International Finance in Indonesia - Research Paper Example

Your Full 4 November, Contents Introduction 3 Political Risks 3 Form of Government 4 Living Standards andIncome Distribution 4 Orderliness and Leadership Succession 4 Cultural and Demographic Characteristics of Population 5 Integration within international Economic System 6 Security Risks 6 Economic Risks 7 Structure of Current Account 7 Resource Endowment, Level of Development, and Economic Diversification 7 Size and Composition of Savings and Investment 8 Rate and Pattern of Economic Growth 8 Effectiveness of Fiscal and Monetary Policy 9 Structural Economic Reforms 9 Long Term Economic Projection 10 Works Cited 11 Introduction The OECD defines foreign direct investment (FDI) as “investment that adds to, deducts from or acquires lasting interest in an enterprise that operates in an economy, arising from outside the country in order to have an effective voice in the management of the enterprise” (Jones and Colin 8). This implies that foreign direct investment is about injecting capital from one country to another in order to gain controlling interest in the firm that the capital is being sent to. Typically, FDI moves from industrialized nations in Europe and North America into emerging markets around the world. In this case, we look at the injection of capital into the Indonesian economy by an American firm that seeks to invest in a clothing manufacturing firm in Indonesia. Indonesia is a state made up of a group of islands located between Southeast Asia and Oceania (Van Zanden and Marks 2). The country is the fourth most populous nation in the world with 252 million people (Van Zanden and Marks 2). The vast majority of the nationals speak Indonesian which is spoken by members of the largest ethnic group, the Javanese. There are 33 provinces in Indonesia and one Specially Administered region in the country. Indonesia was declared independent in 1945 after the Second World War but it was acknowledged by the Dutch colonizers in 1949. Indonesia is currently ruled by Joko Widodo who is the head of the unitary presidential constitutional republic. Political Risks This section of the essay will evaluate the relevant elements of the political environment of Indonesia that can affect a clothing manufacturer from the United States, seeking to invest in the country. Form of Government Indonesia is a republic that is ran as a unitary state; hence all the power is concentrated in the central government with a much lower level of autonomy to regional authorities (Central Intelligence Agency 307). The country’s 1945 constitution has gone through four amendments, and the most modern amendment occurred in 1998 when President Suharto was ousted (Central Intelligence Agency 307). There country has a bicameral parliamentary system which includes the People’s Representative Council which is the lower house and consists of 560 representatives and the Regional Representative Council made up of 132 members. They both monitor the affairs of the executive and pass laws. Living Standards and Income Distribution Indonesia has a GDP per capita of about $10,000 and the country has one of the fastest growing middleclass in the world (OECD 48). The country’s middle class is growing fundamentally because of the reforms made to education in the late 1990s. And this has led to the creation of an urban middle-class who live according to high global and international standards. It is estimated that 11.7% of the population lived below the poverty line in 2012 and this implies that the middle class is rather large when compared to other countries in the southern continents (Van Zanden and Marks 107). This implies that a clothing manufacturing entity in the region is likely to have a local market that could potentially yield profits to support a drive to export to different parts of the world. Orderliness and Leadership Succession Indonesia went through a period of political upheaval in 1998 when President Suharto, who had been in power for over 3 decades was forced to retire. However, the country put in place measures to develop democracy and rule of law by making constitutional rules that strengthened the Executive, Legislature, Judiciary and Civil Society. Currently, the country’s constitution stipulates multiparty democracy based on free and fair elections. Indonesia on the other hand is a country plagued with high levels of oligopoly in its political and economic circumstances (Central Intelligence Agency 46). Small groups of elite persons control most of the country’s political power and wealth. This has led to a tradition of illegal practice and corruption due to the abuse of connections and privileges. Cultural and Demographic Characteristics of Population Indonesia has most of its people living on the island of Java and there are over 300 distinct ethnic groups in the country. Javanese account for 42% of the country’s population. However, the country’s motto is “unity in diversity”. This implies that it seeks to create a unified framework within which all groups and lingual communities can partake without feeling any sense of apprehension. Thus, this unity in the face of fragmentation must form a basis for the success of any MNC seeking to operate in the country. Almost 90% of the people of Indonesia are Muslims, thereby making it the largest Muslim country in the world (Elson 88). However, the constitution of Indonesia recognizes the rights of members of five other religions. The culture of Indonesia is influenced by the Asian and Islamic systems as well as other elements of the Pacific which defines the history and ideological frameworks of the island. Indonesian traditional dressing is along those lines of other Asian peoples, but there is a growing trend towards a more liberal western style of clothing that favors the clothing company that the FDI seeks to achieve. The country has 56% of its population being below the age of 18 (Elson 88). Therefore, there is a promise of a continuous supply of labor and the growth of the markets over the years. This implies that the country will have a lot of people to look up to in the future as western populations dwindle over the years. Integration within international Economic System Indonesia joined the United Nations in 1950, shortly after its independent government gained recognition in the international community (Cribb and Kahin 42). Indonesia is therefore a signatory to most treaties around the world. This includes treaties relating to international trade and human rights. This provides a degree of assurance and guarantee that an MNC in Indonesia is likely to be treated appropriately in the country. Indonesia is a founding member of the Association of South East Asian Nations (ASEAN) which is the regional grouping for the area, recognized by the United Nations. This implies that any business located in Indonesia will get easy access to the rest of the region and gain benefits from such contacts and connections. Indonesia is a member of the Non-Aligned Movement (NAM) and this means the country has connections to other nations in the developing world. It also has links to various Islamic trade blocs and is a signatory to the World Trade Organization Treaty. This means that Indonesia has a lot of links and connections to various nations and can wield a lot of influence over the developing world. Security Risks Indonesia is a major partner with the West in the War on Terror. The country has played various roles in the arrest and prosecution of Islamists and members of Al-Qaeda (Wilson 1). Due to this position taken by the Indonesian government, it has increasingly become unpopular by Islamist groups within the country. Indonesia also has to deal with extremist violence including the Bali bombing that was aimed at Western tourists. This shows that Western interests are targeted by extremists in the country. There have been various incidents of violence and attacks that were intercepted and prevented. There are also separatist movements in Aceh and Papua who have sought to break away from Indonesia in the past. These groups have faced various levels of brutality over the years and as such, will want to use armed conflict to break away from the country. And the case of the success of the breakaway of East Timor gives these groups a high level of encouragement to continue using violence. Internationally, Indonesia has had a few military tensions with its neighbors, Malaysia over the control of certain islands (U.S. Library of Congress para 4). These tensions have led to a form of arms race that provides a major evidence of a potential armed conflict in the future. Economic Risks This section examines the economic risks that could potentially affect the ease of investing and running an MNC in Indonesia. Structure of Current Account As of the year 2011, Indonesia had a total debt of US$260 billion owed to entities around the world (Embassy of Indonesia para 3). This implies that the country has a foreign debt burden that is 26% of its US$1 trillion Gross Domestic Product. This makes it a high risk country to conduct business within. This is because the debt burden shows signs of overdependence on foreign funding sources. However, the country consistently runs a trade surplus over the years. Resource Endowment, Level of Development, and Economic Diversification Indonesia has an abundance of natural resources. It has crude oil, natural gas and gold and it was a member of the Organization of Petroleum Exporting Countries (OPEC) until it ceased to become a net exporter of oil (Holtzappel and Ramstedt 13). However, the country moved onto the path of rapid industrialization in the 1960s and this has led to many changes in the economy. The WTO identifies that Indonesia is the 27th biggest exporter in the world (The Jakarta Post para 1). Also, the growth of the country’s economy has led to the development of the service sector. And in this process, Indonesia has developed tourism significantly. Other sectors like banking have grown significantly, mainly due to the increase in the number of graduates in different fields of expertise that are being prepared for active employment. Size and Composition of Savings and Investment Reports indicate that household saving rates are on the average of 23.4% per household income (Central Intelligence Agency 41). On the global scale, Indonesia is a country with very high saving rates and potentials. However, relative to other Asian countries like Japan, Indonesians save less. It is also reported in many sources that Indonesia’s banking industry is fairly young and less comprehensive in covering the country’s population. This implies that the traditional saving and investment system is quite low. However, with the growth of the banking sector, it is predictable that the country’s savings and investment systems will grow tremendously over the coming years and a firm injecting capital from overseas will be able to get local capital acquisition options to grow and expand. Rate and Pattern of Economic Growth In contrast with other countries in the Western world, the GDP of Indonesia has been growing consistently over the past ten years. In spite of the global financial crisis, the Indonesian economy grew by an average of 6% per annum since 2005 (OECD 47). This shows that the country’s growth is not based on the traditional and normal variables of other nations. The implication is that the country has different dynamics that is not tied to the Western world’s growth and progress. Thus, a firm that seeks to invest in Indonesia must look out for variables that are completely different from what exists in the West. On the other hand, the country responds to Asian conditions and was the hardest hit in the Asian Financial Crisis of the late 1990s. Effectiveness of Fiscal and Monetary Policy The Central Bank of Indonesia plays a major role in contributing to the country’s policies relating to inflation and other matters in the country. In August 2013, due to the fall in commodities pricing, the Indonesian government undertook a quantitative easing to ensure financial stability. Indonesia’s deficits fell over the past three years. However, the country’s inflation rate continued to increase because of the lack of proper mechanisms to guide against it. This culminated in the quantitative easing. However, the quantitative easing has caused the value of the country’s currency to fall significantly against major currencies over the current year. Therefore, new measures are being prescribed by the Central Bank including the restriction of outflows and the reduction in the acquisition of foreign currencies Structural Economic Reforms The main reforms over the past two decades include the reduction in the reliance on primary trade exports like crude oil. These reforms sought to diversify the country’s economy and improve the earning capacity of the country. However, this has caused rapid economic growth and made Indonesia a leading exporter within the international community and within the developing world. Another aspect of economic reforms in Indonesia has to do with the devaluation of the Rupiah, which was not trade by the forces of demand and supply. With pressure from the World Bank and the IMF, the country now has to get their currency to be fixed by market forces. And this has caused the Central Bank to gain more obligations in dealing with the regulation of money flow and the prescription of measures to prevent the fall in the currency’s value. The country has kept a huge reserve that is released as and when the need arises. These two issues make the country a positive grounds for the flow of FDI. However, the downside of all this is the fact that the country is vulnerable and susceptible to rise and falls in its currency’s worth and value. Long Term Economic Projection The Bank Indonesia projects a steady growth of GDP at the rate of 6% in the next two decades. This way, they hope to increase their status and make the per capita income of the country to increase by 100% in the next decade. This system of consistent growth is based on projections meant to modernize the economy and to put Indonesia amongst the category of rich nations. The growth in the population of the country also implies that Indonesia will soon be an attractive hub in the largest region of the world. This is because the region has major population rates and this means that more commerce will come into the region. Thus, Indonesia gives a geostrategic location for businesses to establish and maintain high levels of income and accessibility to different parts of the world. Works Cited Central Intelligence Agency. The CIA World Factbook - Indonesia. New York: Skyhorse Publishing, 2009. Print. Cribb, Richard and Audrey Kahin. Historical Dictionary of Indonesia. Oxford: Oxford University Press, 2004. Print. Elson, Robert. The Idea of Indonesia: A History. Sydney: Federation Press, 2008. Print. Embassy of Indonesia. News – SBY: Indonesia Will Be in the Top 10. 13 June 2011. Web. 5 November 2014. Holtzappel, Coen and Martin Ramstedt. Decentralization and Regional Autonomy in Indonesia. Amsterdam: Kluwer books, 2009. Print. Jones, Jonathan and Wren Colin. Foreign Direct Investment and the Regional Economy. Surrey: Ashgate, 2012. Print. OECD. Perspectives on Global Development 2014 Boosting Productivity. New York: OECD, 2014. Print. The Jakarta Post. Indonesia rises to 27th biggest exporter in the world in 2010. 6 July 2011. Web. 5 November 2014. U.S. Library of Congress. "Indonesia – Foreign Policy". 5 May 2007. Web. 5 November 2014. Van Zanden, Jan Luiten and Daan Marks. An Economic History of Indonesia: 1800-2010. London: Routledge, 2013. Print. Wilson, Chris. “Indonesia and Transnational Terrorism.” Foreign Affairs, Defense and Trade Group. Parliament of Australia (2001): 1-4. Web. Read More