Battered economy back on growth track for 2000 and beyond

By Riyadi

JAKARTA (JP): Following two years of economic turmoil, Indonesia's economy is showing signs of recovery and is expected to post a positive growth in 2000 thanks to the country's relatively peaceful democratization process.

The rising share prices on the Jakarta Stock Exchange, the stabilization of the rupiah at Rp 7,000 against the U.S. dollar, the falling benchmark interest rates to 12 percent per annum and the slowing down of inflation rate to about 2 percent this year are all encouraging signs of macroeconomic improvement.

This recovery process is expected to continue in 2000 with the rise of Muslim cleric Abdurrahman Wahid as Indonesian President having sent strong waves of optimism through the people and investors.

The government, economists and other experts share the same vision of economic recovery and have painted rosy pictures for Indonesia's economy in 2000.

Following a gross domestic product (GDP) contraction of more than 13 percent and hyperinflation of over 77 percent last year, the government predicts that the economy will go flat this year and grow between 2 percent and 3.5 percent next year, with an inflation level of between 4 percent and 6 percent.

The Advisory Group on Economic Industry and Trade (ECONIT) and the Institute for Development of Economics and Finance (Indef) share the government's prediction, estimating a growth rate of about minus 1 percent this year and 2 percent next year, with a single digit inflation rate.

ECONIT has even described 2000 as "a rebirth year of Indonesia's economy."

"If economic restructuring is pursued quickly and systematically, Indonesia's economy will be reborn with a stronger structure and ready to enter the new millennium," ECONIT said in its Economic Outlook 2000.

The pace of Indonesia's economic recovery, however, will depend very much on private capital inflows, domestic consumption, exports and fiscal policy. It will also depend on the speed of banking reforms and corporate restructuring.

Foreign capital inflows are expected to be on the rise. Official capital flows will be positive, with new incoming official loans to finance an expanding state budget deficit.

Private capital flows, however, are still questionable. One of the obstacles to private capital inflows will be the increasing danger of disintegration, with the restive province of Aceh serving as a test case.

Separation

Economist Mangal Goswami of the Singapore-based Economic Research Group Asia Pacific, pointed out recently that secessionist Aceh has been a major source of concern among foreign investors.

Many believe that should Aceh separate from Jakarta, it would put Indonesia's territorial integrity in jeopardy and have an exceptional repercussion on investment.

Therefore, the government's handling of Aceh will determine foreign investors' confidence, the level of foreign investment in Indonesia and eventually the pace of economic recovery.

According to official data, approved domestic investments for the first eight months of this year fell by half to US$2.8 billion, and approved foreign investment plunged 76 percent to $2.1 billion from a year earlier.

The government predicts that net capital flow for 2000 will remain negative, but at a lower level, compared to the estimated minus $7.6 billion in the 1999/2000 budget ending in March.

Minister of Finance Bambang Sudibyo attributes the smaller capital-account deficit to lower capital outflow and higher capital inflow through foreign direct and portfolio investment.

Aside from foreign investment, Indonesia's economic recovery will be influenced by domestic consumption, which shrank by 5 percent in 1998 and an expected 0.5 percent this year. ECONIT predicts that domestic consumption should grow by 3 percent next year because of delayed purchases.

This increasing demand, however, will not be sustainable unless it is followed by income-generating activities.

Exports are expected to grow next year and, thus, contributing to economic growth.

During the crisis, with the free fall of the rupiah, exports should have soared, but it was not the case with Indonesia.

According to the Central Bureau of Statistics, Indonesia's exports during the first nine months of this year dropped 6 percent to $35.01 billion from the level in the same period in 1998. Non-oil exports slumped further by 9.11 percent.

This happened because of a lack of export funding -- no working capital lending and no trade financing available -- and of lower export demand in the international market as well as of lower commodity prices.

Imports for the January-September period of this year dropped deeper by 12.76 percent at $17.59 billion, compared with the level in the same period last year.

Sadder still, consumer goods imports between January and August of this year rose dramatically by almost 30 percent at $1.57 billion, compared to the same period last year.

ECONIT predicts exports will grow by 5 percent next year to reach $40.8 billion. Non-oil exports will remain slow, but it could be compensated by oil and gas exports, thanks to improving international oil prices.

Imports will also rise, simply because of delayed purchases and the falling interest rate, which will stimulate imports of durable goods. Imports are projected to increase by 10.6 percent in 2000.

Trade surplus

According to ECONIT, Indonesia is likely to enjoy a huge trade surplus next year, projected to reach $23.8 billion, slightly lower than $24.1 billion this year. It will still book a positive current account, forecast at $2.5 billion next year, down from $4 billion this year.

When exports and private investments are slowing down, right fiscal policy, with big development spending, could compensate them and stimulate economic activities.

However, Bambang has hinted that the government will set aside only a limited amount of money for development spending. It means that next year's budget will have only a limited impact on economic recovery.

Most of the spending budget for next year will be to finance routine spending, which is expected to take up some 80 percent of all expenditure.

The bulk of routine spending will go to civil servant salaries, which will be raised by some 20 percent, foreign debt servicing and interest cost payment of the huge government bonds issued to finance bank recapitalization.

According to Coordinating Minister for Economy and Finance Kwik Kian Gie, the country's bank recapitalization program will require gross interest payments amounting to some 4 percent of the gross domestic product, absorbing more than 10 percent of the 2000 budget -- which will run from April 1 to Dec. 31, 2000.

On the revenue side, the government has said that it will boost domestic financing resources, including taxes, and reduce foreign borrowing. Nevertheless, the impacts of the crisis and falling interest rates would likely affect domestic revenue from taxes.

The faltering tax income, however, will be compensated by expanding income from gas and oil exports. The government predicts that oil and gas revenues in the next budget will reach Rp 37.4 trillion with an oil price assumption of $18 per barrel and an exchange rate of Rp 7,000 per dollar.

Other important source of domestic revenues will be from the sale of state firms and assets under the Indonesian Bank Restructuring Agency (IBRA). Investor interest in both state firms and in companies under IBRA has been strong, and, therefore, the government can easily reach its target of Rp 5.9 trillion from privatization of state firms and Rp 28.5 trillion from sales of assets under IBRA.

Despite the windfall profit from increasing oil prices and the expected smooth sale of assets, the next budget will still suffer a huge deficit, predicted to reach 5 percent of the GDP, due to huge spending on interest costs of the government bonds and foreign debt servicing.

The government, therefore, will still have to borrow money from international sources to fill in the gap.

Financing needs

Kwik said the external financing needs of the 2000 budget could be largely met by Indonesia's three traditional sources of budget support: the World Bank, the Asian Development Bank and Japan, the largest bilateral lender to Indonesia.

In a bid to refocus its economic program, the government has already canceled $556 million in World Bank undisbursed funds, and Kwik said it has also canceled $460 million in loans from the Asian Development Bank.

Nevertheless, the government's overseas debt is sure to increase next year from the projected $71.9 billion by the end of this fiscal year in March. But the government expects that the country's debt service ratio will fall to 47 percent (of total exports) next year, down from 54 percent in the current budget year.

Money may be trickling back, but critics have warned that the chronically ill banking system and faltering indebted local companies could threaten economic stability.

They also warned that the government's zealous efforts to root out corruption, collusion and nepotism could be counterproductive for the restructuring of bank and the corporate sector. The Texmaco case serves as a good example, in which the government's effort to clean up corruption has dragged down Texmaco's financial arm, Bank Putera.

Legislator Ekky Syachruddin of the Golkar faction suggested, "The government should review its strategy to fight corruption, collusion and nepotism, so that it can catch the fish without dirtying the water,"

Nevertheless, there is no reason to be pessimistic about Indonesia's economic future.

The government, which has proved to be acceptable to the majority of the people, is committed to preparing a sound economic recovery program that will place Indonesia on the road to recovery.

And the multilateral financial institutions have all lined up behind the government to help keep its reform agenda on the right path. The International Monetary Fund, which arranged a $43 billion bailout program for Indonesia, has agreed to come up with new money for the country as it stretches the economic program out for more than two additional years.

Hopefully, this will keep the momentum of economic recovery going and bring the country's economy back to the precrisis growth level in three years time.

Many predicted that most economic sectors, except for finance and construction, will book positive growth next year.

Indef forecasts that the financial sector will still post a negative growth of minus 7 percent next year, after contracting 10.2 percent this year and 26.6 percent last year.

Construction, which suffered most last year by contracting 40 percent, will still post negative growth this year, but mildly, by minus 1.7 percent. Next year, this sector is projected to contract by 0.9 percent.

All other sectors are projected to book positive growth. But the pace of their recovery will be different. Trade services and investment, consumer goods industry as well as mining and agriculture will experience fast recovery, while recovery in infrastructure, basic industry and chemicals will be slow.

Services

Indef predicts that the trade and services sector will grow by 5.3 percent next year, manufacturing by 3.4 percent, utilities by 4.3 percent, transportation and communications by 3 percent, mining by 3.1 percent and agriculture by 2.5 percent.

The positive growths in most sectors will be more meaningful for most people, especially if they are followed by a low inflation rate, falling interest rates and the stabilization of the rupiah.

Economists predict that inflation will rise slightly next year from this year's level of about 2 percent. This year's low inflation was made possible with a reversed imported inflation due to the strengthening of the rupiah against the dollar, improved weather condition that produced good harvests and the dwindling purchasing power of the people.

Indonesia, for the first time, experienced deflation in seven consecutive months through September. Inflation reached only 0.3 percent as of November.

Next year, inflation is projected to rise a bit because of increasing domestic demand and falling interest rates, the removal of a number of subsidies by the government and the planned increase of civil servant salaries.

The government has predicted that inflation should range at between 4 and 6 percent next year, while private experts gave a slightly higher figure of about 8 percent.

Despite the predicted small rise in inflation, domestic interest rates are expected to fall further next year, in line with the central bank's commitment to lowering interest rates to help revive the real sector. The central bank has targeted to lower its benchmark rate to 12 percent per annum by this year's end.

Deposit rates will fall in line with the central bank's low rate policy. Lending rates, however, will remain stubbornly high, simply because banks do not have confidence in local corporations and thus keep their spread wide. When bank and corporate restructuring is completed, lending rates should fall, with a spread of between 3 percent and 4 percent over deposit rates.

Although inflation is rising slightly and deposit rates are falling, the rupiah is expected to remain stable at Rp 7,000 against the dollar because of the expected continuing inflows of official capital, and possibly private capital, and improving exports.

The expected steady rupiah, combined with the positive economic growth and falling interest rates, would have a good impact on the performance of the Jakarta Stock Exchange.

But again, all will depend very much on the government's ability to maintain political stability, territorial unity, contractual integrity and legal certainty.