Indonesia’s Economy: Changing Tides in the World’s Largest Archipelago

Interview by Timothy Higgins of Wijaya Sumono, former Jakarta-based Consultant for The Boston Consulting Group and 2013 graduate of the Johnson School of Management.

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How have declining commodity prices impacted the Indonesian economy, in both the public and private sector?

Declining commodity prices have had a direct negative impact on the Indonesian economy, adversely affecting both the private and the public sectors. Nearly 60% of Indonesia’s exports are commodities, which include coal, palm oil, rubber, coffee, cocoa – to name a few. Coal prices in particular have dropped by some 50% over the past four years ever since China, the world’s largest consumer and importer of coal, actively took steps to reduce coal consumption. Evidence of severe losses in coal mining across Indonesia’s public and private sectors is prevalent, and many mine sites have been abandoned. Similar stories are also heard in other commodity sectors. Take natural rubber for instance. Due to the global economic slowdown, which led to a decline in both the auto and subsequently tire industries, the price of natural rubber has fallen from over $5 per kg in 2011 to $1.4 per kg (according to the price of rubber futures at Singapore Commodity Exchange). Local farmers have since cut down on tapping rubber trees, either to curb losses or to look for better opportunities elsewhere. Production outputs of crumb rubber factories (natural rubber processing plants) subsequently took a deep hit in recent years. In 2015, the Director General of Indonesia’s tax office resigned from his post, having missed its 2015 tax revenue budget by around USD 18 billion, from the original target of approximately USD 94 billion.

Have these declines resulted in a boost to consumer spending from greater purchasing power?

It’s unclear whether lower commodity prices have positively impacted consumer spending, but if anything, the opposite seems to be true. Due to a slowing economy, and hence reduced incomes, consumers have subsequently cut back on spending. The majority of SMEs across virtually all sectors that I have encountered have lamented poor business. One good indicator of healthy domestic consumption is auto tire sales, which have declined by 20 to 30% y-o-y in 2015 (according to the Jakarta Post) – indicating a slowdown in demand for motor vehicles. The only sector bucking the trend seems to be the recently booming tech industry. Venture capital and private equity firms see huge upside potential in Indonesian markets thanks to the country’s large and growing population (the fourth most populous in the world), and several billion-dollar companies have recently been created in the tech space, thanks to large injections of foreign capital.

How have foreign and domestic companies reacted to regional geopolitical issues like conflict in the South China Sea and clashes over fishing rights?

Conflicts in the South China Sea haven’t had a strong direct impact on Indonesia, since it does not dispute over territory to the same extent that China does with Brunei, Malaysia, the Philippines and Vietnam. However, China has contributed to rising tensions with Southeast Asian countries over fishing rights in the region. The waters around the Indonesian archipelago supply approximately 10% of the total global catch, and Indonesia has aggressively strengthened its maritime sovereignty rights, starting with the appointment of Indonesia’s incumbent Minister of Maritime and Fisheries, Susi Pudjiastuti. Minister Susi has been very vocal and aggressive in cracking down on illegal poaching in Indonesian waters. Since 2014, Indonesia has sunk 174 foreign boats caught fishing illegally in Indonesian territories. On Tuesday (April 5th, 2016), Indonesia blew up 23 foreign boats – 10 Malaysian and 13 Vietnamese, to send a clear message on its tough stance over its maritime sovereignty.

Which industries have been most affected by slowing demand in China? Have other importers in the region (Japan, Korea) become stronger trading partners as a result?

Many industries have impacted by slowing demand, and the majority of commodity sectors have been adversely affected. While I don’t have data regarding changes in Indonesia’s trading volume with respect to specific countries, I believe it has stayed relatively constant. Regional slowdown in consumption has had a serious impact on the local economy in other ways than just exports, however. One recent example is from February this year, when Panasonic and Toshiba announced the closure of their TV and lighting plants respectively in Indonesia, leading to almost 2500 layoffs against the backdrop of a series of business closures across the country.

Is there a pervading consensus on the Trans-Pacific Partnership among the Indonesian business community, and if so, what is it?

The Jokowi administration has repeatedly asserted its interests for Indonesia to take a more active role on the international stage. President Jokowi had stated that he will sign the TPP agreement during his meeting with President Obama last year. However, I do not think there is any consensus among the business community on what form that role should take, nor was there much discussion that went on which involved the public.

Dancing to the Petrobeat

By Shohini Kundu

Since the summer of 2015, crude oil prices and the Dow Jones Industrial Average have been dancing a two-step tango. The pivot steps, marked by a sharp change in direction, are fully synchronized even when the music from the Fed signals no such turn. This is a sharp departure from the past five years when every turn of the stock market could be traced back to a change in key, orchestrated by the Fed.

The drivers for the oil market and stock prices are distinctly different. Oil prices are determined by supply and demand: demand increases during economic expansion, and the supply curves follow this trend in demand. The Organization of Oil Producing Countries, better known as OPEC, sought to buck this trend through collusion, and despite brief success in the 1970s in curtailing their crude supply, OPEC has not had a similar accomplishment in the recent past. Rivalry and mistrust among OPEC members and ballooning government budgets nudge them towards greater production, even at the risk of over-supplying the market.   On occasions when oil prices have increased, deflating consumer spending, infrastructure spending on clean technology and energy production has increased, offsetting the negative implications on the real economy. Consequently, the level of correlation between oil prices and the stock market has been low—only around 5%. This begs the question, why is the market ignoring cues from the Fed and dancing this tango with oil prices?

To understand this, one has to look no farther than the disproportionately large role Sovereign Wealth Funds (SWFs) are playing. SWFs are owned by states that seek to invest balance of payment surpluses for maximizing returns – accepting risks over liquidity. Nearly all countries that run a surplus balance of payments have created a SWF, and they generally fall into two categories. In the first category, there are industrial exporter countries such as China, Singapore and South Korea that have accumulated enormous amounts of foreign currency through trade surpluses. These states also have a persistently high rate of savings allowing governments to allocate a sizeable portion of savings for foreign investment. Apart from the obvious benefits of diversification, such investments assist countries in dispersing excess liquidity which may otherwise lead to appreciation of domestic currencies and imperil exports. The second group of countries that operate a SWF are commodity-producing countries. These countries use the SWF to hedge against precipitous drops in commodity prices. In other words, the SWF is used as a vehicle to manage windfalls when commodity prices increase above their fair valuation for use at a later date when the commodity prices fall. In terms of assets, the Norwegian Sovereign Wealth Fund tops with nearly $900 billion in investments, followed by the Abu Dhabi Investment Authority, Saudi Arabia Foreign Holdings, and China Investment Corporation at about $750 billion each, followed by the Kuwait Investment Authority at nearly $600 billion.

While the price of crude oil is set by supply and demand, the cost of production varies widely by country. For obvious reasons, the cost of crude production from shale oil or off-shore drilling is significantly higher than that of light sweet crude produced inland. While the cost of production per barrel of crude oil is just below $10.00 in Kuwait or Saudi Arabia, it is $23.50 in Venezuela, $36.00 in Norway and $52.50 in the United Kingdom.

At current prices of $30-35 per barrel of crude, the profit margin has shrunk significantly for Saudi Arabia and the United Arab Emirates, while losses are mounting for Norway, Brazil, Canada and the UK. Against this backdrop we are witnessing massive selloffs of SWFs by commodity-producing countries to meet pension and social welfare obligations. According to the Financial Times, SWFs from commodity countries pulled at least $46.5 billion in 2015. The rate of selloff accelerated sharply in 2016. The scale of redemption moves inversely with the price of oil; when the price of oil turns lower, the level of redemptions rise bringing the stock prices lower. Hence, we have this two-step tango.

In the long run, stock valuations are determined by earnings, wages, interest rates and production costs. Energy costs today comprise a small fraction of the overall production cost, thus we expect to see that stock valuations will decouple from oil prices. The current tango will end only when the redemption by SWFs wanes in magnitude, which will likely happen when crude prices again go above $50 a barrel. Until then, let us charm ourselves with the two-step tango to the petrobeat: down-down-up-up-down…

Brazil: A Reflection of Latin America

By Ignacio Garcia Conway

During the late 20th century, Brazil’s story was not very different from that of the rest of Latin America. As the 1980s began most South and Central American countries, along other developing nations of the world, faced stagnant economies with high levels of inflation. The Mexican default in 1982 augmented monetary pressures throughout the region, leading to the loss of Brazil’s access to foreign financial markets. By 1985 one thing was clear: economic and fiscal reform was necessary.

For close to a decade, the Brazilian government failed to reduce inflationary pressures or accelerate economic growth. It was not until 1994 and the election of President Fernando Henrique Cardoso, who would serve until 2003, that Brazil would start a successful stabilization program. The “Real Plan” managed to decrease levels of inflation and thus create a new consumer class in Brazil that would push for the development of the country. Initially, investors had doubts on the Real Plan’s success, but these were silenced by an increasing GDP and rapid growth.

The government’s actions were not unique to Brazil, but reflected the results of what economist John Williamson termed the Washington Consensus of 1989. It originally consisted of 10 policy areas Williamson observed to be common in the advice given to Latin American governments by Washington-based institutions such as the International Monetary Fund, the World Bank and the U.S. Treasury. The term quickly went on to represent the neoliberal and market-based approaches most governments took to confront the crisis.

Yet the Washington Consensus had social and political undertones as well. The quick economic recovery was at the expense of many, increasing inequality and leaving lower class citizens out of the equation. This led to a leftist backlash in the region, leading to many political victories for worker and socialist party leaders such as Hugo Chavez in 1999 and Evo Morales in 2006. In Brazil, Luiz Inácio Lula da Silva, founder of the Brazilian Worker’s Party, was inaugurated as president in 2003, and throughout his presidency, the country prospered. Many deemed the new political spectrum of Brazil and other South American countries a success, yet by the end of the decade and the beginning of the next, the economy would suffer a contraction.

Crippled with falling demand for exports, a devaluing currency, increasing levels of unemployment and a new administration, Brazil entered the second decade of the 21st century on tough terms. For most of the 2000s, Brazil had an export dependency on China, but as the Chinese economy began to slow down, fewer Brazilian products were demanded and prices plummeted along with a surplus of goods. Investment fell 12% in the second quarter of 2015 as unemployment rose to 8%. By August 2015, the real had devalued 25% against the dollar. The high levels of public and private debt led to a decrease in consumption of more than 1.5% in both sectors, and by the last quarter of the year, GDP had an annual growth rate of -5.9%.

Amongst all the economic turmoil, corruption scandals involving President Dilma Rousseff, da Silva’s handpicked successor, and Petrobras, a state-owned oil and Energy Company, spread through Brazilian society.  An investigation that began inspecting money laundering in car wash establishments led to the discovery of bribery to Petrobras executives from construction companies in order to secure contracts. It was estimated that the funds used in the scheme amounted to almost $2 billion. Since “Operation Car Wash” became public, many politicians and company executives have been detained and questioned. Coincidentally, the majority of these events were said to take place when Dilma Rousseff was chairman of Petrobras. While the current president denies any knowledge of the alleged events, Senator Delcídio do Amaral testified on March 15, 2016 that Rousseff was aware of the corruption and tried to impede the investigation along with members of her cabinet.  Unfortunately for Petrobras, these accusations greatly affected the company’s market value, reducing it by 60% in 2014.

By late 2015, Rousseff’s approval rating was a dismal 8%, and Brazilian society was infuriated with its government’s affairs and the general economy. Large protests began to form, calling for action, with some even leaning towards military intervention. The president reaffirmed the people’s right to protest and agreed with them that Petrobras should be cleaned up. Yet, she has not taken any immediate action against the company or the members of her party involved, relying on the already corrupt judicial system. The delicate situation reached a climax when former president Lula da Silva’s administration was also called into question.

On March 4, 2016, da Silva’s house was under federal investigation and the former president was taken in for questioning. Investigators claim that Lula da Silva received benefits, including renovations for his beach homes and campaign funding, in connection to the Petrobras scandal. Furthermore, doubts about the success of his presidency emerged. Lula left office with almost 80% approval after having improved the minimum wage and other popular measures, but in hindsight, his failure to deal with structural inequality is now said to have contributed to the current crisis. Moreover, in an attempt to help Lula da Silva avoid prosecution, Rousseff appointed him as her Chief of Staff. A federal judge later blocked the appointment.

Massive protests are calling for the impeachment of President Rousseff, for having allowed the economic situation to worsen as her party is investigated for corruption.  She has refused to step down on the grounds that she was elected in a democratic process, and Rousseff blames her political opponents for prolonging the economic crisis by creating a negative image of her administration, causing political disorder. However, members of the president’s administration also seem to disapprove of her tactics since some, such as Sports Minister George Hilton, have resigned from their positions in protest. As her administration and government coalition crumble before her, Dilma Rousseff’s impeachment becomes ever more likely, and on April 5, a justice of the Brazilian Supreme Court ordered the country’s legislature to begin impeachment proceedings against Rousseff’s Vice President, further deepening the crisis.

For all of the drama surrounding the scandals in Brazil, their government is not the only leftist administration facing problems in Latin America. On November 22, 2015, Mauricio Macri, a center-right politician, won the presidency of Argentina, marking the end of the 12-year Kirchner leftist government. In Venezuela, approval for Chavism has been in decline since 2007 and is now at an all-time low due to President Nicolas Maduro’s unsuccessful attempts to boost the mess that is the Venezuelan economy. Meanwhile, Evo Morales, Bolivia’s democratic socialist President, enters his last term after losing a referendum that would allow him to extend his presidency to a fourth term. A center-right backlash is beginning to solidify throughout most of South America as many of the region’s economies and governments cripple. Could it be then that, like in the late 20th century, Brazil’s story today is not very different from that of the rest of Latin America?