Can Indonesia Break With the Past?

Can President Susilo Bambang Yudhoyono keep the country on the path of reform?

INDONESIA ELECTIONS

Susilo Bambang Yudhoyono, Indonesia’s president, smiles during an election campaign rally for the Democrat Party at Gelora Bung Karno Stadium in Jakarta, Indonesia, on Friday, March 20, 2009. Yudhoyono’s Democrat Party may topple Golkar as the country’s biggest political party in the April 9 parliamentary election, according to a survey released last week by the University of Indonesia, the Indonesian Institute of Sciences and two other organizations. Golkar is the party of the late dictator Suharto. Photographer: Dimas Ardian/Bloomberg News

DIMAS ARDIAN/BLOOMBERG NEWS

For a country that once seemed synonymous with crisis, the financial and economic turmoil of the past two years has been a revelation. Indonesia’s economy has powered ahead during the recent turbulence, with nary a stumble, more in tune with the dynamism of its big Asian partners than with the struggling West. Its 4.5 percent growth rate last year was the third fastest of the Group of 20 countries, after China and India, and output is expected to accelerate to 6.0 percent this year. Living standards have more than doubled over the past decade, lifting tens of millions of people out of poverty. For many Indonesians it’s hard to believe that barely a decade ago the country was on the brink of collapse over the fallout from the Asian financial crisis, political unrest after the resignation of authoritarian leader Suharto, and religious and ethnic conflict in this nation of 240 million people.

“I look at news of Thailand and Greece today, and I think of Indonesia back in 1997,” says Gita Irawan Wirjawan, the former head of JPMorgan Chase & Co. in Indonesia who today, as chairman of the Indonesia Investment Coordinating Board, is the top government official in charge of project investments. “I seriously thought Indonesia would balkanize.”

Far from breaking up, Indonesia has bounced back with surprising vigor. The country made a relatively smooth transition from authoritarianism to democracy with the election of Abdurrahman Wahid as president in 1999, and the government began restoring public finances to health under the terms of a bailout from the International Monetary Fund. Growth and investment have accelerated under President Susilo Bambang Yudhoyono, a former career Army officer whose promises to fight endemic corruption and share prosperity more widely swept him to power in 2004. He appointed a team of tough-minded technocrats, led by Finance Minister Sri Mulyani Indrawati, that cracked down on bribery, slashed the government’s debt and courted foreign investors. The economy grew at an average rate of 5.6 percent a year from 2005 to 2009 and avoided the recessions that hit Malaysia, Singapore and Thailand as part of the recent global slump. That performance helped Yudhoyono win easy reelection last July, with 61 percent of the vote.

“In a way this recent global crisis has been a good opportunity for Indonesia to showcase its good macroeconomic policy settings,” says Michael Buchanan, Asia chief economist for Goldman Sachs Group in Hong Kong. “It came through better than others due to underlying domestic demand and due to policy settings that have been pretty sensible.”

In short, Indonesia seems to have left behind the bad old days of corruption and instability. Or has it? The sudden resignation of Mulyani in early May, after months of attacks by opposition politicians and some members of the governing coalition over a 2008 bank bailout, raised fears that the government’s reform program was running out of steam.

Particularly worrying for many analysts and foreign investors was Yudhoyono’s subsequent move to appoint Aburizal Bakrie, a business tycoon and leader of the Golkar Party, as chairman of the coalition parties in parliament. Bakrie is a billionaire whose family-owned conglomerate, Bakrie & Brothers, rose to prominence during the Suharto regime. He had reportedly clashed with Mulyani over issues related to his business interests and led a public campaign for her resignation over the bank bailout.

“Sri Mulyani’s departure is a bad sign about the Indonesian government’s wherewithal to address corruption and undertake systemic reform, something it desperately needs to do,” says Walter Lohman, director of Washington, D.C.–based Heritage Foundation’s Asian Studies Center.

Yudhoyono insists, however, that the controversy over Mulyani won’t knock the government off course. “After being out of the monetary crisis ten years ago, Indonesia’s economy is now back on track,” he tells Institutional Investor in a recent interview at Istana Tampaksiring, the presidential palace in Bali, one of three that the head of state has in this archipelago nation of 17,000 islands.

The administration will continue its efforts to weed out corruption, which the president acknowledges could threaten the country’s future. “Our campaign is indiscriminate. No one is spared or above the law,” he says in the interview, the first he has given to a foreign media outlet in five years. The government will also keep a firm grip on public finances and maintain an open door for foreign investors, in an effort to accelerate growth to an average rate of 7 percent over the next five years, he adds. “In order to achieve these targets, institutional reforms to ensure good governance would be key. We need strong institutions, public and private, to deliver our development objectives,” he says.

Most analysts are cautiously optimistic that Yudhoyono will be good to his word, even if they have concerns over Mulyani’s departure. They welcomed his appointment of Agus Martowardojo as the new Finance minister last month as a sign of renewed commitment to reform. Martowardojo had been head of Bank Mandiri, the country’s largest state-owned bank, and his a track record of being tough in collecting debts owed by wealthy families in Indonesia suggests he will not be cowed by vested interest groups, says Ambreesh Srivastava, senior director of Asian financial institutions at Fitch Ratings in Singapore. Martowardojo also enjoys a strong reputation in the markets. Analysts and investors voted him as the top bank CEO in Southeast Asia in II’s new survey, Captains of Asian Finance (see story, page 72).

Mulyani’s resignation “is a setback in terms of expectations on the speed and extent of reforms, but we do not see an immediate impact on Indonesia’s ratings,” says Agost Benard, a Singapore-based associate director of sovereign and international public finance ratings at Standard & Poor’s, which has a BB rating on Indonesia’s debt. “Our expectation is that the overall policy direction in fiscal, monetary and debt management will prevail and that most key reforms previously initiated will take place, even if at a possibly slower pace.”

Ostensibly, the controversy over Mulyani stemmed from the government’s decision to bail out Bank Century, a midsize lender that ran into trouble during the tightening of global markets after the failure of Lehman Brothers Holdings in 2008. Officials led by Mulyani and then–central bank governor Boediono, who is now vice president, argued that the government should intervene to prevent a run on the banking system. The legislature approved 1.3 trillion rupiah ($140 million) for the bailout, but the cost of government intervention ultimately escalated to 6.76 trillion rupiah. Megawati Sukarnoputri’s opposition Indonesian Democratic Party – Struggle as well as two coalition parties, Bakrie’s Golkar Party and the Prosperous Justice Party, accused Mulyani and Boediono of mismanaging the bailout and called for them to step down, pending an investigation.

Aides close to Mulyani say the flap over Bank Century is a smokescreen and insist the government handled the case correctly. The real reason the former minister came under attack, they contend, is because of her efforts to crack down on tax evasion by leading business and political figures, including several close to Bakrie. The Finance ministry’s tax office has alleged that Bumi Resources, the mining arm of the Bakrie holding company, and two coal subsidiaries owe 2.1 trillion rupiah in back taxes; the authorities imposed a travel ban on some of the companies’ executives to pursue the tax claim.

Mulyani herself told the Wall Street Journal late last year that her fallout with Bakrie stemmed from late 2008, when she opposed calls for an extended closure of the Indonesia Stock Exchange at a time when global markets were in turmoil and share prices of some Bakrie companies were plummeting. In the two months following the collapse of Lehman Brothers, Bumi Resources shares fell 79.7 percent.

“Aburizal Bakrie is not happy with me,” Mulyani was quoted as saying. “I’m not expecting anyone in Golkar will be fair or kind to me.” Mulyani and Bakrie declined to comment for this article.

In his interview with II, which took place a few days before Mulyani resigned, President Yudhoyono rejected the criticism of his ministers and defended their actions in the bank bailout. “A decision was taken by some of my cabinet members — and at a time when quick action was necessary, they acted fast,” he says. “It has been proven that their actions have saved Indonesia from banking and economic crisis, unlike in 1998.”

Indonesia’s loss will be the World Bank’s gain. After resigning, Mulyani promptly agreed to become one of the three managing directors at the Washington-based institution. Announcing the appointment, World Bank President Robert Zoellick praised her deep knowledge of development issues and “her success in combating corruption and strengthening good governance.” Boediono, who like many Indonesians uses only one name, remains in office as vice president.

Other top officials also insist that the government will maintain its reform efforts despite the recent shake-up. “Indonesia will continue to rise,” says investment board chief Wirjawan. “The country has been doing well in the last five years, and, without undermining what the minister of Finance has done, this success means there are still a lot of capable people in government who will continue to work on the reforms that the country is set to do.”

Yudhoyono, known to many Indonesians by his initials, SBY, is in many respects an unlikely reform leader. The son of an Army officer, he entered the Armed Forces Academy in Bandung in 1970 and graduated at the top of his class three years later, receiving the prestigious Adhi Makayasa medal from then-President Suharto. He joined Golkar, the party that Suharto founded and used to rule Indonesia for more than three decades, and rose rapidly up the Army ranks to become chief of staff for social-political affairs in 1997. Along the way he studied at the U.S. Army Command and General Staff College at Fort Leavenworth, Kansas.

When Suharto was forced from office in 1998, a media-savvy Yudhoyono with excellent command of English stepped into the public eye. He spoke of the need for reform in frequent interviews and gained a reputation as the “thinking general.”

President Wahid brought him into government as Mining and Energy minister in 1999 and later moved him to the post of minister for Political and Security Affairs, with the primary job of getting the Army out of everyday politics. In a striking way he did just that. Facing an impeachment vote in parliament over allegations of corruption and incompetence, Wahid sought to declare a state of emergency, but Yudhoyono refused. Wahid fired his minister shortly before being removed from office, in 2001.

Incoming President Megawati promptly appointed Yudhoyono to his old security post. He burnished his reputation by successfully overseeing the hunt for the Islamic terrorists responsible for the October 2002 bombing of Bali nightclubs, which killed 202 people. The following year the Megawati government adopted his successful strategy to crush the separatist Free Aceh Movement, declaring martial law in Aceh province and routing rebel forces before offering the area semiautonomous rule.

With his popularity running high, Yudhoyono resigned his ministerial post in 2004 and ran as the Democratic Party candidate for president on a reform platform that promised to share the fruits of prosperity more widely in society. He defeated Megawati by a wide margin in a runoff election in September that year.

Yudhoyono handed economic policy over to a team of technocrats, including Mulyani, who holds a Ph.D. in economics from the University of Illinois and previously served as an adviser to Wahid and as Indonesia’s executive director at the International Monetary Fund. She was named minister for development planning in 2004 before being moved to Finance a year later.

In Yudhoyono’s first term the government pushed through an investment law that put foreigners on an equal footing with domestic investors and liberalized banking, finance and capital markets. The initiatives helped increase foreign direct investment to $14.9 billion in 2008 from $4.6 billion in 2004; it slipped to $10.8 billion last year.

At the Investment Coordinating Board, Wirjawan has been leading efforts to weed out nettlesome regulations and create a one-stop shop for approving investment projects. “You no longer need to go to 15 ministers to sign off,” he says. “We help you get a permit in as short as five hours, and no more than seven days. This is down from six months. Everything is done online. All you need is a minimal investment of $250,000.”

Wirjawan has also opened up to foreign investors some industries that were closed in the past. Foreigners are now allowed to take stakes of up 67 percent in health-related projects and up to 49 percent in businesses that grow and trade agricultural commodities. The board is also now pushing to eliminate a ban on foreigners owning real estate.

The government also cracked down on corruption, which had flourished during the Suharto regime. One of Mulyani’s first acts as Finance minister was to fire hundreds of corrupt tax and custom officers. She also revised incentive structures for civil servants in the ministry and raised salaries for tax officials, in a bid to make them less susceptible to bribes.

Many opposition legislators accused the government of being selective in its corruption crackdown. Last year, however, Aulia Pohan, a former deputy central bank governor whose daughter is married to Yudhoyono’s eldest son, was jailed for his involvement in the 2003 embezzlement of 100 billion rupiah from a central bank foundation.

Mulyani also maintained strong control of the government budget. Stronger-than-expected revenues contained the deficit at just 1.6 percent of GDP last year. The tight restraint on deficit spending combined with faster economic growth has reduced government debt to some 30 percent of GDP from 60 percent four years ago. Foreign exchange reserves nearly doubled on her watch, hitting a record high of $71.8 billion in March.

The government’s reforms laid the foundation for Indonesia’s resilience during the past two years, says Ito Warsito, president of the Indonesia Stock Exchange. “Indonesia did exceptionally well,” he tells II. “I was surprised with the result of what the government did in 2007 and 2008, because I actually didn’t think our economy would be sheltered from the global crisis.”

Improved policies have enabled Indonesia to take full advantage of Asia’s wider economic boom. The country has diversified away from a reliance on trade and investments from developed nations like Europe, Japan and the U.S. and deepened economic links with emerging Asian powers led by China and India. China National Offshore Oil Corp., which in 2002 acquired five exploration blocks from Spain’s Repsol YPF for $585 million, is the largest offshore oil company in Indonesia. China Investment Corp., the country’s sovereign wealth fund, invested $1.9 billion in bonds of Bakrie’s Bumi Resources last year.

Many Indonesian business leaders had expressed concern that the country would be swamped with cheap Chinese imports after a free-trade agreement between China and the Association of South East Asian Nations, of which Indonesia is a member, took full effect in January. So far, however, those fears haven’t been realized. “Indonesia has come a long way since the Asian financial crisis,” says Tigor Siahaan, head of the institutional clients group for Indonesia at Citibank. “A lot more people are coming back now to invest. The confidence is coming back. Per capita GDP is $2,200 now; it was $1,000 five years ago. The economy should double in the next five to six years.”

Yudhoyono and his government still face plenty of challenges, though. Even after the gains of the past five years, the country has a long way to go to fulfill the United Nations Millennium Development Goals, which call for, among other things, halving the number of people living on less than $1 a day, reaching full employment, ensuring that all children get a primary education and slashing child mortality by 2015.

“In 2007 nearly half of Indonesia’s population was still either poor or had per capita consumption levels of less than one third above the national poverty line,” the World Bank said in its latest country report on Indonesia. It also cited slow employment growth, inadequate public services and lagging performance on a number of health indicators. “In meeting these challenges, Indonesia’s main constraint today is not a lack of financial resources but the need for effective and accountable institutions that can translate available resources into better development.”

Mulyani certainly understood that challenge. The question now is whether Yudhoyono and his government can meet it without her.

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