A better outlook

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.