A pact with the IMF

The government has signed yet another letter of intent with the International Monetary Fund (IMF) pledging to implement economic reform measures in return for the US$43 billion international assistance that the agency has organized for Indonesia. This is the fourth such letter signed since October, and is a condition for the disbursement of the next $1 billion tranche of the IMF money, which has been due since May, but delayed because of the recent political turmoil.

The latest agreement is essentially a continuation of the previous ones. A revision was necessary since a new government is now in place. But a more important reason for the delay is that the government and the IMF have had to revise their assumptions and economic targets given that the economy has rapidly deteriorated since the last agreement in April.

Although the new letter of intent gives much gloomier economic targets, they are optimistic by today's standards. The government, for example, predicts a 10 percent contraction in gross domestic product (GDP) and an inflation rate of 80 percent for this year. It envisages that the rupiah's exchange rate will strengthen to Rp 10,000 to the dollar by the end of the year, from about Rp 14,500 this week. Only time will tell if these targets are realistic. The previous three letters of intent turned out to be overtly optimistic with their targets as the economy headed south in spite of the agreements with the IMF.

In the latest agreement, the government underlined two sectors for priority: establishing a social safety net to cushion the impact of the economic crisis on poor people, and restructuring the banking sector, which is crucial to arresting the downturn and opening the way for economic recovery. Both entail huge financing, which is where the foreign fund comes in.

The social safety net programs, mostly for financing subsidies in food, medicines, fuel, electricity, labor intensive projects and school grants, are estimated to amount to a staggering 6 percent of GDP. Currently, the government has been printing money, at the risk of fueling inflation, to finance them. The IMF money will go a long way toward easing the inflationary pressures.

More significant than the amount itself is the disbursement of the money, which will be seen as an IMF endorsement of the government of President B.J. Habibie. Many foreign governments and lending agencies that joined in the $43 billion lending consortium in October are waiting for the IMF's signal before making good on their lending commitments.

The letter of intent also indicates the need for further financing of between $4 billion and $6 billion to cover a huge deficit in Indonesia's overall balance of payments this year. Japan and Germany went ahead with their assistance before the IMF, chiefly to finance trade facilitation schemes.

While the IMF's gesture may prompt foreign governments to act, foreign and domestic investors, whose funds are equally vital if the Indonesian economy is to recover, are not likely to be easily impressed, just as they were completely indifferent to the previous agreements between the government and the IMF.

Investors are primarily motivated by profits, while governments extend loans often on compassionate if not political grounds. Investors therefore take a lot more convincing. While disbursement of the IMF money will certainly be a welcomed vote of confidence for President Habibie, it is not enough. Investors will want to see real and solid, rather than make-believe, political stability before they return to Indonesia. That means a real commitment to democracy on the part of the new government. On that front, Habibie and his administration will have to work alone. No amount from IMF can restore investors' confidence.