This article was downloaded by: [Umeå University Library] On: 19 August 2014, At: 01:05 Publisher: Routledge Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK Bulletin of Indonesian Economic Studies Publication details, including instructions for authors and subscription information: http://www.tandfonline.com/loi/cbie20 Survey of Recent Developments a a Stephen Howes & Robin Davies a The Australian National University Published online: 30 Jul 2014. To cite this article: Stephen Howes & Robin Davies (2014) Survey of Recent Developments, Bulletin of Indonesian Economic Studies, 50:2, 157-183, DOI: 10.1080/00074918.2014.938403 To link to this article: http://dx.doi.org/10.1080/00074918.2014.938403 PLEASE SCROLL DOWN FOR ARTICLE Taylor & Francis makes every effort to ensure the accuracy of all the information (the “Content”) contained in the publications on our platform. 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Terms & Conditions of access and use can be found at http://www.tandfonline.com/page/termsand-conditions Bulletin of Indonesian Economic Studies, Vol. 50, No. 2, 2014: 157–83 SURVEY OF RECENT DEVELOPMENTS Stephen Howes and Robin Davies* The Australian National University Downloaded by [Umeå University Library] at 01:05 19 August 2014 SUMMARY Outgoing Indonesian president Susilo Bambang Yudhoyono’s second-term record is creditable, measured against the targets he set himself in 2010, but deficient in key areas: economic reform, infrastructure investment, and anti-corruption. Indonesia’s 2009–14 parliament has been active in economic policymaking, and will leave as its legacy a raft of protectionist legislation. Both presidential candidates, Joko ‘Jokowi’ Widodo and Prabowo Subianto, have appealed to nationalism in their campaigns, calling for Indonesia to assert its sovereignty and increase its self-sufficiency, but Jokowi’s economic platform is more moderate and economically literate than Prabowo’s. The incoming president will inherit an economy that continues to slow. Growth is now not expected to approach 6% until 2015 at the earliest. Having engineered a reduction in the current account deficit, Indonesian policymakers now face the more difficult problem of structural fiscal adjustment. Energy subsidies are the most immediate problem, but fiscal reform more generally will emerge as an overriding and unpleasant imperative for whoever wins the presidential election on 9 July. Unless difficult fiscal policy measures are taken, Indonesia will face major trade-offs between deficit control and investment in social programs and economic infrastructure. The new president will struggle to restrict the deficit to the cap of 3% of GDP: a balanced budget will likely not be feasible for several years. He will need to increase the ratio of revenue to GDP and eliminate fuel subsidies—through a more systematic approach than the infrequent price increases of the past. He will need to choose carefully between competing expenditure priorities, such as infrastructure and defence. The new president would also be well advised to tread cautiously in implementing the legal mandates he will inherit, and to work with parliament to avoid further and unwind current earmarking of public expenditure. Keywords: fiscal reform, energy subsidies, economic reform, trade policies JEL classification: D72, E62, O11, O53 * The authors thank Armida Alisjahbana, Haryo Aswicahyono, Chatib Basri, Faisal Basri, Bambang Brodjonegoro, Pieter Gero, Edimon Ginting, Scott Guggenheim, Anton Gunawan, David Hawes, Mohammad Ikhsan, Noke Kiroyan, Neil McCulloch, David Nellor, Ninuk Pambudy, Raden Pardede, Isa Rachmatawarta, Douglas Ramage, Steven Scott, Alex Sienaert, Jerry Strudwick, Sudarno Sumarto, Wismana Adi Suryabrata, Peter van Diermen, Bill Wallace, Maria Monica Wihardja, Lucky Eko Wuryanto, staff of the political and economic and development cooperation sections of the Australian embassy in Jakarta, and numerous faculty members and associates of the ANU College of Asia and the Pacific. They bear no responsibility for any errors. We also acknowledge excellent research assistance from Ashlee Betteridge and Jonathan Pryke. ISSN 0007-4918 print/ISSN 1472-7234 online/14/000157-27 http://dx.doi.org/10.1080/00074918.2014.938403 © 2014 Indonesia Project ANU 158 Stephen Howes and Robin Davies Downloaded by [Umeå University Library] at 01:05 19 August 2014 This survey begins with a retrospective on the outgoing president and parliament. It then turns to recent political, economic, and policy developments. It concludes with a discussion of the fiscal policy challenges that will confront Indonesia’s new executive and legislature. REVIEW OF THE 2009–14 PRESIDENTIAL AND PARLIAMENTARY TERM Table 1 shows Indonesia’s performance against the key targets set out in the 2010– 2014 National Medium-Term Development Plan, finalised after Susilo Bambang Yudhoyono assumed office for his second term. These are, therefore, the president’s targets. As was the case with his first term (Kuncoro, Widodo, and McLeod 2009), Yudhoyono cannot report that his targets have been fully achieved, but he can certainly point to considerable progress in important areas. Indonesia looks especially good in an international perspective: its economic growth over the last five years was the fourth highest in the G20, though it was helped more than most countries by China’s demand for energy and mineral resources. Poverty in Indonesia has fallen consistently and significantly, though it would have fallen more had the same rate of growth been achieved with a smaller increase in the level of inequality. As table 2 shows, the share of Indonesia’s richest 20% in total household expenditure rose from 42% at the start of Yudhoyono’s first term to 49% at the end of his second.1 Yudhoyono is the first president in Indonesia’s brief democratic era to serve out a full term, let alone two. It was not so long ago that a democratically elected president, Abdurrahman Wahid, was impeached by parliament in questionable circumstances and removed from office under threat of action by the Indonesian military. A major positive legacy of Yudhoyono’s two terms in office is the entrenchment of a vibrant, open, and pluralistic democracy, notwithstanding the drop in the Indonesian Democracy Index score (table 1),2 and, related to this, a perceived rise in, and inadequate response to, religious intolerance (McRae 2013, 301). Yudhoyono’s second-term economic reform record is not impressive, especially given the strong mandate given to him. Protectionism and economic nationalism reasserted themselves during this term, particularly in agriculture and mining. Despite some progress, infrastructure is still a major problem, and the growth of 1. See also De Silva and Sumarto’s (2014) and Yusuf, Sumner, and Rum’s (2014) studies, in this issue. 2. Yudhoyono stated the following at the 2014 World Economic Forum meeting in Manila: ‘We have proved … that we do not have to choose between democracy and development … We have achieved the often elusive connection between democracy and stability … We have become an example that democracy, Islam, modernity can go hand-in-hand’ (Philstar. com, 25 May 2014). The decline in the Indonesian Democracy Index score (table 1) is due largely to a perceived diminution in civil liberties with respect to freedom of speech and the rights of religious minorities. The occurrence of violence in connection with political protests in some provinces also reduced scores in the political-rights component of the index. However, scores for the performance of democratic institutions have improved since 2009. See also Bappenas’s (2014) report and ‘Indeks demokrasi Indonesia turun, ini penyebabnya’ (Indonesian Democracy Index down, the cause) (Kabar24.com, 11 Dec 2013). Increased from 69.7 in 2008 to 70.6 in 2012 Decreased from 7.8% in 2008 to 6.7% in 2012 Partly achieved Partly achieved Note: Targets selected from the main targets of the 2010–2014 National Medium-Term Development Plan (Bappenas 2010). Depending on the data source, base-year data may vary from that provided by Bappenas (2010). Source: Data on economic growth, inflation, unemployment, illiteracy, and the Corruption Perceptions Index from Bappenas (2014); on poverty from Bappenas (2014) and BPS (press release, 1 Jul 2014); on the Indonesian Democracy Index from Bappenas (2014) and BPS (press release, 4 Jul 2014); on production growth from Kementerian Pertanian (2014a, 2014b, 2014c, 2014d, 2014e); on infant mortality and life expectancy from the World Bank (2014b, 2014c). Decreased from 67.3 in 2009 to 63.7 in 2013 Increased from 2.8 in 2009 to 3.0 in 2011 and to 3.2 in 2012 and 2013 Decreased from 34 per 1,000 live births in 2008 to 26 per 1,000 by 2012 6.2% in 2010, 6.5% in 2011, 6.2% in 2012, 5.8% in 2013 (average of 6.2%) 7.0% in 2010, 3.8% in 2011, 4.3% in 2012, 8.4% in 2013 (average of 5.9%) Decreased from 7.9% in 2009 to 6.1% in 2012, increasing to 6.3% in 2013 Decreased from 14.2% in 2009 to 11.3% in 2014 2009–13 averages: rice, 2.9%; maize, 1.2%; soybean, –5.4%; sugar, 0.3%; beef, 5.7% Comments Mainly achieved Not achieved Mainly achieved Mainly achieved Mainly achieved Mainly achieved Assessment Governance Corruption Perceptions Index to reach 5.0 by 2014 Not achieved Indonesian Democracy Index score to reach Not achieved 73 by 2014 Social Infant mortality to fall from 34 per 1,000 live births in 2008 to 24 by 2014 Life expectancy to increase from 70.7 years in 2008 to 72.0 by 2014 Illiteracy in the over-15 population to fall from 6.0% in 2008 to 4.2% by 2014 Economic Average economic growth to reach 6.3%–6.8% Average inflation to stabilise at 4%–6% per year Unemployment to decrease to 5%–6% by 2014 Poverty to decrease to 8%–10% by 2014 Production growth: rice, 3.2%; maize, 10.0%; soybean, 20.1%; sugar, 12.6%; beef, 7.3% Target TABLE 1 2010–2014 National Medium-Term Development Plan Achievements and Targets Downloaded by [Umeå University Library] at 01:05 19 August 2014 160 Stephen Howes and Robin Davies TABLE 2 Welfare and Distributional Indicators, 2002–13 Megawati–Haz Yudhoyono–Kalla Yudhoyono–Boediono 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Downloaded by [Umeå University Library] at 01:05 19 August 2014 Aggregate welfare indicators GDP growth (%) 4.5 4.8 5.0 Poverty (%) 18.2 17.4 16.7 Unemployment (%) 9.1 9.5 9.9 Gini coefficient 0.33 0.32 0.32 5.7 5.5 6.3 6 4.6 16.0 17.8 16.6 15.4 14.2 11.2 10.3 9.1 8.4 7.9 0.36 0.33 0.37 0.35 0.37 6.2 6.5 6.2 5.8 13.3 12.5 12.0 11.4 7.1 6.6 6.1 6.3 0.38 0.41 0.41 0.41 Shares of household consumption expenditure (%) Highest 20% 42.2 42.3 42.1 44.8 42.2 44.8 44.8 44.9 Middle 40% 36.9 37.1 37.1 36.4 38.1 36.1 35.7 36.1 Lowest 40% 20.9 20.6 20.8 18.8 19.8 19.1 19.6 19.0 45.5 48.4 48.6 49.0 36.5 34.7 34.4 34.1 18.1 16.9 17.0 16.9 Source: Data from Bappenas (2014); BPS (2014e, 2014g); Kuncoro, Widodo, and McLeod (2009). Note: Poverty rates, Gini coefficients, and expenditure shares calculated using data from the National Socio-economic Survey (Susenas). non-residential capital stock, though it has risen, still lags significantly behind rates seen in the 1990s.3 As discussed later, the fiscal position has deteriorated. Earlier in his second term, Yudhoyono’s failure to prosecute an anti-corruption agenda was much commented on.4 With Indonesia’s Corruption Eradication Commission increasingly going after very high-profile accused,5 progress in this area now looks more encouraging. However, Indonesia’s rating in the international Corruption Perceptions Index has improved only marginally and by nowhere near enough to hit the president’s target (table 1). Its relative ranking has actually slightly declined. For a radical reduction in corruption, more political leadership will be required to complement the enhanced investigatory effort (McRae 2013, 297–99). During 2009–14, Indonesia’s parliament passed five important pieces of legislation governing agriculture, industry, and trade: Law 13/2010 on Horticulture, Law 18/2012 on Food, Law 19/2013 on the Protection and Empowerment of Farmers, Law 3/2014 on Industry, and Law 7/2014 on Trade. They all either mandate or authorise a protectionist approach to economic policymaking. 3. Van der Eng’s (2008, updated to 2013) study shows that Indonesia’s non-residential capital stock grew, on average, at 12% during 1990–97 but at 6.5% during 2010–13. 4. Emmerson (2012, 72) writes of Yudhoyono’s ‘flagging campaign against corruption’. 5. For example, former traffic chief of the national police Djoko Susilo; Bank Indonesia deputy senior governor Miranda Goeltom; former youth and sports minister Andi Mallarangeng (the first minister to resign in connection with the commission’s investigations); Constitutional Court judge Akil Mochtar; former head of oil and gas regulator SKK Migas Rudi Rubiandini; former Democratic Party chairman Anas Urbaningrum and treasurer Muhammad Nazaruddin; and former religious affairs minister Suryadharma Ali. Downloaded by [Umeå University Library] at 01:05 19 August 2014 Survey of Recent Developments 161 The horticulture law places a 30% cap on foreign ownership, and at the time of writing was the subject of a court challenge. It commits the government to supporting horticulture by providing tax concessions, infrastructure, finance, and training. It requires that permission for horticultural imports be obtained from both the Ministry of Trade and the Ministry of Agriculture. The food law defines three important concepts: food self-sufficiency, food sovereignty (the state’s right to define food policy), and food security (the individual’s ability to secure food). It stipulates that food policy should be based on all three. Under the law, food imports are allowed only if domestic production is insufficient or infeasible. The sufficiency of staple foods is to be determined by the relevant minister. Food imports are not to harm sustainable farming or the welfare of farmers. The government is obliged to balance the interests of farmers and consumers by stabilising staple food prices, whether by fixing producer and consumer prices, managing food reserves, or regulating exports and imports. The farmers law requires the government to prioritise domestic agricultural production and to protect farmers. To this end, ‘The government is obligated to create conditions that produce favourable agricultural commodity prices for farmers’ (article 25).6 This can be done by setting tariffs on agricultural commodities, stipulating their points of entry, and stabilising food prices. Commodities that are particularly important are to have their own tariff policy. As with the food law, agricultural imports are prohibited if domestic production is sufficient, and this is to be determined by the relevant minister. As Nehru (2013) explains, the industry law gives the ministry the power to promote industry by, for example, procuring products from domestic firms; controlling strategic industries; and arranging the selection, procurement, and use of industrial technology. The law decrees that nationals are to be given preference over foreigners, including in access to natural resources. The trade law, also covered by Nehru (2013), is similarly wide-ranging. It authorises the relevant minister to restrict imports to protect domestic industries and ‘to maintain the balance of payments’ (article 54).7 All five laws have varying degrees of flexibility, but all provide a basis on which any trade, industry, or agriculture minister so inclined could build a policy package of high tariffs, quotas, or both. The food and farmers laws are the most clearly protectionist: the former makes self-sufficiency the objective of government, and the latter requires the government to prop up agricultural prices. The European Union, the United States, and New Zealand have complained that the horticulture law violates Indonesia’s WTO commitments (WTO 2013, 2014) and the European Union has suggested that the trade and industry laws do the same (European Commission 2014). The Indonesian government will continue to be constrained by international commitments and public outcries against high food prices, but it will also be under pressure—not least from the parliament itself—to implement what is now the law of the land. 6. See http://usdaindonesia.org/wp-content/uploads/2013/07/Indonesian-Farmers-BillTranslated.pdf. 7. See http://usdaindonesia.org/wp-content/uploads/2014/04/Bill-Trade-Law-ENGLISHFINAL-140219.pdf. Downloaded by [Umeå University Library] at 01:05 19 August 2014 162 Stephen Howes and Robin Davies More generally, the enactment of these and many other pieces of legislation (including Law 5/2014 on Civil Administration and Law 6/2014 on Villages, discussed below) suggests that Indonesia’s parliament has become a key player in policymaking. Law 4/2009 on Mineral and Coal Mining, passed at the end of the previous parliament’s term, is the basis of the current ban on the export of unprocessed minerals, and the parliament also recently passed laws on deforestation, land acquisition, microfinance, higher education, and financial sector regulation. No doubt some of this legislation will languish for lack of implementing regulations or because there is no political will to implement it, but much of it could be influential. We are not in a position to evaluate the relative roles of the president and the parliament in initiating and shaping recent legislation. Most bills are proposed by the president (Sherlock 2007, 28). There is no right of presidential veto, but the president’s approval is required before the parliament can vote on a bill (Sherlock 2007, 7–8). Though Indonesia’s parliament is typically represented as ‘divided [and] fractious’ (Evans 2012, xvii), in fact bills are usually passed unanimously, after extensive negotiations (Sherlock 2007, 3). The legislative program of the current parliament appears to reflect views shared across parties (as do, to a large extent, the political party manifestos discussed later). Not all the legislation passed in the last five years is detrimental to good policy. Law 2/2012 on the Acquisition of Land for Development in the Public Interest, in particular, might help speed up infrastructure projects, and the Financial Services Authority, established under Law 21/2011, might help improve financial sector regulation (Allford and Soejachmoen 2013). There is no doubt, though, that the 2009–14 parliament, acting in collaboration with the president and his administration, has bequeathed to Indonesia a raft of protectionist legislation. There is a risk, but fortunately not a guarantee, that this will become its most important economic legacy. POLITICAL DEVELOPMENTS Parliamentary Elections In the legislative elections held on 9 April 2014, just under three-quarters of Indonesia’s 186 million eligible voters cast their ballots to fill 560 seats in the People’s Representative Council (Dewan Perwakilan Rakyat [DPR]), 132 seats in the Regional Representative Council, and almost 20,000 seats in assemblies at the provincial and city or district level. The election was orderly, peaceful, and, allegations of attempted vote-buying aside, gave observers no cause to doubt that it was substantially free and fair. Twelve political parties contested the elections, down from forty-eight in the 1999 elections, and ten secured seats in the DPR, Indonesia’s primary legislative chamber. The bar for party eligibility was raised in 2011 (by Law 2/2011 on Political Parties) so that now only the largest parties, with chapters across the nation, can field candidates (an exception is made for Aceh) (Freedom House 2012, 2). As a result, and as table 3 shows, the proportion of votes that went to parties that did not meet the threshold for DPR representation fell from 18.3% in 2009 to only 2.4% in 2014 (despite an increase in the threshold itself from 2.5% to 3.5%). Table 3 also shows that votes in both elections were fairly evenly distributed among the parties, and that no party was, at either election, able to gain more than about 20% of the vote. Survey of Recent Developments 163 TABLE 3 Votes and Seats Won in the Indonesian DPR Elections, 2009 and 2014 2009 Votes Downloaded by [Umeå University Library] at 01:05 19 August 2014 Parties gaining seats New secular parties Gerindraa Hanurab NasDem Partyb Established secular parties Democratic Partyc Golkar Partya PDI–Pb Islamic parties Prosperous Justice Party (PKS)a National Mandate Party (PAN)a United Development Party (PPP)a National Awakening Party (PKB)b Totals Total for parties gaining seats Total for parties not gaining seats Total valid votes No. (m) 2014 Seats % No. % Votes No. (m) % Seats No. % 4.6 3.9 4.5 3.8 26 17 4.6 3.0 14.8 11.8 6.6 5.3 8.4 6.7 73 16 35 13.0 2.9 6.3 21.7 15.0 14.6 20.8 14.5 14.1 148 106 94 26.4 18.9 16.8 12.7 10.2 18.4 14.8 23.7 19.0 61 91 109 10.9 16.3 19.5 8.2 6.3 5.5 5.1 7.9 6.0 5.3 4.9 57 46 38 28 10.2 8.2 6.8 5.0 8.5 9.5 8.2 11.3 6.8 7.6 6.5 9.0 40 49 37 47 7.1 8.8 7.0 8.4 84.9 19.0 104.0 81.7 18.3 560 122.1 97.6 2.9 2.4 125.0 560 Parties supporting Prabowo–Hatta Parties supporting Jokowi–Kalla 61.2 51.1 49.0 40.9 292 207 52.1 37.0 Source: Data from KPU (2013, 2014a, 2014b); Kuncoro, Widodo, and McLeod (2009). Note: DPR = Dewan Perwakilan Rakyat (People’s Representative Council). Gerindra = Great Indonesia Movement Party. Hanura = People’s Conscience Party. PDI–P = Indonesian Democratic Party of Struggle. New parties are defined here as those founded after 2005. The NasDem Party was founded only in 2011. Of the two parties not gaining legislative seats in 2014, the Indonesian Justice and Unity Party (PKPI) supported Jokowi–Kalla in the 2014 presidential election and the Crescent Star Party (PBB) supported Prabowo–Hatta. Around 14.6 million votes were spoilt or null in the 2014 elections. a Supporting Prabowo–Hatta. b Supporting Jokowi–Kalla. c Announced support for Prabowo–Hatta at the end of June 2014. Not counted in supporting parties’ total. The Presidential Election Only two candidates were nominated for Indonesia’s 2014 presidential election on 9 July: Joko ‘Jokowi’ Widodo, of the Indonesian Democratic Party of Struggle (PDI–P), and Prabowo Subianto, of the Great Indonesia Movement Party (Gerindra). In the lead-up to the parliamentary elections in April, Jokowi, governor of Jakarta and formerly mayor of Surakarta (or Solo), was widely favoured to win the presidency. Yet PDI–P’s share of the vote, at 19%, fell well short of expectations, and the party was forced into a coalition to marshal the 25% of votes required to be able to nominate Jokowi. Moreover, the Golkar party, which Downloaded by [Umeå University Library] at 01:05 19 August 2014 164 Stephen Howes and Robin Davies received the second-highest share (15%) of the national vote, opted not to pursue a candidacy for its unelectable chair, Aburizal Bakrie, and instead entered into a coalition with Prabowo’s Gerindra. So did three of the four Islamic parties, which collectively accounted for some 21% of the vote. One of these parties, the National Mandate Party, supplied its chair, Hatta Rajasa, as Prabowo’s running mate. Rajasa brings a business perspective and government experience, having been transport minister and, most recently, coordinating minister for economic affairs. Prabowo himself is a former general and businessman, a former son-inlaw of Soeharto, and was an unsuccessful vice-presidential candidate in 2009. Although Jokowi’s party’s share of the DPR vote disappointed his supporters and surprised observers, it was not much smaller than that of Yudhoyono’s Democratic Party in 2009 (21%), and Yudhoyono won that election decisively. Jokowi and PDI–P have assembled a usefully diverse coalition—the People’s Conscience Party (Hanura) is headed by a former general; the National Awakening Party (PKB) is the most popular of the four Islamic parties; and the more youth-oriented National Democratic Party (NasDem) brings access to the extensive media empire of its chair, Surya Paloh. In Jusuf Kalla, Jokowi has a running mate with a broad base of support (including outside of Java), previous vice-presidential experience (2004–9), a reputation for getting things done, and a capacity to engage effectively in political debate. It does no harm that Kalla is a former chair of Golkar. In Indonesian politics, coalition structures, parties’ shares of the vote, and running mates do not necessarily mean much. Voters have demonstrated a propensity to direct their votes to individuals rather than to the parties or party groupings they represent. Most notably, the Democratic Party rose and then fell with the popularity of its leader and founder, Yudhoyono. Viewed as individuals, Jokowi and Prabowo have very different strengths and weaknesses. Jokowi has wide public support owing to his novelty, clean reputation, and common touch. He also has strong backing from the business community, which is not normally aligned with PDI–P but which sees him as likely to push forward in at least some areas of economic reform, not least because he has expressed a disposition to appoint people to key economic ministries on the basis of technical merit. Jokowi is also perceived, perhaps optimistically, as the candidate more likely to resolve long-standing infrastructure bottlenecks, because he has demonstrated a capacity to build consensus and to negotiate to make things happen. Prabowo’s popular appeal speaks to people who believe that Indonesia lacks decisive, clear-sighted, and perhaps even aggressive leadership. Prabowo carries baggage, including allegations that he was involved in human rights abuses as a senior military commander. He, far more than Jokowi, evokes the leadership archetype of the past— but it is a past of which the youngest third of the population of Indonesia has no direct experience. Jokowi performed unremarkably during the early stages of the presidential campaign by tending to overwork his ordinariness. Prabowo, despite notable stumbles, better projected a capacity for national leadership and made up significant ground in the polls. Parties’ and Candidates’ Positions on Economic Policy A review of the major parties’ platforms going into the presidential election reveals a range of positions and emphases, few disagreements, and many areas of Downloaded by [Umeå University Library] at 01:05 19 August 2014 Survey of Recent Developments 165 consensus. In general, the parties’ platforms stress economic ‘independence’ and ‘sovereignty’, the development of infrastructure and the rural economy, and the eradication of corruption. None promises to liberalise the economy, or to undertake what might be termed structural reform. Some, however, call for an increase in the tax-to-GDP ratio—both PDI–P and Gerindra target an increase in this ratio from its current 12% to 16%. PDI–P’s economic platform (PDI–P 2014) begins with the claim that Indonesia is losing its economic, food, and energy sovereignty. It promises to reverse these trends by developing ‘skilled national human resources’, promoting infrastructure, and improving the social security system. At the level of strategy, its nationalism is more limited: PDI–P wants to restrain the foreign ownership of banks and manage energy resources in favour of national industry and domestic investors. While the platform commits to increasing agricultural exports and reducing imports, it does not advocate an overtly protectionist approach. Rather, it promises more support to Indonesia’s farmers by establishing a farmers’ bank, developing rural infrastructure, and limiting the conversion of land in Java. In a long op-ed in Kompas (10 May 2014), Jokowi calls for nothing less than a ‘mental revolution’ in Indonesia to end old, corrupt ways. He also calls for measures to increase food and energy security, saying that achieving these aims is ‘not negotiable’. He suggests, however, that in other sectors he is prepared to allow trade to ‘drive the economy’. He is critical of relying too heavily on foreign investment. In separate comments, Jokowi committed to phasing out fuel subsidies over four to five years (Teraspos.com, 30 Apr 2014). Gerindra’s election manifesto (Gerindra Party 2014) begins, as might be expected, with a heavy emphasis on the need for strong leadership: ‘Weak national leadership is a decisive factor causing deterioration in the nation’s life’. Its economic section begins with a wide-ranging critique of Indonesia’s ‘liberalcapitalistic’ system, which, it alleges, has allowed foreigners to dominate the economy and failed to ensure the welfare of the people. The manifesto advances a cooperative model with a heavy emphasis on state ownership and control. It speaks out against foreign borrowing, and for the restriction of foreign direct investment. It rejects liberalisation and deregulation and favours trade protection, as well as other policies (improved infrastructure, better access to finance) to help farmers and small businesses. The manifesto also includes a strongly worded attack on corruption. Prabowo and Hatta have also released an economic platform (Prabowo–Hatta 2014) as part of their campaign. It focuses on building infrastructure and providing government support for agriculture and other sectors, and also on state-ownedenterprise-led development and on the development of a national manufacturing capability to build motor vehicles, ships, and aeroplanes. Prabowo has in the past spoken out against fuel subsidies, but his most recent public remarks call for their maintenance with better targeting (Jakarta Globe, 21 May 2014). Overall, Jokowi goes into the election with a more moderate and economically literate platform than Prabowo.8 8. For a broader overview of the key commitments of the Jokowi–Kalla and Prabowo– Hatta teams, see ‘What Is on the Political Agenda of Joko Widodo and Prabowo Subianto?’ (Indonesia-Investments.com, 22 May 2014). Downloaded by [Umeå University Library] at 01:05 19 August 2014 166 Stephen Howes and Robin Davies ECONOMIC DEVELOPMENTS Economic Growth Economic growth slowed in Indonesia from 6.5% in 2011 to 6.2% in 2012 and to 5.8% in 2013 (table 2). It seemed to have stabilised in the second, third, and fourth quarters of 2013, with rates of 5.8%, 5.6%, and 5.7%, respectively (table 4), but in fact growth in the last quarter was artificially high as companies rushed to produce and export their unprocessed minerals before the ban on such exports in January 2014. In turn, this ban pushed growth down to 5.2% in the first quarter of 2014. Table 4 shows that fourth-quarter growth for mining and quarrying in 2013 was 3.9% (the highest in several years) but first-quarter growth in 2014 was –0.4%. Exports of the affected commodities—copper ore, nickel ore, and bauxite—were 0.6% of GDP in the first quarter of 2013 (valued in current prices), and 0.0% a year later (BI 2014). This also explains the high export growth in the former quarter and the negative growth in the latter. Some commentators, and the Indonesian government itself, had predicted growth of 5.5%–6.0% for 2014. This now seems unlikely. In May the government conceded that its growth target of 6.0% for the 2014 calendar year was unachievable, and revised it down to 5.5%. Bank Indonesia (BI) adjusted its forecast from between 5.5% and 5.9%—and it had earlier been between 5.8% and 6.2%—to between 5.1% and 5.5% (Jakarta Post, 8 May 2014). This forecast is in line with those of the World Bank and the IMF of 5.3% growth in 2014. The ban on unprocessed mineral exports will continue to dampen growth for the remainder of 2014. There are also risks in agriculture: a press report (Kompas, 3 May 2014) suggests that rice farmers in West Java face the prospect of particularly low harvests in 2014, owing to pest infestation worsened by indiscriminate use of pesticides (Fox 2014; Manning and Purnagunawan 2011). The harvested rice area in January–April decreased relative to the same period in 2013 by more than 97,000 hectares, and production decreased by close to 1 million tonnes of paddy, largely in Java (BPS, press release, 1 Jul 2014). If the El Niño climatic event were to arrive in mid-2014, as predicted, it would reduce rainfall and most likely damage the year’s second rice crop (Reuters, 27 May 2014). BPS predicts that the harvested area during the second rice crop in 2014 will decrease by 168,000 hectares, and that total rice production in 2014 will be 1.4 million tonnes of paddy lower than in 2013. Figure 1 shows recent quarterly year-on-year growth figures for both private consumption and investment. It demonstrates the slowly but steadily rising growth of private consumption, which makes up 55% of total expenditure, but also the fall in investment growth which has been behind the slowdown in GDP growth, and which has reduced demand for imports (World Bank 2014a). On the positive side, the figure suggests that investment growth has at least stabilised. Other positives are the record level of foreign direct investment, and Indonesia’s strategic, political, and social stability, especially given the volatile times that some of its neighbours are enduring. Growth should recover in 2015. The World Bank (2014a) predicts a rebound in 2015 to 5.6%; the IMF (2013, 38) 5.8%. However, some commentators suggest that, until major progress is made in reducing infrastructure bottlenecks, growth will stay closer to 5.0%—even in the medium term. Survey of Recent Developments 167 TABLE 4 Components of GDP Growth (2000 prices; % year-on-year) Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Downloaded by [Umeå University Library] at 01:05 19 August 2014 GDP Excluding oil & gas By expenditure Private consumption Government consumption Investment Construction Machinery & equipment Transport Other Exports Imports By sector Tradables Agriculture, livestock, forestry & fisheries Mining & quarrying Manufacturing Excluding oil & gas Non-tradables Electricity, gas, & water supply Construction Trade, hotels, & restaurants Transport Communications Financial, rental, & business services Other services 6.0 6.7 5.8 6.3 5.6 6.1 5.7 6.0 5.2 5.6 5.2 0.4 5.5 6.8 0.8 2.1 11.3 3.6 0.0 5.1 2.2 4.5 6.6 –0.7 –6.3 12.4 4.8 0.7 5.5 8.9 4.5 6.2 0.8 –4.4 8.3 5.2 5.1 5.3 6.4 4.4 6.7 0.2 –12.1 12.4 7.4 –0.6 5.6 3.6 5.1 6.5 5.1 –9.6 4.8 –0.8 –0.7 4.4 4.2 4.1 4.7 3.8 3.7 0.1 6.0 6.9 7.4 7.9 6.8 6.5 6.0 11.7 8.2 6.5 3.3 –0.6 6.0 6.6 7.1 4.0 6.6 6.4 7.7 12.8 7.7 4.5 3.3 2.0 5.0 5.5 7.0 3.8 6.2 6.1 6.7 11.8 7.6 5.6 3.8 3.9 5.3 5.4 6.5 6.6 6.7 4.8 7.8 11.7 6.8 5.3 3.3 –0.4 5.2 5.6 6.4 6.5 6.5 4.6 8.2 11.3 6.2 5.8 Source: Data from BPS (press release, 5 May 2014; 2014d, 2014f); BI (2014). Balance of Payments Indonesia’s current account balance has been falling since 2009. It turned negative in the fourth quarter of 2011 and reached –4.4% of GDP in the second quarter of 2013 (figure 2). In response, the government introduced policies to reduce the current account deficit (CAD) to below 3% to counter international perceptions of excessive risk. Policymakers achieved their sought-after adjustment by allowing a large depreciation in the exchange rate (of 25% during 2013); by raising interest rates (BI increased the overnight deposit facility rate five times between May and December 2013, from 3.75% to 5.75%); and by increasing fuel prices by 33% in April 2013. In the fourth quarter of 2013 and the first quarter of 2014, the CAD was about 2% of GDP. Exports were flat through most of 2013 but artificially inflated in the FIGURE 1 Growth in Private Consumption and Investment, 2011–14 (2000 prices; % year-on-year) 15 12 Investment 9 Downloaded by [Umeå University Library] at 01:05 19 August 2014 6 Private consumption 3 0 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Source: Data from BPS (2014d); BI (2014). FIGURE 2 Current Account Balance as a Share of GDP, Current Prices, 2009–14 (%) 5 4 3 2 2012 2013 2014 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 1 0 -1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2009 2010 2011 -2 -3 -4 -5 Source: Data from BI (2014; press release, 9 May 2014). Survey of Recent Developments 169 TABLE 5 Balance of Payments ($ billion) 2013 Downloaded by [Umeå University Library] at 01:05 19 August 2014 2014 Q1 Q2 Q3 Q4 Q1 Current account Exports Non–oil & gas Oil & gas Imports Non–oil & gas Oil & gas Merchandise trade balance Non–oil & gas Oil & gas Services Income Current transfers –6.0 45.2 36.8 8.5 43.6 32.3 11.3 1.6 4.5 –2.9 –2.6 –6.1 1.1 –10.1 45.6 37.6 7.9 46.1 36.1 10.0 –0.5 1.6 –2.1 –3.5 –7.1 1.0 –8.6 44.2 35.6 8.5 44.0 32.8 11.2 0.1 2.8 –2.6 –2.8 –6.8 0.9 –4.3 48.4 39.8 8.7 43.7 32.9 10.8 4.8 6.9 –2.1 –3.1 –7.0 1.0 –4.2 44.4 36.7 7.7 40.9 30.5 10.3 3.5 6.2 –2.6 –2.2 –6.5 1.0 Capital & financial accounts Capital account Financial account Direct investment Portfolio investment Other investment –0.5 0.0 –0.5 3.6 2.8 –6.9 8.6 0.0 8.6 3.7 3.4 1.6 5.5 0.0 5.5 5.8 1.9 –2.3 8.8 0.0 8.8 0.5 1.8 6.5 7.8 0.0 7.8 2.9 9.0 –4.1 Errors & omissions Overall balance (change in reserves) Foreign reserves –0.1 –1.0 0.5 –0.1 –1.6 –6.6 104.8 –2.5 98.1 –2.6 95.7 4.4 99.4 2.1 102.6 Source: Data from BI (2014). fourth quarter—and subsequently suppressed in the first quarter of 2014—by the 2014 ban on the export of unprocessed minerals (table 5). The CAD might have been expected to rise as a result, but the fall in exports was offset by a reduction in imports. In fact, both exports and imports fell in the first quarter of 2014 compared with both the previous quarter and the first quarter of 2013. The lower-than-expected CAD for the first quarter of 2014 suggests that the CAD for the full year should remain below 3%, but not necessarily by much. Data for April showed a trade deficit of $2 billion, on the back of rising imports, and in June BI warned that the CAD would exceed 3% in the second quarter of 2014 (BI, press release, 2 Jun 2014; Jakarta Post, 6 Jun 2014 ). The May trade balance showed a very marginal surplus, as imports fell that month (BPS, press release, 1 Jul 2014). The World Bank (2014a) predicts a CAD of 2.9% of GDP for 2014, and 2.1% for 2015. On the capital account, portfolio investments surged in the first quarter of 2014, to $9.0 billion—almost as high as the total for 2013. Net foreign investment in Downloaded by [Umeå University Library] at 01:05 19 August 2014 170 Stephen Howes and Robin Davies Indonesian stocks amounted to $3.6 billion during January–May, but the June figure fell to just $0.1 billion as foreign portfolio investors began to await the results of the presidential election.9 Foreign-exchange reserves continued their climb, which had resumed in the fourth quarter of 2013, and in February 2014 they exceeded $100 billion for the first time in eight months. Other macroeconomic indicators are mainly positive. The stock exchange, after falling in the second half of 2013, more than recovered its lost ground in the first half of 2014, rising 14.8% in the calendar year to 3 July. Inflation peaked at 8.8% in August 2013 (year on year) as a result of the fuel price increases, and was still at that level in December 2013. It has since fallen, however, and was at 6.7% in June 2014 (BI 2014). Growth in both broad and narrow monetary aggregates (M2 and M1, respectively) has fallen since mid-2012, and remains at relatively low levels, according to the latest (April) data. Year-on-year growth in M2 (M1) was 20.3% (23.3%) in April 2012, 14.7% (15.4%) in April 2013 and 11.0% (6.5%) in April 2014 (BI 2014). Growth in cash in circulation, which is more volatile, has in general been higher. It grew at 15.3% for the first four months of 2014, compared with 14.0% for the first four months of 2013 and 16.0% for the first four months of 2012 (BI 2014). The ratio of external debt service to exports has continued to rise (BI 2014).10 The government continues to express concern about this, but has limited scope for action, since most of the debt is private (Ministry of Finance, press release, 22 May 2014). The government has achieved much by stabilising the external balance. Some observers feared that exchange-rate depreciation would accelerate out of control, as it had in 1998. It did not. Although the size of the CAD remains a concern for policymakers, the Indonesian economy is certainly perceived to be less risky in 2014 than it was in 2013. POLICY DEVELOPMENTS Law 5/2014 on Civil Administration President Yudhoyono enacted a new civil service law on 15 January 2014, some two and a half years after it was passed by parliament. According to press reports, the law establishes a new independent Indonesian Civil Service Commission of seven members, with representatives of academia and civil society as well as the government (Jakarta Post, 3 Feb 2014). It moves towards open, merit-based recruitment and performance-based promotion and remuneration. It increases the retirement age of public servants and introduces a new service-wide salary system, which seeks to provide ‘fair and decent wages’ (article 79, own translation), and abolish most allowances, thereby bringing to an end the long-standing practice whereby those in ‘wet’ positions—that is, positions with more access to project funding and/or more prone to corruption—receive more by way of allowances than those in ‘dry’ positions. Indonesia’s salary bill has grown at an average rate of 9% a year (after inflation) during Yudhoyono’s second term (table 7), and observers expect the civil service law to add to it, as it will tend to push up remuneration for ‘dry’ positions to bring them into line with ‘wet’ ones. 9. See http://www.idx.co.id/en-us/home/publication/statistic.aspx. 10. See also Nehru’s (2013) survey for further discussion of this issue. Downloaded by [Umeå University Library] at 01:05 19 August 2014 Survey of Recent Developments 171 Law 6/2014 on Villages Indonesia’s new village law, enacted on 15 January 2014, gives villages the right to regulate and manage local government affairs, community interests, and customary and traditional rights. The law provides villages with significant new funding, much of it from the national government. It entitles villages collectively to an amount equivalent to 10% of central government transfers to lower levels of government (provinces, districts, and municipalities), to be transferred directly from the national budget. The law stipulates that this component of funding for villages should be additional to existing transfers. Villages are further entitled to 10% of the funds received by districts and municipalities from the national government, after subtracting special allocation funds. All funds provided under the law are for development purposes, as defined by villages themselves. The first entitlement, worth Rp 59 trillion if paid in 2014, is new. The second, worth Rp 45 trillion, reflects existing practice (under the Alokasi Dana Desa [village fund allocation] program). If divided equally among Indonesia’s approximately 73,000 villages, these entitlements would deliver Rp 1.4 billion each year to each village, on top of which would be added the relatively small amounts (in most cases) of own-source revenues and 10% of regional funds. It is not clear when direct payments will begin—implementing regulations will be needed, as usual—but it may be as early as 2015, given the law’s strong support (Jakarta Post, 21 Dec 2013). In many ways, the new village law builds on Program Nasional Pemberdayaan Masyarakat Mandiri (National Program for Community Empowerment [PNPM Mandiri]), which was once the Kecamatan Development Program (KDP), Indonesia’s well-known community-driven development program. Having started in 1998 as a World Bank project, the KDP was converted into an Indonesia-wide program by President Yudhoyono in 2006. PNPM Mandiri has an annual budget of about Rp 17.5 trillion.11 The new funding provided under the village law, of around Rp 60 trillion each year, as above, will be more than three times as much. A recent review of PNPM Mandiri (PNPM Support Facility 2012) points to achievements and challenges, but nowhere suggests that it lacks funds. Direct transfers to villages on the scale envisaged could do much to meet local infrastructure shortfalls, but absorptive capacity may be a problem. For one thing, however flexible it is, the village law is designed to finance projects. It will enable villages to build things, not to run them. The village law will also shift the balance of power in village development. The success of PNPM Mandiri relies on multiple checks and balances, such as the use of facilitators to ensure that program guidelines are being met and to mitigate the risks of elite capture, corruption, and waste (PNPM Support Facility 2012). But PNPM Mandiri is an executive-run program without any basis in legislation. Empowering villages, as the village law does, will make mitigation of these risks harder. The village law, then, may continue the successful expansion of community-driven development in Indonesia, or it may undermine the foundations on which it builds. Time will tell. 11. Using an exchange rate of 11,675 rupiah per dollar, as at the end of May 2014, and an annual figure of $1.5 billion (PNPM Support Facility 2012). Downloaded by [Umeå University Library] at 01:05 19 August 2014 172 Stephen Howes and Robin Davies Ban on Unprocessed Mineral Exports Indonesia’s ban on unprocessed mineral exports began in January 2014 as a result of Law 4/2009 on Mineral and Coal Mining. Allford and Soejachmoen (2013), Armstrong and Rahardja (2014), and the World Bank (2014a) all provide extensive coverage. What follows is only a brief overview and update. The ban affects about $5.5–$6.0 billion of Indonesia’s exports, or about 3% of total exports (BI 2014)—principally copper ore, nickel ore (of which Indonesia is responsible for half of global production), and bauxite. Unprocessed exports of nickel and bauxite have been banned altogether; copper concentrate can be exported up to 2017, but companies are required to pay a prohibitive 20% (and increasing) export tax. Exports of these commodities, which traditionally have not been processed on a large scale in Indonesia, have therefore stopped. There has been talk that if companies commit to building smelters they will be allowed to export provided they pay a bond and show progress in construction (Monitor Global Outlook, 13 Mar 2014). Yet there are no confirmed cases of concluded deals or the resumption of ore exports. A challenge to the law is, at the time of writing, before the Constitutional Court. The appellants make the case that articles 102 and 103 of the law require only that ores contain minimum contents (for example, that exports of copper ore contain a certain amount of copper), not that the ores have to be processed to be eligible for export (Jakarta Post, 13 Mar 2014). Japan, which relies on Indonesia for its nickel, has told Indonesia that it intends to challenge the law at the WTO (IndonesiaInvestments.com, 4 Apr 2014). Fiscal Policy If the CAD was the most pressing policy problem last year, then this year it is the fiscal deficit, or, more broadly, the budget. This problem is more difficult and will take longer to solve. Indonesia’s debt has fallen drastically over the last decade but is now starting to inch up. The debt-to-GDP ratio fell from 76.4% of GDP in 2001 to 24.5% in 2012 (IMF 2005, 2013), but IMF (2013) estimates values for this ratio of 26.2% for 2013 and 26.8% for 2014. This reflects the fact that the primary balance (the fiscal balance before interest payments), which determines debt dynamics, has been on the decline since 2002 (figure 3). For the first time since its fiscal rule was put in place (in 2003), the fiscal deficit is close to its mandated limit of 3% of GDP.12 The 2014 budget target for the fiscal deficit was 1.7%, but the revised budget presented to the parliament in May targets 2.5%. Table 6 shows the budgeted and revised budget estimates and assumptions for 2014.13 Uncontrolled fuel subsidy costs are an immediate and familiar problem. The fuel subsidy was originally budgeted at Rp 211 trillion but is now estimated to hit Rp 285 trillion, 36% higher than its level in 2013, despite the 33% fuel price increases introduced in July 2013. The subsidy blowout is due to a higher 12. For discussions of fiscal rules and budgeting in Indonesia, see Blöndal, Hawkesworth, and Choi’s (2009) and Budina et al.’s (2012) studies. The rule is contained in Government Regulation 23/2003 and pertains to Law 17/2003 on State Finance. 13. A mid-year revised budget is a standard part of the annual budgetary cycle in Indonesia. These figures are the ones presented by the government to the parliament. At the time of writing, the parliament had yet to vote on the budget. Survey of Recent Developments 173 FIGURE 3 Primary and Fiscal Balance, 2000–14 (% of GDP) 5 4 3 2 1 Primary balance 0 Downloaded by [Umeå University Library] at 01:05 19 August 2014 -1 -2 Fiscal balance -3 -4 -5 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Data from BPS (2014a, 2014b); BI (2014); Republic of Indonesia (2014). Note: The primary balance is the fiscal balance plus interest payments. Data for 2013 are actuals. Data for 2014 are the revised budget estimates in table 6. exchange rate than that assumed in the draft budget, as well as lower domestic oil production and higher domestic consumption. The government also faces revenue problems. Revenue actuals in 2013 were lower than expected, and although revenue growth of 11% is still planned for 2014 it starts from a 4% lower base. With weaker revenue and a ballooning fuel subsidy, the revised budget cuts expenditure harshly wherever possible: it axes capital spending by 18% (relative to the budget) and material (operations and maintenance) by 29% (table 6). Without major policy reform, this sort of compression of potentially productive expenditure will characterise future budgets, as elaborated on in the next section. Other recent economic policy developments include the long-awaited announcement of a new negative list for investment, perceived to reduce openness, especially in the energy sector (Jakarta Globe, 13 May 2014); a ruling by the Constitutional Court that customary forests should not be classified as state forests, that is, as under state control (Mongabay.com, 17 May 2013); and another ruling limiting the ability of the legislature to modify line-item budget allocations (Jakarta Post, 23 May 2014). Fiscal Policy Challenges for the Next Administration and Parliament Given the low stock of government debt, there is certainly no fiscal emergency in Indonesia. Yet the trend of rising deficits (figure 3) is concerning for three reasons. First, it is symptomatic of strong underlying upward pressure on expenditure not being matched by commensurate revenue growth. This poses a long-term threat to sustainability and a shorter-term risk to the macroeconomy, especially if the CAD remains stubbornly high. Second, the deficit cap combined with the government’s inability to control energy subsidies will crowd out more productive and TABLE 6 Budgets for 2012, 2013, and 2014 (Rp trillion) Downloaded by [Umeå University Library] at 01:05 19 August 2014 2012 2013 2014 Actual Revised Actual Budget Revised Change (%) REVENUES & GRANTS Domestic revenue Tax Domestic Income tax Value-added tax Other International trade taxes Non-tax Natural resource revenues Profits of state-owned enterprises Other Grants 1,338.1 1,332.3 980.5 930.9 465.1 337.6 128.2 49.7 351.8 225.8 1,502.0 1,497.5 1,148.4 1,099.9 538.8 423.7 137.5 48.4 349.2 203.7 1,437.0 1,431.5 1,077.3 1,029.8 506.4 384.7 138.7 47.4 354.2 226.8 1,667.1 1,665.8 1,280.4 1,226.5 586.3 493.0 147.2 53.9 385.4 226.0 1,597.7 1,595.4 1,232.1 1,176.9 562.5 475.6 138.8 55.2 363.3 221.2 –4.2 –4.2 –3.8 –4.0 –4.1 –3.5 –5.7 2.3 –5.7 –2.1 30.8 95.2 5.8 36.5 109.0 4.5 34.0 93.5 5.5 40.0 119.4 1.4 38.0 104.1 2.3 –5.1 –12.8 71.0 EXPENDITURE Personnel Material Capital Interest Subsidies Energy Fuel Electricity Transfers to regions Other 1,491.2 197.9 140.9 145.1 100.5 346.4 306.5 211.9 94.6 480.6 79.8 1,726.2 233.0 206.5 192.6 112.5 348.1 299.8 199.9 100.0 529.4 104.1 1,639.8 221.7 168.5 172.4 113.0 355.0 310.0 210.0 100.0 513.3 96.2 1,842.5 263.0 215.6 184.2 121.3 333.7 282.1 210.7 71.4 592.6 132.3 1,849.4 263.0 153.1 151.3 135.9 444.9 392.1 285.0 107.1 583.7 117.6 0.4 0.0 –29.0 –17.9 12.0 33.3 39.0 35.2 50.1 –1.5 –11.1 –153 –1.9 –224 –2.6 –203 –2.2 –175 –1.7 –252 –2.5 44.0 5.8 8.4 10,460 4.5 106 6.0 5.5 10,500 5.5 105 5.5 5.3 11,700 6.0 105 825 870 818 BALANCE (% of GDP) BUDGET ASSUMPTIONS (AND ACTUALS) GDP growth (%) 6.3 6.2 Inflation (%) 4.3 7.2 Exchange rate (avg Rp/$) 9,384 9,600 SBI exchange rate (avg %) 3.2 5.0 Crude oil price (avg $/barrel) 112.7 108 Oil production (avg ’000 barrels/day) 861 840 Source: Data from BI (2014); BPS (2014a, 2014b); Republic of Indonesia (2014). Note: SBI = Bank Indonesia Certificate. Survey of Recent Developments 175 FIGURE 4 Fuel and Non-fuel Subsidies as a Share of GDP and Government Expenditure, 1990–2014 (%) 6 Downloaded by [Umeå University Library] at 01:05 19 August 2014 5 30 Non-fuel (lhs) Fuel (lhs) Subsidies/expenditure (rhs) 25 4 20 3 15 2 10 1 5 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 0 Source: Data from BI (2014); Republic of Indonesia (2014). Note: Non-fuel subsidies are mainly electricity subsidies. Revised budget figures are used for 2014, as in table 6. equitable expenditures. Third, the preference of the Indonesian legislature to set ambitious sectoral and other spending targets not only adds to these concerns but also increasingly limits spending flexibility. Energy Subsidies Indonesia’s first (and oldest) fiscal policy challenge is, arguably, to tackle energy subsidies. Indonesia has subsidised energy prices since the Sukarno era, but did so only moderately until the late 1990s. During the 1997–98 Asian financial crisis, neither fuel prices nor electricity prices were adjusted to pass through the substantial depreciation in the exchange rate. Since then, energy subsidies, covering both electricity and fuel, have claimed an increasing share of the budget (figure 4). We focus here on fuel subsidies—specifically, for concreteness, the petrol subsidy. Figure 5 shows actual (regulated) monthly petrol prices alongside what they would have been without any subsidy, from January 2005 to April 2014. The prices are all adjusted for monthly inflation. The government increased fuel prices a number of times in the early 2000s, but in 2003 President Megawati reversed an earlier decision to do so. (She also removed an indexation rule, which had automatically linked domestic to international diesel prices.) In 2005, President Yudhoyono, not long after his election, raised the petrol price by 150% (in two stages) and accompanied it with a compensation package to cover this and other large fuel price increases (Sen and Steer 2005). Since the compensation package required legislative approval, in essence so did the fuel price increase. There was another significant price increase in 2008 (33% in the petrol price), accompanied by a similar compensation package. This increase did not last, 176 Stephen Howes and Robin Davies FIGURE 5 Petrol Subsidy and Regulated and Unsubsidised Petrol Prices, 2005–14 (Rp ’000/litre; 2002 prices) 6 Unsubsidised petrol price 5 4 Regulated petrol price 3 Downloaded by [Umeå University Library] at 01:05 19 August 2014 2 1 Per-litre subsidy 0 -1 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: Petrol price data from Mohammad Ikhsan. Monthly inflation data from BPS (2014c). however. Though the compensation package was left in place, the price increase itself was reversed by three price reductions between December 2008 and February 2009, motivated in part by the need for fiscal stimulus and the fall in global oil prices and in part by impending elections. Fuel prices were set to increase again in 2011, but the president abandoned the plan at the last minute. The government made another attempt in 2012, this time with the agreement that any increase would have parliamentary approval. But such approval was not forthcoming: the parliament authorised an increase in fuel prices only if international oil prices rose by 15% above that year’s budget assumption for the oil price, which they did not (Burke and Resosudarmo 2012). Fuel prices finally increased in July 2013 (by 44% in the petrol price), as part of that year’s revised budget (Nehru 2013). This again required parliamentary approval on account of the accompanying compensation package. The government has recognised the need for further fuel price increases. Indonesia’s finance minister, Chatib Basri, has floated the idea of replacing a fixed price per litre with a fixed subsidy per litre, falling over time, to reduce budget volatility and accustom consumers to a flexible fuel price. The president could in principle implement any such reform—whether of the amount of the subsidy or of its design—without parliamentary approval, provided that existing budget ceilings covered any compensation measures (since it is such measures that require parliamentary approval, not the price increase itself). However, any significant price increase will give rise to the expectation of additional compensation and thus, in practice, require parliamentary approval.14 14. There was some expectation that the revised budget would include an increased fuel price, but it did not. All electricity tariff adjustments have to be approved by parliament, which at the time of writing was considering a large such adjustment for July 2014 (Indonesia-Investments.com, 7 Jun 2014). Downloaded by [Umeå University Library] at 01:05 19 August 2014 Survey of Recent Developments 177 The 2015 budget is already being prepared—the outgoing president will present it to the outgoing parliament on 16 August 2014. Some observers argue that Yudhoyono will not want to leave a legacy of fiscal profligacy. While it is possible that the president will propose to increase fuel prices as part of the 2015 budget, in the run-up to the 2009 election the same president reduced fuel prices. Moreover, it would be unusual, and perhaps undesirable, for a lame-duck president to introduce a highly controversial proposal into the political fray after his successor has been announced. Another possibility is that the new president will amend the 2015 budget prior to its approval in order to incorporate fuel price increases. The new parliament will commence on 1 October and the president will be inaugurated shortly thereafter, but the budget is not due to be passed until the end of October. Alternatively, the new president could introduce such increases in the course of 2015, or later, either as part of the revised budget or as a stand-alone measure—or he could decide not to increase fuel prices for several years, which would keep the subsidy bill above 4% of GDP and 20% of total expenditure. As noted earlier, Jokowi has spoken in favour of reducing fuel subsidies over time, but it remains to be seen whether the new president, whoever he is, will be any more successful than his two predecessors in tackling this enduring and politically difficult problem. One lesson from Indonesia’s experience with fuel subsidies is that one-off increases, however large and admirable, are ultimately ineffectual. While Indonesia’s packages of price increases and compensation have been hailed worldwide (for example, Financial Times, 23 Sep 2009), they have not stopped the energy subsidy bill from rising over time. They are so difficult to engineer that they can occur only infrequently. Nor can an approach based on one-off increases rule out oneoff decreases: between 2003 and 2013, the petrol price was reduced (four times) almost as often as it was increased (five times). Figure 5 suggests that the enemy of fuel subsidy containment is not so much a rising international oil price, or even a depreciating rupiah, as simply inflation. After inflation, the subsidised or regulated petrol price is today 22% lower than it was immediately after the large price hikes in 2005. The unsubsidised price is just 6% lower, and the per-litre subsidy 43% larger. Huge political capital has had to be consumed merely to make up for the erosion in the real value of the subsidised price. Given the difficulty of the problem, many ways have been suggested to better target and limit the fuel price subsidy. The tendency has been to look for technical solutions, such as selling petrol only in certain locations (poor areas), or at certain times (not at weekends), or only to certain cars equipped to receive it (to exclude subsidised fuel-efficient cars [Jakarta Globe, 2 Apr 2014]). It is easier to segment the electricity market than the fuel market, and cross-subsidisation has been heavily prosecuted in the former. For example, not only do commercial users pay more than residential, and large commercial pay more than small commercial users, but, now, due to the most recent round of price increases, large commercial companies listed on the stock exchange pay more for their electricity than those not listed. In the fuel market, segmentation is also used as a strategy—industrial users no longer receive subsidised diesel—but none of the many technical proposals has been adopted, and nor are they likely to be, given how easy it would be to evade them. 178 Stephen Howes and Robin Davies FIGURE 6 Government Expenditure and Revenue as a Share of GDP, 1990–2014 (annual and average; %) 22 21 Expenditure 20 19 18 Downloaded by [Umeå University Library] at 01:05 19 August 2014 17 16 Revenue 15 14 1990 1992 2000 2002 2004 2006 2008 2010 2012 2014 Source: Data from BI (2014); Republic of Indonesia (2014). More radical reform is clearly needed, such as a time-bound program with an upfront agreement that the end result would be the elimination of energy subsidies within, say, three or four years.15 Given the political difficulty involved, it may be necessary for the president to seek parliamentary support for such a plan, though history shows that that itself would be a Herculean task. Other Fiscal Policy Challenges If all energy subsidies were eliminated immediately, the government would free up some 4.5% of GDP for deficit reduction or other spending. This would on its own solve Indonesia’s fiscal problems, at least for several years. But it would be naive to propound a fiscal adjustment strategy based only on fuel price reform. A broader approach is needed. Both revenue and expenditure fell, as a percentage of GDP, after the 2008 global financial crisis, but expenditure has since recovered to just over 18% of GDP, the average for the last 25 years, whereas revenue has not, and remains at under 16%, below the historical average of 17% (figure 6). Indeed, expenditure growth has been rapid across the board. Table 7 shows the average growth rates of expenditure during 2009–14, after inflation, for a number of major expenditure items. All have grown faster than GDP, except for interest payments. In addition, a growing proportion of government revenue is earmarked by legislation or Indonesia’s constitution: • The constitution requires that 20% of government spending be on education. While much of this is by subnational governments, in practice this provision pre-commits about 7% of central government expenditure. 15. Jokowi is reported to have committed to something similar: ‘In four years, the fuel subsidy should be eliminated gradually, step by step, until it’s gone’ (Jakarta Post, 2 May 2014). Survey of Recent Developments 179 Downloaded by [Umeå University Library] at 01:05 19 August 2014 TABLE 7 Selected Categories of Central Government Expenditure, Annual Average Growth, 2009–14, and Share in Total Expenditure, 2014 (2005 prices, %) Total expenditure Personnel Material Capital Interest Subsidies Social assistance Transfers to regions Annual average growth rate Share in total expenditure 2009–14 2014 8.4 9.3 7.5 8.6 1.9 19.5 11.4 7.4 100.0 14.2 8.3 8.2 7.3 24.1 4.8 31.6 Source: Data from Republic of Indonesia (2014); BPS (2014c); BI (2014). Note: Revised budget figures are used for 2014, as in table 6. • Indonesia’s complex decentralisation legislation translates in practice to a mandate on the central government to transfer at least 29% of its total revenue to subnational governments. • The new village law requires the central government to transfer 10% of its transfers to subnational governments to villages. This comes to about 3% of total expenditure. • Law 36/2009 on Health requires the non-salary health national budget to be 5% of total expenditure (article 171), much more than currently. If the budget were in balance, these requirements would altogether earmark about 45% of expenditure. A second category of expenditures are inflexible ones, in which we include subsidies and interest payments. Although very different, both are difficult to avoid or reduce. At current levels, inflexible expenditures are just more than a third of revenue, meaning that, in the absence of a deficit, legislated and inflexible expenditure commitments amount to about 80% of expenditure. But, in 2014, salaries, capital, and material (excluding education and health) alone take up more than a quarter of revenue, even after the cuts associated with the revised budget. Social assistance spending is another government priority (5% of revenue); other transfers to regions (on top of what is mandated by law) constitute about 8%. Unless fuel subsidies are quickly and largely eliminated, Indonesia will have to live with deficits for some time—otherwise the quality of spending will deteriorate greatly. Indeed, it will be difficult to limit the deficit to 3% of GDP. To provide a more rigorous, but still illustrative, analysis, we assume that in 2015 Indonesia has a 3% deficit (that is, the maximum possible given existing fiscal legislation), and that the revenue-to-GDP ratio stays at its current level, of 16.7% of GDP. We assume that all expenditures required by legislation (and the constitution) are incurred in full, that the subsidy ratio stays fixed as a percentage 180 Stephen Howes and Robin Davies TABLE 8 Simulation of 2015 Budget Challenges Share of expenditure (%) Share of GDP (%) 84.1 15.9 100.0 15.8 3.0 18.8 D.Legislated expenditure Education Health (non-salary) Mandated transfers to regions Village funds 39.4 7.0 5.0 24.4 3.0 7.4 1.3 0.9 4.6 0.6 E. Inflexible expenditure Subsidies Interest 30.4 23.4 6.9 5.7 4.4 1.3 F. Available funds for discretionary expenditure (C–D–E) 30.2 5.7 G.Policy-compliant discretionary expenditure Defence Other salaries Infrastructure Social assistance Discretionary grants & other 39.2 4.5 6.8 16.2 4.1 7.5 7.4 0.9 1.3 3.1 0.8 1.4 9.0 1.7 Downloaded by [Umeå University Library] at 01:05 19 August 2014 A.Total revenue B. Deficit C.Total expenditure H.Discretionary spending gap (G–F) Source: Indonesian budget documents; authors’ calculations and estimates. Note: See text for explanations. The 2014 base for defence, capital, material, and salaries uses budget rather than revised budget figures (table 6), since these avoid any forced cuts. Revised budget figures are used for interest and subsidy payments. Infrastructure is defined as capital and material excluding estimated defence, education, and health non-salary spending. Other salaries exclude estimated defence and education salaries. Nominal GDP growth for 2015 of 12% is assumed, with inflation of 6%. of GDP, and that the interest burden grows at historical rates (table 7). Under these assumptions, as table 8 shows, legislated and inflexible expenditure takes up 70% of total expenditure, leaving 30% for discretionary expenditure. Current policy settings favour large increases in defence spending (as described in several defence policy pronouncements, which include a spending target of 1.5% of GDP); the salary bill (as shown by past trends, and in line with the new civil service law); infrastructure spending; and social assistance. We simulate policy compliance in these areas by requiring them to grow in line with GDP (we assume a nominal growth rate of 12% for 2015). Other expenditures, mainly non-mandated regional transfers and grants, are merely increased in line with inflation. Under this simulation, even with a 3% deficit, the expenditure envelope is unable to meet spending requirements (table 8). On the contrary, the total available funding for discretionary spending falls short by some 1.7% of GDP or 9% of total available spending. Downloaded by [Umeå University Library] at 01:05 19 August 2014 Survey of Recent Developments 181 In practice, the Indonesian government will square this circle in several ways, including by delaying the full implementation of both the health law and the village law. But note that we are being conservative in our estimates of what policy requires when it comes to our category of discretionary spending. Indonesia needs to spend much more than 3% of GDP on infrastructure, especially when that amount includes maintenance. And, owing to a lack of data, we have not costed Law 40/2004 on Social Security, which obliges the government to establish health and labour insurance programs. As Armstrong and Rahardja (2014) explain, both these programs began in 2014 through the introduction of the National Social Security System (Sistem Jaminan Sosial Nasional), whose costs are expected to grow considerably. For these reasons, the new president will, for several years, find it difficult to restrict the deficit to 3% of GDP. Adhering to the 3% cap (which is important for macroeconomic reasons) is a more realistic short-term goal than eliminating the deficit. The president will need to increase the revenue-to-GDP ratio—at least back to the average of the last 20 years, and then some: Indonesia’s ratio is low compared with those of other lower-middle-income countries (IMF 2011, figure 2). He will need to implement a plan that will result in the elimination of fuel subsidies. He will have to decide which among a number of expenditure priorities are the most important (infrastructure, social assistance, or defence?). He would also be well advised to tread cautiously in implementing the legislated spending mandates he will inherit, and to work with parliament to unwind current earmarking and avoid it in the future. Indonesia has done well over the last five or even ten years. 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