The Biggest Sleeper

March 6, 2006 issue — Sometimes even the starting line is hard to reach in Indonesia. Just ask President Susilo Bambang Yudhoyono. A few weeks ago fans converging on a speedway outside Jakarta for the city's inaugural A1 Grand Prix turned nearby roads into parking lots, trapping the presidential motorcade. So the guest of honor exited his limousine and leapt onto the back of one of his escort motorcycles, weaving through traffic for two kilometers to reach the track and deliver a short opening speech. "I arrived two minutes before the race," he said with a chuckle. "I was really on time."

The same might be said for Yudhoyono's presidency. Inaugurated 17 months ago, he is Indonesia's first directly elected leader, and the first to show a firm hand after a series of sleepy bumblers since the fall of Indonesia's dictator Suharto, in 1998. Yudhoyono led a highly competent response to the devastating tsunami in December 2004, and then exhibited a statesman's touch in signing a visionary peace pact to end the long-running rebellion in the province of Aceh. For the first time in years the ethnically and politically fractured archipelago is relatively stable; the Asia Foundation's Indonesia representative, Douglas Ramage, calls Indonesia "the sleeper democratization success story" in Asia. All this, however, has only brought the country to the starting gate—positioned for a run to reclaim its rightful place as the third giant growth story in Asia.

Though it was a developing world star under Suharto, Indonesia has been fully eclipsed by larger rivals of late. The economies of India and China are each growing faster than 8 percent, while Indonesia's growth is expected to slow down to 5.2 percent this year, which is meager for a big emerging market. For Indonesia to move up faster, it has to work harder to streamline its "high-cost economy," a euphemism for rampant corruption and red tape. The bright side is that bottoming out creates a sense of urgency. While prosperity has dampened the political will to reform in India, fear of falling behind is helping Yudhoyono push through change. The president cut budget-breaking energy subsidies after world oil prices shot up last year, and has since been rewarded by Standard & Poor's, which recently raised its outlook on Indonesia's credit rating to "positive." Indonesia's budget deficit, as a share of GDP, is now just one percent, and one tenth of India's.

To be sure, its comeback tale remains too confusing and uncertain to have attracted foreign investors in large numbers. Indonesia lacks the "two-sentence story" that can draw outsiders to an emerging market, says a Western diplomat in Jakarta, who requested anonymity as a matter of government policy. While China has its rise as an export manufacturing power, and India its emergence as a global headquarters for information services, Indonesia is known mainly for failing to fully exploit a rare abundance of natural resources, from timber to gold, despite booming commodity prices. This tragically botched opportunity is exemplified by the fall of Indonesian oil production (down 20 percent since 2000) in the face of spiking oil prices.

But that problem is now the target of Yudhoyono's next big move. The president appears ready to clear the way for the American giant ExxonMobil to take charge of a long-stalled plan to tap huge oil reserves under the seabed off East Java, sidelining the state oil monopoly, Pertamina. That suggests a strong willingness to take on a powerful lobby and risk a nationalist backlash, all in the name of efficiency. In an interview with NEWSWEEK in Jakarta last week, Yudhoyono signaled a deal of some kind is imminent, without addressing the details: "The bottom line is that I have chosen the type of cooperation and joint operations to accelerate the project and produce oil in the timeliest manner," he said. "It has nothing to do with nationalism versus internationalism."

If ExxonMobil does take over the $2.6 billion project, it would represent the —largest new foreign investment in Indonesia since the Asian financial crisis triggered Suharto's fall. "It's a very pivotal deal," says T. N. Machmud, former head of Arco Indonesia. "This is a great place to invest if we can get our act together." Opening the Cepu offshore oilfield could raise Indonesia's oil output by 177,000 barrels a day, or nearly 20 percent, putting production back on a growth track for the first time in a long time. The imminent deal is "going to put Indonesia back on the map," says the Western diplomat.

Indonesia's political climate augurs well for further reforms. Yudhoyono's approval rating remains above 60 percent, according to opinion polls, despite the sluggish economy. With a string of traumas from Suharto to the tsunami now in the past, the government is moving out of crisis mode for the first time in its brief life as a democracy. Yudhoyono doesn't face re-election until 2009, and he and his team have front-loaded painful reforms so they have time to revive economic growth before the voters pass judgment. Sjahrir, a top Yudhoyono adviser (who goes by one name), routinely draws parallels with a recent American president. "I always quote Bill Clinton's [mantra], 'It's the economy, stupid,' in my memos to the president," he says, adding: "He knows that, too."

Yudhoyono's attack on the "high-cost economy" is a complex war on many fronts. Jakarta has begun to streamline bureaucracy and to rewrite tax, business and labor codes. Citing a favorite World Bank measure of a nation's business environment, Yudhoyono says he has already cut the time it takes to register a business from 150 days to 60, and vows to "do my best to bring it down to one month." He is orchestrating the biggest anti-corruption campaign in Indonesia's history. Since its launch last year the campaign has claimed what political analyst Salim Said says is an unprecedented number of high-profile targets, including a provincial governor and a former cabinet minister. All this bears the stamp of orthodox freemarket reform, as typically prescribed by the World Bank and International Monetary Fund. But don't say that in Jakarta. "We don't want to use the term 'Western style'," says Said. "Western liberalism is anathema, and capitalism is hated here, but we're doing both."

Yudhoyono's campaign is controversial even within his cabinet, which is divided between reformers and nationalists who are less enthusiastic about embracing globalization. The reformers are mainly free marketeers who "hang pictures of Milton Friedman on their office walls," as Ramage puts it, and they control the briefs that set overall strategy, like the Ministry of Finance. But they do not control many of the ministries that actually execute policy, including Health, Agriculture, Education and Tax. The result is that even well-intentioned efforts to improve efficiency can founder. One example: the clumsy response to avian flu, which has spread to 27 of the country's 33 provinces, and killed 20 people. It still takes "nerves of steel" for foreigners to enter the market, says Malaysian lawyer Karim Raslan.

Still, the shake-up at Pertamina has put other state firms on notice. Together they comprise about 30 percent of Indonesia's economy, and most are barely growing. (The military also owns several businesses, which it's in the process of selling.) While there isn't a consensus for privatization, Yudhoyono insists that state enterprises must become more profitable—even if that means entering into joint ventures controlled by foreigners. Pertamina, for example, holds vast oil and gas fields but lacks the money and expertise to exploit them. "To be frank, the business environment in Indonesia is not healthy yet," says Yudhoyono.

The Cepu joint venture had gotten snagged on Pertamina's demand that control of day-to-day operations should alternate between the partners on a five-year cycle, with Pertamina taking the first shift. Yet Pertamina has never independently operated a field that produced more than 12,000 barrels a day—a small fraction of the size of Cepu. The suspicion among analysts and the media is that Pertamina wanted the first five-year shift so it could dole out the millions of dollars in onshore subcontracts that Cepu will generate. The Jakarta Post said in an editorial last week that Pertamina is "perceived to be corruption infested... [and] highly vulnerable to vested political interests." By taking on these interests, Yudhoyono has signaled that state industries will be held to a higher standard in the future. "We are really serious about improving performance," says Finance Minister Sri Mulyani Indrawati.

For all the signs of change, there is still something fundamentally troubling about Indonesia's story. Yes, the country has the most abundant natural resources in Asia, a market of 220 million people, agricultural potential that could one day rival regional leader Thailand and a long history of light manufacturing that could make it a booming export base. Yet no one sector seems big enough to power Indonesia into prosperity. Big oil deals are promising, but oilfields don't produce nearly as many jobs per dollar invested as manufacturing plants or information services. The disadvantage Indonesia faces in competition with India and China comes down to this question, says the Western diplomat: "Can Yudhoyono build a winning team without a superstar?" The Indonesian leader has found the starting line. But this race is a marathon.

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