Indonesia’s Economic Bubble

Recent Features

Features | Economy | Southeast Asia

Indonesia’s Economic Bubble

A star performer for much of the last decade, Indonesia’s economy now faces serious issues, not least a major bubble.

Barely a year ago that Indonesia was considered one of the most attractive emerging markets in the world. Thanks to a decade of banking reform overseen by President Susilo Bambang Yudhoyono, the fourth most populous country in the world had managed to cruise through the global financial downturn with impressive results.

What a difference a year makes. Today, Indonesia faces some serious economic headaches, mostly linked to an emerging markets bubble. The situation threatens to get worse before it gets better.

Reform and Transform

Yudhoyono began his two terms as president in 2004, tasked with transforming Indonesia’s economy into one that was not excessively reliant on exports, yet which could take advantage of the country’s bounteous natural assets. Successful reform of the banking sector, coupled with China’s insatiable appetite for resources, meant that by 2011, the archipelago was one of the best performing economies anywhere in the world.

Massive debt reduction over the decade made headlines, with government debt falling by 35 percentage points from 2004,  to just 25 percent in 2012, and external debt plummeting to 30 percent, down from 140 percent. Numerous other data prompted analysts to forecast annual GDP growth of up to 7 percent.

The real game-changer came when ratings agencies Fitch and Moody’s gave the country investment grade classification. The upgrades, buoyed by strong data, instigated a torrent of foreign investment. By mid 2011, more than a third of government bonds were foreign-held. Widespread participation and attractive yields fuelled impressive growth, and borrowing costs declined for the majority of domestic parties.

The high was to be short lived.

With commodities accounting for more than two-thirds of Indonesia’s exports, any major shift in global commodities markets was bound to have an outsize impact. This came on two almost certainly related fronts: a steady slide in commodity prices and a shift in China’s economic model.

China’s Influence

The Chinese economy – the world’s second largest – is in a state of transition. A consumption-led strategy is seen as being the route forward, rather than the traditional investment-led one. This inevitably requires less of the natural resources that have been such a driving force for Indonesia. Recent Chinese data has been mixed, although economists are confident that the country is beginning to focus attention on consumer spending.

In the meantime, May of this year heralded a dramatic change in Indonesia’s fortunes, with the Federal Reserve Chairman Ben Bernanke announcing the potential tapering of the Fed’s quantitative easing program. This could expose weaknesses across all emerging markets, which have been urged to shore up their economies in preparation.

In July, Indonesia’s trade deficit widened to a record $2.3 billion, considerably worse than had initially been expected, and compounded by the government’s subsidization of fuel. Prices were raised late in June, but the decision did not come soon enough.

Possibly the most significant issue that Indonesia faces, is its severely weakening currency. Since the beginning of 2012, the rupiah has seen around a third of its value shaved against the dollar, and there are few signs this trend will abate. According to Alpari Analyst Joshua Mahony, “The subsequent budget and debt ceiling crisis has done little to help, with a clear ‘risk off’ sentiment gathering pace that saw the Indonesian KYSE lose almost 15% in the last 6 months.”

The concern now is that a vicious circle could emerge, in which depreciation causes faltering sentiment and rising inflation, which in turn encourages depreciation. The bubble could very well burst in the near future, and we can look to tapering worries and the threat of a credit downgrade as potential catalysts.

Corruption Remains

Uncertainty will be playing on Indonesian minds; Yudhoyono will no longer be president come July 9, as he can only serve two terms in office. This would be a source of uneasiness for any economy facing difficulties, but the situation is worse in Indonesia.

Two weeks ago came the announcement that the country’s most senior judge had been arrested, along with a member of parliament and five others, on suspicion of taking bribes. There’s no doubt that concerns over corruption will be deterring a sizeable portion of investors. The departure of the incumbent president will only serve to blur the situation further.

Of course, this isn’t to say that Yudhoyono would be the right man to lead the country out of its economic problems, even if he could serve again. A recent survey revealed widespread disapproval of his second term in office. Of 2,010 participants, 71 percent were unsatisfied with the last four years of economic policy. With such criticism comes a major question – if falling commodity prices and a shift in China’s model were the catalyst for the current situation, did Jakarta do enough to respond?

The answer is actually quite clear: for the most part, the government’s hand had to be forced. Rather than instigate true preventative measures, it has only been able to react to developments as they happened.

There have in fact, been several issues over the past four to five years. The previously mentioned fuel price increase is just one of them. The start of this year saw Bank Indonesia place restrictions on credit card ownership, as the fear of a consumer credit crisis grew. The government has set income thresholds for the number of cards that can be owned, and monthly interest rates have been capped. The problem however, is that concerns over a consumer credit problem were apparent two years ago.

With cheaper credit comes the likelihood of property markets bubbles. In this case, prices have risen across the board, and Bank Indonesia has warned that the real estate bubble might be close to bursting. Of course, there was a response from the central bank in the form of compulsory down payments on second homes, but again, it appears to have been too little too late.

Interest rates have regularly been manipulated in response to wild rates of inflation, and while some may argue that the central bank is on top of interest rates, it’s equally easy to argue that there has been no other option.


While Indonesia’s economy is likely to get worse before it gets better, it still boasts considerable long-term potential. Those natural resources are yet to be exploited fully, and the country has certainly shown that it has the capability and willingness to push on, even in the face of adversity.

Mahony asserts: “Going forward, the inability of the US to deal with the recent budget and debt ceiling in an orderly manner reduces the likeliness of a taper this year and as such gives the possibility of a ‘risk on’ resurgence within the emerging markets. The decision of Bank Indonesia to raise interest rates last month points to this economic confidence alongside a willingness to address the rampant inflation evident within recent months.”

The current situation has been brought about by a culmination of events, some of which are beyond Indonesia’s control; it may yet make sense to be bullish for the future, but if the bubble bursts, we could see fallout comparable to the 1997 Asian financial crisis.

Nigel West is a financial trading journalist, specialist in FX and commodities.