Indonesia’s panacea: Infrastructure improvement

We recently held a Bahana Forum, a gathering of institutional investors including pension fund managers. We were honored to have Dr. Halim Alamsjah, Deputy Governor of Bank Indonesia, as our guest speaker, updating us on current economic trends and the future of Bank Indonesia’s policy.

The timing of the forum and discussion was undoubtedly timely with latest WEF (World Economic Forum) competitiveness report, the IMF’s September report on selected issues in Indonesia as well as Bank Indonesia’s recent plan to raise banks’ reserve requirements.

In the WEF latest report, Indonesia’s competitiveness jumped to 44 from previous 54. However, Indonesia’s rank was still below our neighboring countries such as Singapore, Malaysia, Brunei and Thailand.

On a separate report, the IMF reported that Indonesia’s commodity boom in recent years resulted in significant real exchange rate appreciation that could threaten Indonesia’s exports of manufactured products (Dutch disease threat).

At our Forum, Dr. Alamsjah mentioned several problems surrounding the Indonesian economy at present, highlighting in particular the country’s infrastructure problems — from electricity supplies to road access to ports, which can have profoundly adverse impact on the manufacturing sector’s competitive level globally.

We note that while Indonesia’s manufacturing sector’s contribution to the economy is the largest at around 26 percent, its quarter-on-quarter growth in the second quarter 2010 was only 2 percent, vis-à-vis transport and communication sector of 5 percent. This relatively lower growth performance in the manufacturing sector affects the appetite of the banking sector to provide lending. Based on
2010 Bank Indonesia’s survey, banks propensity to avoid financing manufacturing industries has increased to 32 percent in 2010 from 28 percent in 2009.

The result of the aforementioned BI polls reflects the urgency of the implementation of infrastructure-related projects. It is worth highlighting that around 65 percent of Indonesia’s employment stems from the agriculture and manufacturing sectors. Therefore, better performance in the manufacturing sector would undoubtedly boost domestic consumption resulting in a virtuous circle. Thus, it is safe to assume that lack of proper infrastructure does not only slow the manufacturing sector but is also a drag on domestic consumption (i.e. 65 percent of GDP) and Indonesia’s overall GDP growth.

Another point that also emerged during the Bahana Forum was that infrastructure was also the answer to Indonesia’s effort to contain inflationary pressure amid potential weather anomalies which are threatening the supply of food and processed food commodities. Improved infrastructure projects (e.g. roads, electricity and irrigation) could minimize the impact of food price volatility. Bank Indonesia mentioned that the solution should be in the form of better production system, improved stock management and enhanced distribution.

We believe that better-developed infrastructure could help tame inflation and in the end, maintain consumers’ purchasing power. According to the IMF, Indonesia’s consumer price (CPI) had averaged nearly 12 percent since 1997 and 8.5 percent since the implementation of inflation targeting in 2005. Since 2005, inflation in Malaysia, Thailand and the Philippines all recorded relatively lower figures of around 3 percent-6 percent while Mexico and Brazil inflation only reached 4 percent-5 percent.

In sum, high inflation and greater economic growth hinge on the country’s infrastructure-related projects, which are urgently required not only to raise competitiveness but also Indonesians’ purchasing power.

At this stage of the development, rather than looking at the whole archipelago and wonder where infrastructure development should be focused, the government only needs to concentrate on Jabodetabek (the Greater Jakarta Area), where most of the country’s industrial estates are located.

However, this will be easier said than done given Indonesia’s rapidly increasing car and motorcycle sales in the past few years without new roads being built. This monumental project requires immense and intense coordination between ministries, contractors and banks as lenders. The task is daunting, but progress towards infrastructure development as a panacea is undoubtedly too important to ignore for Indonesia.

The writer is an economist at PT Bahana Securities.