This article first appeared in Forum, The Edge Malaysia Weekly on April 15, 2024 - April 21, 2024

Indonesia has had a good run in its 10 years under President Joko Widodo (Jokowi). The economy has withstood a series of challenges, including the Covid-19 pandemic, the worldwide inflation surge, the spike in global interest rates and the Ukraine crisis. Growth has been fairly steady and the rupiah has stood up quite well in the face of many episodes of global financial turbulence, unlike in the past when it tended to weaken at the first hint of trouble. Within the country, there is a general feeling that Jokowi has delivered for the citizenry — the people see improving infrastructure, decent support for the poor and measures being put in place to take Indonesia forward.

Little wonder then that the mere indication of Jokowi’s support for General Prabowo Subianto’s candidacy was enough to propel the latter to a comfortable victory in the presidential election. Now the question is — where will Prabowo take Indonesia when he is formally sworn in as the country’s new leader in October? He certainly has a strong foundation to build on, which should allow Indonesia to enjoy a period of continued good growth and stability. But this is not a given. If Prabowo can ensure three things — a harmonious political setting; sound fiscal and monetary policies; and well thought out industrialisation strategies — then Indonesia’s future is likely to be bright.

There are reasons for optimism. Since Indonesia began its democratic reforms 26 years ago, it has evolved a system of consensual governance where a large number of political parties form a broad coalition to back each president. We think something similar will be worked out in the coming months before Prabowo formally takes over, although there will be some hard bargaining before there is an agreement. In the end, we think that Prabowo will have a comfortable majority in the new parliament that will allow him to pass legislation to support his agenda.

Such an arrangement is likely to sit well with the major power brokers such as Jokowi. With his son Gibran as vice-president, Jokowi has a strong incentive to lend his considerable popularity to help Prabowo govern. Prabowo is also said to have a good relationship with the leader of the largest party, the PDI-P’s Megawati Soekarnoputri, one dating back to their childhood. The fact that Prabowo had been Megawati’s running mate when she ran for re-election in 2004 should help. The other political parties are likely to see it in their interest to be in the governing coalition and will probably make the compromises needed to do so.

Nevertheless, there are a few things that could go wrong:

•     First, Prabowo will be 73 years old by the time he is sworn in. Although not confirmed, there are rumours suggesting that he has suffered a couple of minor strokes and that he has undergone a number of procedures following episodes of illness. His vice-president Gibran will be only 37 in October and has only a short experience in politics — so any sudden incapacitation of the president would result in political uncertainty.

•     Second, it takes a while for any new president to consolidate his grip on the political system and on state institutions, including the bureaucracy, security apparatus and state enterprises. He will need to place his own people in key positions and purge potentially disloyal or untrustworthy officials. Disgruntled officials and his political rivals could exploit that phase when his grip is less than firm to create problems for him, as we saw with Jokowi in his first 1½ years in power.

•    Third, as support from Jokowi will be critical, any sign of a breakdown in their relationship will be a concern. Trouble could arise from Jokowi’s efforts to retain influence following his retirement — his methods for doing so such as his rumoured desire to take over a large political party such as Golkar may not be welcomed by Prabowo. There have been some reported signs of disagreement between the two men recently, such as over Jokowi’s recent cabinet changes. Nevertheless, it is in both men’s interests to forge a working relationship and to manage away whatever frictions that may arise.

Overall, we think the political risks can be contained so long as Prabowo manages the different factions well.

Much will depend on who is appointed as finance minister and Bank Indonesia governor. Fortunately, there is a long tradition in Indonesia, going back to the time of President Suharto, to keep a watchful eye on the risks posed by inflation and external deficits. This was strengthened after the bitter experience of the 1997 Asian financial crisis. Indonesian presidents have generally been careful to appoint well-respected technocrats to oversee monetary and fiscal policies.

There is good reason to be confident — Prabowo is reported to be advised by his brother-in-law, Soedradjat Djiwandono, the highly respected former central bank governor who courageously stood up to Suharto during the 1997 crisis. Those who know Soedradjad can attest to his rigorous approach to monetary policy.

There have been some concerns over fiscal policy because the signature policy that Prabowo advocated during his election campaign was the costly free school lunch programme, which he wants fully implemented by 2029. At that point, the annual cost could be as high as IDR450 trillion (RM133 billion), which would be close to 10% of total spending. The impetus to provide this social assistance is understandable, given that close to 20% of children in Indonesia are stunted. But sceptics point out that stunting requires intervention at a much earlier age and that the free school lunch programme may not be the best way to achieve this.

Aside from this policy, there will be other demands on fiscal policy. Indonesia also needs to strengthen its defence capabilities, in which it has historically under-invested. The cost of shifting the capital city from overcrowded and sinking Jakarta to the new capital of Nusantara in Kalimantan will also be hefty — the assumption that private investors would fund 80% of the cost of the new city does not seem to be realistic, which means that the central government will have to stump up the money.

In recent statements, Prabowo has signalled that he will maintain fiscal prudence and that the fiscal deficit will be capped below the legally mandated ceiling of 3% of gross domestic product (GDP). But that means that he and his team will need to make some hard decisions on how much government spending should increase by and how this increase should be funded. He will have to cut back on some of his promises — but he probably has the goodwill to do so without too much political damage.

Prabowo inherits an economy that is sound macroeconomically but whose growth rates seem to perennially underperform its potential. He has promised to raise the growth rate to 8% but it is not clear how he intends to achieve this. It is noteworthy that despite progress on many fronts — better infrastructure, labour market reforms, the so-far successful policy to develop the nickel processing industry, reduced limits on foreign investment and so on, Indonesia’s economic growth has barely accelerated, seemingly stuck at 4.5% to 5%. This is in sharp contrast to India, where growth is poised to accelerate sharply as the cumulative effects of similar improvements kick in.

One reason could be that it just takes time before such positive developments produce results. After all, the implementing regulations for the labour reforms to take actual effect are only now being drawn up. The advantages created by better roads, ports, airports and power generation facilities will also take time to be fully appreciated by business as opportunities for profitable investment. Thus, with a lag, investment will rise and so will growth.

But even as investment rates eventually rise, current savings rates are too low to fund such an investment surge without some deterioration in the current account balance — and that might then threaten currency stability and the sustainability of that growth surge. Much more needs to be done to encourage households and companies to save — improvements need to be made to savings schemes and to financial regulation so as to increase confidence in the financial system.

Another fundamental problem is that the tax base is too narrow, leaving the share of tax revenue in GDP at a very low 10%. That means that government spending has to be kept commensurately low so as to keep the fiscal deficit below the 3% legal limit. The unfortunate implication is that the government is unable to spend enough on critical infrastructure and on education, healthcare, research and development, and all the public goods that only governments are able to supply in order to support higher growth. If Prabowo is to achieve higher growth of 8% as he wants, he has to tackle the reasons for this low tax take such as inefficient tax collection and too many exemptions. His proposal to create a separate revenue agency and take it away from the finance ministry may not be the best way to achieve this.

Indonesia’s economy also suffers from too many trade barriers which impede competition. The result is a host of microeconomic inefficiencies that result in higher costs and reduced competition. In addition, progress in curtailing corruption has slowed recently after some initial successes during Jokowi’s first term and during President Susilo Bambang Yudhoyono’s 10 years in office.

Finally, Indonesia needs to work harder at strengthening human capital. The country needs more vocational training to produce skilled workers. While it has a couple of reputable universities, it should also aim to replicate what India achieved with its institute of technology and management whose graduates are so respected that many fill C-suite management positions in the biggest firms in the US and Europe.

The challenge for Prabowo is that Indonesia needs 6% to 8% growth per year to achieve the goal of becoming an upper middle income country by 2045. But at the current pace, Indonesia will not achieve that status. The implications are serious — Indonesia could grow old before it becomes rich, since 2045 is roughly when its demographics turn less supportive of Indonesia’s economy. The new president will have to step up the pace of reforms if Indonesia is to avoid this fate.

Thus, while the Jokowi era saw strong foundations laid for Indonesia’s further development, a lot more hard work is needed before we can safely say Indonesia is on the right economic footing. But the remaining work that Prabowo needs to undertake could prove challenging. Raising taxes will not be popular. Eliminating trade barriers requires overcoming long-standing policy instincts in the country. Introducing more competition in the domestic economy will hurt special interest groups who will certainly resist. A more thoroughgoing crackdown on corruption is also needed — but that too will provoke strong resistance. If Prabowo can pull all this off, his legacy will be an immensely constructive one for Indonesia and the wider region.

Manu Bhaskaran is the CEO of Centennial Asia Advisors

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