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The Coat of Arms of Indonesia is called Garuda...
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By Sara Webb and Sunanda Creagh
JAKARTA, May 3 (Reuters) – Strong growth and political
stability made Indonesia Southeast Asia‘s most attractive
investment destination last year, but the outlook is threatened
by a struggle between reformers and powerful vested interests.
For the moment, the reformers appear to have the upper
hand, but a major setback could rattle Indonesia’s markets and
hurt prospects for a credit rating upgrade with Indonesia now
rated just one notch below the coveted investment grade by
Fitch.
The benchmark stock index has surged 155 percent from its
Oct. 28, 2008, low and reached an all-time high on April 30,
while the rupiah has strengthened from 12,600 per dollar in
November 2008 to trade at about 9,010.
The sovereign credit default swap spread has tightened to
around 161 basis points from 182 two months ago.
Following is a summary of key Indonesia risks to watch:
* GOVERNMENT EFFECTIVENESS IN DRIVING REFORM
President Susilo Bambang Yudhoyono, re-elected with a
strengthened mandate last July, is widely seen as a
progressive, market-friendly reformer. Many investors hoped the
pace of reform would pick up in his second term after he chose
Boediono, an economist, as vice president; kept two key
technocrats — Sri Mulyani Indrawati and Mari Pangestu — in
economic posts in his cabinet; and set up a presidential
delivery unit headed by Kuntoro Mangkusubroto.
Instead, his government was distracted by a highly
politicised inquiry — driven by opponents of reform — into
the rescue of a small bank, which led in March to parliament
recommending a criminal investigation into the bailout
decision. Yudhoyono expressed full support for Indrawati and
Boediono, who had backed the bailout to avoid a collapse of
confidence in the financial sector, signalling their jobs are
safe.
Yudhoyono has shown a preference for incremental reforms
rather than bold and controversial action, disappointing some
investors. However, progress is slowly being made. In March,
Boediono announced a new team to oversee reform of the
bureaucracy, a positive sign for foreign investors.
Also, healthy fundamentals and a large and growing domestic
consumer base still provide reasons to invest in Indonesia even
if reform progress is slower than had been hoped.
What to watch:
— Opponents of reform, including those within Yudhoyono’s
ruling coalition, will probably try to block pro-investment
policies such as changes to the tough labour laws and cuts in
energy subsidies.
— The future of the coalition. The Bank Century inquiry
strained relations between Yudhoyono’s Democrats and coalition
partners Golkar, led by tycoon Aburizal Bakrie and frequently
opposed to reform, and the PKS, an Islamist party which
sometimes takes a nationalist, anti-Western stance. If tensions
deepen, there could be a realignment in parliament, with other
parties being brought in to the coalition to maintain its
majority.
* CORRUPTION AND GOVERNANCE
Corruption emerged as a defining issue at the start of
Yudhoyono’s second term, with popular anger mounting over a
power struggle between the respected Corruption Eradication
Commission (KPK) and the attorney-general’s office and police.
The KPK has made significant progress in investigating corrupt
officials, but this stirred powerful opposition. Yudhoyono has
vowed to back the anti-corruption drive but his slow response
to the KPK scandal disappointed many Indonesians who wanted
bolder steps.
However under Kuntoro, the presidential delivery unit and
legal task force has begun tackling legal reform, for example
exposing graft in the prison system and investigating officials
suspected of perverting the course of justice.
What to watch:
— Effectiveness of Kuntoro’s presidential delivery unit in
tackling legal reform and other issues that deter investors.
— Pace of reform of Indonesia’s civil service, police and
courts. Yudhoyono’s cautious response to the power struggle
over the KPK suggests he will move much more slowly than
markets had hoped, confirming his reputation for preferring
gradual change to bold, sweeping reform. Investors betting on
more decisive reform during Yudhoyono’s second term have had to
adjust expectations.
* HOT MONEY AND CAPITAL CONTROLS
The rupiah was Asia’s best-performing currency in 2009 with
a gain of 17 percent against the dollar, threatening
Indonesia’s export competitiveness, and is up about 4.4 percent
this year, making it one of the region’s better performers.
Memories are still raw of the 1998 Asian crisis, which was
widely blamed in Indonesia on foreign “hot money” being yanked
from the country. The central bank says it will keep
intervening to stem the rupiah’s gains but seems comfortable
with steady appreciation as this helps to contain imported
inflation.
Late last year the senior deputy governor said Bank
Indonesia
was studying the possibility of curbing foreign
ownership of its short-term debt, or SBIs, sparking speculation
about tighter capital controls. Instead, in March, it began
reducing the frequency of auctions for one-month SBIs, which
has resulted in foreign investors shifting to three-month
paper.
What to watch:
— Data on exports and speculative inflows, and whether the
central bank’s measures for SBI auctions has the desired effect
of reducing volatile short-term capital inflows. If problems
arise, controls may be tightened. Draconian measures that send
investors fleeing to the exits are unlikely — measures would
be aimed at directing flows, rather than halting them, so any
negative impact on asset prices would be muted. However, the
issue can still spook markets — the rupiah suffered its
biggest one-day sell-off in nine months last November due to
mixed signals on capital controls.
* SECURITY
Suicide bombings at two luxury hotels in Jakarta last July
were the first major terror attacks in Indonesia since 2005 and
raised concerns that the threat from militants was again on the
rise. Since then, the killings of Noordin Mohammad Top and,
more recently, the bomb-making expert Dulmatin, have
significantly reduced that threat. But some risk persists.
Police recently discovered a new network of armed Islamist
militants operating a secret training base in Aceh in Sumatra
province. Also, analysts have warned that militants are using
the prison system to recruit and spread their ideology, while
recent trials of militants have presented evidence that funding
came from the Middle East — a worrying trend as it show
militants are managing to establish international links.
What to watch:
— Ability of militants to regroup and launch more attacks.
Particularly if remaining militants are able to establish firm
enough links with al Qaeda or allies in Southeast Asia to
secure sustained funding, expertise and recruits, the threat
may be far from over. But Indonesia’s markets have proven
highly resilient to militant attacks. Unless there is a
significant and sustained deterioration in security, or
militants reignite sectarian unrest, any sell-off would be
small and brief.
Source: Reuters

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