Transcript of The Transformation of the Indonesian Economy in Challenging Times by Sri Mulyani

The Transformation of the Indonesian Economy in Challenging Times

By

Sri Mulyani Indrawati

Transcribed by Indra Gunawan

Thank you very much Taka. Especially for a very nice introduction. I was not actually really remember what I did in the IMF until he just reminds me that I was there as an executive director and I would like to thank CIPA as well as The East Asian Institute and the APEC Study Center. And I was told by ibu Marry that BKPM that is The Indonesian Investment Promotion Center [which] is also jointly hosting this event. So thank you very much for inviting me here. On the communication with both, ibu Marry and Taka, they both ask me to speak about Indonesia as well as the global environment, off course, inviting me, I should not only speak about Indonesia now especially in my position that is always the advisor of the World Bank because I am no longer only belong to Indonesian, I am belong to the world, thanks.

So, let me start maybe with a few words on the world that we are all living in since the financial crisis of 2008. When I looked back, where the world was 5 years ago, I see a very different picture. The emerging markets were confident if you looked back in 2009. They came out of the global financial crisis strong, and producing two-third of global growth. While high income economy like the United States, Europe, they are all at that time was struggle to recover from the global financial crisis. But if you look back today’s picture, the situation has changed. China’s growth is slowing, even if you talk Brazil, Russia are in recession. And in Indonesia, my own country, and the country that we want to discuss today, is not living up to its potential. The tone from many policy maker has definitely changed. The confidence is gone, and you hear a lot more humility coming from capitals of emerging markets. The challenges in the global economy are multidimensional and well known. We face low demand from China, that hurting many emerging and the developing countries in the world. In fact, actually, two weeks ago I was in Senegal to discuss about the international development aids [..] review and I can really see and feel that Africa is really affected by the slowing down of the China economy.

We also expect a tightening financial condition following a likely rise of the United States’ interest rates in December. The low commodity prices, rate havoc on the budget of many exporting countries, and the weak global trade is failing to kick start the engine of global growth. So putting all these together, we think that 2016 will continue to be a challenging with significant headwinds on the broad base weaknesses. We will see the global growth continue to disappoint, likely to be only growing around 2.5 percent in 2015 and about 3 percent in 2016, and the recovery in high income economies still uncertain. The US remains strong supported by domestic demand, but recent Euro area growth has been disappointing especially in Germany and France. And Japan recovery – I think this is also have something to do by Professor Ito here, he supposed to be in his own country and taking care of their economy there – the Japan recovery remains fragile.

The outlook for emerging markets is not much brighter. The average growth of 24 emerging markets is now at 4 percent, this is the lowest level since 2011, when it was 6 percent at that time. And if you look at the change in their fortune, it’s really striking. In 2011, all emerging economies had grown 3 consecutive years, and today, six of them are likely to look back on three consecutive years of slowing growth, among them; Brazil, Russia and China. In a more challenging global environment, the space for policy stimulus has shrunken. Since more emerging economies have seen their productivity slow in recent years, the emphasize going forward must be on deepening domestic reform. The goal is to raise medium term growth by seeking to reverse this productivity trend. And this discussion is also true for Indonesia. Let’s now talk about Indonesia.

Indonesia as Professor Ito mentioned, has recovered strongly from the 1998 Asian financial crisis. It seems like far far away if you look at the 1998, Indonesia has become a thriving democracy, and successfully navigated the 2008 global economic crisis. I was finance minister at that time and also as coordinating minister for economic affairs. Facing with global financial meltdown in 2008, Indonesia launched a combination of policy addressing the urgency of restoring or even in this case maintaining a very very fragile confidence especially in the capital market, financial sectors, bank and non-bank financial institution. We did a very thorough detail-balanced analysis as well as trust-test exercises. So many of you may be used [to be] [and] already reading the “Stress Test Book” of Mr. Timothy Geithner, the former US treasury, that is exactly what we did in Indonesia back then when at the same time the United States did the same thing. The Stress Test exercises to detect as well as address the vulnerabilities, especially of many of the financial institution whether bank and non-bank, and even state-owned enterprises. And we used the fiscal policy tools to counter-cycle the weakly economic growth because of the weakening investment and household consumption due to the confidence problem. Since then, high commodity prices and prudent micro fiscal policy management has helped Indonesia to grow solidly and reduce poverty by half. But poverty reduction in Indonesia has been slowing, and many Indonesian, who moved out of poverty are still vulnerable to fall back. The change and the challenging global context – I mention earlier – come at particularly critical time for Indonesia with low commodity prices posing an immediate challenge.

Prices for key export commodity triple between 2000 and 2010. As a result, rising household income significantly boosted private consumption. But if you look since 2011, price has dropped by about 57 percent, coinciding with a rapid increase in oil import and this leading to a significant current account deficit for the first time in 15 years. I think Professor Ito will remember very very clearly, leading to the financial crisis [in] 1998, many of the ASEAN economy including Indonesia, suffering current account deficit which is up to above 3.5 percent of GDP or close to 5 percent, that happened in 2011 and that’s why we have a problem. And at that time also, the situation especially since last year when the Federal Reserve announcing that they are about to normalizing the rate then Indonesia faced with a little bit taper tantrum situation. If you look at Indonesian demography, Indonesia is aging, and the [world] age population will start to decrease in just a decade. As not as severe and China and Japan, but Indonesia is going to have an aging population in a decade from now. So generating the growth that Indonesian need to become prosperous, will definitely become much more difficult. The next stem to 15 years other for critical. Indonesia has to make the most of its existing demographic diffidence to avoid getting stuck in the middle income trap. And if you look at the reform to the list, it is long. Indonesia need to further reduce poverty and reverse the rapid rise in inequality. With commodity prices no longer supporting growth, Indonesia need to enhance the quality and diversity of investment away from resource sectors. What can and need to be done to transform Indonesian economy to realize this aspiration. The most recent World Bank study point to three main sets of priority – and actually I bring over there. So I am going to give the book for whoever going to ask me a very good question about this.

Indonesia need to create growth and job, and need to create an opportunity for all Indonesian, and Indonesia need to do much more to improve governance. The first set of priority creating a higher value job has to do with unleashing the potential of private sector as an engine of inclusive economic growth. For this to happen, Indonesian need address three main constraints – [welcome Prof.[..], please sit down]. So the three main constraints that need to be addressed: first, the large infrastructure gap has cost Indonesia more than 1 percentage of GDP growth over the past decade. Indonesia road as well as port are congested, heavily congested. If you have the experience visiting Indonesia during Lebaran or Ied, then you know very well that the traffic is heavily congested. And that’s not only in Jakarta actually, in many other big cities. Private firm, also has to realize on costly source of electricity. I give you an example, the logistic cost in Indonesia, is actually around 24% of GDP, if you compare with Thailand which is only 16% of GDP, that’s really a big gap, a big difference. Second, uncertainty and too many regulation discourage private investment. The new administration under President Joko Widodo, Jokowi, has adopted a more open stand toward the role of foreign investment in economy. But major challenges persist. Preventing the overall business climate to improve, and exploit the benefit of private investment. Third, skill gap remains large. 60% of Indonesia firms report that finding suitable employee for professional and managerial position is difficult. And if you talk about the manufacturing sector, the number is even higher. So let me add here that how Indonesia chooses to integrate economically with the rest of the world will be particularly important in addressing these constraints, the recent announcement by President Jokowi of Indonesia joining the TPP, is an important first step, I am not going to speak about this too much, because I know Ibu Mary will [be] discussing this in depth, especially in her former capacity as the former minister of trade in Indonesia.

The second set of priority centers around creating opportunity for all Indonesians. Indonesia today is the most unequal country in all of East-Asia. And about one-third of inequality can be traced to inequality of opportunity. Let’s compare, a child born in Jakarta, to a non-poor parents who have at least high school education with a child born in rural area or in a remote island, far away from the center of growth, for example Nusa Tenggara Barat, or Papua or Maluku, to a poor family with a little education. The child born in Jakarta has only 6% chance of lacking proper sanitation, compare with the 98% for the rural child. These differences extent across all other indicators of opportunity such as housing, quality of health services and education, and you’re talking the united of Indonesia, meaning this inequality is become not only a social issue or economic issue can become a political issue.

One of the reasons for poor service delivery is weak tax collection and sub-optimal public expenditure. In fact, Indonesia revenue to GDP and tax to GDP ratio are very low by international standard. The country is collecting less than 50% of its total potential tax revenue and its public spending is much lower compared to its middle-income peers in Asia. I am sure many of you is going to ask me “Well, Ibu Sri Mulyani you were minister of finance before. So for those of you is going to ask that question, I will give you that book”. I will explain you that Professor Ito mentions about the lonely, what was that, you’re using, “The Lonely Battle”. I don’t think today is a lonely battle, it’s not alone definitely, a lot of actually a supporter, but it is a battle. So for Indonesia, need to collect more, and spend better, particularly at the local level. This is especially true because Indonesia especially since the 1998, with many of the political reform, many of the power has been delegated to the local level, lower level that is provincial and Kabupaten district level. The quality of services is persistently low and unevenly distributed across region in Indonesia, and this reflect in part poor spending choices. So not only about the amount of resources but also the choice to spend it which is poor. I give you the example for the figure in 2012, district government or in Indonesia you call it Kabupaten, spend 52% of their budget on personnel, and only 3 percent on capital spending. And that’s not even whether they are really delivered the result, the 3% because of many issues.

The third set of priority has to do with strengthening governance. This is particularly, but not only relevant in the management of Indonesian abundant natural resources which are being depleted at unsustainable grades. Millions of Indonesians in coastal and forest community whose livelihood depends on those resources and who are much more poorer than the average Indonesia are not fully benefiting from these resources. Poor governance in land-use licensing and lack of law enforcement are main causes for this inequitable over-exploitation of natural resources. Coastal deforestation, water pollution and over-fishing will worsen the impact of climate change which will threaten food and water security and as well as fisheries and agriculture. Adapting to those threats together with measure to mitigate the countries contributing to greenhouse gases especially through the burning of pit forest will be major challenges in the country’s developments choice. So realizing the priority I have described will be challenging in the current environment. But the good news is that Indonesia has also many momentum factors that work in its favor. First are demographic factors. As I mentioned earlier, until the demographic window of opportunity began to close a decade from now, Indonesia will continue - at least for 1 decade - enjoy the diffidence of growing working age population. I think many of you know very well the struggle of China’s slowing down [now], one of the most important is actually the shrinking labor force. That’s why they change one-child policy very recently. So, Indonesia always when you talk among Indonesia about this demographic diffident, they always take it for granted. Because they don’t feel that this is really a benefit that they should really be thanked for and can be and should be used productively until you’re in the aging situation just like in China and in this case Professor Ito will talk a lot in Japan.

So today, 50% of the Indonesian population are under 30’s, and this increasingly educated and IT, savvy-youth – I think many of you sitting here the Indonesian students you’re all classified at that group – you’re an asset that can be used to boost overall productivity and economic growth. So really, study hard, get the most important, and then go back to Indonesia to contribute [in] the productivity growth in Indonesia. Off course you will say that “Well, it really depends on the environments over there Ibu. If you have an opportunity I will come back, if it is not, then I will find other better opportunity”, but you are among the most valuable asset of the country. With the right policy, especially in utilizing this valuable labor force, Indonesia can benefit from this demographic diffident.

Second which is also give a positive momentum. A development in China. As you all note China rapidly rising wages present Indonesia with an opening to regain comparative advantage in labor intensive export sectors. China has seen unit labor cost grow by almost 70% since 2005, combined with slower overall economic growth as China rebalances their economic model, this situation could prompt investors to look to country like Indonesia. And the third is urbanization. Rapid urbanization is a third potential advantage for Indonesia.

By 2025, 68% of the population is projected to live in urban area compare with 53% in 2012. In many country, urbanization is always identical with the higher economic growth. In fact the World Bank just actually launches the study on China urbanization last year, which is actually showing how the urbanization contribute to the three decades of a very high growth in China. Indonesia is actually have this potential. As the income rises and existing large metropolitan area such as Jakarta or Surabaya become saturated, the demand for consumer durable growth including housing, shopping space as well as all the office space is going to increase significantly in smaller city. I was traveling and working in South Asia who is now try redesigning there what they call it the messy urbanization in South Asia; India, Bangladesh, Nepal. Africa is also seeing urbanization as the engine of growth, so Indonesia definitely is not an exception, we can see this urbanization as the source of potential economic growth.

The issue of cost how to connect the cities especially the secondary the third city to the rural areas as well as to the global economy that will be essential in attracting firm especially the international also and in achieving the progress and prosperity. With political will and concentrated effort, Indonesia can leverage this opportunity and rise the challenge ahead. At the World Bank group, we are ready to support this effort. Much of the World Bank research and analysis that I presented today will find its way into Indonesian development agenda.

Our work with the Indonesian government, and the private sectors, focused on 6 areas; infrastructure, sustainable energy and connecting millions to reliable electricity, building the maritime economy and improve connectivity, collecting more revenue and spending it more effectively, better services for health care, education, sanitation and water, and the last is holistic landscape management effort to protect Indonesia vast natural resources. Success in all these areas will definitely be critical to address Indonesia challenges. But most importantly, to make use of the Indonesian impressive resources mainly its people, and its natural wealth in a productive and sustainable way. I thank you.