Global Markets

No honeymoon for Indonesia’s Jokowi

30 July, 2014 | Posted By: Marcuard Cyprus

Marcuard's Market update by GaveKal Dragonomics
In the next few days Indonesia’s Constitutional Court will rule on a challenge mounted against Joko Widodo’s victory in this month’s presidential election. All the indications are that the court will dismiss the complaint filed on Friday by defeated candidate Prabowo Subianto, who alleges massive electoral fraud. Yet if the court does throw out Prabowo’s challenge for lack of evidence as expected, Joko’s difficulties will not be over. In all likelihood, they will only just be starting.
When he is sworn in on October 20, Jokowi, as the new president-elect is universally known, will immediately have to tackle one of the most sensitive topics in Indonesia’s political economy: fuel subsidies. Although he pledged in his campaign to eliminate subsidies entirely over the next four years, this is easier said than done. Past fuel price hikes have fomented immense discontent, and in 1998 triggered the unrest that led to the overthrow of President Suharto. Although several political parties that supported Prabowo’s candidacy are now likely to switch their allegiance to Jokowi, the extra support will by no means guarantee the new president’s policy an easy passage. In his ten years in office, outgoing president Susilo Bambang Yudhoyono failed to achieve a consensus on the matter, even though his administration commanded the support of a grand “rainbow coalition” in parliament.
With the government’s deficit threatening to breach its legal cap at 3% of GDP, reducing the fiscal burden of fuel subsidies is becoming increasingly urgent. Artificially low prices have boosted domestic fuel demand even as they have cut the incentive for upstream exploration and production. As a result, Indonesia—once a major oil exporter—has become increasingly reliant on imports of refined fuels. That dependency has not only exacerbated the external deficit. With the rupiah down 15% against the US dollar over the last 12 months, the extra cost of the subsidy programme has also put the government’s finances under severe pressure.
By delivering on his promise to curb subsidies Jokowi will not only alleviate Indonesia’s twin deficits, he will also signal to investors that his government has the momentum to overcome even the most daunting political obstacles. However, reform is the art of the possible, and much backroom dealing and compromise will be needed to get the legislature to work with the government rather than against it. Here, the experience of Jusuf Kalla, Jokowi’s running mate and the vice president during Yudhoyono’s first term in office, will be crucial in building support across party lines. Kalla’s party, Golkar, the second largest in parliament, backed Prabowo for president, but is now likely to switch its support to Jokowi.
There are no quick fixes for an economy that is just past the peak of its business cycle and which faces stiff external headwinds as the China-driven resource boom fades. Jokowi’s plan to lift economic growth to 7%—a pace not seen since before the Asian Financial Crisis—depends on enhancing productivity through increased private sector investment in infrastructure and manufacturing. Cutting red tape and fostering competition in an economy where the line between business and politics is often blurred will be a tall order, but Jokowi’s track record as mayor of Jakarta is encouraging. As a result, the long term prospects for Indonesia remain favourable, even though the short term cyclical headwinds make the situation seem bleak.