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Indonesia: The Infrastructure and Bureaucracy Challenge
Economic powerhouse in waiting: Indonesia must address infrastructure and bureaucracy challenges to realise its potential. Antara/M. Agung Rajasa.

Indonesia: The Infrastructure and Bureaucracy Challenge

By Shakeeb Saqlain | January 09, 2015

Indonesia: The Infrastructure and Bureaucracy Challenge
Economic powerhouse in waiting: Indonesia must address infrastructure and bureaucracy challenges to realise its potential. Antara/M. Agung Rajasa.

Pencak silat is an Indonesian martial arts, initially developed around the Islands of Java and Sumatra. It represents diversity, with hundreds of different styles; and survival, with ancient Indonesian kingdoms settling rivalries and wars, using its various forms.

The modern-day Indonesia is like pencak silat. Over 18,000 islands, inhabited by the world’s fourth largest population of almost 250 million people, speaking 300 local languages. The country is a melting-pot of races and ethnicities, using its diversity as a foundation for social and economic development.

Asian Financial Crisis & the Road to Recovery

But 17 years ago things looked very different. At the height of the Asian financial crisis in 1997, many feared that Indonesia would “tear itself apart” [1], unable to handle the economic collapse engulfing the region and emerging markets around the world.

The assessment was not always this bleak. Indonesia received glowing praise from its international partners, for its economic transformation. Even on the eve of the financial crisis, the International Monetary Fund (IMF) noted that the “country’s economic management had been impressive” [2] and private foreign capital inflows reached almost $18 billion [3] during 1996. The markets were in bullish mood. However, with the ratio of nonperforming banking loans to total loans reaching 9% in early 1996 [3], trouble was not far away. The crisis led to the President Suharto government reaching an agreement with the IMF on a $40 billion bailout package. The recovery was long and painful, eventually leading to Suharto's resignation in May 1998.

Following the financial crisis, the Indonesian government embarked on an ambitious reforms programme, strengthening the banking sector, improving transparency and corporate governance and removing restrictions to trade and competition. The country eventually navigated its way out of economic turbulence, as shown by Exhibit 1.

Exhibit 1: Recovery of the Asian Tigers

Indonesia: The Infrastructure and Bureaucracy Challenge

Exhibit 2: Recent Policy Measures

Instrument                                                                   PolicyRationale
1. Exchange rate policyRupiah appreciation: 14.9% in 2009, 4.6% in 2010, 5.4% to August 2011To stabilize exchange rate and help mitigate imported inflation from high global commodity prices
2. Capital flows management

Apply holding period on BI certificates, from one month since June 2010 and to six month since May 2011.

Reinstate limits on short-term offshore borrowing of the banks to a maximum of 30% of capital, January 2011

To “put sand in the wheels” on short-term and speculative capital inflows, and mitigate risks of sudden reversals.

To limit FX exposure of the banking system and short-term/volatile capital inflows.

3. Macroprudential measuresIncrease Rupiah reserve requirement from 5% to 8%, effective Nov 2010.To absorb domestic liquidity and enhance liquidity management of the banks, without exerting negative impact on lending that are needed to stimulate growth.

Source: Perry Warjiyo, Bank for International Settlements [6]. 

In the last decade, reforms have gathered pace, with particular focus on macroeconomic management, regulatory reform and decentralization [4]. The economic growth has also been impressive, as the country becomes the second fastest growing economy, after China, in the G20 [1]. With this, investors’ confidence has grown and foreign capital inflows have returned. Capturing the renewed sense of optimism, in a report on Economic Reform by Standard Chartered [4], it is estimated that the Indonesian economy will become the sixth largest economy in the world by 2030.

However, as the report notes, Indonesia is in danger of not reaching its potential. The country lags behind its Southeast Asian rivals in the quality of infrastructure and bureaucratic reform.

The Infrastructure Deficit

Developing effective infrastructure, such as quality of roads, railways, air transport, and ports in addition to reliable energy supply and robust telecommunications network - is the most important ingredient in getting goods to markets and improving productivity. Moreover, good infrastructure can increase private investment and reduce social inequality.

With the number of vehicles on the roads increasing to over 11 million; 40% of the population do not have access to electricity (with demand continuing to increase by 8% per year), the government has recognised that more investment is needed [5]. Indeed, estimates show that $1.4 trillion is needed for infrastructure projects, but the government is only willing to contribute around a third of this figure, with the rest being expected from the private sector [4].  

Exhibit 3: Infrastructure Quality in Indonesia, Compared to Other Asian Countries

Indonesia: The Infrastructure and Bureaucracy Challenge

The challenges are more than just financial. Indonesia’s geography and some of the existing port (Exhibit 4) and railways and have been described as “mediocre” [5]. The infrastructure problem is compounded by land clearance, red tape and legal failings (with central and local government regulations placing additional burden on businesses).

Exhibit 4: Seaport Capacity

 

Indonesia: The Infrastructure and Bureaucracy Challenge

Bureaucratic Reform

Indonesia’s bureaucratic challenge remains equally daunting. A survey in 2010 noted that business executives are most concerned by inefficient bureaucracy and red tape, even ahead of infrastructure and corruption issues [5].

With 4.6 million civil servants, (mainly employed by the local government) and 20% of central government expenditure going to personnel, the country’s bureaucracy is not prepared for the challenges ahead. It is not only the size, but the effectiveness and corruption within the sprawling bureaucratic system that is stifling future economic development.

Exhibit 5: Government Spending on Payroll vs. Capital Expenditure

 

Indonesia: The Infrastructure and Bureaucracy Challenge

As shown by Exhibit 5, Indonesian government spending on personnel is greater than capital expenditure. Effectively, excessive bureaucratic costs and inefficiencies are restricting infrastructure development, which will hinder the long-term progress of Indonesia.

The government is taking notice, with civil servants that are older than 50 being offered early retirement; and training budgets have been increased for existing staff.

Indonesia has a history of resilience and survival. Recovering strongly from the Asian financial crisis has given the country a renewed sense of confidence. But the government must recognise that there is no room for complacency, and continue to focus on infrastructure developments - including land reforms, dealing with overflowing roads and limited port capacity - and improve its vast, sprawling bureaucracy.

 

References

[1] Indonesia: Lessons for the World, Edward Parker, 2014: http://thediplomat.com/2014/01/indonesia-lessons-for-the-world/

[2] Indonesia: Annual Report 1996, International Monetary Fund (IMF): http://www.imf.org/external/pubs/ft/ar/97/pdf/file06.pdf

[3] Rejecting Exceptionalism: Reinterpreting the Asian Financial Crises, Ilene Grabel, University of Denver: https://www.mtholyoke.edu/courses/sgabriel/ilene_grabel.htm

[4] Economic Reform: An Unfinished Agenda, Standard Chartered Bank, 2012: https://www.sc.com/privatebank/gb/resources/pdfs/pvb-reports/from-our-experts/Unfinished-agenda.pdf

[5] The Indonesia Competitiveness Report 2011, Sustaining the Growth Momentum, World Economic Forum: http://www3.weforum.org/docs/WEF_GCR_Indonesia_Report_2011.pdf

[6] Indonesia’s monetary policy: coping with volatile commodity prices and capital inflows, Perry Warjiyo, Bank for International Settlements: http://www.bis.org/publ/bppdf/bispap70r.pdf


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