The world’s largest archipelago, consisting of 18 thousand islands and islets, is home to 278 millions of Indonesians and an economy that has grown at an average annual rate of 5% since the turn of the millennium.

Over the same period, Japan’s economy lost its forward momentum under an increasing burden of unresolved structural problems, barely eking out an average annual growth of 0.8%.

Those remarkably different growth paths of the two economies happened despite vastly unfavorable initial conditions prevailing in Indonesia during the late 1990s.

Indonesia was at the epicenter of the Asian financial crisis of 1997-1998, while Japan was largely spared from the wave of currency devaluations, capital flight, soaring interest rates, corporate bankruptcies and political turmoil.

IMF deal: a blessing in disguise

To salvage its economy, Jakarta had to enter a conditional lending deal with the IMF in January 1998. Fortunately, that was a well-designed financial support of a program of structural reforms and trade adjustment policies. Six years later, on December 19, 2003, Indonesian authorities were commended for having successfully completed the IMF’s Extended Fund Facility Arrangement of $5.3 billion.

And, as the saying goes, Jakarta never looked back.

Two weeks ago, Indonesia confirmed that its GDP last year grew 5.05%, a somewhat weaker performance than a 5.31% growth rate in 2022 owing to slower export sales.

A tight monetary policy has also contributed to stabilize aggregate demand at a somewhat slower pace. But that has now opened up the possibility of interest rate cuts in the months ahead. Indeed, inflation in January was down to 2.5%, the mid-point of the inflation’s official target range of 1.5% to 3.5%.

Under those circumstances, the real policy interest rate of 3.5% -- the difference between the nominal policy rate of 6% and the inflation rate of 2.5% -- is clearly on the high side. That leaves plenty of space to reduce the real policy interest rate to its neutral position of about 2% to support domestic demand and protect the economic growth forecast of about 5% for 2024.

Roughly balanced public finances and external accounts are also outstanding achievements.

The budget deficit last year was reduced significantly to 1.65% of GDP. That is a pleasant surprise in view of politically motivated forecasts that spending in an election year and the rush to complete various infrastructure projects would lead to a widening budget gap.

Indonesia’s gross public debt of 38% of GDP is also a remarkable statistic, compared to 123% of GDP for the U.S. and 90% of GDP for the euro area.

Most of the negative comments about Indonesia now refer to politics; the sound economic outlook is largely glossed over.

Leading ASEAN’s quest for peace and prosperity

Votes are still being counted in the presidential election. Prabowo Subianto, the defense minister in the outgoing government, is a clear frontrunner and, at the time of this writing, he appears to have won. Subianto’s running mate is a son of the current, and very popular, President Joko Widodo. And that looks like an auspicious sign of stable continuity.

Japan’s economy is a very different story. A steadily declining population -- resulting from falling birth rates and family formations -- means that domestic demand cannot be the key lever of economic activity. To grow, Japan must be catering to external demand with appropriately designed products and services.

Last year, 53% of Japan’s GDP growth was generated by its trade surplus as exports increased 3.1% and imports declined 1.3% due to slumping household spending and private investments.

The role of exports became even more crucial when the domestic demand literally collapsed in the second half of last year. Japan managed to avoid a recession at the time of normally strongest domestic spending during year-end holidays only as net exports rose 1.6% to deliver a 1.4% GDP growth in the last two quarters of 2024.

The message here is simple: Tokyo must have trade partners who will accept to tolerate substantial and systematic deficits with Japan on goods and service transactions.

For whatever reason, the U.S. is the only country willing to do that. According to Japanese trade data for the first 11 months of last year, the U.S. took a $54.4 billion deficit on its Japanese merchandise trade. That covered 80% of Japan’s trade deficit with China, ASEAN and the E.U.

Instead of throwing $70 billion in a losing battle for microchip supremacy -- and betting the survival of its automobile industry on an elusive hydrogen power -- Japan should fix its economy by urgently reversing its population decline, stopping the gross mismanagement of its public finances and straightening out its monetary policy.

Maybe the OECD and the IMF can help -- with support from Japan’s allies?

Meanwhile, Indonesia will lead its ASEAN friends to write a new chapter of economic development, peace and prosperity in East Asia.