Risk survey shows Indonesia is not for the faint-hearted

Sulphur mining at Ijen volcano complex in Indonesia

The risks in Indonesia have increased massively in 2020, according to economists and political scientists taking part in Euromoney’s Country Risk Survey and who are now doubting the safety of foreign investments in the previously much-heralded archipelago.

The country has fallen a whopping 30 places in the survey’s rankings, to 101^st out of 174 countries, and into tier four – of five – containing the high, but not highest, risk sovereign borrowers.

The country is struggling with a large debt burden that will rise as the fiscal deficit moves above 6% of GDP this year, according to the IMF’s latest (October 2020) forecasts. Revenues will fall and more spending is needed to protect households and businesses through the crisis.

The country has an unenviable reputation for widespread corruption, a factor in scoring the lowest of all the political risk indicators in Euromoney’s ‘crowd-sourcing’ assessment.

It has a weak governance record, too, encapsulated in a poor score for institutional risk. 

Both factors should signal caution as the government looks to set up a $5 billion sovereign wealth fund, especially in light of the recent 1MDB scandal in Malaysia.

Indonesia’s Euromoney risk ranking puts in doubt its sovereign borrower investment grades from the main credit rating agencies, which would appear to be ignoring key risks, including an array of economic indicators that have been marked down heavily this year.

Covid-19 effects

Of course, Indonesia is not the only country to be badly affected by the Covid-19 pandemic, but it has around 268 million inhabitants and requires rapid growth for development: this year it will see its 5% real-terms growth rate vanish.

Officially, the number of cases is now approaching 400,000, with more than 13,500 losing their lives to the disease, but there are likely to be many unreported cases and deaths. Worse may yet come as the government fails to gain control over the pandemic's spread in all provinces.

The economic impact is underlined by a 5.3% year-on-year contraction in real GDP in the second quarter of 2020, which was the first drop since the Asian financial crisis in the 1990s.

The manufacturing purchasing managers index has bounced back since, but fell to a low of 27.5 in April and is still below 50 – the point dividing expansion from contraction – with the global economy weakening again in the fourth quarter on the back of a second wave of Covid.

Arjen van Dijkhuizen, senior economist at ABN Amro and a regular contributor to Euromoney’s global risk survey, says that although the country’s strong FX reserves buffer is a mitigating factor, “key external financial risks stem from the relatively high foreign debt-to-exports ratio and the fact that foreign investors hold a relatively large share of Indonesia’s government bonds.”

The economic impact is underlined by a 5.3% year-on-year contraction in real GDP in the second quarter of 2020 

He also notes that the rupiah is a volatile currency. It proved its vulnerability during the emerging markets capital outflow episode last spring, losing a fifth of its value against the dollar, and while it then regained most of the losses it has “weakened again somewhat” in recent months.

Another contributor, Yannick Bineau, director of the Asia-Europe Foundation, cautiously warns that the country faces challenges.

He notes that, following the health crisis, “the reduction in activity among many economic partners led to a sharp reduction in the country's export markets, not to mention the impact linked to the reduction in international mobility of people and the induced effect on tourism.”

The health crisis then affects fiscal stability, and since tax revenues are lower it makes it difficult for the government as a regulator.

“It also increases income inequalities that are already significant in this country,” Bineau says, "in particular to the detriment of the poorest categories and those working in the informal sector. They are strongly affected by the health crisis and the decision taken by authorities to reduce the impact of the outbreak.

“These budget cuts can also reduce the ability of the authorities to conduct policymaking to support the economy,” he adds, which is one of several economic factors marked down in the survey’s metrics.

Labour market reforms

Several analysts believe the authorities’ efforts to reform the labour market to make Indonesia more attractive to international investment are another problem.

“They are not well received by the population, leading to unrest in several cities, and in particular Jakarta,” notes Bineau.

In recent weeks, the police have used tear gas to disperse protestors angered by the government passing a new 905-page bill amending 79 laws governing environmental management, the labour market and planning policy.

Institutional investors, mindful of the challenges posed by climate change and their reputations among environmentally aware investors, are expressing heartfelt concerns about forest protection – highlighting how business-friendly legislation must also take into account the environmental impact.

For Indonesian investors eyeing the country’s considerable opportunities, they cannot complain they haven’t been warned.