Helping Indonesia to help ourselves

Australia needs Indonesia to succeed. Canberra’s job is to make sure we remain friendly with, and even indispensable to, Jakarta.

Australia’s strategic future hinges on Indonesia. Right now, Indonesia is struggling in the face of the health and economic pandemic unleashed by COVID-19. Australian support could make a pivotal difference.

Devising the best way forward requires a clear understanding of Australia’s long-term strategic interests, a little policy imagination, and a shot of political leadership.

Indonesia is now critical for Australia’s security and sovereignty in a way it never was in the Cold War. Back then, both Indonesia and China were weak and inward looking, and we had the US on our side. No foreign power could coerce Australia or threaten its territory.

But America is getting weaker and in the near future, Asia will be run by Asians.

China will be the biggest power, and it wants to displace the US as regional leader. Whether it does so will be decided by Asia’s other great powers. For Australia, the most important will be Indonesia.

With almost 270 million people and a fast-growing economy, Indonesia could one day rank alongside Japan, Britain, and Russia on the world stage. That’s if it succeeds. If it goes backward, it becomes less able to resist the new regional order China is trying to build.

Australia needs Indonesia to succeed. Canberra’s job is to make sure we remain friendly with, and even indispensable to, Jakarta as Indonesia rises.

Much uncertainty

Unfortunately, the virus could hit Indonesia very hard. Indonesia’s healthcare system is weak and risks being quickly overwhelmed. Indonesia’s economy is also vulnerable. It has been among the worst affected by the rush of panicked investors fleeing emerging markets worldwide, threatening financial stability.

Worse, this is severely hampering Indonesia’s ability to deliver fiscal and monetary support to keep the economy (and society) afloat through the pandemic. If it is unable to do so, there is a big risk that the temporary shock from COVID-19 could lead to much longer-lasting damage, triggering a financial crisis in the worst case or otherwise resulting in economic turmoil and feeble growth that could last for years.

Much is uncertain. But, given the stakes, it is worth taking out some insurance.

Indonesia’s size makes it difficult for Australia to make a major difference on the health front – though we may yet need to donate testing kits or deploy medical personnel.

On the economic front, however, there is more scope to have a pivotal impact. Indonesia’s economic fundamentals are sufficiently healthy that, with some outside support, it could be in a relatively strong position to get through this crisis.

One might prefer that Indonesia simply turned to the International Monetary Fund. But the Fund is still politically toxic in Indonesia – a legacy of its involvement during Indonesia’s last crisis in the late 1990s. If Australia wants to be a trusted partner, we need to respect that sensitivity. In any case, Indonesia probably wouldn’t turn to the Fund until it was too late.

Instead, Australia should offer sizeable bilateral support, which could be done as part of a multilateral approach involving other regional powers and led by the World Bank or Asian Development Bank. For Australia, that could include a large ‘standby’ loan facility – as much as $US10 billion ($15.5 billion) – that could be drawn upon if Indonesia ran into difficulty raising adequate budget financing from the market. This could be complemented by also extending a currency swap line – perhaps for another $US10 billion – to bolster Indonesia’s foreign exchange reserves if needed.

This needn’t be a 'soft loan'. Australia’s credit terms could be anchored against Indonesia’s 'normal' sovereign borrowing costs.

Doing so would address the two big interrelated problems facing Indonesia’s economy: financing a sufficiently large budget deficit to keep its economy afloat through the pandemic, while also defending against destabilising currency swings and financial outflows. Combined with realistic financing from other players, this could provide Indonesia with the scale of support it requires.

We have done similar things before. Only this time it needs to be much bigger.

This needn’t be foreign aid or a "soft loan". Unlike past arrangements, Australia’s credit terms could be anchored against Indonesia’s own "normal" sovereign borrowing costs. That would allow Australia to both provide the scale of support Indonesia requires while coming at little-to-no cost to the Australian budget – since the credit terms would be priced for any risk of Indonesian default.

This also meets two important political objectives: minimising the risk of Australian public resentment at a time of economic hardship, and reinforcing the partnership of equals Canberra needs to build with Jakarta.

What if Indonesia did default? That is very unlikely. If it did happen, it would require an Indonesian crisis so deep that default would be the least of our worries. The best strategy is to act now to reduce the risk of such a crisis happening in the first place.

Australia needs a strong Indonesia. We should be there when Indonesia needs us.

Roland Rajah is Director of the International Economy program at the Lowy Institute; Sam Roggeveen is Director of the International Security program at the Lowy Institute.