Dressed in brightly coloured tracksuits, the children of Yogyakarta start exercising before the sun is fully out and the morning’s first classes start. Walk through the narrow lanes surrounding the Kraton, home of Yogyakarta’s governor Sultan Hamengku Buwono X, at 07.30 and you’ll spot them out in force, marching in neat lines, arms swinging or doing jumps across tidy schoolyards.

With a population of just under half a million, Yogyakarta is the cosier version of Jakarta, minus the bad traffic and 1990s-style skyscrapers. The tallest building here reaches just eight floors. One hour’s plane-ride southeast of the Indonesian capital, Yogyakarta, or Yogya as it’s called locally, is the cultural and educational capital of Java and a semi-autonomous region.

“The social make-up of Yogyakarta makes it unique,” says local architect Eko Prawoto, as he tours the city’s newest gallery, which he designed, in the leafy area of Bayeman Permai. “People here are open and tolerant. The gap between rich and poor isn’t that big. We have an openly gay community here – that doesn’t work in other [Indonesian] cities.” Founded as a kingdom in 1755, Yogyakarta was allowed to retain its independence and un-elected head of government as thanks for funding the guerilla fighters who sacked Indonesia’s Dutch colonisers during the independence struggle from 1945 to 1949 (and in exchange for giving up two thirds of Java). It served as the nation’s capital during those years and still retains a rebellious streak. People simply do things differently in Yogya than in the rest of the country. Here, the Sultan rules by benign decree and is revered by most – he focuses more on creating an equal society (as far as a sultan can) and less on seeing economic growth-figures soar. The result is a lack of slums and a relatively happy population.

Another man Yogyakartans are fond of is Herry Zudianto. The city’s former mayor, who was elected in 2001 and served for two terms, dramatically reduced corruption in local government. With first-hand knowledge of the crippling effects of double-dealing officials (he used to run a batik business) Zudianto incorporated the various government departments involved in business licensing into one, which prevented money being siphoned off to the wrong people.

He also made it easy for people to set up businesses in Yogyakarta, a first for a country where endemic corruption hampers an otherwise booming economy. Yogyakarta got the World Bank seal of approval as Indonesia’s most investor-friendly city in 2010 and took top spot for ease of starting a business this year. Dressed in the obligatory batik shirt, Zudianto sits on his terrace in the quiet residential neighbourhood of Umbulharjo, the sound of hotel-lobby-style jazz music coming from the loudspeakers and birds chirping in the lush garden. An avid amateur photographer, he fiddles with his camera while talking about good governance. “For me, the worst kind of corruption is systemic. I made a commitment to clean governance. I built a participatory society, which means the government is conducing itself transparently and with accountability.”

Today, the retired Zudianto campaigns for an increase in cycling on the streets of Yogyakarta. You’ll see him cycle everywhere on his Dutch-made Sparta bicycle. On Sundays, he hits the town with the 100-plus members of Yogyakarta’s cycling club, all donning Dutch colonial-style cycling gear and riding antique Dutch bicycles. The pressure is on the new mayor-elect Haryadi Suyuti to continue building on Zudianto’s groundwork. Things seem to be keeping apace. Yogyakarta’s small-to-medium-sized businesses are flourishing. Batik makers dominate the cottage industry – shop owners selling batik clothes are crammed in along the main shopping street Malioboro – and Yogyakarta’s resident Korean community is doing good business making golf-wear and wigs at its 50-odd factories dotted around the region. Many locals, including graphic designer Arief Noor and product-designers Satya Bramantya and Sapta Nugraha, work with Yogyakarta’s small-scale workshops to make products distributed across Indonesia and overseas.

Noor produces 30,000 t-shirts a month under the label Dagadu Djokdja with the help of Yogya families who embroider and print his pieces. The clothes are packaged at his small factory in the southwest of the city. Meanwhile, Bramantya designs furniture and business partner Nugraha makes handbags. Both lines are handmade from local materials and put together at their workshop in the city, before they are exported everywhere from the US and Spain to Japan and Brazil.

It’s to the outside world Yogya is looking next. There is talk of the Koreans building a fishing-port on the Yogyakarta coast where construction of the new airport in Kulon Progo starts in 2014. Set in motion by a British-Czech consortium, the airport will be run by New Delhi-based infrastructure giant gvk and will accommodate the a380 to service the 2,300km-route to Australia. Australian-listed Indo Mines is investing €460m in an iron sand plant, also in Kulon Progo. In addition, Australia and Indonesia are due to sign an economic partnership programme next year, which Yogyakarta could cash in on. The president of the Indonesia Australia Business Council’s Yogyakarta office George Marantika is a busy man. Sitting by a round table in the Hyatt Regency restaurant on the outskirts of Yogyakarta, Marantika hands monocle five business cards – he’s also rector of the local Ukrim University and holds two posts in the Indonesia Chamber of Commerce and Industry. Both involve building business-links within Australasia. “Yogyakarta has strong potential to become the little Bangalore of Southeast Asia,” he says, pointing out the growth-potential of the local software and animation sectors. “The capacity is there. The engineers are there. The demand is there.”

He has grand plans for the region and hopes Yogyakarta’s 30,000 university-based programmers will serve as the springboard to closer cooperation between Australia and the city. Marantika wants to give Australia access to Indonesia’s 240 million-strong consumer market in exchange for Australia developing a regional knowledge-based economy here. He even argues that there are possibilities of developing new sea-lanes off the south coast where international ships could bypass the clogged-up Malacca Strait, an idea, he confesses, that would be “a geopolitical hot potato.” It’s doubtful whether Yogyakarta’s young want a part in becoming the Bangalore of Southeast Asia but it’s undeniable that this city has the talent to put a bright gloss on Yogyakarta’s prospects for development.

The city struggles to retain many of the locally educated graduates but the young generation that makes up the arts community is here to stay. Among these is Eko Nugroho, who has made quite a stir with his life-size animal and robot sculptures, and is exhibiting batik work and paintings in Berlin this month. Husband- and-wife team Santi Ariestyowanti and Miko Bawono have just come back from showing at Hong Kong’s annual international art fair. They’re not afraid to criticise Indonesia through their creations. Together, they’re assembling a miniature bicycle, which represents the people, and a wooden palace-like house with a grinning face – a caricature of the government weighing down the spindly bike. Future agreements signed between Indonesia and other nations will have a huge impact on Yogyakarta but hopefully this rebel spirit will remain intact.