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The Bottom Line: Indonesia's new statesman

By
GREGORY FOSSEDAL, UPI Columnist

WASHINGTON, Oct. 15 (UPI) -- For many countries, merely getting through an election with a reasonably honest vote count, and minimal violence, is a cause for celebration. Indonesia this year managed several votes, and elected as president Susilo Bambang Yudhoyono -- a respected former general who not only has a solid plan for economic growth, but appears to have a statesman's touch.

Having been bullish all year on the country, "Bottom Line" is not inclined to change: still bullish.

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Indeed, with a 60-percent-plus mandate, and divided control of the two houses of parliament, Susilo, or "SBY" as he's often called, has a strong hand to implement a growth agenda. His goal, appropriately, is to lift the country's recent trend growth in the 4-5 percent range to levels of 7 percent and above -- a level more appropriate to an emerging market tiger.


Jobs, taxes, regulations


The first of several jobs for Susilo, as with many developing country chief executives, is jobs itself. Indonesia's biggest resource is people, but with double-digit unemployment, and unimpressive education levels compared to much of Asia, that resource is not fully employed.

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SBY, led by chief economic Irzan Tandjung, proposes to reduce tax rates on human labor (currently 10 percent to 30 percent not including social security rates), corporate profits (30 percent), and investment (10 percent).

Indonesia's tax code already places it on the below such countries as Korea, Turkey, Malaysia, Thailand, and Taiwan. This is deceptive, however, given that those countries enjoy a more mature manufacturing base and higher education levels, particularly among their large and growing middle class.

Indonesia's top tax rate of 30 percent on labor, for example, is less competitive compared to Russia (13 percent), Hong Kong (15 percent), Singapore (22 percent), Brazil (20 percent). Even some Eastern European countries (Estonia, Latvia) have reduced top tax rates on labor into the high teens and low 20s. Not by coincidence, these countries have enjoyed strong employment levels and stock markets that are a magnet for foreign investors.

There's a global competition among middle-income countries to achieve low penalties for bringing human capital into use. (See Bottom Line's "Global tax cut dominoes," December 2003.) Indonesia needs to compete with these countries, not so much in terms of its corporate and capital gain rates, but in reducing the tax penalty for adding human beings to the production mix.

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"SBY is attracted to a number of tax cuts to make foreign investment more attractive," an advisor comments. It's not clear if he leans toward relieving the tax wedge on people or physical capital or both. But some mix of cuts is being discussed as the president-elect prepares for his October 20 inauguration and a new administration.

More important, he plans to ease regulations on hiring and firing employees that, as in India, have the affect of depressing job formation. Such measures, it is often feared, will reduce employment by making it easier to lay workers off. In fact, they tend to have the opposite impact. Knowing that it will be easier to make layoffs if they're needed in future years, companies in a more flexible labor market are less fearful of hiring people now.


Building infrastructure


To stimulate jobs directly on the demand side, Susilo plans to seek out investment, aid, and an expanded government capital budget to build up the country's still-thin infrastructure: roads, telecommunications, schools. This will not only create jobs (but sensible ones) in the near term, but raise the country's attractiveness to manufacturers and out-sourcers in the long run. SBY might want to take a clue from South Korea's wise investment in broadband internet several years ago, which has raised the competitiveness of Korean workers and corporations alike.

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Yet in an interview with U.S. financial press, the president-elect indicated he does not intend a spending binge. "There's a limit to how much the country can absorb at once," he comments. A sound, steady plan is better than boom-and-bust. If combined with budget reforms and international bond issues, the plan should help Indonesia separate out such long-term investment from cash-account deficits.


Tearing down oil subsidies


A major sectoral problem for the country is energy. Perversely, oil-rich Indonesia has become a net importer of energy due to heavy subsidies on the domestic market. After subsidies, Indonesians pay less than $1.25 per gallon of premium gasoline. That's below Japan (more than $3.40), India (nearly $2.90), and even the gas-guzzling U.S. (about $2).

The subsidies, maintained through this election year by the outgoing administration of President Megawati, are not only a costly budget drag, but skew incentives throughout the economy. Energy efficiency is discouraged, overuse subsidized. "Because it wasn't done gradually," Izran comments, "we now face a problem."

Maybe so, but the problem must be tackled. And, if done in combination with a package of the other policy changes outlined above, the energy subsidy is actually an opportunity -- to cut spending in an area that skews the economy, and shift resources to better projects, not to mention the private sector.

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Indeed, if combined with tax cuts and infrastructure programs, the net impact on the income of the poor and middle class should be negligible. The result would be a much healthier pattern of development in the years to come as Indonesia relieves itself of a 60 trillion rupiah burden.


Parliamentary objections


The outlook in the legislature has improved in recent weeks. On Oct. 1, the People's Representative Council, or upper chamber, put the Golkar Party, the pre-Megawati ruling party, with 127 seats, in its chair. On Oct. 6, though, the People's Consultative Assembly, or lower chamber, elected Hidayat Nurwahid, chairman of the Prosperous Justice Party, as speaker. Thus no one opposition party is in the lead of the two houses.

SBY's own party is dwarfed in both houses -- parliamentary elections were held in April and the more established parties won more seats. There was support for Susilo, however, from large numbers of voters in both these parties in this fall's general election.

Can SBY work with the divided parliament to win quick action on economic measures? He showed his political skill in the days following his election victory. Ms. Megawati, like many losing election candidates around the world this year, complained of irregularities -- and declined for many days to do Susilo and the country the courtesy of issuing a concession statement.

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Against this backdrop, Susilo took the high road.

"I praise highly President Megawati Sukarnoputri," he said in a speech to the nation on Oct. 4, "who laid the basis for a good democracy in this country." The remarks were at once gracious, and smart, defusing concerns that the post-election honeymoon might turn bitter.

Reports that SBY will reach into several of the major opposition parties to help staff his cabinet suggest he's appropriately attentive to the imperative to build coalitions.


The Bottom Line


Susilo ran a publicity-shy campaign and has a track record of working quietly and cautiously as a former cabinet member. This may well be to his advantage in the highly divided legislature, but there's a danger of missed opportunity if his administration doesn't hit the ground running and press for a growth agenda promptly.

SBY's 61-percent mandate is strong now, but will erode over a period of months, especially if policy changes get bogged down in parliament.

So far, though, he's run an effective campaign and a deft transition. The tone is positive as Susilo prepares to take office and seek implementation of tax rate cuts, infrastructure buildup, and energy policy restructuring. Still fully invested.

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Gregory Fossedal manages international investment research for Emerging Markets Group. His clients may (and usually do) hold long and short positions in many of the investment securities and opportunities mentioned in his reports. "The bottom line" is compiled from sources we believe to be reliable, but no representation is made that they are necessarily accurate or complete. Investors should perform their own due diligence and consult their own professional advisor before buying or selling any securities. Mr. Fossedal's opinions are entirely his own, and are not necessarily those of UPI or EMG. Furthermore, they are subject to change without notice.

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