Indonesia growth: 5% is not good enough

Mirza Adityaswara, senior deputy governor at the country's central bank, tells FinanceAsia the budget needs to be re-allocated to achieve 7% growth target.

Indonesia’s president-elect Joko “Jokowi” Widodo has promised GDP growth of 7% by 2019. However, infrastructure is in a parlous state, commodity prices  the country’s main export  are falling and an impending cut to fuel subsidies could prove a hot potato. Mirza Adityaswara, senior deputy governor at Bank Indonesia, the country’s central bank, told FinanceAsia at BI’s Jakarta offices what needs to be done to fulfill the country’s oft-touted potential.

You kept the benchmark interest rate steady at 7.5% today (September 11). Are you happy with the way things are going, economically?
Mirza Adityaswara: Bank Indonesia has maintained rates since last year. Year-to-date inflation is within our tolerance range of 3.5%-5.5% and we think by the end of the year inflation will be 5.2%-5.4%. Since the end of 2011 we have had a current account deficit, which is getting bigger. The deficit in first-quarter 2014 was 2% but then it hit 4.2% in Q2. The reason is because the coal price has continued to weaken [and] oil imports remained high. That is why we think, even though inflation is already coming down, we maintain a ‘tight bias policy’. Also, we know that US rates will rise and there is a risk of an increase sooner than what the market thinks. That’s why we need to be prudent with monetary policy. 

Economic growth is at 5.1%. Do you think Widodo’s target of 7% growth by 2019 is realistic?
In terms of potential, with the right economic policy, we can have 7% growth by 2019. What is the right economic policy? Firstly, we need to re-allocate the government’s budget for a more productive use. This means the fuel subsidy expenditure, which is now Rp400 trillion ($33.7 billion), needs to be re-allocated; for infrastructure, hospitals, water sanitation, education. That’s one.

Another is to continue structural reforms. This means Indonesia needs to reduce dependency on commodities. It needs to strengthen manufacturing competitiveness; and this needs infrastructure – roads, sea ports, railways – investment incentives and a good labour policy that supports economic growth.

And we need energy diversification. Indonesia is now becoming an importer of fuel even though we have sources of geo-thermal, water and coal but now the majority of our coal is exported [rather] than used for domestic power. We need support from the central and local governments.

Are the central and local governments doing enough in this regard?
Central government is not the only institution that is important for economic growth. There is local government, which is very important because execution is [carried out by] local government. Before reform, in 1988, we had about 220 local governments; now we have 580 local governments and the quality is various. Some are very investment oriented but some don’t realise its importance.

So, is 7% realistic? It depends on whether central and local governments can execute. If not, Indonesia will grow at around 5%, which is still good compared to other countries but not good enough when you think of our potential.

That word potential. Whenever anyone talks of Indonesia they speak of potential. Does more need to be done to encourage foreign investors to realise this potential?
Of course. Again, the current account deficit needs to be financed. This can come from 2 sources: portfolio investment and foreign direct investment (FDI).  FDI will have a direct impact on employment and it is not volatile; it doesn’t easily come and go, while portfolio investment does easily come and go.

Also if we can reduce the deficit it is even better because this means we can reduce [our] financing needs. How to reduce the deficit? We need to increase exports and/or reduce imports. [On the] exports side, we need to diversify to non-commodities. Ie, manufacturing. For imports we need to reduce imports of energy, meaning we also need to diversify. But [we must] obviously focus on products in which we are competitive.

We have a lot of potential for tourism but the number of tourists who come here compared to Malaysia and Thailand is still [few]. It is a good opportunity [for us] to grow outside Java. Our places for tourism are not only Bali actually. But for tourism, again, you need infrastructure.

Why is the infrastructure in Indonesia so bad?
First, there has been a mis-allocation of resources; going to fuel subsidy and not infrastructure. Second, there is a plan for infrastructure but the execution is slow. It is not only about funding but also execution. If you want to build a road, from west to east Java for example, you need not only funds but land acquisition agreements.

This is already a democracy. You need support from local governments. You need to build transmission lines, which will pass through several provinces, so you need support. It is easy to say but you need time because we are still learning about democracy and decentralisation. So far we are moving forward but maybe not as fast as people want.

How happy are you with the banking system in terms of whether it can absorb shocks?
Capital adequacy ratios are very high, and banks also have sufficient loan loss coverage. 500% of NPLs. Indonesia’s banks are still very profitable, even though net interest margins have declined during tightening. But they are still high compared to Singapore and Hong Kong. That’s why foreign investors are still looking to buy Indonesian banks.

That said, are there too many?
Yes, consolidation is good. Because 15 banks already cover maybe 90% of the banking system and we have 120 commercial banks.  We have rural banks also but they are very tiny. So it is good if we can consolidate the small banks. But if not, at least the small banks are relatively healthy. Of course there are some banks that need to be restructured but that’s not a major issue.

The rupiah has been on a rollercoaster. Where do you see it? Is it under control? Is it ever under control?
The rupiah, at its present level, is at a level we are comfortable with. Some people say that Rp10,000 [to the dollar] is better than Rp11,800 [its current level]. This is not right. Rp10,000 is proper for a current account surplus. In a deficit situation, Rp10,000 will only make you import more and your exports will suffer. That is why we think the present level, as long as it is stable, is comfortable.

What is the risk that it might become unstable?
The risk is about US rates increase and about China slowing down faster and lower than forecast. Now people can accept that China’s economic growth is around 7.4% [7.5% in Q2] but if this falls to below 7% next year, it will create problems for emerging markets. Exports will fall and commodity prices will fall further.

People say that Indonesia is no longer in the fragile five [most vulnerable currencies]. So we don’t want to be included again in the fragile five. Indonesia has high potential but this is a stabilisation period. We prioritise stabilisation over growth.

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