With Indonesia's economic growth among the strongest in Southeast Asia and brightening future prospects for the resource-rich country, economists are weighing whether it should be the next country added to the BRIC grouping of fast-growing emerging economies comprising Brazil, Russia, India and China.
When US investment bank Goldman Sachs came up with the BRIC acronym in 2001, it projected that the combined economic size of the four countries would be bigger than all Group of 7 countries except the United States by 2050, according to Milan Zavadjil, country director at the International Monetary Fund's (IMF) Indonesia office. (The other G-7 countries being Japan, Germany, the United Kingdom, France, Italy and Canada.)
Sticking to that definition, Indonesia is arguably ripe for inclusion to the club. For some financial analysts, Indonesia's BRIC designation would be symbolic of the gathering global shift in economic power away from the developed G-7 economies and towards faster-growing emerging ones. It would also give a boost to President Susilo Bambang Yudhoyono's economic management credentials.
Indonesia still lacks certain BRIC indicators, including large-scale foreign capital inflows, which until now has allowed the government to maintain a relatively hands-off approach to rising inflationary pressures. If capital inflows were to rise significantly above current levels, Bank Indonesia, the central bank, would be put to an important test, economists say.
There are limits to building up foreign reserves and allowing the exchange rate to appreciate, said Zavadjil, who believes sustained investor interest in Indonesia will depend more on achieving investment grade credit ratings than BRIC admission. In January, Fitch Ratings upgraded Indonesia's sovereign credit rating to BB+, based on improvements in the country's public finances and the economy's resilience to the global crisis. Fitch research estimates that Indonesian banks enjoy some of the strongest lending margins in Asia, and limited competition means that yields should remain strong over the medium term.
The stable rating is still one level below investment grade. Ai Ling Ngiam, the lead analyst covering Indonesia at Fitch in Singapore, said reservations remain about upgrading Indonesia to the coveted A rating, which would signal to investors that Indonesia is capable of meeting its financial commitments even in adverse economic conditions.
"The growth side has been acknowledged, " said Ngiam. "But what has been lacking is infrastructure improvements and cooperation from local governments to get projects underway." She says the government often says the right things, but then fails to act.
Indonesia's past crisis responses may justify the need for caution. By not factoring in the risk of rising inflation, the government would have to move quickly if sudden vulnerabilities arise that would call for strong policy adjustments, said Ngiam. She argues that more pre-emptive measures are needed to hedge against fast fluctuating foreign capital flows in and out of the country's illiquid financial markets.
That said, many economists believe that Indonesia is now in an economic sweet spot, with economic growth poised to hit 6% this year after gross domestic product (GDP) rose 6.2% year on year in the second quarter. President Yudhoyono is even more bullish, predicting that economic growth will reach 6.6% by year's end.
The Jakarta Composite Index, Asia's second-best performing stock exchange so far this year after Japan, has reflected the bullishness, hitting a record high on July 29 following the appointment of Darmin Nasution as Bank Indonesia's new head, ending a 14-month impasse over the central bank's leadership and signaling to the market a move towards prudent macro-economic management.
Foreign direct investment (FDI), meanwhile, hit $7.8 billion in the first half of the year, a 49% gain over the same period in 2009. Indonesia's investment coordinating board now predicts FDI could reach $13.1 billion by the end of the year.
Resilient in crisis
When the global economy started to unravel in early 2008, some economists and investors worried that Indonesia would repeat the tailspin that devastated its economy and emptied the national coffers during the 1997-98 Asian financial crisis.
The government responded to that crisis by raising interest rates and tightening fiscal policy, but those interventions failed to stop the rupiah from plunging 85% against the US dollar. The subsequent double-digit inflation triggered steep gains in the prices of key staples such as rice and cooking oil, and sparked the riots that eventually forced then president Suharto to resign.
When the 2008 global recession hit, Indonesia was better prepared. The central bank had built up adequate foreign exchangereserves to cushion against foreign fund outflows and expansionary fiscal policies stoked strong domestic demand. Abundant natural resources, such as palm oil, coal and timber, have also allowed Indonesia to manage the downturn with only a moderate slowdown in economic growth thanks to steady demand from places like China, which is increasingly relying on Indonesia to help meet its growing energy needs.
Investors have since watched Indonesia's recovery with interest. Rapid population growth, a growing middle class, abundant natural resources and low levels of government and household debt give the $690 billion economy - Southeast Asia's largest - an advantage as an investment destination over mature economies such as the United States and Europe, said Zavadjil. "In a not very bright global economic story, Indonesia stands out," he said.
Yet short-term risks remain, namely rising inflation, which has accelerated to 6.98% year on year after an unexpected jump to 6.22% in July. While most of Asia's major economies have raised interest rates to stem inflationary pressures - India has raised its rate four times since the start of 2010 - Indonesia has taken a different tack, holding its benchmark interest rate at a record-low of 6.5% for the 12th month in a row.
Some economists say Bank Indonesia will need to raise rates to 7% before the end of the year to keep inflation within its targeted 4-6% band and to strengthen its own credibility in international markets. BI governor Nasution says that for now, the government prefers to emphasize economic growth over stability.
Last month, he blamed the up-tick in inflation on unseasonably wet weather that has hurt harvests and forced up the cost of vegetables and spices. That means an increase in interest rates would have little impact on the price of these goods, which Nasution predicts will fall after the Muslim fasting month of Ramadan. The cost of goods typically rises during Ramadan when food consumption increases due to the fast-breaking events and charity that mark the holiday.
In the longer term, analysts say income inequality could prove more problematic since Indonesia still trails far behind the BRICs on per capita investment in major infrastructure and human capital.
"The government has failed to perform the most basic functions to support economic growth," economist Jonathan Pincus wrote in an e-mail to Asia Times Online. "Infrastructure development is slow, particularly in power and transport; the education system is failing to provide people with basic skills and to prepare them to acquire more advanced technological skills; the legal and judicial system are dysfunctional. "
Pincus, dean of the Fulbright Economic Teaching Program in Ho Chi Minh City, Vietnam, recently co-authored a report, "From Reformasi to Institutional Transition" that argued Indonesia's economic strategy relies too heavily on natural resource exploitation and is lagging behind competitors in the region in manufacturing exports and employment growth.
"Negative [Suharto era] New Order legacies have left Indonesia with a political and administrative system that creates obstacles to enterprise and innovation," Pincus wrote. He also argued that overcoming entrenched nepotism and corruption will require much deeper reform and investment, and warned that investor sentiment is not a good indicator of the country's long-term growth prospects.
Still Indonesia's relatively cheap labor force and perceived political stability under Yudhoyono is attracting multinational companies that are looking to establish production bases in Southeast Asia. Indonesian authorities expect to lure more foreign funds as manufacturers expand their existing operations to take advantage of the rising purchasing power of Indonesia's growing middle class.
Zavadjil says companies that do not have a presence in Indonesia are taking a look for the first time and some small companies are looking to upgrade their activities. Indeed, corporate giants from Japan, China and South Korea are all making new investments in the country. For instance, Panasonic has started to redesign certain of its products to appeal to the Indonesian market and Nissan has outlined plans to more than quadruple its local sales by 2013.
There is no denying the strong fundamentals offered by Indonesia's market of 240 million people, and economists say the foundations are largely in place for the country to continue down the path to sustained growth regardless of short-term inflationary pressures. But at least for now, those building blocks may not be solid enough to be considered among the BRIC countries.
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