Are current world events bad for Indonesia?

Are current world events bad for Indonesia?

Fauzi Ichsan
Gobal Markets Economist
Standard Chartered Bank
Jakarta
Fauzi.Ichsan@id.standardchartered.com

As accounting scandals rock the United States, sending the New
York stock market into a tailspin, some economic analysts are now
predicting "gloom and doom" for Indonesia. Their analysis is
pretty straightforward.

Americans love to spend on credit and they generally do not
mind borrowing as long as the values of their assets, their
houses and company shares, are going up. Now, the analysis goes,
crashing U.S. share markets will make Americans reluctant to
borrow and spend more because their company shares are diving in
value.

A decrease in U.S. domestic spending will then restrict its
economic growth. Because the U.S. economy generates around 40
percent of the world economy, a stagnant U.S. economy will surely
keep the world economy, including Indonesia's, stagnant too.

True, the fall of the U.S. share markets might make Americans
spend less. But U.S. company shares were highly "overvalued" in
the first place. Even now, prices of U.S. company shares are
still relatively expensive and can still fall.

For example, the U.S. S&P 500 companies have a price-to-
earnings per share ratio (PE ratio) of around 33. This means the
average share price of the largest 500 US companies is 33 times
its earning per share.

In comparison, the PE ratio of the Hong Kong stock market is
16 and that of the Jakarta stock market is about 9. Furthermore,
if US companies revise their accounting methods to follow
stricter standards (such as expensing stock option compensations
to corporate executives), the PE ratio of S&P 500 companies may
indeed rise to exceed 45. Hence, the large fall of the US equity
markets may actually be seen as "predictable market corrections"
to more reasonable levels.

Now, in spite of the sharp fall in U.S. share prices, American
households keep spending because housing prices in the U.S. have
not collapsed. This is because the U.S. central bank, the Federal
Reserves Board (the "Fed"), has aggressively cut interest rates,
making mortgage financing for home purchases very cheap.

The result of the robust U.S. housing market is therefore not
surprising: U.S. consumer demand is rising. Hence there is little
doubt that the U.S. economic recovery is fragile and the
corporate accounting scandals have not helped. However, there is
also little doubt that the U.S. economy is likely to grow faster
in 2002 than in 2001.

U.S. economic growth is expected to rise from 1.1 percent in
2001 to 2.5 percent (the U.S. government is predicting 3 percent
to 3.5 percent) in 2002. Consequently, the world's economic
growth is also expected to rise from 2.5 percent in 2001 to 3
percent this year.

Hence the likelihood of the world economy growing faster
cannot be bad for Indonesia.

As far as international relations and economic policy are
concerned, the benefits of the world events for Indonesia are
more apparent. Take the U.S. foreign policy on Indonesia.

After Sept. 11, its foreign policy priority on Indonesia has
shifted from human rights to the war on terrorism. Our support
for the U.S. in this war has certainly helped smoothen the
support given by the IMF and the international donor community to
Indonesia.

After Sept. 11, U.S. support to Indonesia has indeed widened
from financial assistance to military assistance, including what
seems to be the gradual relaxation of the U.S. military embargo
on Indonesia.

Continual IMF assistance to Indonesia is important for two
main reasons. Firstly, IMF's "seal of approval" on the Indonesian
government's economic policy is necessary to help ensure
financial support from the rest of the international donor
community: the World Bank, Asian Development Bank, etc. Hence,
the direct impact of IMF support is a budgetary impact.

The second reason why IMF support is necessary for us is that
the "IMF economic program" is seen as a "market benchmark" to
judge whether the Indonesian government is doing the "right
things". Market players' focus on the implementation of the IMF
program, which determines relations between the IMF and
Indonesia, should not be underestimated.

A Bank Indonesia survey reveals that the rupiah exchange rate
is determined mainly by two factors. One, the Indonesian
political situation, and two, the government's relations with the
IMF. Hence, if the political situation is stable and Indonesia's
relations with the IMF are good, the rupiah is likely to be
stable or likely to strengthen.

This perception is supported by evidence. Earlier this year,
the sale of Bank Central Asia, which was part of the IMF program,
greatly helped strengthen the rupiah from 10,400 at the end of
last year, to 9,000 to the US dollar.

With an international environment that is becoming positive
for Indonesia, why is our economy growing at only 3 percent to 4
percent a year compounded by an alarming decrease of foreign
investment?

The answer is that we basically have six structural obstacles
to rapid economic recovery: (1) political uncertainty; (2) a
paralyzed banking sector; (3) a technically bankrupt corporate
sector; (4) an ineffective legal system; (5) lack of confidence
among Indonesia's own economic elite; and (6) poor foreign
investor confidence.

To remove these obstacles, Indonesia must introduce serious
structural reforms, ranging from legal reforms to redefining
regional autonomy. The tasks may take years, if not a whole
generation, to complete.

However, these changes are absolutely crucial if Indonesia is
to once again become a "haven" for foreign or domestic investors.

Therefore current world events may present an opportunity for
us to speed up economic recovery as long as Indonesia does more
to make herself attractive amid increasing global competition for
investment capital.