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Surmount · #**120** Thursday, August 07, 2008

ECONOMY

Indonesia has a market-based economy in which the government plays a significant role. There are 158 state-owned enterprises and the government administers prices on several basic goods, including fuel, rice, and electricity.

In the mid-1980s, the government began eliminating regulatory obstacles to economic activity. The steps were aimed primarily at the external and financial sectors and were designed to stimulate employment and growth in the non-oil export sector. Annual real gross domestic product (GDP) growth averaged nearly 7% from 1987-97 and most analysts recognized Indonesia as a newly industrializing economy and emerging major market. The Asian financial crisis of 1997 altered the region's economic landscape. With the depreciation of the Thai currency, the foreign investment community quickly re-evaluated its investments in Asia. Foreign investors dumped assets and investments in Asia, leaving Indonesia the most affected in the region. In 1998, Indonesia experienced a negative GDP growth of 13.1% and unemployment rose to 15-20%. In the aftermath of the 1997-98 financial crisis, the government took custody of a significant portion of private sector assets via debt restructuring, but subsequently sold most of these assets, averaging a 29% return. Indonesia has since recovered, albeit slower than some of its neighbors, by recapitalizing its banking sector, improving oversight of capital markets, and taking steps to stimulate growth and investment, particularly in infrastructure. GDP growth has steadily risen this decade, achieving an estimated 6.2% in 2007.

Economic Policy: After he took office on October 20, 2004, President Yudhoyono moved quickly to implement a "pro-growth, pro-poor, pro-employment" economic program. He appointed a respected group of economic ministers who announced a "100-Day Agenda" of short-term policy actions designed to energize the bureaucracy. President Yudhoyono also announced an ambitious anti-corruption plan in December 2004. The State Ministry of National Development Planning (BAPPENAS) released in early 2005 a Medium Term Plan focusing on four broad objectives: creating a safe and peaceful Indonesia; creating a just and democratic Indonesia; creating a prosperous Indonesia; and establishing a stable macroeconomic framework for development. President Yudhoyono reshuffled his cabinet in December 2005, appointing former Finance Minister Boediono as Coordinating Minister for Economic Affairs, and moving Sri Mulyani Indrawati from the National Development Planning Agency to the Finance Ministry. In early 2006, the Government of Indonesia announced new policy packages for stimulating investment and infrastructure.

The Yudhoyono administration targeted average growth of 6.6% from 2004-2009 to reduce unemployment and poverty significantly. Indonesia's overall macroeconomic picture is stable and improving. By 2004, real GDP per capita returned to pre-financial crisis levels. In 2006, domestic consumption continued to account for the largest portion of GDP, at 62.6%, followed by investment at 24%, government consumption at 8.6%, and net exports at 4.8%. By all measures, investment realization has climbed in each of the past several years.

The government raised fuel prices by an average of 126% on October 1, 2005 in an effort to reduce Indonesia's fuel subsidy burden, which had been projected to reach Rp 89.2 trillion in 2005, or 3.3% of GDP. The fuel price hikes led to a surge in inflation as consumer price inflation reached 10.5% for 2005 and 13.1% for 2006, before returning to an estimated 6.3% in 2007. The Indonesian Government implemented a quarterly cash compensation package for low-income families and an extra range of benefits including subsidized rice, improved health and social services, housing subsidies, micro credit, and family planning programs.

Banking Sector: Indonesia currently has 130 banks, of which 11 are majority foreign-owned and 28 are foreign joint venture banks. The top 10 banks control about 67% of assets in the sector. Four state-owned banks (Bank Mandiri, BNI, BRI, BTN) continue to dominate the sector with approximately 40% of assets. The Indonesian central bank, Bank Indonesia (BI), announced plans in January 2005 to strengthen the banking sector by encouraging consolidation and improving prudential banking and supervision. BI hopes to encourage small banks with less than Rp 100 billion (about U.S. $11 million) in capital to either raise more capital or merge with healthier "anchor banks" before 2009, announcing the criteria for anchor banks in July 2005. In October 2006, BI announced a single presence policy to further prompt consolidation. The policy stipulates that a single party can own a controlling interest in only one banking organization. Controlling interest is defined as 25% or more of total outstanding shares or having direct or indirect control of the institution. BI plans to adopt Basel II standards beginning in 2008 and to improve operations of its credit bureau to centralize data on borrowers. Another important banking sector reform was the decision to eliminate the blanket guarantee on bank third-party liabilities. BI and the Indonesian Government completed the process of replacing the blanket guarantee with a deposit insurance scheme run by the independent Indonesian Deposit Insurance Agency (also known by its Indonesian acronym, LPS) in March 2007. The removal of the blanket guarantee did not produce significant deposit outflows from or among Indonesian banks. Sharia banking has grown considerably in Indonesia in recent years, representing 1.4% of the banking sector, about $2.2 billion in assets at the end of 2005.

Exports and Trade: Indonesia's exports grew to a record $100.7 billion in 2006, an increase of 17.5% from 2005. The largest export commodities for 2006 were oil and gas (21.2%), minerals (15.7%), electrical appliances (14.7%), rubber products (6.9%), and textiles (3.4%). The top four destinations for exports for 2006 were Japan (15.4%), the U.S. (13.4%), Singapore (9.8%), and China (6.9%). Meanwhile, total imports were $61.1 billion in 2006, including: raw materials and intermediaries ($47.2 billion), capital goods ($9.1 billion), and consumer goods ($4.6 billion). The U.S. trade deficit with Indonesia decreased by 16.5% in 2006 to $7.2 billion ($4.0 billion in exports versus $11.2 billion in imports).

Oil and Minerals Sector: Indonesia, the only Asian member of the Organization of Petroleum Exporting Countries (OPEC), ranked 20th among world oil producers in 2006, with about 1.3% of world production. Crude and condensate output averaged 1.07 million barrels per day (b/d) in 2006. In 2006, the oil and gas sector, including refining, contributed $23 billion, or 24% of government revenues. U.S. companies have invested heavily in the petroleum sector. Due to limited refining capacity and growing domestic demand for petroleum fuels, Indonesia became a net oil importer in 2004 and continued to be a net oil importer through 2007. Indonesia ranks eighth in world gas production. In early 2007, Qatar passed Indonesia as the world's number one exporter of liquefied natural gas (LNG). Despite the declining trends, Indonesia's oil and gas trade balance remained positive at $1.8 billion in 2005 and $2.3 billion for 2006, according to unofficial statistics.

Although minerals production traditionally centered on bauxite, silver, and tin, Indonesia is expanding its copper, nickel, gold, and coal output for export markets. In mid-1993, the Energy Ministry reopened the coal sector to foreign investment. Total coal production reached 159 million metric tons in 2006, including exports of 119.8 million tons. Two U.S. firms operate two copper/gold mines in Indonesia, with a Canadian and U.K. firm holding significant investments in nickel and gold, respectively. In 2006 Indonesia ranked eighth among the world's top gold concentrate producers. Indonesian gold production in 2006 was 85.4 tons, down about 50% compared with 167 tons in 2005. Indonesia achieved its peak output in 2001 with 180 tons. Production mainly came from Freeport's Grasberg mine, the world's biggest gold-producing mine. Indonesia's share of global hard rock mining exploration spending has dropped from 3% to 1%. Since 1998, only three new gold mines have opened. This decline does not reflect Indonesia's mineral prospects, which are high; rather the decline reflects uncertainty over mining laws and regulations, low competitiveness in the tax and royalty system, and investor concerns over divestment policies and the sanctity of contracts.

Investment: Since the late 1980s, Indonesia has made significant changes to its regulatory framework to encourage investment and economic growth. This growth was financed largely from private investment, both foreign and domestic. U.S. investors provided a majority of the investment in the oil and gas sector and undertook some of Indonesia's largest mining projects. In addition, the presence of U.S. banks, manufacturers, and service providers expanded, especially after the industrial and financial sector reforms of the 1980s. While many petroleum and mining investors remained after the 1997 financial crisis, the number of U.S. investors in other sectors declined. Other major foreign investors include Japan, the United Kingdom, Singapore, the Netherlands, Hong Kong, Taiwan, and South Korea. Infrastructure investment declined steadily after the financial crisis and has not yet recovered. In November 2006, however, the Indonesian Government announced that it is opening up 110 infrastructure projects valued at $16.5 billion and is working on 120 regulations to encourage infrastructure investment.

President Yudhoyono and his economic ministers have stated repeatedly their intention to improve the climate for private sector investment in order to raise the level of GDP growth and reduce unemployment. In addition to general corruption and legal uncertainty, businesses have cited a number of specific factors that have reduced the competitiveness of Indonesia's investment climate, including: corrupt and inefficient customs services; non-transparent and arbitrary tax administration; inflexible labor markets that have reduced Indonesia's advantage in labor-intensive manufacturing; increasing infrastructure bottlenecks; and uncompetitive investment laws and regulations. A February 2006 policy package to improve the investment climate in Indonesia for both domestic and foreign investors--Presidential Instruction (INPRES) No. 3/2006--was designed to strengthen investment services, harmonize central and regional regulations (Perda), improve customs, excise, and taxation services, create jobs, and support small and medium enterprises; it has not been fully implemented. A new investment law was enacted in 2007, which contains provisions to restrict the share of foreign ownership in a range of industries. Long-planned tax and labor reforms have been delayed.

The passage of a new copyright law in July 2002 and accompanying optical disc regulations in 2004 greatly strengthened Indonesia's intellectual property rights (IPR) regime. Despite the government's significantly expanded efforts to improve enforcement, IPR piracy remains a major concern to U.S. intellectual property holders and foreign investors, particularly in the high-technology sector. In March 2006, President Yudhoyono issued a decree establishing a National Task Force for IPR Violation Prevention. The IPR Task Force was intended to formulate national policy to prevent IPR violations and determine additional resources needed for prevention, as well as to help educate the public through various activities and improve bilateral, regional, and multilateral cooperation to prevent IPR violations. It has yet to fully realize these aims. In 2007, Indonesia was removed from the U.S. Trade Representative's "Priority Watch" list and placed on the "Watch" list.

NATIONAL SECURITY

Indonesia's armed forces (Tentara Nasional Indonesia, or TNI) total approximately 350,000 members, including the army, navy, marines, and air force. The army is the largest branch with about 280,000 active-duty personnel. Defense spending in the national budget accounts for 1.8% of GDP, but is supplemented by revenue from many military businesses and foundations.

The Indonesian National Police were a branch of the armed forces for many years. The police were formally separated from the military in April 1999, a process that was completed in July 2000. With 250,000 personnel, the police represent a much smaller portion of the population than in most nations.

Indonesia has peaceful relations with its neighbors. Without a credible external threat in the region, the military historically viewed its prime mission as assuring internal security. Military leaders have said that they wish to transform the military to a professional, external security force, providing domestic support to civilian security forces as necessary.

Throughout Indonesian history, the military maintained a prominent role in the nation's political and social affairs. A significant number of cabinet members have had military backgrounds, while active duty and retired military personnel occupied a large number of seats in the parliament. Commanders of the various territorial commands played influential roles in the affairs of their respective regions. With the inauguration of the newly-elected national parliament in October 2004, the military no longer has a formal political role, although it retains important political influence.

FOREIGN RELATIONS

Since independence in 1945, Indonesia has espoused a "free and active" foreign policy, seeking to play a role in regional affairs commensurate with its size and location but avoiding involvement in conflicts among major powers. Indonesian foreign policy under the "New Order" government of President Soeharto moved away from the stridently anti-Western, anti-American posturing that characterized the latter part of the Soekarno era. Following Soeharto's ouster in 1998, Indonesia's Presidents have preserved the broad outlines of Soeharto's independent, moderate foreign policy. The traumatic separation of East Timor from Indonesia after an August 1999 East Timor referendum, and subsequent events in East and West Timor, strained Indonesia's relations with the international community.

A cornerstone of Indonesia's contemporary foreign policy is its participation in the Association of Southeast Asian Nations (ASEAN), of which it was a founding member in 1967 with Thailand, Malaysia, Singapore, and the Philippines. Since then, Brunei, Vietnam, Laos, Burma, and Cambodia also have joined ASEAN. While organized to promote common economic, social, and cultural goals, ASEAN acquired a security dimension after Vietnam's invasion of Cambodia in 1979. The security policy aspect of ASEAN expanded with the establishment of the ASEAN Regional Forum in 1994, in which 22 countries participate, including the United States. At ASEAN's Singapore Summit in November 2007, the organization's members signed a new charter, a small step toward the agreed goal of creating an ASEAN Community to propel greater integration in the areas of political and security affairs, economics, and socio-cultural affairs. Indonesia was a strong proponent of further integration. Indonesia also was one of the founders of the Non-Aligned Movement (NAM) and has taken moderate positions in its councils. As NAM Chairman in 1992-95, Indonesia led NAM positions away from the rhetoric of North-South confrontation, advocating instead the broadening of North-South cooperation in the area of development. Indonesia continues to be a prominent leader of the Non-Aligned Movement.

A secular state, Indonesia has the world's largest Muslim population and is a member of the Organization of the Islamic Conference (OIC). It carefully considers the interests of Islamic solidarity in its foreign policy decisions while providing a moderating influence in the OIC. President Wahid, for example, pursued better relations with Israel; Foreign Minister Wirajuda participated in the November 2007 Middle East peace conference in Annapolis.

After 1966, Indonesia welcomed and maintained close relations with the donor community, particularly the United States, Western Europe, Australia, and Japan, through the Intergovernmental Group on Indonesia (IGGI) and its successor, the Consultative Group on Indonesia (CGI), which have provided substantial foreign economic assistance. Donors in recent years have expanded assistance to Indonesia, due to its rapid democratic consolidation.

Indonesia has been a strong supporter of the Asia-Pacific Economic Cooperation (APEC) forum. Largely through the efforts of President Soeharto at the 1994 meeting in Bogor, Indonesia, APEC members agreed to implement free trade in the region by 2010 for industrialized economies and 2020 for developing economies.

Indonesia often supports Non-Aligned Movement (NAM) and Group of 77 (G-77) foreign policy views, taking positions regarding human rights contrary to the United States. In May 2005, the Yudhoyono administration, in a major effort to reinvigorate its leadership of the NAM and reset the movement's future course, hosted an Asia-Africa Summit to commemorate the founding of the NAM in Bandung, Indonesia in 1955.

President Yudhoyono has sought a higher international profile for Indonesia. In March 2006, Yudhoyono traveled to Burma to discuss democratic reform and visited several Middle Eastern countries in April and May 2006. Yudhoyono delivered a major speech in Saudi Arabia, encouraging the Muslim world to embrace globalization and technology for greater social and economic progress. In November 2006, Indonesia sent about 1,000 peacekeeping troops to southern Lebanon to be part of the UN Interim Force in Lebanon (UNIFIL) and replaced those troops with a second contingent a year later. In 2007 and 2008, Indonesia holds a non-permanent seat on the UN Security Council.