Are today's events bad for us?

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.