Indonesia rediscovers the Faustian bargain of FDI

June 11, 2012

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Indonesia is rediscovering the Faustian bargain that is foreign direct investment. Record FDI represents a big vote of confidence, but it doesn’t give policymakers carte blanche. The more money foreign investors put at stake, the more they worry over the kind of policy wobbles emanating from Jakarta. Their anxiety is punishing Indonesia’s currency, turning fickle policy into a problem for the central bank.

There is a tendency in Jakarta to think of the record $5.6 billion in FDI that poured in during the first quarter as a kind of cloak of invincibility. Politicians gearing up for elections next year are pressing their perceived advantage, demanding a sweeter deal for their impoverished nation and, investors suspect, their campaign coffers. So Indonesia has moved to limit foreign ownership of mines and banks and has banned exports of some minerals to encourage investment in downstream projects.

FDI is stickier than portfolio investment, which can take flight at the first sign of trouble. Money already invested in a project is difficult to take out. But Indonesia needs a steady stream of new FDI to keep balancing its trade deficit, a deficit which is widened by need for imported equipment to make the FDI work. Indonesia is running its biggest current account deficit since the 1980s.

Although that deficit is still not worryingly large, it does put downward pressure on the currency. Capital investment inflows offset that pressure, but that won’t be enough if portfolio investors turn pessimistic. Europe’s troubles have already reduced global investors’ stomach for risk, and shifting goalposts may discourage them further.

Foreign investors have sold $934 million in Indonesian stocks and $732 million in bonds in the past month, helping push the rupiah down 2 percent. Their exit is stretching the supply of dollars at local banks, prompting the central bank to sell its own dollar reserves to prop up the currency. It is also offering banks dollar deposit accounts in hopes of luring more of the dollars they have stashed in Singapore and elsewhere overseas. But as long as investors are fearful of Jakarta’s caprice, Bank Indonesia may be waging a losing battle.

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