For the decade following the 1997-8 Asian crisis, Indonesia struggled to lift its growth rates back to the pace recorded during the Soeharto era: an average of 6-7%. Now two achievements have triggered a spate of favourable stories in the foreign press: maintaining positive growth during the 2008 global financial crisis, and getting GDP growth back to 6.5% in the latest GDP figures.

In fact, the whole macro picture looks good, all the more so because most of the rest of the world looks so dismal. Indonesia's inflation is running at a historically low 4%, and both the current account and the budget are close to balance. Investment is growing strongly and now accounts for more than 30% of GDP. And it's not just resources powering the economy: domestic consumption is the main driver of growth. Half of Jakarta is astride their motorbikes, checking Facebook while heading out for a bowl of bakso down at the new mall.

With this performance, the recent upgrading of Indonesia to 'investment grade' by two of the three major rating agencies elicits just one reaction: why did it take them so long to get Indonesia's rating above those of the disaster-destined European peripheral countries? Once again, the rating agencies have been looking into the rear-vision mirror and failed to pick the emerging realities. Belatedly, they have caught up.

Foreign investors were quicker to see the improving performance. Indonesia's foreign investment flows were quite small until recently, but increased sharply last year. Foreigners were also attracted by the high rates of interest available on financial assets.

Foreigners might expect some appreciation of the rupiah, as well as a good yield. These inflows may themselves present challenges for the Indonesian authorities. The name of the game is to keep things growing at a sustainable pace. The danger is not only that foreign capital flows can drive asset-price increases, but they are always pro-cyclical and may push the economy beyond its capacity limits. Faster growth may put pressure on inflation, and at some stage Indonesia needs to raise petrol and electricity prices to reduce the budget-sapping subsidies involved in the current artificially-low administered prices.

Handling this is tricky. Attempting to slow the economy by raising interest rates just attracts more capital inflow, putting the exchange rate under upward pressure, thus losing international competitiveness. Direct measures to slow credit growth would just encourage bigger firms to get cheap dollar-denominated credit from Singapore, adding to the foreign inflow pressures and creating dangerous currency mis-matches.

The main threat to Indonesia's continuing excellent performance is, however, the possibility that the economic mess in the mature countries might finally spill over, most likely in the form of weak demand for Indonesia's exports. So far, so good. Indonesia, like Australia, will probably be fine as long as China remains largely decoupled.

Photo by Flickr user moriza.