IMF is wrong in Indonesia, again<\/p>\n
By Jonathan Pincus<\/p>\n
LONDON (JP): The International Monetary Fund presents its
\nposition in Indonesia as a clear-cut choice between right and
\nwrong. Indonesia's young democracy, they would have us believe,
\nhas indulged in the deadly sins of corruption, profligacy and
\nprice inflation. But redemption is still within reach if
\nIndonesia will accept the warm embrace of central bank
\nindependence, tight money and fiscal rectitude.<\/p>\n
This sort of economic moralizing plays well in the world's
\nfinancial capitals and in the financial media. But within
\nIndonesia things are less clear-cut. Certainly corruption is rife
\nin Indonesia, and any long-term solution to the country's
\neconomic woes must begin with a strengthened legal system and
\nimproved public sector and corporate governance.<\/p>\n
But the problem should be viewed in its proper context. Thirty
\nyears of military rule under former President Soeharto left a
\nruinous legacy of corruption that will not be reversed overnight.<\/p>\n
Although shaken by its own scandals, the Abdurrahman Wahid
\ngovernment has taken some tentative steps to reinforce anti-
\ncorruption laws and to bring some of the country's most notorious
\noffenders to justice. These include the infamous Soeharto cronies
\nMohammad \"Bob\" Hassan, Prajogo Pangestu and former minister of
\nenergy and mines Ginandjar Kartasmita.<\/p>\n
But the list is long, and close relationships between the
\nmilitary, legislators, big business groups, and Soeharto's
\nbureaucratic elite stand in the way of a swift and clean break
\nwith the past.<\/p>\n
These moves by the government are all the more reason for the
\ninternational community to support reformers in the government
\nsuch as Justice Minister Baharuddin Lopa and Coordinating
\nMinistry of the Economy Rizal Ramli.<\/p>\n
Instead, the IMF has held up the latest tranche of its three-
\nyear, US$5 billion assistance package because of the government's
\nattempt to remove Bank Indonesia governor Sjahril Sabirin and
\nother central bank officials implicated in corruption scandals.<\/p>\n
Sjahril, a Soeharto appointee, has been accused of the misuse
\nof some $15 billion in emergency funds disbursed by Bank
\nIndonesia between 1997 and 1999. A recent IMF-sponsored audit
\nfound that $9 billion remain unaccounted for.<\/p>\n
Yet the IMF, in a farcical defense of the principle of central
\nbank independence, actively resisted the government's efforts to
\nremove those responsible. Although this may be puzzling to
\noutsiders, Indonesians view the Fund's position as a natural
\nconsequence of the close working relationships developed over the
\nyears between IMF and Bank Indonesia staff.<\/p>\n
An independent panel consisting of two members appointed by
\nthe government and two by the IMF recently submitted proposals
\nfor revision of the Central Bank Law designed to make Bank
\nIndonesia more accountable. The adoption of the proposed changes,
\nhowever, will not resolve the dispute unless the IMF also agrees
\nto stop meddling in the government's attempts to clean up Bank
\nIndonesia.<\/p>\n
The IMF is also at odds with the government over interest
\nrates. Anoop Singh, the Fund's deputy director for Asia and
\nPacific, argues \"it is crucial to maintain a tight monetary
\nstance until inflation risks have been firmly contained, and for
\nBank Indonesia to act flexibly and preemptively for this
\npurpose.\"<\/p>\n
The IMF's friends in the central bank have heeded his advice,
\nraising the rates on its benchmark SBI securities six times in as
\nmany months.<\/p>\n
But is this tight money policy really necessary? Consumer
\nprices are only rising at about 10 percent per annum, levels
\ncomparable to those of the Soeharto era when the IMF routinely
\npraised Indonesia for its conservative macroeconomic management.<\/p>\n
In the context of a slowing world economy, excess domestic
\nindustrial capacity, mass underemployment and a fragile banking
\nsystem, moderate price inflation is the least of Indonesia's
\nproblems.<\/p>\n
But even if inflation were a genuine concern, higher interest
\nrates would do nothing to address it. Far from overheating, the
\nIndonesian economy is still struggling to regain its footing
\nfollowing a depression of historic proportions.<\/p>\n
More than anything else, Indonesia's mild inflation is due to
\nthe weakening rupiah and the resulting price effects on imported
\nraw materials, intermediates and consumer goods. The persistent
\ndownward pressure on the currency is obviously caused by
\nrecurrent bouts of speculation following episodes of political
\ninstability and communal violence.<\/p>\n
The deteriorating relationship between the government and the
\nWashington institutions has been singularly unhelpful from this
\nperspective.<\/p>\n
As in the early stages of the financial crisis, the Fund is
\nlaboring under the illusion that rising domestic interest rates
\nwill strengthen the rupiah.<\/p>\n
This is an experiment that has been tried and clearly failed,
\nand there is no reason to repeat the mistake now. To the extent
\nthat further rate increases succeed in choking off economic
\nactivity, they are more likely to accelerate currency
\ndepreciation rather than reverse it, much as they did in 1998.<\/p>\n
Similarly, a sustained strengthening of the rupiah is only
\nlikely to follow an increase in economic activity, as during 1999
\nand 2000.<\/p>\n
Much the same can be said about the fiscal deficit, which the
\nFund predicts will reach six percent of gross domestic product in
\nthe absence of corrective measures.<\/p>\n
The government and IMF are committed to reducing the deficit
\nto less than four percent of gross domestic product before the
\nend of the fiscal year. This will no doubt mean a reduction in
\nfuel subsidies, although the government realizes that too rapid
\nan increase in fuel prices is tantamount to political suicide.<\/p>\n
Soeharto discovered as much during the April 1998 protests
\nwhen he attempted to implement a similar IMF proposal in April
\n1998. Even fuel subsidies are really beside the point.<\/p>\n
Two-thirds of central government expenditures go towards
\nservicing international and domestic debt. This means that the
\nsize of the deficit is extremely sensitive to domestic interest
\nrates and the value of the rupiah against the US dollar and
\nJapanese yen.<\/p>\n
For example, every one percent increase in interest rates adds
\nRp 2.7 trillion to the budget deficit, mainly in the form of
\nhigher payments on government bonds issued to bail out the
\nbanking sector.<\/p>\n
Similarly, a 10 percent depreciation of the rupiah adds Rp 3.8
\ntrillion to international debt service payments. These two
\nfactors together account for the difference between the
\ngovernment's projected and target deficit for the current fiscal
\nyear.<\/p>\n
Economic growth is the only viable solution to the deficit
\nproblem. In contrast to the IMF plan, monetary policy should
\nprovide a mild stimulus as a means of encouraging investment,
\nincreasing demand for the rupiah and boosting domestic demand.<\/p>\n
This would also have the positive effect of immediately
\nreducing domestic debt service obligations, providing some relief
\nfor government finances.<\/p>\n
The IMF could make an important contribution to this process
\nby dropping its insistence on excessively tight money and
\nreaching an agreement with the government over issues such as
\ncentral bank independence and the orderly disposal of government
\nassets under government control.<\/p>\n
A flexible partnership with the IMF would do much to reassure
\nnervous investors and would probably result in an immediate
\nrevaluation of the rupiah and a reduction in political tensions.
\nA positive role for the IMF would require the kind of political
\nwill shown by the organization in Turkey, where a new $10 billion
\nIMF bailout program was agreed in principle as negotiations with
\nIndonesia broke off at the end of April.<\/p>\n
As the ink dries on this deal, Turkey's third in six months,
\nIndonesians will ask whether economic distress in their country
\nranks as highly on the IMF's agenda as that of NATO's ally on the
\nedges of Europe.<\/p>\n
At the moment, the answer appears to be that it does not.<\/p>\n
Help for the Abdurrahman government has fallen off the agenda
\nin Washington, both in the United States Treasury, and, by
\nextension, the IMF. From this perspective, the Fund's
\ninflexibility in Indonesia has more to do with Washington's
\nstrategic calculations than with right and wrong.<\/p>\n
The writer is lecturer in economics at the School of Oriental
\nand African Studies, University of London.<\/p>",
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