Volatility in a Post-QE World
Indonesia: Fierce Tiger or Sick Cat?
Once touted as a BRIC country, Indonesia is now a member of the "Fragile Five," its economic weaknesses exposed by the retreat of hot money. What are the prospects for this country in transition?
Indonesia: Fierce Tiger or Sick Cat?By Hsiang-Yi Chang
From CommonWealth Magazine (vol. 543 )
Scene 1: National Highway No. 1 between Jakarta and the Airport
Slowing Down a Lamborghini
Late in the afternoon traffic slows to a crawl 15 kilometers outside downtown Jakarta, and impatient motorists take out their frustrations by pounding repeatedly on their horns.
"It's like this every day now. We still have about an hour before we can reach the downtown area," says a taxi driver.
Looking out the taxi's window, one sees a bright orange Lamborghini and a rundown six-seat cargo truck side by side. The flamboyantly dressed Lamborghini driver and the team of workers in the truck are equals on the highway, both staring ahead helplessly.
This somewhat absurd image vividly depicts today's Indonesia and many other emerging markets.
Indonesia is full of polar contrasts: incredible wealth and extreme poverty; nearly boundless natural resources and stagnant industrial growth; a large influx of foreign investment and a constant outflow of domestic capital; a "Harvard Cabinet" full of vision and local governments full of corruption; a reputation as the fifth BRIC country yet a member of the "Fragile Five."
These countless contradictions co-exist side by side throughout Indonesia, much like the incredibly expensive Lamborghini and the dilapidated cargo truck.
Over the past five years, the country's average annual economic growth rate of 6 percent has blinded foreign analysts, corporate investors, media outlets and even the Indonesian government into seeing only the bright side of an economic picture bolstered by the injection of hot money.
But with the United States Federal Reserve starting to taper down its quantitative easing program, leading to the outflow of hot money, and the country's main highways growing increasingly clogged, one suddenly becomes aware that Indonesia's underlying problems have been building up for a long time.
Indonesia, with a population of nearly 250 million people and a GDP that is more than half the combined size of the 10 ASEAN member states, has become one of the most important and highly regarded targets for investment flowing into Asia's emerging markets.
The man who coined the term "BRIC" (Brazil, Russia, India and China), former Goldman Sachs economist Jim O'Neill, more recently described Indonesia as one of the emerging MINT economies (Mexico, Indonesia, Nigeria and Turkey), and other economists have suggested that Indonesia should be the fifth BRIC (or BRIIC) country.
In the second half of last year, however, the global flow of hot money reversed course, returning to Europe and the United States, creating major challenges for Indonesia's economy, including inflation that rose as high as 8.7 percent, a 20 percent devaluation of its currency and a ballooning balance of payments deficit. That led Morgan Stanley to include it in August 2013 as one of its "Fragile Five" (Brazil, Indonesia, South Africa, India and Turkey), emerging markets with troubled currencies under the most pressure against the U.S. dollar.
Scene 2: Bumi Serpong, 30 Kilometers from Downtown Jakarta
A 'Middle Class' Gateway in Name Only
Indonesia's budding middle class, which has drawn the attention of global investors, has been the group hardest hit by the retreat of hot money and the resulting inflation and currency devaluation.
One of those affected is Wayan Setinwan, a resident of Bumi Serpong, a suburb of the Indonesian capital. At around 6 a.m. CommonWealth Magazine reporters got on a bus with him that slowly made its way to downtown Jakarta about 30 kilometers away.
A graduate of Nanyang Technological University in Singapore, the well-dressed Setinwan, a senior accountant at one of Indonesia's best known department store groups, earns about US$1,000 a month. That's well above the threshold for middle class recognized by Indonesia's central bank and international statistics agencies (Indonesia's middle class is defined as having annual disposable income of between US$2,500 and US$3,500).
"But I really don't feel that I'm part of the middle class. I'm just trying to stay out of poverty," he says in fluent English with a smile that carries a tinge of bitterness.
Bumi Serpong seems a world apart from the towering skyscrapers and constant bustle found in Jakarta. Only the main roadways are paved, with dust flying everywhere else. Nearby public schools still do not have potable water, leaving teachers and students to fend for themselves.
Indonesia's strong economic growth over the past five years has been accompanied by soaring housing and commodity prices, rendering countless white collar professionals like Setinwan "middle class" in name only and forcing them to struggle to survive.
Cost of Living in Line with Taiwan's
The cost of housing in Jakarta, for example, has more than doubled since 2010. Standard apartments of under 100 square meters in central Jakarta now sell for the equivalent of more than NT$12 million, which, when combined with relatively high mortgage interest rates of nearly 10 percent, has made it nearly impossible for salaried workers to afford housing in the city.
Like Setinwan, many Indonesian white collar workers choose to live in the suburbs, but even there real estate is no bargain despite inadequate public infrastructure and occasional power outages and water shortages. Affected by skyrocketing prices in downtown Jakarta, houses in areas such as Bumi Serpong now cost nearly US$2,120 per square meter (about NT$64,000). Setinwan himself spends two-thirds of his take-home pay to finance the mortgage on the house in which he lives with his wife and parents.
Hurt by soaring inflation, the cost of basic goods in Jakarta has risen to levels seen in Taipei. A cup of coffee at a coffee chain costs 30,000 Indonesia rupiah (about NT$80), and a hamburger meal at a fast food restaurant costs just over 40,000 rupiah (about NT$107).
To Setinwan, who is left with less than NT$6,000 per month after paying his mortgage and utility bills, going to a food court in a shopping mall for a meal has become a rare treat.
Yet many middle-class Indonesians continue to spend freely as inflation erodes their purchasing power, driving down national savings rates to relatively low levels.
According to government statistics, savings in Indonesia have fallen below 40 percent of GDP in recent years, the lowest of any ASEAN member state. The trend bodes poorly for domestic investment or raising capital at home, and raises doubts about whether opportunities presented by domestic demand, which amounts to 69 percent of GDP, can continue multiplying at the rapid pace of the past few years.
Scene 3: Grand Hyatt, Bundaran Hi Area, Central Jakarta
Real Estate Speculation out of Control
If young Indonesian white-collar workers are unable to afford houses in central Jakarta, grassroots workers are even in a tighter bind. The minimum wage now stands at about US$200 per month, and that's only after repeated large-scale strikes and labor demonstrations forced the Jakarta government to raise the minimum wage by more than 50 percent over the past two years.
Yet new luxury residential developments are visible as far as the eye can see, often completely empty despite the many "Sold" signs hanging outside several units.
According to international property consultant Knight Frank's Prime International Residential Index, upscale residential property prices rose 38 percent in Jakarta in both 2012 and 2013, the highest among dozens of global markets surveyed in both years.
"Real estate in Jakarta is being bought up by wealthy buyers from around the world and of course not by average salaried workers," says the general manager of one major Indonesian development company on condition of anonymity.
"It can be luxury residences, commercial buildings or land. Large domestic conglomerates sell them to smaller business groups, who then sell them to foreign investors who then sell them to other foreign investors just entering the market. Over the past few years, the flow of foreign investment has been endless, creating no shortage of buyers."
Indonesian law clearly stipulates that foreign investors can only acquire land usage rights, and their ability to gain residency in Indonesia, transfer property or get loans is limited by several restrictions. But local entrepreneurs in the know help investors get around the constraints, advising foreign nationals to first get a foothold in Indonesia by setting up a company as a form of foreign direct investment (FDI). Once that's done, the investor has unrestricted access to the real estate market in the guise of buying a "commercial office building for the company," "employee housing," or other pretexts.
The International Hot Money Challenge
"Indonesia does not have any special controls on foreign investment, and the channels for guiding investment are inadequate. The result is that in recent years, international hot money has poured in. Although it's been called FDI, only about 30 percent has actually been directly invested in real businesses, while 70 percent has been parked in the property and equity or foreign exchange markets to make money," says veteran diplomat Chang Liang-jen, Taiwan's representative in Indonesia.
"This is a phenomenon common to many emerging countries in Asia in the past, but it is now creating its biggest challenge with the pullback in quantitative easing."
Though foreign investment in Indonesia has repeatedly set new highs, most of it has been funds from domestic conglomerates or international hot money speculating in local assets.
Today, hot money still comes and goes freely (if FDI is pulled out, it normally is not reflected in changes to official statistics on foreign investment), leaving Indonesia with little more than a potential debt time bomb in the financial sector.
The volatile flows of foreign funds have prompted both the World Bank and the International Monetary Fund to issue warnings of rising financial risk in Indonesia in the coming years.
Scene 4: North Jakarta, Tanjung Priok Port
Selling Resources, Funds Flowing Abroad
Intentionally or not, the government is enabling global hot money to speculate in the country's assets, inflating the real estate bubble in central Jakarta and increasing the risk of another financial crisis. Yet this is not what most pains those knowledgeable about the country.
Forty kilometers north of downtown Jakarta is Tanjung Priok Port (also known as Jakarta Port), the spot that truly reveals Indonesia's growth bottleneck.
At 8 a.m., the port is already jammed with medium-sized and large ships. Handling 70 percent of Indonesia's total throughput, it has always stood as a symbol of the country's export strength.
But the vast majority of cargo ships setting out to sea are packed with tin, nickel, copper, gold and other minerals mined by international mining companies. All of the higher value-added links of the mining industry chain are completed in neighboring Malaysia, China or Australia.
The entire money trail, from financing, taking orders, and negotiating letters of credit to cash management after the transaction is completed according to the model of "accepting orders in Singapore, making delivery from Indonesia." The entire operation is handled by financial services companies in Singapore.
"The money earned by big companies on exports of raw materials has never gone through Indonesia. How can this country possibly upgrade itself?" wonders Effendy Wen, a third generation Indonesian of Chinese descent and the director and CEO of A2Z Technology.
The mining industry accounts for 30 percent of Indonesia's exports, seemingly bringing in huge export earnings for the country, but the biggest beneficiary is actually Singapore, with its strong financial sector and sound infrastructure and legal system.
Scene No. 5: Jakarta Provincial Government
Backward Infrastructure, Lagging Investment
Why is it that Indonesia has opened its doors and welcomed foreign investment in brick and mortar businesses, yet most of the fund inflow has been targeted at speculation in the real estate and foreign exchange markets?
And despite Indonesia's abundant natural mineral resources, placing it among the top one or two countries in Asia, why have the giant international mining conglomerates been unwilling to invest in processing and refining plants in Indonesia, preferring to pay higher freight costs and ship raw materials overseas?
In both cases, the answer revolves around the country's lack of basic infrastructure.
The Taiwan-based Hon Hai Group, known better in other parts of the world as Foxconn, committed in mid-February to investing NT$30 billion (US$1 billion) in Indonesia over the next three to five years. The world's largest contract electronics manufacturer had announced its intention to invest as early as two years ago but was unable to finalize its plans over that time. Instead of setting up a plant in the Yogyakarta area as had been rumored, it eventually signed a letter of intent to invest in Jakarta Province.
Much of Hon Hai's indecision resulted from the company's dissatisfaction with the Indonesian government's approach of soliciting investment without showing any willingness to help with infrastructure.
"In Indonesia, the government welcomes you to invest there. But when it comes to widening roads, approving licenses, and providing water and electricity to your manufacturing facility, (it says) 'sorry' and leaves you to your own devices," says one person familiar with Hon Hai's negotiations with Indonesian authorities.
'Harvard Cabinet' Thwarted at Local Level
Outsiders have a hard time understanding why the country's basic infrastructure is so seriously inadequate despite the country's high growth rate for many years and its ascendance as ASEAN's biggest economy. The answer is simple: the lack of effective governance.
"Indonesia's problem is that even if the government sees problems and comes up with solutions, by the time they reach elected councils or local governments, collusion among deeply rooted interests and the efforts of businesses to thwart government policies reduces or completely eliminates the policies' effectiveness," says Chen Ching-yen, who has worked for domestic chemical and energy conglomerate PolyChem Indonesia since 1982. Because of this pervasive corruption, important public infrastructure projects have been repeatedly put off.
Indonesia's president Susilo Bambang Yudhoyono hoped to change the culture by recruiting several top Indonesians educated abroad, such as Finance Minister Chatib Basri and Trade Minister Gita Wirjawan, to form a "Harvard Cabinet."
Their carefully crafted policies, however, lost their punch in the transition from the central to local government levels, thwarted by the complicated compromises and vested interests existing at both party and government levels.
Indonesia is blessed with abundant natural resources and a young population, and most observers believe that even if its economy slows down over the next one to three years, those assets could easily fuel renewed economic vitality and growth.
And despite its many structural problems, Indonesia has also emerged as an important new investment destination for major Japanese and Korean companies that are seeking to diversify risk in Southeast Asia amid ongoing political turmoil in Thailand.
Once a "BRIIC" economy but now one of the "Fragile Five," Indonesia's changing face has resulted from its inability to keep foreign funds in the country, make good use of its resources, adjust its economic structure, reform long-standing political issues, and upgrade and transform its economy.
Stung and exposed by the tapering of quantitative easing and the pullback of hot money, and mired in major bottlenecks, Indonesia's economy and its many dramatic contrasts will continue to present challenges to the government, investors, and especially the rising middle class that is seeing its standard of living eroded by factors beyond its control.
Translated from the Chinese by Luke Sabatier