Over half of the world’s population will vote to elect their country’s leaders this year. This includes elections in eight of the world’s most populous countries: India, Brazil, Indonesia, the US, Bangladesh, Mexico, Pakistan and Russia.
Indonesia, the largest country in Southeast Asia with a population of 277 million, had 204 million eligible voters cast their ballots on Feb 14 to elect the eighth president. This marks only the fifth election since Indonesia became an independent republic in 1945. The first president, Sukarno, held power for 22 years after consolidating control and becoming “President for Life”.
However, years of economic hardship, characterised by hyperinflation and rising threats from communist ideologies, led to Sukarno’s replacement by another authoritarian leader, President Suharto, who ruled from 1967 to 1998.
Suharto was forced to step down after the 1997 Asian Financial Crisis due to severe domestic economic instability, a collapsed currency and widespread unrest across Indonesia. The first elections were held in 1998.
Since then, Indonesia has entered a new political era called Reformasi. Significant reforms have transformed the judiciary, legislature and executive branches, including abolishing the “President for Life” title and limiting presidential terms to two five-year periods. These changes have been crucial in making Indonesia a more democratic society, strengthening the rule of law and promoting political stability.
Stability and growth under Jokowi
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Fast forward to the presidency of Joko Widodo, popularly known as Jokowi. The well-loved outgoing president has maintained an approval rating above 60% throughout his 10-year tenure. Jokowi effectively engaged with the younger generation through social media, inspiring many Indonesians with his story of rising from a humble background to become the country’s leader through hard work.
His administration delivered strong economic development and job growth, ensured robust government budget control and furthered reforms to the state machinery to increase efficiency and reduce corruption. The Jokowi government is the most stable in modern Indonesian political history.
The 2024 presidential elections concluded smoothly in February, with only one round of voting. The elected pair, President Prabowo Subianto and Vice President Gibran Rakabuming Raka (Jokowi’s eldest son), is seen as a continuation of the Jokowi platform.
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Prabowo, who will assume office in October, has pledged to continue Jokowi’s reforms. These include expanding commodity processing, building infrastructure, and relocating the capital to Nusantara in East Kalimantan, which offers reassurance about policy continuity.
Investor concerns
Even so, this incoming administration leans towards populist policies, which will likely increase the government fiscal deficit from 1.7% to the 3% statutory limit, pushing government debt-to-GDP from the current 40% closer to 50%.
Prabowo’s campaign policies include free lunch plans for every student, higher spending on infrastructure and ramping up defence capabilities. While Prabowo mentioned the deficit would likely be funded by higher tax collection from improved automated tax systems and various tax reforms, including removing tax incentive programs, the feasibility remains in question.
Indonesia’s tax system remains manual and cumbersome, resulting in a low tax-to-GDP ratio of 11%, compared to the average of 14% to 17% in other emerging Asian countries.
Prabowo’s proposed policies have worried some of Jokowi’s cabinet ministers and global bond investors. The week after the election, the Indonesian rupiah weakened 0.42% against the US dollar, while the Philippines peso weakened only 0.19% over the same period.
Since the election, Indonesian government bonds have lagged behind their Southeast Asian peers. Announcements such as Prabowo’s nephew, Thomas Djiwandono, being appointed as the second deputy finance minister have heightened concerns among investors about a potential increase in bond supply.
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Despite concerns about higher public debt levels, the market reaction is overdone. Even with a 50% debt-to-GDP ratio, Indonesia’s debt is still substantially lower than that of other Southeast Asian economies: 63% for Malaysia, 61% for the Philippines, and 60% for Thailand. Indonesia is unlikely to be downgraded by rating agencies since its debt-to-GDP level remains within the range for Baa/BBB-rated sovereigns.
Deutsche Bank estimates that if the deficit-to-GDP ratio increases from low 2% to 3%, even without growth in government revenue collection, the debt-to-GDP ratio is unlikely to exceed 50%.
The government can also utilise its US$30 billion ($40.1 billion) cash balance, currently three times higher than pre-Covid-19 levels, to fund the increase in future spending, thus reducing reliance on additional government bond issuance. Indonesia can, therefore, afford a slightly higher fiscal deficit, especially if the spending raises productive capacity without a rise in corruption.
Market outlook
Indonesia has maintained tight control over its government budget for decades, leading to underinvestment in infrastructure needed for its growth (see Figure 1).
While Jokowi’s infrastructure drive has helped Indonesia catch up with the rest of Southeast Asia, much work remains to improve connectivity across the nation’s 17,000 islands.
Prabowo’s planned infrastructure push is necessary to continue diversifying away from commodities exports by enhancing infrastructure for manufacturing, processed commodities, transport, sustainable energy and tourism. Improved infrastructure will be key to attracting foreign investment and boosting industrial productivity.
Indonesia is at a critical juncture in its economic development. With a relatively young and increasingly educated population, the country has a conducive backdrop for productivity growth. Prabowo’s GDP growth target of 8% aligns with what is needed for the country to avoid the ‘middle income trap’ (see Figure 2) and achieve high-income status before the population starts ageing.
Indonesia has posted strong GDP growth of over 5% for the last three decades, except during the Asian Financial Crisis and the Covid-19 pandemic. Yet, the rate still undershoots its growth potential of 7% to 8%.
Indonesia is a lower-middle-income economy, with a GDP per capita of US$4,800 in 2022. Achieving high-income status will require coordinated efforts from the public and private sectors to innovate and raise productivity.
We will continue to monitor Indonesia closely over the coming months as details of economic policies and incoming minister appointments are finalised. Global investors will remain cautious about any perceived departure from Jokowi’s administration direction.
Meanwhile, Bank Indonesia (BI) and US monetary policy will remain the key domestic bond market performance drivers. BI’s ability to follow the pace of US rate cuts depends on the stability of the Indonesian rupiah (IDR) and the issuance of short-term notes (Bank Indonesia Rupiah Securities or SRBI) at 7% to 7.5% for a 12-month tenor has improved the rate of return on IDR.
If this proves effective in stabilising the currency and with foreign investors’ participation in Indonesian government bonds at an all-time low, we believe the conditions are improving for Indonesian bonds to join a global rally led by rate cut expectations.
Peermpa Janjumratsang is Portfolio Manager, Asia Fixed Income, M&G Investments
