Indonesia is on course to re-elect President Joko Widodo, better known as Jokowi. The results will be announced on 22 May. In his second five-year term, Jokowi could struggle to sustain the vigorous economic momentum achieved over the past several years, but policy continuity and an orthodox fiscal stance support our positive outlook for Indonesia in the medium term.
First-term successes and challenges
Under Indonesia’s technocratic finance minister Sri Mulyani Indrawati, the economy has performed well. GDP has not grown at the 7% annualized pace Jokowi promised five years ago, but steady 5% growth has been enough to see Indonesia’s GDP surpass 1 trillion USD (U.S. dollars) in 2017. Fiscal discipline has been maintained with a deficit below 2% of GDP and low government debt.
Jokowi has focused on much-needed infrastructure. Jakarta’s mass rapid transit system, delayed for decades, opened in April, and the Trans-Java toll road, begun in the 1980s, opened last December.
The president has eased internal imbalances by adjusting fuel subsidy policies. This drove a meaningful decrease in household consumption, however, which we expect Jokowi to address in his next term. CPI inflation has dropped to 3.0% from 6.5% in 2014 when Jokowi first gained power.
Jokowi’s first five years also revealed some shortcomings. He was not able to advance land and labor law reforms that we believe could accelerate foreign direct investment in manufacturing and help improve the country’s productivity. And in most remote corners of this far-flung archipelago, access to health care remains limited and the quality of services is fragile.
Second-term policy outlook
On the positive side, Jokowi’s re-election would ensure a reasonable degree of policy continuity and political stability, which in turn should support Indonesia’s economy.
However, we see several reasons why Jokowi’s second term likely would not match the achievements of his first. In an effort to leave a political legacy, the president would probably spend more time making alliances and reinforcing his power base rather than pushing for unpopular but structurally important reforms around labor, oil and gas upstream development, and land regulation. Jokowi would likely also shift his focus from infrastructure investment toward education, health care, and youth employment in a country with a large demographic dividend. Such efforts are worthwhile over the long term, but would not bolster the economy to the same degree as further infrastructure development, in our view.
On the business side, Jokowi has proposed reviewing the corporate tax scheme to keep Indonesian manufacturing competitive. However, with fiscal revenue at only 12% of GDP (among the lowest rates in Southeast Asia), we believe there is limited fiscal space for corporate tax reform unless it is funded by an unpopular hike in the value-added tax (VAT), which seems unlikely.
Indonesia’s economic profile and political leadership has us constructive on the country’s medium-term trajectory, though the longer-term outlook for structural reform is less clear given Jokowi’s likely priority shifts. Given its current strength and expected leadership continuity, Indonesia is an attractive investment grade sovereign credit, in our view.
On local rates, we remain positive on local currency Indonesian government bonds. Given benign inflation and following the 175 basis point hiking cycle in 2018, Bank Indonesia has monetary policy space to reduce rates as needed.
On currency, we are neutral on the rupiah (IDR) ahead of likely seasonal headwinds due to dividend and coupon payments in May. We recognize that balance-of-payment pressure is easing on portfolio inflows – especially after the Federal Reserve’s dovish pivot earlier this year – and we see tentative signs that Indonesia’s trade deficit is improving.
On external credit, we are constructive on the sovereign and quasi-sovereign complex given the policy anchor and active role of the quasi-sovereigns on broader policy implementation. On financials, we favor major Indonesian banks given what we believe to be solid net interest margins and strong profitability, as well as majority government ownership. On corporate bonds, we prefer utilities and independent power producers and commodity-linked companies over property developers, due to valuations.
Another election with implications for Asia and the broader global economy is taking place in India – read our analysis here.
Isaac Meng is an emerging markets portfolio manager in the Hong Kong office. Roland Mieth is an emerging markets portfolio manager in the Singapore office.