Indonesia’s Economy Is Surging Forward, but Challenges Abound
With GDP growth of more than 6% expected this year, Indonesia’s economy is stronger than it has been in years. The country is soon expected to join the club of nations with an annual GDP of more than $1 trillion, and foreign direct investment is at a record high. The stock market is booming and net foreign debt is less than 10% of GDP. Still, according to experts from Wharton and elsewhere, Indonesia faces several challenges. The country will need to continue economic reforms in order to sustain its performance.
Indonesia is in the middle of an unprecedented consumer boom. Scooters, cars, smartphones, ice-creams and skincare products are all in demand. The middle class is growing, and newly affluent Indonesians are spending. Big brand names are visible on televisions, bill boards and on Jakarta’s streets. When it comes to commodities, the growth of China and India has given a fillip to the Indonesian economy. Both demand coal and gas while the entire world is hungry for palm oil.
Indonesia should focus on infrastructure and human capital formation to wean itself away from its resource base.
Indonesia could be one of the leading economies in the world,” but to get there, the country will need to implement reforms.
Between 2003 and 2010, roughly 50 million Indonesian people entered the middle-income bracket, defined by the World Bank as those who spend between $2 and $20 a day. In 2011, Indonesia’s GDP per capita topped $3,600, exceeding that of India, Asia’s second largest consumer market after China.
President Susilo Bambang Yudhoyono has set out an ambitious $400 billion 15-year development plan, nearly a quarter of which will go toward projects such as highways,
ports and power plants. But a decision by Parliament in April to continue supporting fuel subsidies constrains the government’s ability to redirect spending toward vital infrastructure and improve the country’s business climate, which still ranks low on global indexes.
China’s slowing growth
Economists’ opinions about just how far China’s economy will fall range widely. Also, exactly what constitutes a “hard landing” for a country that has until now been viewed as an almost unstoppable economic powerhouse varies from analyst to analyst, although most point to China’s growth rate as a key defining factor. “People give different definitions,” notes Wharton finance professor Franklin Allen. “Mine would be growth below 5%.”
Despite the fact that China is one of the few countries that routinely surpasses growth projections, this time reality might come closer to the government’s target. Wei Yao, a Hong Kong based economist at Societe Generale Cross Asset Research, forecasts that China’s economy will grow at an 8.1% pace in 2012, slowing to 7.7% growth in 2013 and 7% in 2016. “I do not think that China will have a hard landing this year, but what will happen by 2014 really depends on what the government does in the next few years,” she says. Given the many issues the country’s leadership is juggling — including the property bubble, local government debts, income gaps between rich and poor and rampant corruption — “it will be a challenging task to avoid a hard landing.”
Beijing’s Balancing Act
Despite the myriad internal and external constraints confronting China’s leaders, Beijing has various options for helping to shift the economy from an investment driven model to one fueled by consumer demand. First, China needs to improve its allocation of resources to better balance the economy — a step that only can follow reforms in interest rates and other pricing mechanisms. “China has all the wrong prices — including exchange rates, interest rates, gasoline prices and land prices. Those prices are all controlled and managed by the government. If you have the wrong prices, you will have wrong allocations,” notes Yao of Societe Generale. Mispricing of credit makes investment costs cheap for state-owned companies and local governments, encouraging excess construction and waste on projects that yield little or no returns and do not necessarily improve productivity or public services.
China’s handling of its 10.7 trillion RMB in local government debts is typical of this imbalance in the economy. In early February, the central government asked Chinese banks to roll over local government debts that accrued during the massive recession-fighting stimulus binge in 2009 — essentially sweeping them under the rug for a later reckoning. More than half of those loans are to come due over the next three years.
By far, many analysts say, the biggest shift required is a redistribution of resources that will unleash the potential spending power of the Chinese public. “China needs to rebalance the composition of its GDP more toward consumption, develop a more market-based monetary policy, reduce the excessive privileges of state-owned enterprises, ease income inequality and focus on promoting more productive and environmentally friendly industries,” according to Rob Subbaraman, chief economist with Nomura International in Hong Kong. Moving toward a more market-based monetary policy, involving a more flexible exchange rate and deregulated interest rates, would push bank deposit rates higher, helping to reduce the need for saving and also improving investment options so that families do not rely so heavily on real estate to grow their nest eggs.
Apart from the overall structure of the economy, another key reason for the Chinese obsession with scrimping and saving is the dire lack of public services and social welfare. Education, likewise, is a huge cost for most
families. “Right now, taxes are too great a burden for households and the private sector, while China spends too little on social security, medical care and education.
There is a lot they can do there,” says Yao. Meyer agrees. “There is room to repair the social safety net. Since there is not adequate medical care and social security in China, people feel they have to save 40% to 50% of their income. If they feel they have some safety net in their old age, they will be less prone to save.” As China’s population ages, it will have a growing need for services for the elderly, and spending on such areas will increase if the supply is there to meet demand, Meyer says. “You can increase consumption if customers get what they want.”
In fact, Bottelier sees China’s services sector as one of the most powerful potential engines for growth, and one that has not been fully realized. “Even at lower growth rates of 6% or 7%, China can maintain full employment if the contribution of the service sector to the economy expands more rapidly than the contribution of construction or manufacturing.
The consensus among most economists is that it is time for China to bite the bullet and move ahead on politically difficult, painful reforms that could lay the foundation for sustainable growth in the future.