Indonesia today stands out for its relative calm in a world awash with troubles. This contrasts sharply with previous periods of stress in global financial markets, such as the taper tantrums in 2013 when Indonesia’s rupiah tanked with other emerging market currencies.

Despite the war in Ukraine, a slower world economy, an energy and food price shock of epic proportions, aggressive monetary tightening by the US Federal Reserve Bank and China’s poor economic health, Indonesia has done better than its peers in terms of economic growth, inflation and currency stability.

We believe this improvement is the product of a structural improvement in Indonesia. In particular, Indonesia’s growth potential has been enhanced, while its resilience to external shocks has also been strengthened.

The chances are that this improvement can be sustained. Realistically though, we must accept that much more needs to be done. Whether Indonesia can keep buttressing its fundamentals will depend on the continued commitment of the political leadership to the sound policies Indonesia has enjoyed in recent years. Thus, the 2024 presidential election will be critical.

The economy is currently in a good position, but there are some signs of slowing

The economic recovery from the ravages of the pandemic seems to be intact. Economic growth bounced to 5.5% in the second quarter of this year, up from 4.3% in the first quarter. The purchasing manager survey for September was upbeat, with the index level for the manufacturing sector at the highest level in eight months. Encouragingly, the pipeline of new business is picking up, jobs are being created at a vigorous rate and manufacturing firms sound a tone of confidence about prospects.

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Not surprisingly, there are some early signs that the troubles in the world economy are beginning to reach Indonesia. Global inflationary pressures have caused the country’s inflation rate to rise to 6.0%. The reason for the spike in September was that the government realised that subsidies that helped contain fuel prices could not be sustained for too long without damaging the government’s budgetary position. The resulting higher prices are hurting consumer confidence — Bank Indonesia’s consumer confidence index slipped further in September to a four-month low. Given the rise in price pressures and the aggressive monetary tightening elsewhere, the central bank has had no choice but to raise rates in Indonesia. This will impact the country’s economic growth in the coming quarters.

There are sound reasons to expect that the deceleration in Indonesia will be mitigated. Despite weaker consumer confidence and the shock of higher fuel prices, for example, growth in retail sales perked up to 5.5% in September, rising from 4.9% in August. One reason is that the reduced consumer activity during the pandemic-related restrictions allowed excess savings to build up about 10% of private spending. Consumers and businesses can spend out of this savings hoard to support domestic demand. Indonesia has benefited from higher commodity prices as well. Moreover, with the borders now open, tourism is beginning to flourish again, boosting economic performance even in the face of a slower world economy.

We see full-year growth in Indonesia of around 5% for this year. A modest slowdown in 2023 should still leave the economy expanding at above 4%, barring a disaster in the world economy.

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Why we think that the improvement is structural and not a one-off

Indonesia’s better performance is the product of reforms implemented since the Asian Financial Crisis, significantly expanded by President Joko Widodo (better known as Jokowi) after he took office in 2014. The earlier phase of reforms addressed the weaknesses that contributed to Indonesia’s collapse in 1997. Monetary policy was more rigorous while the exchange rate was no longer pegged and vulnerable to speculation. The central bank, which oversaw monetary policy and the currency, was greatly strengthened.

Financial markets now view Bank Indonesia with greater credibility. Rules were also brought in to ensure that the fiscal position would be kept sustainable. A new financial supervision agency was established, which introduced and enforced rules on capital adequacy and governance, significantly reducing the risks of a financial sector meltdown of the kind we saw in 1997. Indonesia’s largest banks are today among the best capitalised in the world.

President Jokowi has built on these reforms. Upon taking office in 2014, one of his first acts was the unpopular one of reducing fuel subsidies. This demonstrated to financial markets that the political leadership had the will to undertake unpopular actions to safeguard the economy. More recently, despite the threats from his opponents and trade unions to mount protests against the move, the President further reduced fuel subsidies. Not only did he stare down his opponents, but he also won sufficient trust from the populace that they were prepared to trust him and swallow the pain of higher prices.

Having secured greater resilience to external shocks, President Jokowi went further to build the foundations for accelerated economic growth. His administration has been energetic in promoting an infrastructure programme, yielding improved connectivity and lower logistics and transport costs. Jokowi also streamlined bureaucratic procedures to improve the business ecosystem. It is still not as easy to do business in Indonesia as in Malaysia or Thailand, but the ecosystem has improved.

The president also skilfully assembled a substantial majority in parliament to push through reforms of Indonesia’s notoriously difficult labour laws, which had deterred investors for a long time. Restrictions on foreign investments have also been rationalised.

Jokowi has also pursued industrial policies to promote economic development. These have resulted in significant investments to process commodities such as palm oil or nickel, which used to be exported in their crude form. Some results have been impressive, and foreign and domestic investors have begun to notice. It is not an exaggeration to say that there has been a veritable boom in investment in nickel processing. The fact that Indonesia has some of the highest-quality nickel ore in the world has also encouraged investments in batteries for electric vehicles.

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We are confident that these improvements will boost Indonesia’s underlying economic growth potential to above 7% on a sustained basis once the global environment recovers.

Political developments will determine whether Indonesia’s promise can be realised

Indonesia’s better economic performance is indeed well-founded. However, there is still some distance before we can be entirely confident about the economic acceleration. The system has vulnerabilities and weaknesses that can still trip Indonesia up.

Some of these weaknesses are in the economic domain, but the others are institutional and require strict measures to resolve — which only a strong leader can get done:

• Indonesia’s narrow tax base is one big challenge. At around 10% of GDP in 2020, its tax take is one of the lowest among developing economies in Asia. With a low tax, Indonesia’s government cannot spend on the public goods the country needs, like faster infrastructure building, wider social safety nets, a higher quality education, climate change mitigation and the like. More needs to be done in terms of improving tax collection, reducing corruption and attacking evasion by the powerful.

• Strong policy leadership is also needed to reform overly nationalistic rules and policies which hold Indonesia back. For example, Indonesia probably has much more natural gas reserves that it can exploit — that would improve energy security while reducing the need to burn dirty coal to provide electricity. But the unexploited reserves are mostly offshore and require foreign technology to thrive. Indonesia’s current oil and gas sector rules deter foreign energy companies from bringing in the expertise needed.

• The recent scandals involving the police force also show a vital need for more governance reforms in essential agencies of the state. It is also fair to say that vested interest groups still retain too much influence over policymaking and legislation and influence state agencies. Many non-governmental organisations worry that the anti-corruption campaign has lost momentum.

Hard decisions need to be made to overcome these obstacles. That requires more than just bold and thoughtful reforms that Indonesia’s excellent technocrats can implement. What is needed is political leadership that is savvy enough to provide the political cover to get these reforms done — as Jokowi has done in many but not all areas. In other words, for Indonesia’s continued success, the 2024 presidential elections must produce a president and national legislature that will tackle these remaining areas that cry out for reform.

It is premature to judge the outcome of the elections, which will be held in two stages starting in February 2024. Currently, the race seems to have whittled down to a three-horse race. Central Java governor Ganjar Pranowo has emerged from relative obscurity to take a pole position in opinion surveys. Anies Baswedan, who just stepped down as Jakarta Governor, is also a leading candidate. This former university president gets firm backing from the more devout Islamist stream in Indonesia’s electorate but is also seen as pragmatic and competent. Defence Minister General Prabowo Subianto, the son-in-law of the former strongman Suharto who lost the election to Jokowi in both 2014 and 2019, is also poised to make a third attempt to win the presidency.

Like Jokowi, Ganjar has a pragmatic streak and has performed well as governor. He is perceived as espousing moderate religious views, has a broad appeal and demonstrates a keen political instinct. For him to have overcome the lack of name recognition sufficiently to overtake the better-known and popular Anies and Prabowo means that he has struck a chord with voters. If he can persuade a political grouping with 20% of the seats in parliament to nominate him, he stands a good chance of becoming Indonesia’s next president.

Indonesian democracy is not perfect, but it has done well enough. President Jokowi’s good performance has set a standard that Indonesian voters will use to judge who they will favour as the next president. On balance, we believe that the next president will be one who can continue Jokowi’s performance.

If that comes to pass, it becomes more likely that Indonesia will enjoy an acceleration of economic growth and an even more exciting economic transformation. That will be good for Indonesia and be suitable for all its neighbours.

Manu Bhaskaran is CEO at Centennial Asia Advisors

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