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Over the past 20 years or so, the Indonesian economy has really done quite brilliantly. Indonesia has consistently posted remarkably strong growth figures and has quietly become, if you adjust for purchasing power, the seventh largest economy in the world, according to the latest IMF data. At the same time, the country has developed a hard-won reputation for fiscal prudence. Indonesia has consistently run manageably small budget deficits and its debt to GDP ratio has generally stayed below 40%.
However, in the past year or so, the vibes have suddenly shifted, prompting a sell-off in both Indonesia's bonds and currency and provoking some increasingly unorthodox policy reactions from the government. So, in this video, we thought we'd explain why the Indonesian economy is looking a bit shaky and why things look like they might get worse before they get better.
Anxieties about material self-sufficiency, a turn towards protectionism, great powers asserting their spheres of influence. This all looks suspiciously similar to the buildup to the First World War. In the latest issue of our magazine, we explore the remarkable parallels between now and then and ask whether we can avoid a third one. That's just one of 80 pages in the magazine, though, because as always, there's more to Too Long than you'd expect. Purchase your copy by clicking the link in the description.
So, as we see it, arguably the root cause of Indonesia's recent economic shakiness are the government's big spending plans. For context, since coming to power in late 2024, Indonesia's president Joko Widodo has announced a number of costly policies, including an ambitious housing plan, a program for 80,000 village cooperatives, and his flagship free nutritious meals program, which aims to provide free and nutritious lunches to more than 80 million people, mostly school-aged children and pregnant women. These sweeping programs were already taking their toll on the state finances. The free nutritious meals program alone accounts for something like 10% of all Indonesian government expenditures, but they've since come under even more strain since the war in Iran and the subsequent increase in global energy prices. This is both because Indonesia imports most of its oil, which means the recent increase in oil prices has put a dampener on the economy and decreased tax revenues, but also because the Indonesian government subsidizes fuel. So, as global oil prices have surged, the cost of these subsidies has ballooned.
Now, to be clear, we're not saying that governments shouldn't spend money or that these are bad policies, per se. However, the problem in Indonesia's case specifically is how these big spending plans interact with so-called state finance law, which limits budget deficits to 3% of GDP. For context, the state finance law was passed in the wake of the 1998 financial crisis, which hit Indonesia incredibly hard. Indonesia's currency, the rupiah, lost 80% of its value against the US dollar. Inflation surged over 60% and GDP contracted by roughly 13% in 1998 alone, the steepest decline among the crisis-affected nations. The economic devastation triggered widespread social unrest, which contributed quite directly to the fall of President Suharto in May 1998, ending a 31-year period of authoritarian rule. After elections in 1999, Indonesia's first post-Suharto parliament passed the state finance law in 2003. The law basically copied and pasted the EU's so-called Maastricht criteria for aspiring Eurozone members, limiting budget deficits to 3% of GDP and the overall debt to GDP ratio to 60% and was framed as a guarantee against a repeat of the 1998 crisis. It's proved remarkably durable with the exception of the worst pandemic years. Every Indonesian government since has stuck to it and Indonesia has earned a reputation for fiscal competence with the international markets.
Now, Widodo's big ticket programs were already testing these limits. With the deficit coming in at 2.9% of GDP last year, but when the war in Iran kicked off and energy prices started surging, it quickly became clear that if he wanted to keep the deficit below 3%, Widodo would have to either wind down one of his big policies or scrap the fuel subsidy with the finance ministry forecasting a 3.6% deficit if fuel prices stayed around $90 a barrel. But Widodo has refused to do either of these things and has instead resorted to a series of financial tricks to keep himself in the green. Perhaps most notably, it looks like he's pressured the Indonesian central bank into lending a hand via a so-called burden sharing agreement agreed last year. The specifics are complicated, but the basic idea is that the central bank is printing money to buy up government debt and also giving some of the interest it earns on that debt back to the government. This looks like a rather blatant violation of the central bank's nominal independence, which has been under threat since Widodo installed his nephew as deputy governor last year. To ease the burden further, Widodo has also strongarmed Indonesia's oligarchs into buying billions of dollars worth of so-called Patriot bonds. There has also been some suggestion that the government is fiddling with the GDP numbers because a bigger GDP number would allow the government to run a bigger deficit. This might sound conspiratorial, but Indonesia's GDP numbers have been coming in suspiciously consistent at basically 5% every quarter for the past few years, despite the fact that Indonesia is a big commodity exporter and should thus be affected by swings in global commodity prices. More recently, the government has claimed that growth is accelerating, coming in at a 3-year high of 5.6% in the first quarter of this year. But this looks somewhat implausible. Not only was this headline number well above forecast, which has started happening suspiciously often with Indonesia's GDP prints, but when you dig into the data, there were some weird numbers. For instance, the government claimed an implausible 25-fold jump in the value of inventories. And a fair bit of the headline growth was apparently driven by growth in manufacturing, even though electricity use, which usually tracks manufacturing output, fell at the same time. Nor is this the first time that economists have cast doubt on Indonesia's official data. Last August, after quarterly data showed the country growing at its fastest rate in 2 years, local economists held a private meeting with the finance ministry asking for clarifications about the data and especially the implausibly high investment numbers.
Anyway, this has all provoked some anxiety in the markets leading to a sell-off in Indonesia's government bonds and its currency with the rupiah reaching a post-crisis high of nearly 18,000 to the US dollar. Widodo has tried to stem this decline in the rupiah by imposing some remarkably draconian capital controls. In other words, by making it harder for people to get their money out of the country. In January, the government imposed new laws, basically requiring big commodity exporters to keep their foreign currency earnings locked up in the state-controlled banks for at least a year with strict conditions and limits on withdrawals. Then last month, Widodo took things a step further when in a much-anticipated speech on fiscal policy where most people expected him to try to calm the markets, he instead announced the creation of Dana SMI Indonesia, or DSI, a new state-owned agency within Indonesia's sovereign wealth fund. DSI will apparently take near total control over Indonesia's commodity exports. Exporters will first have to sell their commodities to DSI, which will then sell them onto the global market. The DSI will initially cover coal, palm oil, and certain nickel products, for all of which Indonesia is the world's largest exporter, but could yet be expanded into other sectors, too. Widodo has framed this as an anti-tax avoidance initiative, accusing exporters of selling their commodities to offshore subsidiaries at below market prices, but it looks like a sneaky way for the Indonesian state to get its hands on even more foreign currency to defend the rupiah. Unsurprisingly, none of this has calmed the markets and the sell-off in the rupiah has actually accelerated. The risk here is that surrounded by yes-men, Widodo gets stuck in a sort of doom loop with economic turmoil inviting draconian policy interventions leading to more economic turmoil, etc.
The latest issue of our magazine, Too Long, is out now. And if you want our best value ever, subscribing and using the code summer26 gets you your first copy for as cheap as £4.99, as well as 20% off as long as you stay subscribed. I actually told you about one of the articles in this edition of the magazine at the start of this video, but this issue is also jam-packed with other content from all around the world. Obviously, the headline section is our rundown of Trump's wars around the world, discussing all of the different countries and regions which have faced Trump's military wrath, going nation by nation through the timeline, and reaching the ultimate question, has Trump launched a modern holy war? From there, we dive into our regional sections, starting with the UK, where we unpack the results of the recent May elections, take a look at the UK's odd foreign posture, and discuss whether Britain has become ungovernable. Then, in the EU section, we discuss how Russia's sphere of influence is fading, why Europe's energy transition isn't what you expect, and also look at the euro's missing members. Finally, in the global section, we discuss if we're seeing echoes of the First World War, what's next for Iran, as well as what really came from the Gen Z protests we saw emerging last year. But that's not even everything. With this 80-page issue, our joint longest ever, there's even more to read than I've even been able to mention here. So, click the link in the description to learn more and grab your copy of Too Long today.