Indonesia, explained.

Mass Rapid Transit construction in Jakarta, 2016 (Photo: Getty ImagesBloomberg/Dimas Ardian)

Infrastructure: How Indonesia could shift up a gear

The drastic infrastructure deficiency can be viewed as an opportunity.

Stephen Grenville

28 March 20175 min read

Next year Indonesia will host the annual meetings of the International Monetary Fund and World Bank in Nusa Dua, Bali. This is a big deal: these meetings leave Washington only once every third year and involve thousands of high-level participants. In announcing that Indonesia would host the 2018 meetings, IMF Managing Director Christine Lagarde said that it would be 'a great opportunity to showcase Indonesia's impressive economic and social achievements'.

What will the meeting participants make of the Indonesian economy? It will be 21 years since the 1997 Asian Crisis. This did enormous harm to Indonesia, and the scars still show. In the three decades before the crisis, Indonesian GDP grew at an average annual rate of 7%. Since then, macro-policy has been more cautious and foreign markets have remained unhelpfully sceptical (for instance, consider their readiness to list Indonesia among the 'fragile five' in 2013). Post-Suharto democracy and the devolution of power to the local level of government have both presented additional challenges for economic policymakers. Nevertheless, Indonesia has maintained a steady 5%-6% growth rate, with only a tiny hiccup during the global crisis of 2008. This is no match for China or India, but it is enough to double GDP every 15 years, giving rise to confident predictions that Indonesia will be the fourth biggest economy by the middle of this century.

Thus Lagarde's positive sentiment has a solid core of substance. It will, however, be hard for meeting participants to make their own judgement if they remain confined to the artificial enclave that is Nusa Dua. This area – part of the almost self-contained Bukit Peninsula attached onto the southern end of Bali – is a miracle of urban planning in a country characterised by unremitting urban chaos. The Bukit Peninsula was largely uninhabited until the late 1960s, as it had no water. This isolation provided a unique opportunity; when piped water made development feasible, strict regulation kept building heights down (lower than the coconut palms, at least in theory), roads were built wider, and broad areas were devoted to tropical gardens and a golf course. Beaches are kept free of the plastic rubbish that is ubiquitous elsewhere. Development is exclusively tourist-oriented. A security checkpoint as you enter the Nusa Dua hotel enclave offers some reassurance to the nervous visitor.

Any conference visitor who crosses over the isthmus into Bali itself, beyond the airport freeway that slices through the mangrove lagoon, will see a different Indonesia – one that cries out for infrastructure spending. Visitors to the iconic village of Ubud (of Eat, Pray, Love fame) will find this trip, which used to take about an hour, is now more likely to take two. While the choked roads may be the infrastructure deficiency most apparent to foreigners, they hardly notice the greater problem of electricity shortages. All their hotels are equipped with 'emergency' generators whose routine use keeps their air conditioners going. Power shortages are not the only issue. Anywhere in Indonesia, only the brave or foolhardy would drink the water straight from the tap – that is, if they were lucky enough to have piped water.

During the Suharto period, Indonesia spent around 4% of GDP on infrastructure. This fell drastically with the crisis (especially with cancellation of large power generation projects). Even with the subsequent recovery, infrastructure spending is running at around 2.5% of GDP, half the pace the latest Asian Development Bank (ADB) Asian infrastructure report says is necessary.

The electricity projects cancelled during the 1997 crisis might have had questionable governance, but if they had gone ahead their output would have found a ready market. Similarly, Jakarta's abandoned urban rail would have offered an alternative to the notorious traffic jams.

Let's be more positive. This drastic infrastructure deficiency can be seen not as a problem, but as an opportunity. In a world concerned by secular stagnation and demand-deficiency, Indonesia has lots of good investment projects. While some outlandish schemes are put forward from time to time, there is very little chance that any half-sensible infrastructure project (whether in power, transport or telecommunications) would turn out to be a white elephant for lack of demand. Any extra capacity will have a high social return.

President Joko Widodo has made infrastructure a priority. Much has been done (or is in process) to expand electric capacity. Still more capacity is needed, with this making up over half of the ADB's budget of infrastructure requirements. Indonesia's per capita electricity consumption is less than one tenth of Australia's. A limited mass rail system is under construction in Jakarta, although a decent network is still many decades away. Meanwhile new tollways have sped up some journeys, at least until you leave the tollway to join the regular road system.

Of course finance is a challenge. The ADB approach is to estimate what could be financed from the government budget, and assume (or hope?) that the private sector comes up with the balance. But this gives too large a role for Public-Private Partnerships (PPPs). On past experience (including in Australia), the private partner usually manages to shift the risk back to the public sector, benefiting from successful projects and unloading loss-makers onto taxpayers. Indonesia will have to rely more on funding either from the budget or from state-owned enterprises (SoEs). Currently over half of Indonesia's infrastructure is funded from the budget, with SoEs providing about a third, leaving the private sector contributing a tenth. It is not realistic to think that this share will radically increase.

Indonesia starts with low government debt, but the budget deficit cannot exceed 3% of GDP, by law. The obvious candidates to take a greater role are the SoEs, but there are still governance concerns. Funding solutions involving 'value capture', or more effective pricing of infrastructure services, are often discussed but rarely implemented.

In any case, the constraints on expanding infrastructure are more often to be found in detailed implementation. Land acquisition is painfully slow. The list of operationally 'shovel-ready' projects is not long, despite the demonstrable needs.

Those who cross over from Nusa Dua's hotel enclave to look at the real Indonesia will witness everywhere the small-scale entrepreneurial vibrancy that refutes the World Bank's ranking of Indonesia's ease-of-doing-business – 91st out of 190. If only the government could get its act together on infrastructure, Indonesia could easily shift up a gear, to grow at the same 6-7% seen in China and India. This small acceleration is worthwhile: 7% growth would double GDP every decade.

Stephen Grenville

About the author

Stephen Grenville

Dr Grenville is a Nonresident Fellow at the Lowy Institute.

Topics

Indonesia