Challenge of sustaining recovery<\/p>\n
By Anoop Singh<\/p>\n
JAKARTA (JP): With a much more stable macroeconomic
\nenvironment, the successful completion of historic elections,
\nstrong international support for Indonesia's economic reforms and
\nan ongoing recovery, market confidence should be on the rise.<\/p>\n
However, this is not yet the case, and the question on
\neveryone's mind is how Indonesia can best sustain the recovery.
\nIn addressing this issue, let me touch on three main topics<\/p>\n
* First, it is useful to remind ourselves how far Indonesia
\nhas come since the crisis in 1998.<\/p>\n
* Second, the economic factors that are weighing down market
\nsentiment, especially the burden of government debt.<\/p>\n
* Third, the approach of the economic program in addressing
\nthe problem of government debt and assuring sustained growth over
\nthe medium term.<\/p>\n
It is hardly necessary to recall the crisis that prevailed in
\nIndonesia just two years ago. By mid-1998, the exchange rate had
\ncollapsed, reaching a low of more than Rp 15,000 to the U.S.
\ndollar.<\/p>\n
Output was contracting sharply and, with rising food
\ninsecurity, the country was on the verge of hyperinflation. The
\nbanking system had virtually ceased to function and the corporate
\nsector was weighed down by the recession, inflation and debt. In
\nshort, Indonesia was in a vicious downward spiral.<\/p>\n
Much of this now seems long ago and far away. Output has been
\ngrowing steadily for about a year. Inflation has been kept low.
\nThe rupiah has been much more stable, fluctuating in the range of
\nRp 8,000 and Rp 9,000, which is lower and more volatile than
\njustified by the fundamentals, but certainly much better than
\nbefore.<\/p>\n
Finally, the poverty rate -- by most accounts -- has fallen
\nback sharply to well below its level at the peak of the crisis.<\/p>\n
What explains these results? What stands out is the
\ndevelopment and implementation of a sound macroeconomic
\nframework, especially a radical reorientation of monetary policy
\nfocused on the targeting of base money, and a fiscal policy that
\nhelped expand the social safety net. This was supported by
\nsuccessive measures to restore confidence in the banking system
\nand rebuild key economic institutions.<\/p>\n
Let me now turn next to discuss the challenges that lie ahead.
\nThe most immediate of these challenges is to restore market
\nconfidence in Indonesia's economic prospects -- this is crucial
\nto revive the investment and capital flows necessary to deliver
\nsustained growth.<\/p>\n
Among the economic factors weighing down market sentiment is
\nthe slow progress Indonesia has made in asset recovery or
\nrestructuring, relative to the large size of the problem. This
\nhas led to concerns about fiscal sustainability.<\/p>\n
Fiscal sustainability means the government is in a position to
\nrepay its debts, both now and in the future, in an orderly way --
\nwithout resorting to extraordinary measures.<\/p>\n
A simple measure of sustainability is a declining trend in the
\ndebt-to-GDP ratio. Such an outcome generally requires the rate of
\neconomic growth to exceed the real interest rate. Without this
\ncondition, the burden to run a fiscal surplus increases.<\/p>\n
Markets worry about fiscal sustainability in Indonesia because
\nthe government's debt amounts to around 90 percent of its annual
\noutput, which is one of the heaviest debt burdens in the region.<\/p>\n
Thus, it is very important for markets to be reassured about
\nthe government's ability to meet its debt servicing burden in an
\norderly way. As long as investors doubt this ability, real
\ninterest rates will have to remain high.<\/p>\n
There are many international examples of countries where
\nconcerns about fiscal sustainability kept interest rates well
\nabove the inflation rate, contributing to low growth. Therefore,
\nit is imperative to prevent Indonesia from experiencing the same
\nfate.<\/p>\n
I will now briefly discuss the elements in the government's
\napproach to support this objective.<\/p>\n
The importance of fiscal sustainability -- of bringing down
\nthe debt burden in an orderly way -- was well recognized by the
\nlegislature last year, when it enunciated the State Policy
\nGuidelines.<\/p>\n
The present economic program builds the framework to
\naccomplish this reduction in the government's indebtedness, and
\nseeks to do so in an orderly way.<\/p>\n
The basic strategy relies on maintaining a favorable
\nmacroeconomic environment, making progress with fiscal
\nconsolidation and driving asset recovery.<\/p>\n
All of these factors would have a mutually reinforcing effect
\non stimulating new productivity -- enhancing investments and
\ncapital flows, reducing real interest rates and raising growth,
\nthereby satisfying the conditions for reducing the debt ratio.<\/p>\n
Setting in train -- and entrenching -- such a virtuous cycle
\nis the fundamental aim of the economic program. If fully
\nachieved, our projections point to the government debt ratio
\nfalling to about 67 percent by 2004.<\/p>\n
Let me now go on to discuss in more detail the principal
\navenues available to the government to bring down the debt ratio
\nin the next few years. Many of these avenues will tend to --
\nindeed are necessary to -- raise efficiency and factor
\nproductivity at the same time.<\/p>\n
First, adjustments in the government budget.<\/p>\n
During the crisis, Indonesia's budget balance moved into
\ndeficit because of the need to support domestic demand, cushion
\nthe output decline and expand support for the poor. Now that
\nrecovery is underway, it is appropriate that the process of
\nscaling back the fiscal deficit should begin.<\/p>\n
This will not be an easy process. Many parts of the
\nexpenditure budget have already been squeezed, and there is still
\nsubstantial need for infrastructure and social safety net
\nsupport.<\/p>\n
That is why a strong political consensus will be needed on how
\nbest to pursue fiscal consolidation and to make the necessary
\nchoices:<\/p>\n
* There is also considerable scope to strengthen the revenue
\nbase of the government. Commendably, the government has already
\nexpressed its intention to rationalize the large number of
\nexemptions and tax holidays which have reduced the revenue base,
\nin many cases, without commensurate benefits.<\/p>\n
* Within expenditures, civil service reform is an avenue for
\nbudgetary savings -- and also greater efficiency. Because of
\nsuccessive and large wage increases over the past two years, the
\ngovernment's wage bill -- as a ratio to GDP -- has risen to above
\n5 percent of GDP, which is above that of many similarly placed
\ncountries.<\/p>\n
* During the crisis, government spending on subsidies
\nincreased. However, much of the budgetary subsidies are not of a
\ntargeted nature, and there is no assurance that the benefits
\naccrue to the poor. Such untargeted subsidies presently amount to
\nas much as 3 percent of GDP, almost equal to the entire
\ninternational support for the budget, and can be reduced without
\naffecting the poor.<\/p>\n
Second, implement fiscal decentralization without adding to
\nthe budget deficit.<\/p>\n
The government is currently preparing to implement fiscal
\ndecentralization in 2001. The international experience clearly
\npoints to the risk that the general government deficit could rise
\nfollowing decentralization. If this were to happen, it would make
\nit all the more difficult to bring about a reduction in
\nIndonesia's burden of government indebtedness.<\/p>\n
For this reason, the government is taking a number of actions
\nto preserve fiscal neutrality during the decentralization
\nprocess.<\/p>\n
Perhaps the most important enabling condition is to ensure
\nthat expenditure functions are transferred to local authorities
\nto match the revenues that they are receiving.<\/p>\n
If this is not done, an additional burden would be placed on
\nthe government budget, at a time when it can least afford it. In
\nshort, finance should follow function, and not the other way
\naround.<\/p>\n
The government is also considering other measures that would
\ncontain the macroeconomic risks of fiscal decentralization and
\nensure that the overall debt reduction strategy remains on track.<\/p>\n
International experience strongly suggests that borrowing by
\nsubnational governments should be subject to strict limits,
\nparticularly in the early stages of decentralization.<\/p>\n
Also, the overall budget framework of the central government
\nneeds to retain some flexibility in case some of the risks do
\nmaterialize. This is commonly done, in many countries, by
\ncreating a margin within expenditures that is maintained as a
\ncontingency against unexpected risks.<\/p>\n
Third, pursue recovery from publicly held bank and nonbank
\nassets.<\/p>\n
Asset recovery is of the highest priority in the economic
\nprogram, and not only because of its considerable potential to
\nhelp bring down the government's debt. Of equal importance is the
\nrole that asset recovery can play in sustaining the recovery.<\/p>\n
As is well known, the Indonesian Bank Restructuring Agency
\n(IBRA) controls a very large amount of assets -- whose book value
\nhas been measured at close to one-half of annual GDP. These
\nassets need to be put back in the private sector where they would
\nbe more efficiently deployed.<\/p>\n
The longer the assets remain in the hands of the government,
\nand despite the best intentions of IBRA, the more likely the
\nassets will deteriorate.<\/p>\n
The same with asset sale prices; delaying asset sales until
\ntheir prices firm usually produces the opposite result. These are
\nthe clear lessons from every country that has been faced with
\nthis task, and they are also the emerging lessons from
\nIndonesia's own experience.<\/p>\n
In contrast, accelerating asset recovery would jump start the
\nrevival of foreign investment in Indonesia and raise factor
\nproductivity, both of which are crucial for sustaining growth,
\nwhile also helping strengthen the rupiah closer to its
\nfundamentals.<\/p>\n
Overall, over the next few years, bank asset recovery and the
\nproceeds of nonbank privatization could be as important as the
\nadjustment in the budget deficit in their contribution to
\nreducing the debt ratio.<\/p>\n
All the institutions concerned need to play their part --
\nespecially IBRA and the Jakarta Initiative Task Force (JITF) --
\nas well as the government as the owner of the state-owned
\nenterprises.<\/p>\n
Fourth, safeguard public resources from being used for
\nadditional bank recapitalization.<\/p>\n
The principal reason why Indonesia's government debt has risen
\nso much during the crisis is because of the need to recapitalize
\nthe banking system. Indeed, there were previous episodes of bank
\nrecapitalization at public expense in the 1990s.<\/p>\n
For this reason, it is critical to ensure that, once the
\npresent recapitalization is completed, the government does not
\nneed to lead another bank recapitalization in the future.
\nEnsuring this entails the following:<\/p>\n
* Enhanced supervision of the banking system is paramount to
\nprotect against the abuses of the past repeating themselves.<\/p>\n
* Transformation of Indonesia's banks into genuine
\nintermediaries of the financial savings of the community. For far
\ntoo long, the banks have been the vehicles of directed lending,
\nof one sort or another, and this was the true heart of
\nIndonesia's financial crisis. Nothing short of a culture change
\nis at stake.<\/p>\n
* Privatization of the large state share in the banking
\nsystem. Such a process, as observed elsewhere in Asia, will not
\nonly bring in much needed new capital into the banking system and
\nstrengthen its ability to extend new credits, but also build up
\nthe financial and competitive strength of the banking system.<\/p>\n
In conclusion, I have stressed that a coordinated strategy to
\nreduce the government debt is an essential part of the process of
\nrestoring market confidence and sustaining the emerging recovery.
\nOf course, this is not the only part of the process, but it may
\nwell lie at the heart of it.<\/p>\n
The international community is fully committed to helping
\nIndonesia meet the challenges that are involved in this task.
\nJust recently, the International Monetary Fund's executive board
\ncompleted the second review of Indonesia's fund-supported
\neconomic program, and I speak on the eve of an important meeting
\nof the Consultative Group for Indonesia.<\/p>\n
Our role -- that is to say, the role of the international
\ncommunity -- is to give technical assistance, policy advice and
\nfinancial support for the implementation of the economic program.<\/p>\n
The program itself, as repeatedly emphasized by Coordinating
\nMinister (for the Economy) Ramli, is very much that of the
\ngovernment. We are there to support it.<\/p>\n
The writer is the IMF deputy director for Asia Pacific. The
\narticle is based on his talk at the University of Indonesia's
\n50th Anniversary Conference.<\/p>",
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