By Sunanda Creagh
JAKARTA, Jan 28 (Reuters) - Indonesian President Susilo Bambang Yudhoyono's re-election victory last year raised hopes of a renewed reform push, hopes that now look over-optimistic and could eventually result in investor disappointment.
The first three months of Yudhoyono's second, five-year term have highlighted his weaknesses: his mistake of awarding cabinet seats to coalition partners who do not support his policies and his own ambivalent support for reform.
His second term -- like his first -- continues to be overshadowed by the power struggle between the country's reformers, intent on shaking up a bloated, corrupt bureaucracy, and the political old guard who stand to lose out.
The outcome will determine the pace of reform in the civil service, judiciary, and police, seen as critical to spur the country to reach investment-grade status within the next five years, a prospect drawing investors to its bonds and currency.
"The first 100 days ... have been a great disappointment, both for him and the electorate," said Marcus Mietzner, a political analyst at Australian National University.
"As a result, many key policy areas -- economic reform, further institutional change, improvements to infrastructure, climate change -- have taken a backseat. Only six months after his landslide victory, Yudhoyono appears defensive, insecure and self-absorbed."
Indonesians, who gave him a 61 percent majority win, have also registered disappointment. Yudhoyono's 100th day in office on Thursday was marked by mostly peaceful anti-government demonstrations in Jakarta and other major cities.
Public satisfaction with Yudhoyono has dropped 15 percentage points to 70 percent, a survey by the Indonesian Survey Institute (LSI) released on Wednesday showed, from 85 percent in July 2009.
Last year, the prospect of continued political stability and reform measures fuelled a surge in Indonesian assets, driving stocks up 87 percent, local currency government bonds up as much as 22 percent, and the rupiah up 17 percent.
Fitch Ratings this week upgraded Indonesia's sovereign debt rating to BB+, one notch below the coveted investment grade level that analysts said may take another two to three years to obtain. Investors see G20 member Indonesia, with 240 million people and abundant natural resources, joining the emerging market elite alongside BRICs Brazil, Russia, India and China.
Analysts said even if Indonesia muddles along at the same pace as during Yudhoyono's first term, the sheer fact it is doing better than its neighbours, politically and economically, will still prove a draw for investors.
"Investors are wary of Malaysia and concerned about Thailand. Indonesia is still the least problematic in the ASEAN (Association of South East Asian Nations) bloc," said economist Song Seng Wun, of brokerage CIMB in Singapore.
"Investors seem to be quite forgiving and look at Indonesia in a favourable light. It's three steps forward, two steps back, but Yudhoyono's administration is still heading in the right direction," said Song.
He expects demand for Indonesian bonds and stocks, especially banks, plantations and consumer plays, to remain strong this year, with the index forecast to gain a further 15 percent.
KEEPING REFORMERS KEY
The risk to that relatively rosy picture is if Yudhoyono loses his star reformers Vice President Boediono and Finance Minister Sri Mulyani Indrawati -- a scenario which currently seems unlikely but could become a catalyst for investors to pull out funds.
Boediono, a former central bank governor, and Indrawati, a former IMF executive, have been the subjects of a highly politicised parliamentary inquiry over their decision to bail out Bank Century, a small lender, at the height of the 2008 global financial crisis.
Protestors on Thursday dragged a coffin with "Mulyani" written on it along the streets towards the Presidential Palace.
Yudhoyono gave several cabinet seats to his coalition partners, hoping in exchange he would secure their support in parliament and on influential parliamentary committees.
Instead, his coalition partners have proved fickle allies who prefer to pursue their own diverse agendas.
His coalition partners have attacked both Boediono and Indrawati, and opposed important policies including the China-ASEAN Free Trade Agreement which came into effect this month, and the politically sensitive issue of fuel and electricity prices.
For now, it seems likely Indrawati and Boediono will survive the Bank Century investigation given that the parliamentary committee lacks the power to force their resignations. But that is unlikely to end the power tussle between reformers and Suharto-era politicians such as Aburizal Bakrie, the tycoon who heads the Golkar Party.
Yudhoyono himself has made few public pronouncements of support for either Boediono or Indrawati.
And despite winning the election on an anti-corruption platform, he appeared slow to defend the Corruption Eradication Commission when evidence emerged of a police plot to frame anti-graft officials.
After much public pressure, Yudhoyono vowed to address legal reform, putting another of his trusted technocrats, Kuntoro Mangkusubroto, in charge of a new legal reform unit.
A prison official was fired this month after Mangkusubroto's team conducted a spot check on a Jakarta jail, accompanied by TV cameras, and found that wealthy prisoners were living in the lap of luxury with access to karaoke rooms and spa treatments.
Political risk analyst Kevin O'Rourke said he saw potential for progress in the areas of institutional reforms, including the civil service, the judiciary and legal system, particularly under Mangkusubroto's direction.
But there was less scope for progress in market-oriented reforms including power pricing, investment conditions for energy projects, and labour market laws, he said.
"Right now the cabinet reformers and Golkar are enemies so the prospect of getting any type of cooperation there is even more bleak than usual," O'Rourke said. (Additional reporting by Telly Nathalia; Editing by Sara Webb and Bill Tarrant)