As economic indicators go, Lady Gaga isn’t a big market mover.

The pop superstar’s decision to scrap a sold-out concert in Indonesia last month had the country in the news for all the wrong reasons. Threats and protests by Islamic hardliners made it easy for the performer ― who advocates gay rights and features sexually suggestive dance routines in concert ― to bypass Jakarta on her Asian tour.

Such local sensitivities risk upending something bigger: the very direction of Southeast Asia’s largest economy.

International investors rarely know what to do with displays of social or religious intolerance. Lady Gaga’s cancellation came two weeks before Alexander Aan was sentenced to 2 1/2 years in jail for posting “God does not exist” on Facebook. Although this stands as a blight on Indonesia’s democratic credentials, it’s an ambiguous signal to an American, British or Singaporean investor.

The same can’t be said when intolerance extends to economic matters. The poster child of this is the proposed $7 billion takeover of PT Bank Danamon Indonesia by Singapore’s DBS Group Holdings Ltd. The deal is in question as Indonesia considers restricting foreign ownership of lenders for reasons that smack more of emotion than rationality. New taxes on metals, curbs on raw-material shipments and laws that require some foreign companies to divest stakes in local projects have left Indonesian stock markets with some of the weakest returns in the region this year.

Why all this nationalistic noise now, when foreign investment is sorely needed? Why engineer such a gaping self- inflicted wound at a time when the world economy is reeling? It really does make you wonder what President Susilo Bambang Yudhoyono is thinking.

Foreign direct investment jumped 20 percent last year to a record $19.3 billion. In the first quarter, foreign and domestic investments increased by $7.5 billion. That’s quite a feat considering the deepening crisis in Europe and the U.S. slowdown. In the space of five weeks in December and January, Fitch Ratings and Moody’s Investors Service raised Indonesia’s debt to investment grade.

More capital is essential. Yudhoyono took Indonesia from bankrupt dictatorship to fiscally stable democracy. Expectations were low when the retired general was elected in 2004. Three presidents had already come and gone since 1998, when Suharto was ousted by huge street protests. The vast kleptocracy he built over three decades is still being dismantled. Although much work remains, Yudhoyono increased transparency and began attacking the corruption that squanders so much of Indonesia’s $700 billion of annual output.

After winning re-election in 2009, Yudhoyono wisely focused on Indonesia’s abysmal infrastructure. Ask any chief executive officer why he or she doesn’t put more factories in Indonesia and the dire state of roads, ports, railways, airport terminals and power grids is sure to come up. Yudhoyono wants to spend $18 billion this year on upgrades.

Getting there requires lots of foreign money. It’s worth noting that the biggest source of foreign-direct investment in 2011 was neighboring Singapore, where DBS (DBS) is trying to invest in Indonesia’s development. Sadly, traders are betting that Southeast Asia’s largest banking takeover will unravel.

One can understand the impulse. Indonesia’s long history of colonialism bred resentment of foreigners seeking to develop resources. Many Indonesians say oil companies are to blame for the nation’s paradox of plenty: Amid energy riches, about 110 million people ― almost half the population ― live on less than $2 a day.

Many still seethe over the 1997-1998 Asian crisis. When Indonesia’s banking sector crashed, a number of institutions were sold to foreign banks. Now, as a booming Indonesia looks to expand overseas, including in Singapore, the welcome seems lukewarm from Jakarta’s point of view.

Indonesia needs to find a middle ground. Reading from the playbook of Venezuela’s Hugo Chavez won’t get you very far. Reducing corruption, increasing productivity and improving education are important pursuits, but so is creating a stable, predictable regulatory environment. If Indonesia seeks a better overseas reception for its banks, why not go further to strengthen its financial sector? Even those who argue that Indonesia isn’t alone in limiting foreign ownership have to admit the government is handling the process clumsily.

As with the Lady Gaga story, this is a tale of misplaced anger. Taste and decorum are in the eye of the beholder. Indonesia is home to the world’s largest Muslim population, and if its people find an entertainer too racy for local consumption, then so be it. Beyonce has run into similar trouble in Malaysia. It would be nice if there were comparable outrage over the grinding pace of reducing corruption and poverty.

There should be anger, too, at every retrograde policy step that holds back the nation’s 238 million people. Attracting more foreign capital is vital to rectifying much of what ails Indonesia. Increased international involvement makes graft harder to hide and perpetuate. It makes the economy more competitive. It helps create the good-paying jobs needed to raise living standards.

Investment is what propelled last year’s 6.5 percent growth, the fastest since the Asian crisis, and more is needed to sustain that pace. Local sensitivities have their place. Just not when they are such clear roadblocks to a nation’s potential. 

By William Pesek

William Pesek is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)