The stability premium of large economies

FT has a feature on the success of Indonesia under Joko Widodo,

At a time when the global economy is being battered by the war in Ukraine and the global energy, food and climate crises, Indonesia has emerged as an unlikely outlier, boasting both a booming economy and period of political stability. Gross domestic product expanded 5.4 per cent year on year in the second quarter, well above forecasts. The country’s inflation rate of 4.7 per cent in August, prior to a recent petrol subsidy cut, is one of the lowest globally. Its currency, the rupiah, is among the best performing in Asia this year and its stock market is hitting record highs. The resource-rich archipelago, south-east Asia’s largest country with 276mn people, is riding high on soaring commodity prices. Exports rose 30.2 per cent year on year to $27.9bn last month, the most on record. The world’s largest producer of nickel, a critical component in electric vehicle batteries, Indonesia is putting in place plans to benefit from the upcoming boom in EVs… 

With inflation relatively low, Indonesia’s central bank only raised interest rates for the first time in three years in August to 3.75 per cent. Banks are also still lending and exports are booming, not just from commodities. Widodo’s signature “omnibus law” that loosened employment regulations to help job creation has encouraged more foreign investment, as some producers diversify manufacturing away from China... One of Widodo’s principal achievements has been to expand infrastructure on an unprecedented scale for Indonesia, a vast country of more than 17,000 islands. His governments have constructed 2,042km of toll roads in eight years, he says, compared with about 780km in the prior 40 years, as well as 16 airports, 18 ports and 38 new dams.

And the main reason for this success has been the political stability under President Widodo,

Much of the credit for this boom has gone to President Joko Widodo, who has managed to maintain popularity with both ordinary Indonesians and investors alike after eight years in power. A poll released this week by research firm Indikator Politik Indonesia showed 62.6 per cent of Indonesians approved of the charismatic former furniture salesman’s performance... Support for Widodo, who is known as “Jokowi”, is so strong that at one point his supporters were pushing to change the constitution to allow him to stand for a third term in office.

Coupled with opportunistic policies, 

Yet by far the flagship industrial policy of Widodo’s second term has been his attempt to use Indonesia’s giant nickel reserves — which are tied with Australia as the world’s largest — to create a domestic electric vehicle industry. In 2020, the government banned outright the export of nickel ore, forcing foreign companies, many of them Chinese, to begin refining it onshore. While most of the end-product is going into the stainless steel industry, the aim is to begin extracting more higher grade material for use in batteries. Indonesia is expected to provide a significant part of the new nickel supply needed by the global EV industry but its reserves of laterite ore require more processing... Widodo credits the restrictions with lifting the value of nickel ore-related exports from $1.1bn annually five years ago to nearly $20.9bn last year. “After [this], we can export maybe more than 40 times or 60 times [more],” he says. “Indonesia has the largest nickel reserves in the world, around 21mn tons, [or] around 30 per cent of world reserves.” He adds that the next step could be to extend the policy to Indonesia’s large reserves of bauxite and copper. Demand for the materials, used for aluminium production and renewables, is also growing globally...

The plan to refine Indonesian ore into battery-grade material is still just starting, with one refining plant commissioned in May last year and seven more in the pipeline, all on the island of Sulawesi... Near Jakarta, South Korea’s LG Energy Solution and Hyundai Motor Group are building the country’s first electric vehicle battery cell plant while Hyundai is building an EV plant nearby. Indonesia says China’s CATL, the world’s biggest EV battery maker, has agreed to invest in an EV battery plant and Widodo says he was also wooing Tesla.

There are striking similarities with India. 

There is a strong case that political stability by itself contributes to economic growth. And if the government does not mess around with the macroeconomy and allows things to play out, even without any major reform there comes a growth premium with political stability. Further, if the country is a large enough market, the premium becomes substantial. 

For investors used to policy flippancy in developing countries, the familiarity of nearly a decade of the same government is an under-appreciated factor. Even without any Big Bang reforms, a government that does not rock the boat and provides reasonable policy predictability is a boon for investors. In fact, the stability premium explained a significant part of foreign investor interest in China in the last three decades. 

Into this mix, if governments can focus on the plumbing issues - human capital development, infrastructure provision, and enabling policies for economic growth - then the stage is set for sustainable growth. 

This is the main takeaway from my first book, Can India Grow. Forget the fetish with high growth rates and Big Bang reforms. Neither does the country have the foundations to sustain high growth rates for extended periods nor are there any such implementable Big Bang reforms. In the circumstances, the preferred strategy should be to target the baseline growth of 5-6% for the next three decades, while also opportunistically grabbing the occasional short high-growth episodes. This requires hunkered down execution to painstakingly expand the physical, human, and financial capital foundations.  

In so far as economic growth is the biggest poverty eradication strategy, India and Indonesia have lucked out with political stability, at least for now. They need to focus more on the plumbing to build sustainable and higher growth foundations.