Give me graft, but also roads

09/17/2010 11:17 am ET | Updated May 25, 2011

The IMF's latest assessment on Indonesia's economy provides a handy thumbs up to Southeast Asia's largest economy. Now if it could just work on its infrastructure

All the talk in the United States of the need for new and improved infrastructure development is particularly familiar in Indonesia, where talk of terrorism or rampant graft seems to draw most international headlines.

The International Monetary Fund takes those concerns into account in a new report released online today. But it highlights infrastructure gaps rather than corruption as a bigger threat to investor confidence in Southeast Asia's largest economy.

The IMF says the main risks facing Indonesia are delays in implementing planned infrastructure improvements and efforts to manage volatile capital inflows, the flight of which aided Indonesia's crash during the 1997-98 Asian financial crisis.

For the most part the report hands Indonesia a warm review, crediting Indonesian authorities with applying prudent policy measures that helped steer Indonesia out of the global financial crisis. It also says the country's currently monetary policy is "appropriate" as long it takes action to keep expected inflation within its 4-6% window.

In an August interview with this correspondent, the fund's Indonesia director, Milan Zavadjil said Indonesia was in a sweet spot. The country came through the crisis fairly unscathed, it has low-levels of government-held debt and there is a general perception of improved economic management.

The report gives a nod to that sentiment: "Sound policies and structural reform, helped Indonesia recover quickly from the 2008 global crisis," it says.

Of course, weak law enforcement and graft are certainly still in the minds of investors. And the impact could be felt in sectors where Indonesia is most in need of development.

Analysts say Indonesia needs to invest $140 billion over the next five years in infrastructure development. But the government puts the estimate around $210 billion, of which roughly one-third would need to come from the private sector.

Foreign investment is therefore necessary to fund Indonesia's expansion. And the country appears to be attracting attention from countries such as China, which is in dire need of Indonesia's vast natural resources and cares less about its lack of transparency.

Japan and Korea are also looking to the rising Southeast Asian powerhouse as a production base for manufactured goods. And with 240 million people (and a growing middle class), Indonesia is proving profitable for countries that understand the consumer market and can target it accordingly.

Not all is shining
The IMF predicts that growth in Southeast Asia's largest economy will reach 6.2 percent next year, up from 6 percent this year and 4.5 percent in 2009. But the government's decision not to intervene to stem rising inflation is causing some concerns at the Fund.

On the IMF's website, the fund's Asia-Pacific division chief Thomas Rumbaugh says the country will need to be more "proactive" on its monetary policy by committing to reducing inflation and keeping it low.

Indonesia, which has held its benchmark interest rate at 6.5% for a year, has bucked the trend in Asia by not raising interest rates in recent months, preferring to foster growth rather than respond to rising inflation.

On September 6 the country's Central Bank Governor Darmin Nasution said the country would remain stable as long as it could manage its monetary variable "by other instruments."

Overall, the IMF report reflected positive developments in Indonesia, though it did say more work was needed - and when is it not?

"Specifically, reducing energy subsidies would create additional fiscal space for much needed infrastructure spending and transfer programs for the poor, with little impact on debt sustainability," the report said.

To put that sentence in context, the IMF analysis comes on the back of several recent reports that reveal poverty in Indonesia has improved little despite growth in the economy.

The Food and Agriculture Organization will release a hunger report in October that lists Indonesia among just seven other nations that account for that two thirds of the world's undernourished. And a joint assessment by the Rajawali Foundation and Harvard's Kennedy School notes that while official statistics show Indonesia to be a pro-poor growth story, this is an illusion.

Inequality is rising in Indonesia, and according to any realistic poverty line about half of Indonesians are poor, Jonathan Pincus, the co-author of a report, wrote in a recent e-mail exchange. By its very nature increasing inequality is bad for growth - as is persistently high poverty rates.

And according to Pincus, the government has failed to perform the most basic functions to support economic growth. "Infrastructure development is slow, particularly power and transport; the education system is failing to provide people with basic skills and to prepare them to acquire more advanced technological skills; [and] the legal and judicial system are dysfunctional."

Indeed, while officially the number of people living below the national poverty line (about $1.50 a day) account for around 14% of the population, around half of the population lives just slightly above that metric, on less than $2 a day.

Love not lost
Indonesia has had a rocky relationship with the IMF since it came to the country's rescue during the 1997-98 financial crisis by providing a bailout to the tune of $43 billion.

But the Fund maintains a presence here in Indonesia, and Trade Minister Mari Elka Pangestu recently threw her backing behind further support from the monetary body. In an interview with Bloomberg news, she said an IMF safety net that emerging nations can draw on during a financial crisis to stem capital outflows should be agreed on by the Group of 20 nations in November.