A better outlook

The verdict of economists is virtually unanimous. Despite the tough challenges -- strong inflationary pressures and high interest rates -- the economic outlook for next year is brighter because the foundations for stability are now in place.

True, the government has conceded, and most analysts also agree, that the 6.2 percent economic growth target next year is far too optimistic. They predict an expansion of between 5.3 percent and 5.7 percent, compared to an estimated 5.3 percent for this year.

However, the government has learned good lessons from the economic turbulence in the latter part of 2005, correcting big mistakes that damaged the market's confidence in the Cabinet's economic team.

The economy actually performed robustly during the first six months (October 2004-March 2005) of President Susilo Bambang Yudhoyono's administration, with gross domestic product growing by 6.65 percent on a yearly basis in the fourth quarter of last year and by 6.12 percent in the first quarter of this year. The quality of growth also increased significantly as the prime drivers shifted to investment and exports. Investments grew by 15 percent during the first quarter, as evidenced by a robust 40 percent increase in capital goods imports, and exports expanded by 13 percent.

Evidencing the political courage to cut fuel subsidies, part of its larger determination to continue fiscal consolidation, the government's decision led to an average 29 percent hike in fuel prices in March. The market reacted positively to this policy, however, and also to the work of the central bank to control inflation and defend the rupiah.

However, as the government sat back and international oil prices continued to rise, to a high of US$70/barrel by the middle of the year, the market became increasingly nervous about the government's ability to manage the budget.

Market perceptions of the President's economic team dropped to new lows after evidence emerged Cabinet members may have abused their positions of authority for personal gain. They went even lower when public disagreements between leading officials looked to jeopardize the coordination of policy. The government's proposal on Aug. 16 for an extremely irrational 2006 budget was the last straw.

The market immediately punished the government, attacking the rupiah, pushing it down to a five-year low of Rp 12,000 to the dollar in early September and setting off a stronger wave of inflationary pressures.

Though rather late, the government did act boldly in early October to slash the fuel subsidies again, this time raising fuel prices by more than an average of 125 percent. In one stroke, the government restored market confidence in its policy making, reducing pressures on the rupiah and reviving a productive circle within the economy.

Confidence in economic management received another boost this month after Susilo installed a new, solid economic team led by chief economics minister Boediono. This also ensured stronger coordination between fiscal and monetary authorities because the core members of the new team and the central bank's board of governors consist of like-minded professionals with a strong sense of mutual trust.

Good coordination becomes even more vital for stemming another new wave of economic turbulence next year -- as the government continues to cut fuel subsidies despite the strong inflationary pressure -- at least until June. A good balancing act is needed between the government, which manages supply, and the central bank, which manages demand.

However, strengthening stability is not the only pressing task confronting the government. Reinvigorating the microeconomy is equally vital, requiring quick reform in important areas like customs, taxation and in basic infrastructure to encourage new investment.

For only new investment will generate jobs -- and purchasing power -- for the millions of people who have suffered from the October price hikes.