By Will Hickey

The Indonesian Rupiah’s recent slump to 12,300 to the dollar was entirely predictable.  Indonesia has historically relied on exporting raw materials such as thermal coal to Korea, iron ores to China, gold condensate and crude palm oil to Singapore and Taiwan, without getting much in return, the classic North-South issue of development is manifest. The boom times may be over though, as future investors will try to play Indonesia against other countries to strike a better bargain. The recent cut in the fuel subsidy and heavy push for the 2009 Indonesian Coal and Mining law (Indonesia mining law 4/2009), which bans unprocessed resources from being exported and has recently gone into effect, will  only help marginally, if at all, as both are focused on bottom line outputs and not processes.  In other words, the budget deficits really result from systemic problems in the Indonesian economic structure: educational, legal, and physical.

With the Rupiah dropping, the chance of inflation setting in is noticeable in everyday life in Indonesia.  The Indonesian government, however, considers this de-facto devaluation as a good thing, namely as it lets them off the hook for structural economic changes in an election year,  2014. Yet, food prices are changing rapidly, and luxury hotels in cities like Bali and Lombok are taking payments in U.S. dollars rather than Rupiah. This situation may extend to other industries before it gets better as the Rupiah undergoes an intense devaluation. While Indonesia has banned the pricing of goods in foreign currency, this ban has not been enforced as aggressively as in Argentina, where currency control policies led to a steep 30% rise in domestic inflation.  A recent devaluation of the Peso (officially now at 8:1, but as low as 13:1 on the black market) means that Argentina’s structural issues are not being seriously addressed.  They will be seeking agricultural exports more than ever before to pull themselves out of this economic tailspin.

Like Indonesia, Argentina continues to depend on exports for its economy.  In Indonesia, however, the Bank of Indonesia, (BI) has overseen a ‘slow bleed’ of its currency by refusing to raise interest rates.  This has brought about a new normal of a weakened currency that many Indonesians are told to accept.  The government is in denial of a crisis that it helped create.

The tried and true playbook of increasing exports to offset deficits may not work so well anymore.  It may even be irrelevant in the 21st century. As economist Lester Thurow has said, while it seems ‘right’ for a singular developing country to rely solely on exports to increase its balance of payments, problems arise when all countries rely on exports at the same time.  When supply surpasses demand, exports weaken.  This is playing out in Indonesia.  With governments like the U.S. and E.U. printing large quantities of currency (so called ‘quantitative easing’) and buying their own bonds, more strategic investment has been going to stronger export countries such as Australia and China.

Recently, the US governments Federal Reserve has said that it will reduce its ‘quantitative easing’ stance (printing money) and taper off its bond buying programs. The markets have taken quick note of all of this by pulling their money out of Indonesia and thus exacerbated the Rupiah’s quick decline. This is not a new event to Asia, it has also happened in other regions and countries. One might only consider India in 2013 where the Rupiah went from 50 to almost 70 Rs./$ overnight, or Thailand, where the Baht has declined due to capital flight over political instability.  It seems the problem of capital flight didn’t end in 1998 with the first Asian economic crisis, but continues to ebb and flow.

Unfortunately the leaders of Indonesia and other countries got addicted to this cheap investment money. The boom and bust cycle repeats itself, and this is a direct result.  Instead, these leaders, (be they Prabowo, Joko Widodo, Ical Bakrie, or whomever assumes the mantle of directing the disperse archipelago of Indonesia), both for suzerainty and culturally, must seek to change some of the structural economic processes to which they address these deficits, such as educational reform, reduction in administrative layers, and legal impediments.  Changes in processes are much more difficult to realize, but these will yield greater cyclical stability long term.

Changing these processes can ‘smooth out’ this boom and bust cycle by increasing the value added activity in a country. Some economists call it the endogenous growth cycle. This takes political willpower, but South Korea has done it, China is halfway there, and Malaysia and Kuwait have also realized its long term value proposition. These types of process changes means that outside investments must be clearly aligned to higher value added technology transfer. It must be that investments are linked not to one-off tax policies, manpower payments, subsidies, but rather to skills development.  Proper investment in skills development would help Indonesia create greater value added products by turning oil to chemicals, ore to metals, etc.

History has shown that value added activity through strategic skills development has lifted incomes by creating better domestic demand for products (and services) and higher value added export activity. Nowhere has a country enriched itself by relying on long-term exports of raw materials, taxing those exports, buying back bonds, or devaluing its currency.  Continuing these policies will leave Indonesia behind and in financial trouble. Indonesia must develop its vast manpower reserves and create a knowledge economy from its diminishing natural resources. This requires a significant skills upgrade and technology transfer policy.

Indonesia’s leaders, especially with the upcoming Presidential election,  must stop looking at the old playbook of failed remedies that many developing countries have tried before and consider that the information economy of the 21st century is what mints winners and creates economic stability. These countries are defined by strong currencies and balance of payments, such as Norway and Switzerland, not gaping deficits. Their citizens are never told to ‘get used to’ a lower currency and by extension a lower standard of living. Indonesia has the resources to do this, if the processes of value added can be structured correctly.  Policy must incorporate knowledge exchanges and develop industries for future investment in order to successfully bring Indonesia forwards.

About the Author

Will Hickey is associate professor of Global Business at Linton Global College, Hannam University Daejeon, Republic of Korea. Twice a Fulbright professor of energy and human resources, he has lectured on human resource development and economics in eight Asian countries, and resides part year in Indonesia.