Bottom Line: Indonesia tsunami opportunity


WASHINGTON, April 13 (UPI) -- Indonesia was hit harder than any other country by December's deadly tsunami, and deserves sympathy and praise for its response to the crisis. But investors, like natural disasters, are an unsentimental lot, and, like weathermen, are more concerned about the future than the past.

President Susilo Bambang Yudhoyono, or SBY, won high marks from his own people and world leaders for his skillful and energetic organization of humanitarian aid in infrastructure-poor Indonesia. In recent days, he's responded wisely to the difficulties in the country's delayed debt offering (more fallout from Argentina), and the mixed signals from Australian and other Western businessmen concerned with the slow pace of some regulatory changes.


SBY has reportedly kept major members of his economic team in town, and working around the clock, to get economic policy back on track. Finance Minister Jusuf Anwar, for example, canceled a trip to Washington, D.C., to take part in the International Monetary Fund's posh annual conference, to nose-grindstone his way towards a revised debt offering and -- perhaps -- tax reform proposals as well.

The administration's most impressive achievement to date, perhaps, came in March, when SBY followed through on a keystone of his economic agenda, reducing Indonesia's absurd subsidies on domestic energy consumption by about 30 percent.


True, Yudhoyono failed to remove the subsidies completely, leaving the price of a gallon of gasoline still well below the world market average at about $1.20 per gallon. The action, however, was economically smart and politically tough, coming as opposition politicians organized and encouraged civil unrest. And 30 percent is a nice, healthy start.

"Legislators Warn of Monetary, Political Crisis," warned on March 2. Yet once Yudhoyono stuck with his guns, the protests died down, and the marketplace began imposing needed efficiencies on both businesses and commuters. SBY's stock, if anything, has risen -- as is usually the case when leaders lead.

"Susilo is not without political leverage," Endy M. Bayuni wrote in an influential analysis in The Jakarta Post on March 23. Indeed: In addition to his still-strong political standing, SBY now enjoys a spending-cut windfall from the reduction in energy subsidies. Not only will the government enjoy a direct 30 percent cut in its subsidies but, as energy prices rise, consumption will fall, bringing still further savings.


Indonesian politicians, predictably, are falling all over themselves figuring out ways to spend the windfall. Many of their causes are noble, from improving the education system to helping small- and medium-sized enterprises. All this is abetted by the tsunami and recent earthquakes, which focuses legislators on the opportunity to "help out" by showering government aid on spending projects.


Ironically, both the government and the public rightly fear that any spending binge will simply wind up fueling more of the corruption and favoritism for which Indonesia's bureaucrats are famous. This has led to redoubled efforts to battle corruption and expose past wrongdoing. That's a strategy followed, for example, by the Philippines in the late 1980s.

All noble goals, but not something that raises the incentives for human beings to produce goods, take risks, invent products, and start new businesses now and in the future -- human beings, of course, being Indonesia's largest, and most underutilized, natural resource. A much simpler way to fund some tsunami relief, and help things like small business formation and education, would be to avoid government-mediating institutions and "spend" the oil subsidy savings from the bottom up -- namely through voucher and tax-reduction plans that would let the public keep more of its own money in the first place. And a tax rate cut, unlike even successful anti-corruption or top-down spending efforts, would do an end run around government bureaucrats, and improve incentives for future production.

The government is working on a tax-reform program, but unfortunately, according to the Jakarta Post's Endy and other informed observers, there's no rate cut component. A search for the words "tax cut" or "tax reform" in headlines in the Jakarta Post for the last 90 days turns up the following number of articles: zero. Searching for those words even in a full article turns up only three entries, all having to do with a proposed tax amnesty that aims to bring in revenues -- another reasonable idea, but another idea that focuses more on government revenues and the past.


Tax rates, Indonesians say, are hardly high to begin with. By global standards, they're right: 30 percent top rate on personal income, 30 percent on corporate income. "Our tax rates are not uncompetitive," a finance ministry official working on the tax reform package observed.


Yet as other countries trying to spur domestic growth and attract capital in the last 25 years have learned, being "not that uncompetitive" isn't always enough. Countries that have enjoyed economic-growth and stock-market booms in recent years have tended to have highly competitive rates or sharp reductions. Those rate cuts at once make human labor highly competitive on the margin and -- perhaps most important -- liberate the forces of domestic small-business formation that, in most of the world, are the linchpin to a surge of employment.

Personal rates are critical here. In most countries, even including the United States, small business are, well, small, and wind up paying tax under the personal income code.

"Registered personal income taxpayers are still less than 2 percent of the 120-million-strong workforce," The Jakarta Post notes. "The tax ratio (tax receipts against gross domestic product) is less than 13 percent, the lowest among ASEAN countries."


This low ratio resembles that of Russia and Pakistan during the 1990s -- when officials feared they couldn't reduce rates because tax participation was "too low already." It is a measure of how much the tax yield could be increased if rates were reduced, unleashing a bottom-up, entrepreneurial surge. Russia's stock market took off beginning in 2001 when Vladimir Putin slashed top tax rates on human beings to 13 percent. Latvia, Slovakia, Bulgaria and other countries looking to attract capital and liberate domestic production slashed top personal tax rates to a range of 19 to 26 percent, and have outperformed Old Europe ever since, as have low-tax Britain, the United States, Norway, and Switzerland.

Egypt (where Dr Ahmed Nazif slashed rates in half, to 20 percent), Jordan (25 percent) and even violence-torn Iraq (25 percent), have all established low top rates on personal income. Each was among the top-performing stock markets in the world in 2004 (abetted by rising oil prices that have lifted the Middle East's economy, to be sure).

By my own static analysis, given low participation in Indonesia's personal tax code, the top tax rate could be cut to below 23 percent and still absorb less than half of the savings from oil subsidy cuts. Of course, if the oil subsidy were reduced further, a top rate of 15 percent to 17 percent could be achieved. Anyone who thinks such a plan would truly cost revenues, of course, has not studied the history of personal rate reductions in countries with a large pool of human capital. Russia's tax rate cut has led to a tripling of the tax yield over five years. (See for example, "What the tax reformers are missing," The Wall Street Journal, October 1996.)


SBY's administration is not even talking about rate reduction as a part of tax reform -- not a good sign. A plan to reduce corporate rates to 25 percent from the present 30 percent was put forward by Chief Economics Minister Aburizal Bakrie in December, but has scarcely been mentioned since. (Nor are corporate rate cuts very helpful.)

Yet in a series of lectures given in the United States in 1999-2002, Susilo clearly indicated his interest in the tax experience of America and many of its neighbors dating back to the early 1980s. In his campaign of 2004, moreover, SBY made "increasing employment" a key theme -- appropriately enough in a country where 40 percent of the population does not enjoy reliable work. The prime source of most employment booms? In the countries mentioned above, and even in the developed United States and Britain, it's been small businesses.


Governments hit with a tsunami, whether of the natural or political sort, can go in one of two directions. In recent years, Germany (top tax rate on people, 45 percent, on companies, 25 percent) and France (54 percent tax on people, 34 percent on companies) have seen continuing unemployment and stagnant growth which still has not succeeded in rousing their governments out of their torpor. Governments there, as in much of the world, focus on reducing the burden on "capital," forgetting that the largest source of it, and ultimate creator of all capital, is DNA-based.


Similarly, the Philippines used the Marcos wealth and the need to "battle corruption" as an excuse for slow growth and policy stagnation for years. Meanwhile, such Asian tiger neighbors as Hong Kong (15 percent top tax rate) and Singapore (22 percent) cheerfully lapped Manila again. Russia slept its way through the 1990s, blaming the rise of the mafia and the hangover from communism for stagnation. Enter Putin, who it realized that one of the best anti-corruption tools is to keep resources out of the hands of government officials to begin with.

On the other hand, in Pakistan and the United States after 9/11, leaders understood there was all the more need to spur economic growth, seized the moment, and drove through policy reforms even more bold than they had envisioned before.

SBY seems more like the latter style of leader than the former. He's still waiting, however, for his Ground Zero moment -- where he takes the megaphone, asserts his vision, and shapes the winds rather than responding to them.


Bottom Line always strives to get to a buy or sell, but right now, on Indonesia -- our favorite emerging market in 2004, and one of the world's top performers -- we're a wishy-washy "hold." My advice to investors is, monitor that tax reform package. Sell if the government drifts into focusing on this-or-that foreign investment deal, or obsesses about micro-regulation reform or uncovering past corruption, raging against the past like King Canute.


Buy if (as expected), SBY's administration returns to talking about tax reform with a rate-cutting bias, especially on the personal side; a Bush-Putin-Musharraf model.

To fight a tsunami, you need a tsunami: a man-made tidal wave of opportunity and growth.


(Gregory Fossedal is an advisor to investors on global development trends and ideopolitical risk, and a research fellow at the Alexis de Tocqueville Institution ( His clients may hold long and short positions in many of the investment securities and opportunities mentioned in his reports. 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 his clients or AdTI. Furthermore, they are subject to change without notice.)

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