Too late to shuffle cards in Indonesia game-plan

About two years ago on a visit to Jakarta, I called on a Korean manufacturer of household goods, who had set up a plant there. I wanted to see just how his sort of business operated in Indonesia.

The man on the spot was forthright about costs, labour quality and all these sorts of things and then I asked him what he thought about political risk.

'Well, I don't see any major problems,' he replied. 'Kim Young-sam won't stand for re-election and I don't expect the North to invade the South.' 'Excuse me,' I put in. 'I didn't mean Korea. I meant Indonesia.' He laughed and made what I then thought was an obvious point.

'Do you really think that whoever comes into power in this country would want to turn the clock back by ordering us out and banning foreign investment?' he said.

Well, I haven't seen him since and I don't know if he's still operating but I hear that one of Indonesia's biggest categories of exports at the moment is production machinery, unbolted from the shop floor, crated and sent back home. The risk was not what the Korean plant manager thought it was.

His mistake was to look at Indonesia not as an export processing zone but a potentially huge domestic market. He was making cheap washing machines on the reasoning that of 200 million people perhaps two million would want one and this, he reckoned, was a good-sized market.

His company set up locally because it expected to enjoy tariff protection longer than the World Trade Organisation had in mind. It would therefore have an advantage over competitors still shipping completed washing machines to Indonesia.

Should tariff protection later vanish the company could gradually make the change to an exporter with an established low-cost production base.

I have heard this reasoning many times in Jakarta. It was inherent in such projects as the national car and the national aircraft. I have even heard it from a commercial banker who last year touted his stock as a sure winner because its strategy was to expand its branch network rapidly, mobilise the country's growing savings base and direct it into loans to large enterprises catering to booming consumption.

Investment approval figures show that Indonesia embarked on a boom of foreign investment in 1994 and that, paradoxically, the figures were rising again last year as the economy began to crumble (see the chart below).

If this money had gone into industrial enterprises treating the country as an export processing zone the problems would perhaps not be so great now. Component goods sourced in foreign currencies would come in, be processed by labour paid in cheap rupiah, and sold again to strong foreign markets in strong currencies.

There would still, of course, be some hiccups in financing. Riots would also undoubtedly have slowed things down. But the export sector could still survive under these conditions.

Unfortunately, much of the investment emphasis was on the domestic market and the effect is crippling. Mom and pop cannot buy anything that has a foreign currency element when their money is worth less than a quarter of what it was last year.

It will make recovery all the more difficult. My Korean acquaintance thought he had been dealt kings and queens when he peeked at his hand and saw mom and pop. Unfortunately, he looked at the cards before the deck was shuffled.