 Construction on a 27.8-km elevated monorail network was started in Jakarta in 2004, but languished partly due to funding shortfalls. Recent efforts suggest a possible revival of the project. | | | | | Indonesia—Rubber Must Hit the Road I recently returned from a trip to Jakarta, the capital city of Indonesia.
Indonesia is a heavily hyped investment destination these days. The local stock market has been "on fire" during the past two years, rising over 268% in U.S. dollar terms between October 2008 and October 2010. Yet I have vivid memories from a time—not all that long ago—when the city of Jakarta itself was literally on fire. The currency crisis that swept through Asia in the late 1990s instigated the downfall of the long-standing and dictatorial regime of President Suharto. As that government crumbled, Indonesia was engulfed in a political and economic firestorm, and angry mobs took to the streets. Most of the physical wounds of that era have healed with the passage of time; yet other intangible scars persist.
Unfortunately, the economic environment that emerged in the post-Suharto era was not conducive to sustained levels of capital investment. Both private and public institutions shied away from major investment programs in the country. Their reasons were manifold: unclear and unstable regulatory structures; opaque and often slow decision-making on the part of the government; endemic corruption and graft. In many cases, corporate investment programs became jaundiced. Companies would commit only small sums to the market, and even those investments were subject to aggressive "payback" assumptions. Investments were undertaken only if they could be recouped in two or three years. It was rare for a company to commit a material sum based on a "long-term view" of the country.
That state of affairs was (and still is) deplorable. It has meant that the development of various types of infrastructure—for transport, energy, and mass production—has been stunted. Nowhere has this deficiency been more evident than in the country's oil industry. A decade ago, Indonesia produced far more oil than it does today, and much more than it was able to consume at the time. It was once so "oil-rich" that it was able to export its surplus, and held a membership in OPEC (the Organization of the Petroleum Exporting Countries). A decade later, after chronic underinvestment, Indonesia's oil production has fallen dramatically, and it has pulled out of OPEC. Sadder still, its consumption has been stifled by its own production shortfall (see chart). 
Certainly, we would all like to see the world shift toward clean, environmentally friendly sources of energy. Even so, Indonesia remains a poor country; if it is ever to shed the shackles of that poverty, it should not undergo a contraction in its oil consumption—at least not at this stage of its development. In my view, the glaring shortfall in capital investment is one of Indonesia's greatest tragedies. Unless it is corrected, the country will likely remain mired in poverty, and many of its 240 million citizens will fall short of their potential. Sub-par economic growth is usually measured in terms of foregone income and wealth; but it can also be assessed in terms of human lives—in opportunities lost, personal indignities and suffering.
Yet perhaps there is reason to believe that this slow-moving tragedy can be averted. I encountered something different on this trip to Jakarta: several of the companies I met revealed plans for sustained, long-term investment. Some were contemplating capital expenditure programs denominated in hundreds of millions—or even billions—of dollars, rather than the trivial sums of the past. The largest projects had payback periods that could span a decade. Instead of cynical, short-term attitudes, many management teams appeared to recognize what hung in the balance: the potential to nurture and tap the demand of a vast domestic market.
For a decade now, corporate capital expenditure in Indonesia has grown at a rate much faster than that of the overall economy, but from a woefully small base. Even today, such expenditure hovers near 2% of GDP. By contrast, India—another county that has suffered from chronic underinvestment in the past—has managed to expand its investment to 7% to 8% of GDP. If Indonesia is to meet its potential and live up to the lofty expectations of investors, there is no time to lose: rubber must hit the road.
 | Andrew Foster
Portfolio Manager
Matthews International Capital Management, LLC |  | | You should consider the investment objectives, risks, charges and expenses of the Matthews Asia Funds carefully before making an investment decision. This and other information about the Funds is contained in the prospectus, which may also be obtained by calling 800.789.ASIA (2742). Please read the prospectus carefully before you invest or send money as it explains the risks associated with investing in international markets. These include risks related to social and political instability, market illiquidity and currency volatility. Investing in foreign securities may involve certain additional risks, exchange rate fluctuations, less liquidity, greater volatility and less regulation. Single-country and sector funds may be subject to a higher degree of market risk than diversified funds because of a concentration in a specific sector or geographic region.
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