in the June quarter due to continued growth in imports and falling prices for commodity exports. The trade environment has deteriorated in 2012, and new divestment and domestic processing requirements are likely to further reduce investor interest in the mining sector.

President Yudhoyono has recently made several speeches calling for a ‘green growth agenda’. Some progress has been seen in slowing deforestation and in establishing mechanisms for facilitating payments to reduce emissions from deforestation, but loss of natural forests remains rapid. Carbon dioxide emissions from energy are growing quickly, stoked by increasing use of coal. The proposed 2013 budget continues to be heavily burdened by energy subsidies, which encourage over-consumption of fossil fuels. In most respects, therefore, the business-asusual trajectory of the Indonesian economy is unlikely to be particularly green.

A barrier to subsidy reform is its perceived unpopularity, including the threat of public protests such as those witnessed in March. To gauge current opinion we carried out a survey of Jakarta-based university students. The results indicated majority support for the removal of fuel subsidies, but some respondents said they would protest against fuel subsidy reductions, highlighting the politically sensitive nature of the issue.

Indonesia has witnessed booms in the coal and palm oil sectors in recent years, becoming the world's largest exporter of both commodities. We review the benefits from these two booms and the tensions between the development of these sectors and environmental goals. We also review the tourism sector, which remains relatively under-developed outside Bali. Tourism is a potential source of long-run growth that may be aligned with a green economy. The development of the sector would be aided by infrastructure improvements and a renewed focus on the conservation of natural assets.     

Survey of recent developments

SUMMARY Despite a bomb attack in Jakarta in August, the main financial indicators of macroeconomic health have continued to improve. Inflation is much lower than in 2002, and the exchange rate has remained fairly stable. Public debt as a percentage of GDP continues to fall, and foreign exchange reserves to increase. Deposit and money market interest rates have declined further, although this has yet to translate into significantly lower lending rates. Share prices have also been increasing rapidly, and Moody's recently upgraded Indonesia's credit ratings. The markets responded calmly to the largely political decision to terminate the IMF program at the end of 2003, reassured by a relatively conservative budget for 2004, and by the articulation of a longer-term strategy of balancing the budget by 2005.     

Survey of recent developments

The Indonesian public is becoming increasingly concerned about the gap between policy rhetoric and action. A strong contributor to this has been a long-running corruption saga involving a tax official, Gayus Tambunan, whose activities have helped confirm the public's worst fears about the ineffectiveness of the anti-corruption campaign. Claims of progress in this and other fields, including the economy, are often overstated, and opinion polls suggest that people are increasingly unwilling to take them at face value.

Nevertheless, the most recent data reveal a surprising surge of GDP growth, driven mainly by investment spending. Inflation has been quite steady for the last six months, albeit a little above the target range; this is disappointing, but not a major problem. In response to surging food prices the government has temporarily removed tariffs on rice, wheat and soybeans, and ordered increased rice imports. Energy subsidies continue to weigh heavily on the budget; the plan to remove the subsidy from petrol used in private cars but not from that used in motor cycles makes good political – if not economic – sense, since motor cycle owners greatly outnumber car owners. The 2011 budget is unlikely to have a stimulatory impact.

The composition of exports has altered quite dramatically over the last two decades, albeit in unexpected directions. The pattern of export destinations has also undergone significant change, reflecting the growing relative importance of Asia to the global economy.

The president's proposal for a new capital as the solution to the congestion problem in Jakarta is questionable. If policy makers fail to understand why existing cities perform their diverse functions poorly, the creation of a new capital is more likely to replicate than to solve problems. Cities are crucial to the modernisation of the economy, and are important vehicles for poverty reduction. City governments could greatly improve their performance by adopting a strategy of financial self-reliance.

The decision to establish a single authority to supervise the entire financial sector has now been delayed for almost 11 years. The draft law currently under discussion suggests that the central bank has no intention of giving up its role as supervisor of the banks. This means there would be wasteful and confusing duplication of that function in the new authority. In any case, it remains unclear exactly what purpose the authority's establishment is intended to achieve.

There have been several reminders recently of Indonesia's vulnerability to natural disasters, including multiple eruptions of Mount Merapi in central Java, which caused almost 400 fatalities and considerable damage to the local economy and infrastructure. Evacuation of residents of the area worst affected seems to have been handled well. An important policy decision needs to be made about whether those who lost their houses, crops and livestock should be permitted to return permanently to their villages.     

Survey of recent developments

Considerable media criticism has been directed recently at parliamentarians’ enthusiasm for costly overseas ‘working visits’ with little obvious benefit to the nation, and at their plans for a new parliamentary building. The criticism may not be fully justified, especially in relation to the latter, but is symptomatic of a high level of cynicism towards the parliament. Many of its members have been embroiled in corruption, and it is performing poorly in terms of the number of bills passed. Indonesia experienced two bomb explosions in the period covered here, while at least eight other bombs were defused. In contrast with previous patterns, the recent bombings are the work of small, mainly localised groups with only tenuous links to established terrorist organisations. This suggests that terrorism will remain a problem for many years.

Economic growth remains quite healthy, albeit not as strong as had been indicated by the data for the December quarter of 2010. Of greater concern is disequilibrium in the balance of payments, manifested in rapid accumulation of reserves. The current account is strong, and capital inflow is soaring in response to relatively high domestic interest rates, now combined with significant appreciation of the rupiah and the unlikelihood of any depreciation in the near future. The consequence is a rapidly increasing cost to Bank Indonesia (BI), because losses resulting from the negative interest margin between its assets and liabilities are now being exacerbated by the declining value of its foreign assets. On current trends the central bank's capital will be quickly exhausted. There is renewed concern about the fuel subsidy as world oil prices continue to rise, pushing the budget further into deficit and wasting vast sums that could be used for vital investments in infrastructure, education and health. Given that it is not possible to avoid these opportunity costs except by taking the politically difficult decision to raise petrol prices, the government has postponed indefinitely any action to reduce the subsidy.

The government is putting considerable emphasis on efforts to reduce poverty and increase household resilience to shocks. The focus is on the multi-dimensional and long-term nature of poverty reduction, and on shifting from universal subsidies to properly targeted social protection programs. The National Team for Accelerating Poverty Reduction is coordinating many of these efforts, under the guidance of the vice president. Poor quality education inhibits poverty reduction and economic growth, so international mathematics, science and reading assessments showing that Indonesia lags far behind its neighbours are of great concern. The government's flagship program to address educational quality, a teacher certification system initiated in 2007, appears to hold little promise, since policy makers have backed away from any attempt to reward good performance on the part of individual teachers. For comparison, the survey also describes two programs to improve school quality being implemented by non-government organisations.     

Survey of recent developments

The president reconstituted his cabinet in early December, focusing primarily on the economic team. The highly experienced Boediono was appointed as Coordinating Minister for Economic Affairs, while Sri Mulyani Indrawati was promoted from chair of the planning agency to become Minister of Finance. The former economics coordinating minister, Aburizal Bakrie, was made Coordinating Minister for Social Affairs—out of the economic limelight, but still with considerable influence. These changes overall have been well received by the markets, as indicated by a considerable strengthening of the rupiah.

The challenges facing the new cabinet remain immense, however. On a range of macroeconomic variables, performance has fallen well short of the government's targets. Output growth declined to just 4.9% p.a. in the December quarter from 6.5% a year earlier. Investment growth has fallen to a very low level, giving rise to concern about the creation of job opportunities. In a booming global economy, exports grew by only 7.4% in the four quarters to December, despite Indonesia's wealth of natural resources. The inflation rate doubled from September to October to almost 18% p.a., although subsequent price increases have been much slower.

The president's anti-corruption campaign continues to generate much attention. The number of corruption cases involving government officials and state enterprise managers brought to the courts continues to increase. Some high-profile cases have resulted in convictions, but others have not. The campaign seems likely also to be extended to judicial reforms, which are clearly crucial, but one urgent issue yet to be tackled directly is the widespread suspicion that funding of major political parties derives largely from abuse of power by government officials.

Numerous floods and landslides early in 2006 resulted in deaths, injuries and considerable physical damage. The frequency of such natural disasters has risen significantly over time, suggesting that governments at all levels need to develop mechanisms to manage them and implement policies to mitigate or prevent them.

Reconstruction progress in Aceh and Nias during 2005 was disappointingly slow. The reconstruction authority predicts dramatic improvement in 2006, but there appears to be a need to clarify the relationships among its three components, and to make some adjustments to its master plan, particularly in relation to land use planning. A reallocation of available funds among major activities, better coordination of implementing organisations, and a rethinking of conflicts between the authority's roles as implementation agency and coordinating agency may all be needed if the ambitious and urgent targets are to be met.     

Survey of recent developments

The composition of the incoming cabinet has been a disappointment: the president's clear election victory seemed to give him the opportunity to appoint a more strongly reformist group of ministers. The new government says it intends to involve the private sector heavily in infrastructure provision, and that it recognises the need to improve the business environment, but there has been little concrete progress so far, and it has yet to show the will and capacity to do what is required.

In late December Aceh province was devastated by an earthquake and a catastrophic tsunami. About a quarter of a million Indonesians were killed and countless others injured. Vast numbers have lost their livelihoods, and material damage is estimated at $3 billion, although the natural gas producing facilities remain intact. The international community showed itself to be favourably disposed to the incoming government, and committed generous disaster assistance.

The economy grew increasingly rapidly in 2004, and investment spending has at last begun to record sustained high rates of growth. The budget outcome for the year is expected to be reasonably close to plan, despite the previous government's failure to reduce the enormous waste resulting from electricity and fuel price subsidies. Monetary policy was tightened toward the end of the year in response to accelerating inflation. A deposit insurance agency to be established under newly enacted legislation is unlikely to be able to prevent banking collapses, or the transfer of the resulting losses to the general public; the legislation seems merely to codify most of the actions taken on an ad hoc basis in 1999–98 when the banking system collapsed. Meanwhile, yet another banking scandal has led to the closure of a private bank, after a seemingly unwarranted delay by the central bank.

The government has announced its intention gradually to adjust electricity and fuel prices upwards. The Constitutional Court has annulled a new electricity law allowing greater private sector participation and competition in this sector, however. Similar court actions now seem likely whenever the government enacts laws aiming to enhance efficiency through these means.

After less than four years of decentralisation, the underlying laws have been replaced. The new laws can be interpreted as an attempt to shift government authority back towards the centre, but there has also been an attempt to redress the regionally inequitable fiscal impact of current revenue sharing arrangements.     

Survey of recent developments

Sri Mulyani's resignation as finance minister in May disturbed markets and aroused concern about the government's commitment to reform. This concern was partly alleviated by the appointment of two well-respected individuals as finance minister and deputy finance minister. Further progress with reform will depend heavily on this new team and other key officials. Strong presidential support will also be needed to resist attempts by parliament to interfere excessively with the finance ministry's work.

The economy continued its steady recovery from the impact of the global financial crisis (GFC), but the recovery could still be jeopardised if sovereign debt concerns in Europe persist and block the rebound in global trade and commodity prices. Inflation continues to accelerate, suggesting little room for complacency on monetary policy. Fiscal policy, on the other hand, remains conservative. The higher deficit in the revised 2010 budget is not excessive, and is unlikely to be realised in any case. The real budget challenge is to spend budgeted amounts fully and well. The new five-year plan is also conservative and does little to clarify spending priorities, including for the president's ‘connectivity’ agenda.

Despite the GFC, poverty continued to decline, thanks largely to the uninterrupted expansion of GDP and to cash transfers to the poor. Unemployment also continued to fall, although particular groups suffered slight increases in unemployment (young workers 15–25 years old) and somewhat larger reductions in working hours (urban, non-poor, and male-headed households). Nevertheless the large and sustained deceleration of manufacturing growth and the closely related dramatic shift of employment from the formal to the informal sector provide cause for concern. Distortionary labour market policies may help to explain both.

A new mining law significantly alters the legal environment for firms in this industry, and also introduces long discredited policies intended to ‘increase value added’ by requiring the domestic processing of minerals. A new law on local government taxes attempts to reduce uncertainty for citizens and investors, but the nature of overall spending by local governments is of much greater importance for the investment climate. The central government has recently been seeking to restore the role of the ‘missing intermediate’ level of government and to boost the centre's indirect control over local governments through provincial governments and governors. This strategy is unlikely to succeed, but it highlights the conflicting requirements for provincial governors to act as agents of the central government while also being accountable to their provincial electorates.     

Survey of recent developments

Despite a turbulent global economy and expectations that declining exports would cause an economic slowdown, the Indonesian economy grew at 6.5% in 2011. The growth rate was supported by high consumer confidence – the result of lower inflation of just 3.8% in 2011. Nevertheless, there were indications that the global financial crisis had had an impact on Indonesia in the last quarter of 2011, notably on the growth of exports and imports.

In October 2011, President Yudhoyono reshuffled his cabinet, citing a need to improve its performance in the administration's remaining three years. The reshuffle showed that the president is still subject to political party pressures. Moreover, the governing coalition of parties remains weak. Agreements made within coalition meetings are often broken in the parliament, and coalition parties are frequently distracted by media polemics. The case of former Democrat Party treasurer Nazaruddin, arrested in Colombia following a two-month manhunt, has revealed the magnitude of the money politics surrounding the Democrat Party, whose ratings are declining rapidly.

Indonesia enters 2012 bolstered by the restoration of its investment-grade credit rating. This will expose Indonesia to increased capital flows, since many funds are permitted to invest only in investment-grade countries. The effects on foreign direct investment (FDI) are not automatic, however. These investors evaluate the wider business climate and economic governance in making their investment decisions.

The fuel subsidy remains a challenge for Indonesia in 2011/12. Parliament rejected a proposal to limit fuel consumption from April 2012 over doubts about the government's readiness to handle the policy's technical complexity. Now the government is again considering a fuel price increase, and will have to seek parliamentary approval soon.

Indonesia faces a long-term problem of regional inequality. After four decades of economic development there is little variation in the shares of GDP across regions, but GDP per capita in some regions is slipping behind that of Java. Regional development policy needs to generate more economic activities in the outer islands, and to learn from the mistakes of past initiatives to promote economic development and growth centres in the regions. It is important to align policies with the current decentralisation arrangements.

The government is revising Law 33/2004 on Intergovernmental Finance with the aim of improving some dimensions of decentralisation in Indonesia. Revenue certainty is to be enhanced in part through changes to the general allocation grant (DAU) formula and the disbursement mechanism for intergovernmental transfers. The planned revision has not, however, addressed sufficiently the problem of inefficiency in regional spending. In fact, some of the proposed solutions may well create further spending inefficiency.

The main barrier to increased FDI is infrastructure development, whose progress has been slowed by land procurement problems. Unfortunately, Law 2/2012 on Land Procurement for Public Purposes seems unlikely to deliver a clear solution to the key problem of determining fair prices for land compensation. What is needed is the creation of more independent price-setting committees, with sufficient capacity to disentangle the problems of land acquisition.     

Survey of recent developments

The process for Indonesia's 2014 parliamentary and presidential elections is underway. A few discernible patterns have emerged, yet the political situation at this early stage remains fluid and both races are open. Recent events have shown, however, that Indonesian democracy itself is still relatively young and evolving, the balance of power between key institutions is still unsettled, and constitutional checks and balances are still being tested.

Macroeconomic developments over the last few months have been mixed. Economic growth stayed above 6%, despite a difficult external environment, and inflation, which climbed in the first quarter, began to ease in April and May. At the same time, slower investment growth, deficits in the current and capital accounts of the balance of payments, downward pressure on the rupiah, and the risk of further increases in interest and exchange rates cast a shadow over near-term growth prospects. The recent rise in global interest rates triggered a capital outflow that contributed to a stock-market correction and placed the rupiah under new pressure. Bank Indonesia responded by raising the overnight rate, which helped to calm markets. But given relatively large non-resident holdings of Indonesian stocks and bonds and continued upward pressure on global interest rates, Indonesia's balance of payments and capital market will likely remain under strain for the foreseeable future.

Policy developments were also mixed. The appointment of a technocrat as finance minister sent a reassuring signal to markets and investors. And parliament finally approved a revised budget based on more realistic assumptions and included a much delayed across-the-board increase in fuel prices, together with compensatory programs for the poor. This achievement should help boost investor confidence and generate public resources for urgent infrastructure and social-assistance programs. At the same time, however, recent measures to restrict imports of horticultural products attracted the ire of trading partners and domestic consumers, leading to their partial reversal. These measures, together with draft trade and industry laws awaiting parliamentary approval, represent a new economic nationalism that seeks to protect domestic producers against what is seen as unfair international competition

The fuel-price increase, rising income inequality and an ambitious target of reducing the poverty rate to 8%–10% in 2014 – the last year of President Yudhoyono's final term – brings into focus the efficacy of Indonesia's social-assistance programs. It also adds fresh urgency to government efforts to improve the coverage, financing, targeting, and institutional arrangements underpinning these programs. The challenge has always been, and remains, that without central monitoring and oversight, local political pressures tend to dilute program benefits for the intended beneficiaries.     

Survey of recent developments

In the 15 years since the Asian financial crisis, the Indonesian economy has benefited from a stable macroeconomic policy framework and prudent macroeconomic policy settings. Economic growth has been solid, inflation has been contained and government finances have strengthened. Indonesia weathered the global financial crisis better than many countries, and it subsequently benefited from the low global interest rates resulting from highly stimulatory monetary conditions in many advanced economies, especially the US.

In the middle of 2013, however, speculation on when the US Federal Reserve would begin to unwind its program of quantitative easing saw global interest rates jump. Short-term capital flowed out of Indonesia, causing the stock market to fall, the currency to depreciate and interest rates to rise. On top of this, GDP growth appeared to be slowing, the trade balance worsening and inflation increasing. In late September and October, the failure of the US to raise its legislated debt ceiling led to speculation that it might fail to meet some of its debt obligations, which fuelled financial-market volatility.

It is yet to be seen whether the Indonesian economy and its financial markets are sufficiently flexible to make a smooth transition to the new external reality. The policy tools available to the government to deal with the short-term economic challenges are limited: it introduced an economic policy package in August, and Bank Indonesia (BI) raised official interest rates in August and September, following two increases earlier in the year.

These pressures from global financial markets have drawn attention to the need for further structural reforms in Indonesia, including those aimed at deepening financial markets, strengthening financial-sector supervision, freeing up trade and encouraging competition, and maintaining the government’s revenue base in the face of falling commodity prices. While some reforms, particularly in financial-sector supervision, are already in train, it may be difficult for Indonesia to make serious gains on longer-term economic reforms before the 2014 presidential elections.     

Survey of recent developments

There is a growing confidence in policy, business and finance circles about Indonesia's ability to withstand global economic and financial shocks, and a renewed belief in domestic sources of growth. Despite uncertainty in Europe and slower than expected recovery in the US, Indonesia is well placed for moderately high growth in the medium term, and economic stability in the shorter term. At the end of June 2011, foreign reserves were at a record high, inflation was down, annual growth was steady at 6.5%, and investment – especially foreign direct investment (FDI) – was up significantly.

Consumer price inflation had fallen to just below 5% by August, from double-digit levels earlier in the year. This was due partly to low food prices and success in sterilising the effects of capital inflows. However, turmoil in international markets led to a sharp fall in the Indonesia stock exchange index and a mild currency depreciation in August– September, prompting central bank intervention in the foreign exchange market. Fiscal policy has remained conservative, aiming for a balanced budget by 2014. However, the government has still not moved to reduce growing fuel and energy subsidies.

While the service sectors have continued to record high rates of growth, there has been a revival of manufacturing in 2011. This is partly underpinned by strong inflows of FDI, and is especially evident in the labour-intensive textiles, clothing and footwear industries after a decade of stagnation. Multinationals have announced plans to expand operations in Indonesia in the past six months to take advantage of new tax incentives. Overseas investors have also been attracted by Indonesia's growing middle class – a result partly of higher rural incomes driven by the commodity boom outside Java.

Some recent ministerial announcements about initiatives to promote domestic industry have a protectionist flavour. A cabinet reshuffle in October may signal a more dirigiste approach to industrial policy – especially the shifting of internationally respected economist Mari Pangestu from the trade portfolio to that of tourism and creative economy.

One important outcome of recent growth has been falling unemployment rates. However, youth unemployment remains a major problem, and efforts to overcome it have been fragmentary. A recent ban on overseas migration of domestic helpers (maids) seems certain to add to labour supply pressures among young people.

The government is now considering how to mobilise its large population base, abundant natural resources and strategic location to play a greater role in the world economy. These assets are central to the ambitious ‘Master Plan’ for longer-term development (2011–25), announced in May. It focuses on developing the resource-rich Outer Island regions, with massive investments in energy and ‘connectivity’ to link the major centres and islands with each other, and centres with their hinterlands. Funding (to come mainly from the private sector), implementation and coordination are all major challenges.     

Survey of recent developments

Two major factors, one internal and one external, shaped developments through the middle of 2004. The internal factor was the national election process, which led to a realignment of political power among the parties in the legislative elections in April, and offered the prospect of even greater changes in the presidential election to follow. The external factor was foreign capital, which readily flowed into Indonesia in the early months of 2004, reflected in a series of record highs in the Jakarta Stock Exchange index, but then seemed to waver in May, perhaps because of the growing threat of higher US interest rates, uncertainty about the election, or concern about inflation. Sharp declines in the value of the rupiah and local stocks mirrored similar though less severe developments throughout Southeast Asia and around the globe.

The imminent first-ever election of an Indonesian president through a direct vote by the public raised hopes of change for the better, particularly with respect to governance and the performance of the economy. However, the structural factors that have held back economic growth in Indonesia since the crisis of 1997–98 will not change overnight. The new president could have a popular mandate, but will have to assemble a coalition in a parliament in which power will be more fragmented than ever.

As the presidential election approached, polls showed the electorate's top priorities to be an improved economy and reduced corruption. However, recent months have witnessed several steps backward, as interventions in domestic trade and the escalation of fuel subsidies have created costly inefficiencies and new opportunities for corruption. A recent proposal to establish a vast new social security system monopolised by the government is also problematic in an environment in which governance remains weak. Personal income tax changes being considered by the Ministry of Finance could significantly reduce government revenues, an outcome the government can ill afford.

Despite enactment of a host of new laws in the last six years in such areas as anti-monopoly, bankruptcy and anti-corruption, as well as the initiation of a long-term judicial reform process, recent events have shown that the legal system remains a major source of uncertainty in the business environment.     

Survey of recent developments

The arrival of a new year has brought with it an increased focus on Indonesia's 2014 legislative and presidential elections. While voters may be disillusioned with established political figures, a strong presidential candidate has yet to emerge. Many voters appear to yearn for an experienced and uncorrupt leader with new and proactive policies, which is why Jakarta's new governor, Joko Widodo, is being viewed as a potential candidate.

The Constitutional Court has made two major, controversial rulings in recent months: the first concerned the upstream oil and gas regulator BPMigas, the second the international-standard pilot-project schools (Rintisan Sekolah Bertaraf Internasional, RSBIs). The Court ruled both institutions unconstitutional and called for their immediate disbandment.

In 2012, Indonesia's year-on-year economic growth slowed slightly, to a still healthy 6.2%, owing to continued weak global demand for its exports and a contraction in government expenditure. In contrast, foreign direct investment and portfolio investment were particularly strong, with respective increases of 25% and more than 142%. At 4.3%, inflation for the 2012 calendar year still remains well within the government's and Bank Indonesia's expectations. However, inflation expectations are high for 2013, owing to likely reforms to energy subsidies; the expected effect of bad weather on food prices; and increases in minimum wages, which attracted attention in 2012 because of their magnitude and their apparent disparity among regions. Concerns also exist that these rises in minimum wages will hamper Indonesia's international competitiveness and could discourage investment in labour-intensive industries.

Minimum-wage policy is also controversial because of doubts about its relevance to the genuinely poor sections of society – those in informal employment or with primarily subsistence income, who constitute a large proportion of the population. Indonesia has experienced a steady increase in income inequality in the last decade, indicating that the benefits of strong economic growth have not been shared equally. Potential reasons for this increasing inequality relate to labour-market segmentation amid a growing middle class, weak institutional foundations, and commodity-driven growth.

It appeared in 2012 that Indonesia has also been one of the world's poorest performers in HIV/AIDS prevention in recent years. While prevalence rates are low, the number of new HIV infections in 2011 was more than four times that of any other South Asian or Southeast Asian country, and the infection rate among the working-age population has risen by more than 25% since 2001. Infection rates among high-risk groups are also alarmingly high compared with those of other Southeast Asian countries. Targeted prevention, treatment and support programs among these groups are paramount.     

Survey of recent developments

Little has happened to dispel concern that reform momentum is dissipating. New National Economic and Innovation Committees to help accelerate development will probably achieve little: resolving many key economic policy issues is straightforward technically, so the real obstacle to doing so is lack of political will and leadership.

It appears that economic growth has stabilised rather than continuing to accelerate. Investment is still strong, but fiscal policy is no longer providing a stimulus. Soeharto-era attachment to small budget deficits remains evident in the 2011 budget, which persists in spending heavily on subsidies at the expense of investment in sorely needed infrastructure. The demand for net exports had temporarily constrained growth, but by Q2 2010 this was no longer the case. Manufacturing has been in the doldrums, partly because of surging export commodity prices and volumes, but its recent growth seems more promising. International reserves continue to accumulate because of the commitment of Bank Indonesia (BI) to avoiding rupiah appreciation, which makes monetary policy difficult and costly to implement. BI has responded by allowing some appreciation, an acceleration of inflation and a small increase in the interest rate on its certificates of deposit, and by forcing banks to place more funds with it at low or zero interest. At last it has begun to tighten monetary policy, but this is likely to increase capital inflow, despite the introduction of a new capital control. The incompatibility of BI's monetary and exchange rate policies will therefore continue to cause problems. Rapid rice price inflation, however, is not the fault of the central bank, but a consequence of the policy of preventing Indonesia from participating more fully in the world rice market.

Official indicators suggest that the banking sector is in good condition. One concern is that interest margins are too high, which seems to be attributable to inefficiency in government-owned banks. If pressure to prevent or roll back increased foreign ownership of Indonesian banks is successful, this is likely to make the banking system even less efficient. Indonesia continues to have difficulty competing for foreign investment with comparator countries such as Thailand, Vietnam and Brazil: much remains to be done to improve the climate for doing business. The government appears to be pondering more serious approaches to tackling the problem of Jakarta's congestion, although conflicting signals on this have emerged. Solutions are seen in expansion of transport infrastructure and improvement of its management, and in the introduction of electronic tolling on main roads.     

Survey of recent developments

The economy continues along the general trajectory described in recent Surveys. Growth is picking up, led by consumption but restrained by investment. Inflation has fallen well below Bank Indonesia's current target rate. Most interest rates have followed suit, including key lending rates. Bank lending has been expanding at around 20% p.a. for the past year or so, and international portfolio investors are again interested in Indonesia. But a scare in the mutual funds industry and scandals at two state banks remind that trouble still simmers just below the surface in the financial sector.

Fiscal policy continues its conservative stance. The government is likely to have achieved its 2003 deficit target, and the budget for 2004 envisages further narrowing of the deficit. Still, the deadline for achieving a modest budgetary surplus has slipped two years, to 2006. Draft amendments to the income tax law foreshadow a probable reduction in corporate tax rates, increases in personal rates, and removal of certain key exemptions. Proposed administrative changes would give tax officials significantly greater powers of investigation and prosecution; observers foresee increased scope for extortion by unscrupulous officials. Monetary policy has become increasingly expansionary, given the central bank's desire to support economic recovery and its success in driving inflation down. This is reflected in quite rapid base money growth and sharp falls in policy interest rates, notwithstanding some efforts by Bank Indonesia to slow their decline. Trade policy has been dominated by increasing signs of resurgent protectionism, including a shift away from a transparent tariff regime to rent-generating systems of licensing.

On the political front, opinion polls in advance of the national elections suggest a considerable shift in the parliament, away from PDI-P in favour of Golkar. The size of this shift will be critical in determining the choice of candidates for the subsequent presidential elections. At present, Megawati Sukarnoputri remains the front-runner, but almost any combination of major parties could still form a coalition and make a credible run at the presidency.

With elections looming, little further progress can be expected on the economic policy front in 2004. In these circumstances, the focus for progress shifts to a politically independent Bank Indonesia. With strong policies in its areas of responsi-bility—inflation, monetary policy and financial sector development—further progress is achievable even during an election year. This would lay a solid foundation for robust economic recovery, hopefully policy driven by the next administration.     

Survey of recent developments

Recent political developments are slowing reforms. The Corruption Eradication Commission (KPK) and the finance ministry find themselves entrapped in legal inquiries and political wrangling that seem intended to weaken their reforming zeal. KPK's effectiveness has been undermined by legislative changes and the arrests of three of its commissioners. Meanwhile, the costly bail-out of a small bank has provided an opportunity for attacks on leading reformers – Vice President Boediono and the Minister of Finance, Sri Mulyani Indrawati. The president's diffident stance in both instances has played into the hands of the opposition and, although key reformers are likely to remain in office, the political imbroglio has nonetheless eroded confidence in the government.

Year-on-year GDP growth recovered strongly to 5.4% in the fourth quarter of 2009. Government spending has been the key driver, while household spending slowed and investment remained low. Both exports and imports have returned to modest growth. Although 2009 ended with low inflation, Bank Indonesia (BI) has set its target inflation rate for 2010 at double the rate it achieved in November. BI is likely to bow to populist demands to lower nominal interest rates rather than raising them somewhat to prevent inflation accelerating, even though its real policy rate has been consistent with significant acceleration of GDP growth. The 2009 budget outcomes confirm that the fiscal stimulus in response to the global financial crisis has been less than hoped for. As for 2010, high world oil prices will imply huge subsidies, given that the government is unwilling to increase domestic fuel and electricity prices commensurately.

The president announced that virtually all the government's ‘first 100 days’ program targets have been met. However, half of the ‘action plans’ amounted to nothing more than issuing or announcing new regulations, plans, blueprints, guidelines, recommendations or policies, or simply preparing drafts of these. No real progress has been made in relation to the most urgent reforms, particularly on energy subsidies and labour market regulation. Realising that the whole population would benefit in net terms, the previous government signed the ASEAN–China Free Trade Agreement (ACFTA) in November 2004. But just when the agreement was to take effect, strong resistance from business and parliamentarians emerged, leading to the government's decision to re-negotiate many tariffs with China. This is disappointing: failing to uphold its commitments under this long-standing agreement makes Indonesia appear unreliable as an economic partner.