Two quandaries are threatening Indonesian growth

Indonesia’s booming economy could fail to meet expectations if the government’s quandaries over fuel subsidies and a mining tax aren’t resolved.

Image courtesy yohanes budiyanto: http://www.flickr.com/people/joe-joe/

Skyline of the capital of Indonesia - Jakarta

Indonesia (IDX, quote) is projected to grow 6.1% this year; however, elevated crude and internal politics may threaten the medium-term growth of this exciting emerging market.

Currently, Indonesia heavily subsidizes fuel for its citizenry. Consistently high global oil prices have pressured the coffers of the Indonesian treasury as it costs progressively more to pay for the pre-set domestic price of crude.

This has created a dilemma for the Indonesian government. It is unable to continue subsidizing oil at current levels without violating the 3% deficit spending threshold enshrined in Indonesian law. Despite this, the Indonesian government opted not to raise the price of domestic fuel or cut subsidies so as to prevent backlash from constituents.

“Effective spending on infrastructure and education, along with measures to improve the business climate, could potentially boost Indonesia’s growth rate up to 7% or higher,” claimed Shubham Chaudhuri, the World Bank’s lead economist for Indonesia.

Further, recent hostility towards foreign entities in Indonesia’s massive mining sector has been disquieting for existing and potential foreign investors. A few weeks ago, the government curtailed foreign ownership over certain mines. Now, Indonesia is considering implementing a 25-50% export tax on coal in order to keep more energy resources at home, as opposed to fueling growth abroad. Such a tax would render a number of mines unprofitable.  

While analysts are under the impression that this tax will not come to fruition, the Financial Times contests that “the level of uncertainty threatens investment in the sector, where capital expenditures and exploration costs can take years to deliver a return.”

Investors interested in going long Indonesia should continue to monitor the government’s approach to fuel subsidies and mining taxes. Indonesia remains a compelling emerging market middle class growth story, but consistently elevated fuel prices and a further increase in antagonism towards foreign miners could signal it’s time for traders to give the IDX a breather.

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