Survey of recent developments

Summary

The arrival of a new year has brought with it an increased focus on Indonesia's 2014 legislative and presidential elections. While voters may be disillusioned with established political figures, a strong presidential candidate has yet to emerge. Many voters appear to yearn for an experienced and uncorrupt leader with new and proactive policies, which is why Jakarta's new governor, Joko Widodo, is being viewed as a potential candidate.

The Constitutional Court has made two major, controversial rulings in recent months: the first concerned the upstream oil and gas regulator BPMigas, the second the international-standard pilot-project schools (Rintisan Sekolah Bertaraf Internasional, RSBIs). The Court ruled both institutions unconstitutional and called for their immediate disbandment.

In 2012, Indonesia's year-on-year economic growth slowed slightly, to a still healthy 6.2%, owing to continued weak global demand for its exports and a contraction in government expenditure. In contrast, foreign direct investment and portfolio investment were particularly strong, with respective increases of 25% and more than 142%. At 4.3%, inflation for the 2012 calendar year still remains well within the government's and Bank Indonesia's expectations. However, inflation expectations are high for 2013, owing to likely reforms to energy subsidies; the expected effect of bad weather on food prices; and increases in minimum wages, which attracted attention in 2012 because of their magnitude and their apparent disparity among regions. Concerns also exist that these rises in minimum wages will hamper Indonesia's international competitiveness and could discourage investment in labour-intensive industries.

Minimum-wage policy is also controversial because of doubts about its relevance to the genuinely poor sections of society – those in informal employment or with primarily subsistence income, who constitute a large proportion of the population. Indonesia has experienced a steady increase in income inequality in the last decade, indicating that the benefits of strong economic growth have not been shared equally. Potential reasons for this increasing inequality relate to labour-market segmentation amid a growing middle class, weak institutional foundations, and commodity-driven growth.

It appeared in 2012 that Indonesia has also been one of the world's poorest performers in HIV/AIDS prevention in recent years. While prevalence rates are low, the number of new HIV infections in 2011 was more than four times that of any other South Asian or Southeast Asian country, and the infection rate among the working-age population has risen by more than 25% since 2001. Infection rates among high-risk groups are also alarmingly high compared with those of other Southeast Asian countries. Targeted prevention, treatment and support programs among these groups are paramount.

Political developments

Indonesia has now entered a very politically active period leading up to the legislative and presidential elections in 2014. Ten political parties passed the factual verification process of the Elections Commission (Komisi Pemilihan Umum, KPU), which approved fewer than 25% of applications – compared with around 50% in 2009 – reflecting the stricter eligibility requirements of the new Election Law 8/2012.1 The final list of eligible parties has not come without disputes from smaller, ineligible parties and controversy over a perceived lack of transparency in the KPU's verification process (Jakarta Post, 8/1/2013). Furthermore, nine of the 10 successful parties currently hold seats in the House of Representatives, which makes critics pessimistic about the prospect of any real change in the national political landscape (Jakarta Post, 9/1/2013).

Many of the names regularly mentioned as potential candidates for the 2014 presidential election are veteran politicians, including Golkar chairman Aburizal Bakrie; former commander of the Army Strategic Reserve (Kostrad) Prabowo Subianto; former vice president Jusuf Kalla; and former president Megawati Sukarnoputri.2 But many Indonesians appear to yearn for a new face and new policies, for a candidate untainted by allegations of corruption and nepotism. If such a person were to appear in time for 2014, however, they would be unlikely to have enough experience to make them a realistic contender.

Once thought to be a likely successor to Susilo Bambang Yudhoyono (SBY) for the presidency (Jakarta Post, 31/5/2010), Anas Urbaningrum of the Democratic Party (Partai Demokrat, PD) has had his chances quashed by allegations of his involvement alongside other key PD figures in the Hambalang sports-complex graft case and, more recently, by his being formally named as a suspect by the Corruption Eradication Commission (Komisi Pemberantasan Korupsi, KPK) (Olivia and Yamauchi 2012; Kompas, 23/2/2013) and by his subsequent resignation as PD chairman.

Developments in the Hambalang case have escalated since December 2012, when the KPK named then Minister of Youth and Sports Andi Alfian Mallarangeng as a suspect, leading to his immediate resignation (Jakarta Post, 7/12/2012). At the time, political analysts predicted this would trigger a cabinet reshuffle, enabling SBY to ‘clean up’ his ministry and regain some much-needed public support (Vermonte 2012). Instead, in a move deemed likely only to inflict further damage on PD's troubled image (Jakarta Post, 14/01/2013), lawmaker and telecommunications expert Roy Suryo Notodiprojo – who has no public profile in youth affairs or sport – has been appointed as Mallarangeng's replacement, prompting much public criticism via social media. In contrast, a strong and vocal commitment to moral integrity has seen Constitutional Court Chief Justice Mohammad Mahfud emerge as one of the more popular potential presidential nominees from outside a major party. A member of parliament during 2004–08 for the small National Awakening Party (Partai Kebangkitan Bangsa, PKB), Mahfud has seen his popularity grow recently, following the controversial ruling on the BPMigas case (discussed in the ‘Constitutional Court decisions’ section of this survey).

With no apparent ties to corruption, a willingness to meet the ‘little people’ on their turf and a ‘can do’ attitude, Jakarta's new governor, Joko ‘Jokowi’ Widodo, is leading the presidential popularity polls (Jakarta Globe, 7/2/2013). Jokowi's ambitious new policies include the Jakarta Health Card (Kartu Jakarta Sehat, KJS), which allows free health treatment at community health centres and free thirdclass hospital-room treatment for all Jakartans; the Jakarta Smart Card (Kartu Jakarta Pintar, KJP), which assists low-income families with the costs of education; street-vendor management; and kampung revitalisation projects (Jakarta Post, 22/12/2012, 14/1/2013). The KJS, in particular, has been adopted widely since its launch, and consequently it is unlikely that Jakarta's budget and current hospital systems will be able to support the demand.

Some of Jokowi's decisions, however, have met with opposition. His election promises included improving Jakarta's public transport system; reducing the city's reliance on private cars by improving the TransJakarta busway; developing a mass rapid-transit system; reviving the abandoned monorail project; and introducing an odd–even licence-plate system, which would restrict the number of private vehicles on the road (Jakarta Post, 12/01/2013). But his subsequent approval of six new toll roads in Jakarta has called into question his commitment to these promises. Critics see only the relatively well-off car owners benefiting from the development; the governor maintains that all Jakartans would benefit, because public transport would also use the new roads (Jakarta Post, 11/1/2013).

Jokowi takes on Jakarta with a successful record of reform during his time as mayor of Solo (McLeod 2008), but sceptics still doubt his ability to address Jakarta's myriad problems without corruption or controversy. Nonetheless, proactive reform is surely the only way forward, and there are positive signs of progress in Jakarta that deserve recognition. A presidential run in 2014 may be too soon for Jokowi – what his popularity reflects, though, is the electorate's disillusionment with established politicians. Leaders who can articulate a fresh vision, take positive action and avoid corruptive influences are likely to be rewarded in the polls.

Jakarta floods, again

A state of emergency was declared in the capital in January, as torrential rain and burst canal dykes led to flooding that killed at least 20 people and displaced as many as 50,000 from their homes (ABC News, 21/1/2013). While the number of fatalities and the displacement rate are lower than those of the 2007 flood – in which 57 people died and 450,000 were evacuated (Jakarta Post, 18/1/2013) – January's inundation of the CBD caused greater economic losses, estimated at up to $3.3 billion (Jakarta Globe, 1/2/2013).

Jha, Bloch and Lemond (2012) point to a number of underlying systemic causes of flooding in Jakarta, which are not dissimilar to those faced by governments in many developing countries: rapid urban population growth; insufficient maintenance and improper operation of flood-control systems; limited coverage of solid-waste collection services; lack of coordination between authorities responsible for flood management; and land subsidence. Removing these underlying causes requires practical changes to major infrastructure and services, which in turn require a strong, competent government with the capacity to make them. The extensive disruptions and heavy criticism that resulted from the floods demonstrate the consequences of failing to deliver.

The disaster has prompted the government to develop further flood-prevention programs, some of which will start immediately and some of which will take place over a longer time-frame. An allocation of Rp 2 trillion from central administration will see the building of a spillway in the Ciliwung river, a widening of the river and the relocation of riverbank squatters. Longer-term programs include the building of reservoirs, pump systems, wells and a tunnel spanning the city (Jakarta Post, 21/1/2013). Despite their significant funding, these programs are ambitious; time will tell whether the government can deliver them.

Macroeconomic developments

Economic growth

In 2012, Indonesia's economic growth slowed slightly to 6.2% year on year, compared with 6.5% in 2011. Oil production declined,3 but growth in the non–oil and gas sector remained relatively high, at about 6.8% (table 1). The non-tradables sectors showed substantially high growth in 2012: 12.1% in communications; 8.1% in trade, hotels and restaurants; and 7.2% in financial, rental and business services. The tradables sector also showed positive growth, with rates of 6.4% in non–oil and gas manufacturing and 4.0% in agriculture, livestock, forestry and fisheries. Meanwhile, the mining and quarrying sector continued its trend of very low growth. This is not unexpected, given the decline in commodity prices and a government ban on exporting certain mining commodities.4

TABLE 1 Components of GDP Growth (2000 prices; % year on year)

Source: CEIC Asia Database.

Indonesia's lower rates of growth in 2012 were due to the continued weak global demand for its exports and a contraction in government expenditure. Export growth was only 2% in 2012, compared with 13.6% in 2011 and 15% in 2010. With negative growth in the EU, and with the US and Japan growing by just 2.3% and 2% respectively and China slipping to 7.8%, this slowdown in export growth was to be expected.5 The decline in Indonesia's exports in 2012 was due not only to weakening demand and lower commodity prices but also to policyinduced reductions in supply, via export restrictions. These restrictions include already imposed export taxes on commodities such as leather, wood products, cocoa and palm oil; a 20% export tax on certain mining commodities; and new regulations on the exporting of these commodities (Burke and Resosudarmo 2012; Anas 2012). The IMF (2013) projects that global growth will follow an upward trend in the next couple of years; as long as supply-side policies and capacities align with any increased demand, this should have a positive effect on Indonesia's exports.

Government expenditure increased by only 1.3% in 2012, as a result of the contraction in spending in the second half of the year and in line with the spending cuts outlined in Presidential Instruction 7/2012. Investment (plus change in inventories) grew at 9.8%, and private consumption grew at 5.3% – in line with the emergence of what the McKinsey Global Institute (2012) has labelled the ‘consuming class’,6 which comprised about 45 million people in 2010. This number is expected to almost double in the next 10 years (McKinsey 2012).

Inflation

Indonesia's inflation rate in 2012 was 4.3%, higher than its 3.8% in 2011 (Mahi and Nazara 2012: 12) but still well within the government's and Bank Indonesia's (BI's) expected target of 3.5–5.5%. Core inflation was 4.4%, administered goods inflation was 2.7% and food inflation was 5.7% (BPS 2013).7 The pressure on prices may increase in 2013, owing to likely reforms to energy subsidies, the expected effect of bad weather on food prices, and increases in minimum wages.8

BI has kept its policy rate at 5.75% since February 2012. Used by BI to anchor inflation, the policy rate is an imperfect measure of BI's stance on monetary policy, because it is not linked to any instrument in the market (McLeod 2011).

BOX 1 INDONESIA TO HOST 2013 APEC SUMMIT

Indonesia has begun to prepare for its hosting of the 25^th Asia-Pacific Economic Cooperation (APEC) Summit – ‘Resilient Asia-Pacific, engine of global growth’ – in Bali, in October 2013. The summit will focus on building economic resilience, in light of the recent global downturn and amid numerous natural disasters in the region. Indonesia has added three priorities to the APEC agenda for 2013 (Jakarta Globe, 29/12/2012):

1.	continuing efforts towards attaining the Bogor goals of free and open trade and investment;
2.	achieving sustainable, equitable and ‘green’ growth; and
3.	promoting connectivity, including physical infrastructure, institutional connectivity and people-to-people connectivity in the region.

These priorities reflect the recent maturing of a more outward-looking and open economic diplomacy for Indonesia. The summit itself is expected to symbolise Indonesia's commitment to expanding trade and connectivity, as well as presenting an opportunity for Indonesia to promote itself to APEC and the wider international community. Holding 42 APEC-related meetings and workshops during 2013, Indonesia expects to attract more than 30,000 delegates and business people, and to generate at least $105 million in income (Jakarta Post, 11/2/2013).

Around $300 million has been earmarked to finance the summit and its associated infrastructure: works include expanding the Ngurah Rai airport, building a new convention centre in Nusa Dua, and constructing a toll road between the airport and the convention centre (Jakarta Post 29/09/2012). While a renovated airport and a new toll road are likely to provide some benefits after the summit to local transport and tourism (Burke and Resosudarmo 2012), other expenditure may not provide any benefits beyond the summit itself (see, for example, Zimbalist 2010).

In contrast, the Bank Indonesia Certificate (SBI) rate is determined by the money market, and it remained below the policy rate throughout 2012. The real SBI rate9 has been marginally positive since September 2012 (figure 1).

FIGURE 1  Monetary Policy and Inflation, 2011–12 ^a (% p.a.)

^a CPI = consumer price index; SBI = Bank Indonesia Certificate.

Source: CEIC Asia Database.

Exchange rate and stock market

A decline in export earnings, alongside high demand for foreign exchange to finance imports and the current account deficit, has resulted in a shortage of foreign exchange and has caused the rupiah to depreciate by 5.4% against the US dollar in 2012 (figure 2), despite a surge in capital inflows.

FIGURE 2  Composite Stock Price Index (CSPI) and Exchange Rate, 2011–12

Source: Indonesia Stock Exchange; Pacific Exchange Rate Service.

In an attempt to prevent further depreciation of the rupiah, BI has undertaken a number of initiatives to increase the supply of US dollars. First, in 2011 it introduced a regulation that required exporters and debtors to withdraw any funds parked overseas and deposit them in Indonesian-based banks. The regulation has not been well received or followed, especially by some large contractors in the oil and gas sector, who contest that their production sharing contract provides them with the right ‘to freely lift, dispose of and export their share of petroleum and retain the proceeds abroad’ (Jakarta Post, 12/2/2012) and who may seek international arbitration (Jakarta Post, 21/2/2013). Second, in June 2012 BI introduced a weekly US dollar term-deposit auction as a new instrument in the foreign exchange market (Nasution 2012), in a bid to retain dollars in the domestic banking system. Third, in November 2012 BI introduced a new regulation involving ‘trust rights’, a legal framework for local banks to manage dollar-based funds aimed at encouraging exporters to invest their currency in Indonesia: BI sets eligibility criteria and considers applications from banks seeking trustee status. Eligible banks are then required to set up separate entities, with separate book-keeping, to manage the funds. This arrangement is designed to give investors greater security; if a bank with trustee status were to be liquidated, the funds would be protected.

Given the depreciating rupiah and a relatively low inflation rate, Indonesia's commodities ought to be more competitive. It is likely that trade policy interventions have distorted this competitiveness and led to the decline in export growth that began in the second quarter (Q2) of 2012.

Indonesia's stock market performed well in 2012, reflecting market confidence in the economy. The Composite Stock Price Index has followed an upward trend since July, reaching its highest point in history on 26 November and closing the year with an overall increase of 11.9% – Asia's fourth best performer in 2012 (IDX 2012; Investor Daily, 28/11/2012). Market capitalisation for the year also increased, by 15.5% (IDX 2012). Foreign interest in Indonesia's stock market continues, with net purchases of Rp 15.8 trillion ($1.7 billion) by foreign investors in 2012 (IDX 2012).

Balance of payments

Indonesia's current account deficit rose to $24.2 billion in 2012, a major change from the $1.7 billion surplus in 2011 (table 2). This is the first time that the current account balance has been negative since 1997, when it peaked at a $5.2 billion surplus after being in deficit throughout most of the 1980s and 1990s. Last year's deficit is due largely to a 75% reduction in the merchandise trade surplus, to $8.5 billion, stemming from a 6.3% decline in exports since 2011. Added to that are continued net services imports of $10.8 billion and net income payments overseas of $25.8 billion.

TABLE 2 Balance of Payments ($ billion)

^a Provisional figures.^b Very provisional figures. Source: Bank Indonesia.

The current account deficit in 2012 was sustained by the very significant influx of capital, with foreign direct investment (FDI) of $14.4 billion (25% greater than in 2011) and portfolio investment of $9.2 billion (142% greater) (table 2). This high influx of FDI was somewhat expected, after Indonesia regained its high investment rating while the EU and the US faced bleak investment outlooks (Olivia and Yamauchi 2012: 149; Mahi and Nazara 2012: 15). The surge in portfolio investment occurred not only in the equity market but also in the bonds markets. Indonesia's 10-year bond yield dropped briefly to 5.1% in January 2013, but it remains high relative to those of most countries in the region.10

In addition, the surge in FDI in 2012 occurred mainly in the secondary and tertiary sectors, with the secondary sector attracting 50% of FDI inflows and the tertiary sector attracting 30%.11 The mining sector remained a significant destination, attracting 17% of FDI inflows (BKPM 2013).12

In all, the surplus in the balance of payments shrank to only $0.2 billion in 2012, or to just 2% of the 2011 surplus, which implies that Indonesia's stock of foreign reserves increased marginally.

The 2012 and 2013 budgets

The level of expenditure in the revised 2012 budget was about Rp 1,548 trillion ($163 billion), with revenue of Rp 1,358 trillion ($143 billion), resulting in an overall deficit of 2.2% of GDP (table 3). As expected, by the end of the 2012 fiscal year the government had used 95% of the approved revised budget. Disbursements for materials and capital were only 69% and 83% respectively, while spending on energy subsidies (for fuel and electricity) was 151% of the allocated budget (table 3). The low disbursement of materials coincides with the contraction in government consumption in Q3 and Q4 2012, as shown in the national accounts (table 1).

TABLE 3 2012 Budget Outcome and 2013 Budget ^a (Rp trillion)

^a VAT = value-added tax; SPN = Treasury bills; MBOEPD = million barrels of oil equivalent per day. Source: Ministry of Finance.

Under-spending in general was partly a consequence of President SBY's June 2012 instruction to cut spending in expectation of soaring energy-subsidy costs after the fuel subsidy was not cut in April 2012 (Olivia and Yamauchi 2012: 151). On top of this, it can be argued that the under-spending is due to weak budget preparation and complex procurement procedures (World Bank 2012).

The government has recently introduced several technical regulations to address the persistent problem of under-spending, including the 2012 law on land acquisition for public infrastructure and revisions of the 2010 presidential regulation on the procurement of public goods and services. The land acquisition law is expected to hasten infrastructure development and increase the rate of disbursement of capital expenditures. The revised presidential regulation on procurement raises the limit for direct procurement from Rp 100 million to Rp 200 million and for simple tender from Rp 200 million to Rp 5 billion. It also allows direct appointments for procurement values up to $100 billion, which, in all, is expected to increase the rate of disbursement of materials and capital expenditures.

The 2013 budget was approved by parliament on 23 October 2012, with total expenditure of Rp 1,683 trillion ($177 billion), 2% higher than first proposed (table 3). The budget deficit is predicted to be 1.7% of GDP. Taxation will be the main source of revenue in 2013, comprising 78% of total government revenue, and more than half of it will come from income tax. On the expenditure side, 69% of the budget is allocated to central government spending and the remaining 31% to regional transfers. Parliament recently approved material spending of Rp 200.7 trillion, 26% higher than in the proposed budget. The energy subsidy has been approved at the proposed rate of around Rp 274.7 trillion, much lower than its blowout in actual expenditure in 2012. In contrast to the 2012 budget, abolishing or reducing a fuel subsidy no longer requires parliamentary approval, which may make it easier for the government to keep subsidies within the budgeted amount. Parliament has also approved an increase in electricity prices, which will reduce the energy subsidy slightly and allow more funds for infrastructure. However, it is unlikely that the government will significantly reduce the fuel subsidy in the year before a presidential election.

Overall, the 2013 budget has a primary deficit13 of around Rp 40 trillion, which indicates that the revenue base is still not sufficiently broad to sustain the government's desired level of spending. This year's primary deficit is similar to that of 2012 (Rp 44.6 trillion), but it is likely to increase alongside government expenditure in the lead-up to the 2014 elections – especially if the government opts not to reduce fuel subsidies.

The 2013 budget is based on a series of assumptions about economic growth, financial indicators and prices of key export commodities (table 3). In January 2013, the Minister of Finance, Agus Martowardojo, whom President SBY has recently nominated as the sole candidate for the role of BI governor, reported to parliament that the assumptions for the 2013 budget might be incorrect: GDP growth is likely to fall short of the current projection and the rupiah has continued to depreciate, reaching Rp 9,695 per dollar at the end of January 2013. In addition, Minister Martowardojo has predicted that oil production will be 50,000 barrels per day below the level assumed in budget calculations (Jakarta Post, 15/1/2013). These early indications suggest that the budget will need to be revised, and that the likely outcome will show a deterioration in revenue and increased expenditure, resulting in a greater deficit.

Constitutional court decisions

The Constitutional Court (Mahkamah Konstitusi, MK) has made two major, controversial rulings in recent months. The first concerned upstream oil and gas regulator Badan Pelaksana Kegiatan Usaha Hulu Minyak dan Gas (BPMigas), the second the international-standard pilot-project schools (Rintisan Sekolah Bertaraf Internasional, RSBIs). The Court ruled both unconstitutional.

BPMigas

BPMigas was created pursuant to Oil and Gas Law 22/2001, which outlined the industry regulator's authority and function. In 2012, a number of Islamic organisations and other prominent figures petitioned against this law, which they saw as too liberal and a violation of the sovereign energy policy. The ensuing judicial review saw the Constitutional Court rule BPMigas unconstitutional, having considered point 2 of article 33: ‘land, waters and natural resources within shall be under state control and shall be used for the greatest benefit of the people’. The Court's decision hinged on its interpretation of ‘state control’, which has long been a contentious issue (Butt and Lindsey 2008). In 2003, a judicial review of Electricity Law 20/2002 led to the development of an analytical framework of state control to aid in the interpretation of article 33 (Al'Afghani 2013). The framework comprises five elements: policy making, administration, management, supervision and regulation (MK 2012: 20). The Court ruled that BPMigas did not adequately satisfy all five elements of state control and was thus in violation of article 33 (2).

In response to the binding Court decision, SBY immediately issued Presidential Regulation 95/2012, to transfer the powers and responsibilities of the independent agency BPMigas to the Indonesian Ministry of Energy and Mineral Resources. Minister Jero Wacik then established SKK Migas, which would take over the duties and functions of BPMigas.

Indonesian nationalists saw BPMigas as favouring foreign contractors rather than working towards the national interest (Kompas, 14/11/2012; Jakarta Globe, 14/11/2012), and they have applauded the Court's decision; but Moody's Investors Service has expressed concern for investment in the sector (Jakarta Globe, 20/11/2012). More investment is needed in exploring oil reserves if the government is to reverse declining levels of oil production,14 yet the Court's decision only adds to existing investment uncertainties. Furthermore, the decision to dissolve BPMigas in order to purge inefficiencies and suspected misconduct has been likened to ‘burning down the barn to kill the rat’ (Jakarta Globe, 16/11/2012).

RSBIs

The Court's second controversial ruling, on RSBIs, closed the case brought by a coalition of parents and concerned citizens. A seven-year trial project of the government, RSBIs are public schools that teach to an international standard curriculum as well as to the Indonesian national standard (Australian Government 2013). By teaching predominantly in English, RSBIs aim to produce graduates with greater international employment prospects.

Ministerial Decree 78/2009 sets out the objectives of RSBIs and outlines their standard operation, curriculum, learning process and financing. In particular, it states that RSBIs are to be financed by public funds. In practice, however, they demand substantial additional funding from parents, and only those able to afford the high tuition fees can enrol. Petitioners argued that this provides unequal access to quality education and therefore violates the Indonesian Constitution.

All but one Constitutional Court judge considered RSBIs as breaching article 50 of the National Education System Law, which explicitly allows local and central governments to establish within their jurisdiction at least one school that teaches to an international standard curriculum (at any level of education). This shows that in making their ruling, the majority of judges concentrated not on the law itself but more on the practice of RSBIs as stipulated in the ministerial decree.

The government's response to previous cases brought to the Constitutional Court indicates that it will not always immediately follow the Court's rulings (Butt and Lindsey 2008). It acted swiftly in response to the Court's decision on BPMigas, but it is allowing Indonesia's existing 1,300 RSBIs to operate until the end of the 2012–13 academic year, in June. Nevertheless, the BPMigas case suggests that strategic economic activities, such as oil and gas production, which are subject to article 33 of the constitution, remain at risk of being declared unconstitutional as long as there is an eligible person to take the case to the Court. The Constitutional Court and its judges must be provided with adequate technical expertise, so that errors in the legislative process do not automatically lead to the annulment of laws for the sake of constitutional arguments.

Minimum wages

Indonesia's labour market in 2012 was characterised by a concerted and effective union-led campaign of strikes, which focused on increasing minimum wages, ending outsourcing and ensuring that workers would not be required to contribute financially to the national health-care program (Jakarta Post, 23/11/2012). The campaign to end outsourcing found success in November 2012, with the enactment of a ministerial decree to more tightly regulate employers’ use of contract labour (Jakarta Globe, 10/10/2012).

The campaign for higher minimum wages saw Jakarta's governor, Joko Widodo, be among the first to agree to a rise of 44%; other administrative heads soon followed, with increases of as much as 70% (Jakarta Post, 4/12/2012). Minimum wages across Indonesia are determined at the provincial level of government (and sometimes also at the district and municipality levels), so the increases are not consistent across all regions. Table 4 presents some examples of this disparity.

TABLE 4 Indonesia's Minimum-Wage Rate, 2012–13 (Rp/year)

Source: Various media reports.

West and McKee (1980) present the standard economic argument in support of setting minimum wages: that they prevent workers from being exploited amid uneven levels of negotiating power in the labour market. Like many heavily populated developing nations, Indonesia has relatively few formal employers but an excess of unskilled workers. Workers lack the power to negotiate higher wages because there will always be others who will accept a lower wage. Setting and enforcing a minimum wage for formal employment alleviates this perceived market failure.

Conversely, there are two main arguments against a minimum-wage policy: the poor ultimately bear the cost of higher minimum wages in the formal sector, and raising minimum wages reduces national competitiveness and discourages investment.

Who bears the cost of minimum-wage increases?

Indonesia has long adopted a minimum-wage policy (Manning 1994), determining rates by allowing for the purchase of a basket of minimum basic needs and therefore ensuring that even low-wage earners can enjoy a decent (minimum) standard of living. In the context of the public debate about the merits of the recent substantial increases in minimum wages, it is important to identify the relative costs borne by each of the stakeholders: the workers (through reduced employment); the owners of capital (through lower profits); and the consumers (through higher prices) (Macurdy and McIntyre 2001).

The standard neoclassical model of the labour market predicts that enforcing a minimum wage above the market-clearing wage lowers the demand for labour and reduces total employment. The model, however, is built on various assumptions (Stiglitz 2002), including complete coverage and enforceability of the minimum wage; perfect information; fixed worker effort; and a competitive labour-market structure. Departures from these assumptions can affect employment differently, even positively (Fields 1994); the actual impact of a minimumwage policy is therefore an empirical question.

A small number of studies have investigated the effects of large increases in minimum wages on earnings and employment in Indonesia. Rama (2001) examined the consequences of a doubling of minimum wages in the early 1990s and found it reduced urban employment by up to 5%. In contrast, Islam and Nazara (2000) found no negative implications for employment or business profitability during this period. Using data from Jabotabek manufacturing establishments between 1990 and 1996, Alatas and Cameron (2008) found that increasing minimum wages resulted in job losses in small, domestic establishments but created job opportunities in some large firms. SMERU Research Institute (2001) found that vulnerable groups such as women and unskilled, blue-collar workers suffered from reduced employment following minimum-wage increases, while skilled, white-collar workers benefited. A recent World Bank (2010) study corroborated this result for women but found the opposite for skill.

Bird and Manning (2008) concluded that while most households with a lowwage, formal-sector worker benefit from higher minimum wages, the majority of the working poor are engaged in the informal sector and therefore face higher prices but receive no wage compensation. Furthermore, Chun and Khor (2010) found no evidence that wages in the informal sector increase in response to a rise in minimum wages in the formal sector.

It is difficult to draw definitive conclusions from the empirical evidence to inform the current discourse around minimum wages – not least because of the unprecedented magnitude of the recent increases, which could have effects different from those previously observed. In broad terms, though, the evidence suggests that these increases will benefit some workers while disadvantaging many others.

The World Bank (2010) sees minimum wages in Indonesia more as a wagesetting signal for formal-sector wages than as a safety net for low-income workers, arguing that there are other and more direct ways of providing a safety net for the poor. As a current example, under Law 24/2011 on Social Security Providers (Badan Penyelenggara Jaminan Sosial, BPJS), to be implemented in 2014, the government intends to cover the health insurance premiums of eligible low-income earners.

Do rising minimum wages hurt investment?

The World Bank (2012) predicts that increases in Jakarta's minimum wages for 2013 will push Indonesia's unskilled labour costs above those in the capital cities of its neighbours, which could hinder Indonesia's competitiveness and discourage investment in labour-intensive industries. This appears to be happening now among large players in the footwear industry (Manning 2012).

In contrast, standard efficiency wage theory (for example, Leibenstein 1986: 28) suggests that increasing workers’ wages can be an effective way of achieving valuable gains in labour productivity, particularly in labour-intensive industries. Even Jakarta's minimum wage in 2013 represents an income of less than $1 per person per day.15 Increases in household income at this low level can have a nontrivial positive impact on worker productivity by improving nutrition and allowing better access to health care.

Figure 3 indicates that Indonesia's neighbours have also experienced large increases in minimum-wage rates over the last three to four years. In particular, China's minimum wage increased by more than 80% between 2009 and 2012, and Thailand and Vietnam showed increases not dissimilar to Indonesia's between 2011 and 2012. These rates are consistent with significant and rapid rises in average wages. Despite these wage increases, China, Thailand and Vietnam achieved sustained high growth in manufacturing output during these years, suggesting that increased labour costs did not restrict investment.

FIGURE 3  Average Minimum-Wage Rates in Capital Cities of Selected Asian Countries, 2007–13 ($/month)

Source: Indonesia Stock Exchange; Pacific Exchange Rate Service.

Islam and Nazara (2000: 18) claim that investors tend to be ‘more concerned about policy predictability, political stability and law and order rather than labour costs’. However, it could also be argued that an announcement in December 2012 of wage increases of up to 70% taking effect from January, with the prospect of further increases in 2014, hardly gives investors stability and predictability. Indeed, some Korean companies are reported to be relocating because of increased labour costs (Jakarta Post, 21/1/2013). The government could make the process more predictable by setting targets for regional minimum wages in the medium term (for example, over three years) and then publishing any increases in advance.

The politics of minimum wages

Manning (2012) asserts that the extraordinarily large recent increases in minimum wages are born of a stronger and more vocal union movement; the government's move away from outsourcing and ‘cheap wage’ policies towards those supporting a more productive and skilled workforce; and an effort to boost incomes at the lower end of the distribution, for fear they will be left behind by the growing middle class. Other studies highlight the potential for minimum wages to be used as a tool in a more ‘populist’ approach to social policy (SMERU Research Institute 2001), which may be particularly relevant in the lead-up to the 2014 elections.

Understanding the politics of minimum wages requires information about the process by which regional minimum wages are set. It begins around August or September each year, with surveys of basic commodity prices and wage components in local markets (as provided for in revised Ministerial Decree 17/2005). These surveys gather data for calculating the district's ‘minimum cost of living’ (kebutuhan hidup layak, KHL), or the cost of a basket of goods required for a basic (minimum) standard of living. Tripartite wage committees, comprising unions, employers and local governments, then begin to negotiate on rates, based on the KHL, inflation, economic growth and employers’ financial capabilities. These committees recommend minimum wages at the district level,16 which are then submitted to the provincial governor for formal approval. The new rates then take effect at the beginning of the following year. In accordance with Ministerial Decree 231/2003, employers are entitled to submit an official objection to the rates, and to apply for a delay or a waiver on financial grounds (subject to an audit). At the end of January 2013, 641 companies had applied for a delay to this year's rates, and around 80% of these applications are likely to be granted (Jakarta Globe, 7/2/2013).

Figure 4 shows the average regional minimum wages by selected major island groups over the last 10 years.17 Jakarta consistently had the highest minimum wages, while Java (without Jakarta) and Maluku had the lowest. Rates increased universally and steadily until 2012, with larger increases in 2013. Figure 5 adjusts the nominal wages for the KHL in the same year, effectively taking into account regional differences in the cost of living. We no longer see such an obvious upward trend in minimum wages, suggesting that the increases largely reflect movements in the cost of living. Consequently, Jakarta is now much more closely aligned with the rest of Java.

BOX 2 INCOME TAX REDUCES THE WELFARE EFFECT OF HIGHER MINIMUM WAGES, AT LEAST IN SOME REGIONS

Recent research has suggested that the sharp rises in minimum wages in 2013 will result in the income of some minimum-wage recipients rising above the tax-free threshold for the first time. Atma Jaya Catholic University's Solihin Makmur Alam (2013) has analysed the new minimum monthly wages that are now in effect in 152 provinces, regencies and cities across Indonesia and compared these with the latest tax-free thresholds. Alam estimated that full-time workers would be employed continously throughout the year. He also assumed that they would have no additional sources of income and receive no other financial benefits – apart from the obligatory religious allowance of one month's salary, and a 5% deduction for occupational expenses allowed by the Ministry of Finance Regulation 250/PMK.03/2008.

Using the latest ruling on the tax-free threshold for personal income tax in Ministry of Finance Regulation 162/PMK.011/2012, Alam estimated that in several regions minimum net annual income will for the first time exceed the Rp 24.3 million threshold for an unmarried individual. This will most affect workers in those regions that have introduced the highest new minimum wages – in the Jabodetabek area and in Karawang, Serang and Cilegon. In other words, in the majority of cases (140, in Alam's data set), regional authorities have set annualised minimum wages below the Ministry of Finance's threshold for personal income tax.

In none of the regions will the minimum net annual income exceed the threshold of Rp 32.4 million for a married individual with other dependents. Nor will it exceed the threshold for the second income-tax bracket (Rp 50 million). Nevertheless, the 5% tax rate in the first bracket will marginally reduce the welfare effect of minimum-wage increases. The take-home pay of unmarried individual workers who receive exactly the minimum wage will, in the regions mentioned above, be 0.1% to 0.5% lower than the stipulated legal minimum wage.

FIGURE 4  Average Nominal Provincial Minimum Wages for Select Major Island Groups, 2004–13 (Rp ‘000/month)

Source: BPS, Perkembangan Beberapa Indikator Utama Sosial-Ekonomi Indonesia (Trends of the Selected Socio-Economic Indicators of Indonesia), 2004–12, and various media reports.

FIGURE 5  Ratio of Provincial Minimum Wage to Minimum Cost of Living, 2004–12^a (averages for select major island groups)

^a CV = coefficient of variation.

Source: BPS, Perkembangan Beberapa Indikator Utama Sosial-Ekonomi Indonesia (Trends of the Selected Socio-Economic Indicators of Indonesia), 2004–12, and various media reports.

According to the World Bank (2012), minimum wages are largely ‘endogenous’ – that is, driven by undisclosed market and political conditions and by stakeholder consultations, and only weakly related to the cost of living. Figure 5 appears to contradict this view: its relatively stable ratios suggest a strong link between minimum wages and the cost of living, but it does not reflect the reality in which political manoeuvring takes place. There is likely to be significant political and stakeholder influence on the KHL data themselves, in that they show faster trend increases over time than the more rigorously defined consumer price index.

Sinaga (2008) points to a large degree of variation in the ratio of KHL to minimum wages across provinces between 2006 and 2008. For example, North Maluku's minimum wage in 2007 was only 45% of the province's KHL, while provinces in neighbouring Sulawesi, Papua and Nusa Tenggara recorded proportions closer to 100%. As figure 5 demonstrates, minimum wages in Maluku fall well below the KHL. Such discrepancies suggest geographic variations in the levels of influence of key stakeholders in setting minimum wages.

If minimum wages were determined by economic fundamentals and movements in relative prices, one would expect the rates in different provinces and islands to converge over time. Everything else equal, labour and/or capital would shift to regions that offer more attractive economic opportunities, causing relative wages to move towards the average. This is not to say that wages would be equal across regions – sizeable differences would persist, for example, in infrastructure and development. The theory of convergence suggests that the gap should narrow over time, despite these differences. However, a wage-setting process that is driven predominantly by political forces would not necessarily display such convergence. The coefficient of variation (CV) in the ratio of the provincial minimum wage to KHL (figure 5) may demonstrate convergence when it moves towards zero. Clearly there is neither convergence nor divergence in minimum wages across island groups, whether in nominal terms or after accounting for KHL. This result is robust when examined at the provincial level, which suggests that any trend towards convergence is very slow at best.

In an era of decentralisation, it is not surprising that the government has avoided imposing a national minimum wage. Islam and Nazara (2000: 5) argue that this is a good thing, recognising ‘the country's economic diversity characterised by distinct local labour market conditions and spatial variations in the cost of living’. However, the power to make decisions about minimum wages is ultimately in the hands of politicians, who could benefit directly from popular decisions. The risk, therefore, is that minimum-wage increases will be used as a political tool at the expense of sound economic management. Perhaps there is a case for refining the process of setting minimum wages, in order to retain some input from the regional tripartite wage committees while increasing their accountability to an impartial central body (as occurs in countries such as Malaysia, the UK and Australia).

Compliance

Indonesia's formal sector employs only 37% of its workforce (World Bank 2010), and the level of non-compliance with minimum-wage legislation is moderate.18 In interviews with workers, SMERU Research Institute (2001) found that firm size is key in determining payments at or above the minimum wage, for two possible reasons. First, the cost of enforcing legislative compliance is high; it is often not economically feasible for tax offices to investigate small firms, whereas economies of scale apply to investigations of larger firms. Second, larger, foreign-owned companies have tended to pay above the minimum wage, complying by default.

Inequality

Owing in part to sustained strong economic growth, the overall incidence of poverty in Indonesia has declined substantially in the last decade (Olivia and Yamauchi 2012). However, as middle-class incomes rise rapidly, the level of inequality appears to be increasing – indicating that the benefits of growth have not been shared equally. While this could be seen as an inherent part of economic progress, high levels of inequality in an economy can restrict growth, by impeding efforts to reduce poverty (Sumner, Suryahadi and Nguyen 2012); increasing crime and violence (Kennedy et al. 1998); de-stabilising the political situation; and leading to volatility in consumption (Furman and Stiglitz 1998).

Figure 6 shows that, in 2011, Indonesia's expenditure-based Gini ratio exceeded 0.40 for the first time, and that it remained that way in 2012, in contrast with a Gini ratio of 0.32 less than 10 years earlier. However, this significant increase needs two qualifications. First, there are concerns with data quality. Leigh and Van der Eng (2010: 173) point out that data from the National Socio-Economic Survey (Susenas) have inadequately represented high-income groups, although the Central Statistics Agency (BPS) may have made recent efforts to address this. Such improvements in coverage would explain part of the apparent increase in inequality in recent years. Second, most of Indonesia's neighbours have substantially higher Gini ratios – income-based national measures of inequality show that Thailand's Gini ratio in 2009 was around 0.54, China's 0.48, Singapore's 0.47 and Malaysia's 0.46 (CIA 2011). The comparable income-based figure for Indonesia was 0.41 (Nugraha and Lewis 2013).

FIGURE 6  Gini Ratio for Indonesia, 2000–12

Source: Calculations based on expenditure data from the National Socio-Economic Survey (Susenas).

Using the 2012 expenditure-based Susenas data, Sumarto (2013) calculated Gini coefficients at the provincial level, which revealed a great deal of spatial variation in inequality. Some of the highest levels of inequality in 2012 exist in the more developed provinces in Java, such as Jakarta, West Java and Yogyakarta (with Gini ratios in 2012 of 0.42, 0.41 and 0.43 respectively). In contrast, most provinces in Sumatra, Kalimantan and Maluku, as well as parts of Nusa Tenggara, had Gini ratios well below 0.40.19

Increasing inequality is a common characteristic among the group of ‘emerging economies’, which includes Indonesia. These economies typically have a growing number of middle-class workers in the formal sector, alongside a large pool of low-skilled workers in the informal sector.20 Many of them also do not have the institutional foundations from which to build a solid taxation system or socialwelfare program, and this impedes the ability of public services to reduce the economic disadvantages of the poor.

Emerging economies are often exposed to fluctuations in commodity production and prices. Indonesia is currently experiencing a boom in export revenue from coal and palm oil, in particular (Burke and Resosudarmo 2012), but such commodity-driven growth rarely brings broad-based benefits and is likely to increase inequality, especially in the short term. Having studied a set of villages in Jambi province that were experiencing changes in access to the global palm-oil market, McCarthy, Vel and Afiff (2012: 531) concluded that ‘under favourable conditions, smallholders can obtain income from oil palm that is significantly higher in terms of return-to-labour than other options. … However, smallholders who have been left out, or included on less favourable terms, suffer as their agricultural products and rural wages fail to keep up with food price increases. Many are forced to sell land under livelihood crises.’

Growing concern with HIV/AIDS

The most recent World AIDS Day (1 December) saw the release of the 2012 United Nations report on the global HIV/AIDS epidemic, which included Indonesia among the world's poorest performers in HIV/AIDS prevention in the last 10 years. Indonesia's Minister of Health and former secretary of the National AIDS Commission, Nafsiah Mboi, described this result as ‘embarrassing’ (Jakarta Post, 21/11/2012).

Globally, AIDS-related deaths have declined by 24% since 2005, owing largely to higher rates of prevention and treatment in sub-Saharan Africa, where the prevalence rate is almost 5% (UNAIDS 2012). Outside of sub-Saharan Africa, however, South Asia and Southeast Asia recorded the highest number of new HIV cases since 2001, and in 2011 the number of newly infected people in Indonesia was more than four times that of its neighbours (UNAIDS 2012). Furthermore, the infection rate among the Indonesian working-age population (15–49 years old) has risen by more than 25% since 2001 (UNAIDS 2012). Infection rates among high-risk groups are alarmingly high compared with those in other Southeast Asian countries: the prevalence among intravenous drug users is more than 36%, among sex workers around 9% and among men who have sex with men around 8% – compared with respective rates of 22%, 3% and 20% in Thailand, despite Thailand's much higher prevalence rate overall (1.2% compared with Indonesia's 0.3%) (UNAIDS 2012).

Prevalence rates in Indonesia have a high geographical variation (figure 7), with rates highest in the provinces of Papua and West Papua (2.4%) and Jakarta (1.3%). Transmission modes also vary geographically: in Papua and West Papua, for example, unsafe heterosexual sex accounts for the highest number of infections; in Java and Bali, unsafe intravenous drug use. More recently, however, the national pattern has shifted towards married women, infected by their husbands, who then put children and future generations at high risk (National AIDS Commission 2011).

FIGURE 7  HIV Prevalence Rates among the Adult Population, by Province (%)

Source: National AIDS Commission (2011).

Economic impacts

In addition to its obvious health ramifications, HIV/AIDS, like other diseases, can be economically debilitating. In the worst-affected countries (the majority of which are in sub-Saharan Africa), the disease is estimated to reduce annual economic growth by one to two percentage points, owing to the costs of providing health services and the disease's effect in reducing labour supply (Access Economics 2001).

For individual households, the economic burden of a sick family member can be disastrous. People of working age are the most likely to acquire HIV infections, which often force them to stop working, in turn reducing household income. Other family members are often then forced to stop working, or to drop out of school, to care for the sick, reducing household income even further. In addition, the cost of health care is high: Indonesia's public provision for HIV/AIDS treatment in 2008 equated to around $55 per person with HIV/AIDS per year (WHO 2008), but Access Economics (2001) estimates that the actual cost is almost 100 times this amount. In this context, any increase to the prevalence of HIV/AIDS in Indonesia would strain household and government budgets, suggesting there is a strong economic case for public investment in preventive measures.

Programs and policy

Presidential Regulation 75/2006 established the National AIDS Commission, which disseminates HIV-related information, supplies and services for key affected populations, and aims ultimately to reduce the rate of new infections. Initially the commission's prevention education programs were small-scale but flexible, location-specific and targeted to specific high-risk groups. Many of these programs have been successful and have been introduced nationally; others have not been as successful. For example, despite its effectiveness in Thailand, the 100% Condom Use campaign, designed to prevent sexual transmission of HIV, was initially ineffective in Indonesia, owing to inadequate distribution mechanisms and a lack of political and societal support (National AIDS Commission 2011: 12). Subsequent programs tailored to Indonesia have been more successful.

One of the commission's key achievements has been its expansion of voluntary HIV counselling and testing sites, from 51 (in 2006) to 460 (in 2012) (Ministry of Health 2012); this has contributed directly to the apparent substantial increase in the identified number of infections.

Looking to the future

Since the release of the 2012 United Nations report, Health Minister Nafsiah Mboi has asserted that the government remains committed to providing universal access to HIV prevention programs, treatment and support. The Social Security Providers (BPJS) HIV package, for example, includes HIV screening, anti-retroviral treatment for HIV-positive patients and mother-to-child transmission prevention. In addition, the KJS (Jakarta Health Card) allows for free health services for people with HIV/AIDS, and provider-initiated counselling and testing sites21 are scheduled for development. AusAID and the Ford Foundation have also funded the film Cinta dari Wamena (Love from Wamena), which was initiated by the district government of Jayawijaya and will screen from March 2013 (Jakarta Post, 5/12/2012).

Nonetheless, many areas need to be improved, such as the low level of access to medical and support services, particularly in remote areas. There is also an obvious need for targeted prevention, treatment and support programs among groups with high prevalence rates of HIV/AIDS, such as sex workers, intravenous drug users and men who have sex with men. These groups are at risk of experiencing stigma and discrimination in Indonesia's morally conservative society (ABC, Frontline program, 19/6/2006), highlighting the need for customised programs.

Acknowledgements

The authors thank Dandy Rafitrandi (Center for Strategic and International Studies), for compiling data for the ‘Macroeconomic developments’ section; Sudarno Sumarto (National Team for Accelerating Poverty Reduction), for calculating Gini figures referred to in the ‘Inequality’ section; and Abdurahman (Fiscal Policy Agency, Ministry of Finance), for providing the 2012 actual budget figures.

Notes

¹Eligibility relates to minimum requirements in the number, gender and geographical distribution of supporters – see IFES (2012) for details. In 2009, 34 of around 60 applications were passed (Jakarta Post, 8/7/2008).

² Hamid (2012) discusses the jockeying for position of individuals and parties for the 2014 elections, noting that electoral support for an individual presidential candidate does not necessarily equate to support for particular parties and their candidates in the legislature.

³We discuss the decline in oil production in the BPMigas section of this survey.

⁴The ban was lifted after the Supreme Court ruled that it was not consistent with Law 4/2009 on mineral and coal mining (Jakarta Globe, 5/11/2012).

⁵The growth data are taken from the IMF (2013). Together, Japan and China accounted for about half of Indonesia's exports in 2011.

⁶The McKinsey Global Institute (2012) defines the consuming class as those individuals with an annual net income above $3,600 in 2005 purchasing-power-parity dollars.

⁷See Mahi and Nazara (2012) for definitions of core and administered inflation.

⁸For more detail, see the ‘Minimum wages’ section of this survey.

⁹The real SBI rate is the SBI rate minus the inflation rate.

¹⁰See <http://www.bloomberg.com/quote/GIDN10YR:IND > and <http://asianbondsonline.adb.org/newsletters/abowdh20130128.pdf?src=spotlight>.

¹¹In the secondary sector, metals and electronics, food, and automobiles benefited the most from FDI inflows; in the tertiary sector, transport and storage were the main beneficiaries.

¹²BKPM does not record investment in the oil and gas and financial sectors, where the licences are issued by the respective ministries.

¹³The primary deficit is defined as total expenditures minus total revenue (excluding interest payments).

¹⁴PWC (2012) reported that oil production declined sharply from 1.3 million barrels per year in 2001 to 902,000 barrels per year in 2011, and that proven reserves declined from 5 billion barrels in 2001 to 4 billion barrels in 2011.

¹⁵For a single-income household of four.

¹⁶The recommendation in several provinces is for a city or provincial wage

¹⁷Not all rates are available for 2013. Where there are several minimum wage levels within a province, we have used the lowest of these minima as the relevant value.

¹⁸The World Bank (2010) reported non-compliance rates of up to 55%.

¹⁹Rapid urbanisation and industrialisation augment this growing disparity in labourmarket incomes. Heavy industrialisation in Java adds a spatial dimension to this trend, consistent with higher levels of inequality in parts of Java than in the outer islands.

²⁰Indonesia has one of the largest informal sectors among emerging economies (OECD 2011).

²¹Provider-initiated counselling and testing is defined as ‘HIV testing and counselling which is recommended by health care providers to persons attending health-care facilities as a standard component of medical care’ (WHO 2007: 19).