'Benefit of the doubt' for RI's economy

By Laksamana Sukardi

The following article is based on a paper presented at a "power breakfast" meeting organized by the International Advertising Association at the Hilton Executive Club on Nov. 21, 1997 in Jakarta. This is the first of two articles.

JAKARTA: In the span of only a few months Indonesia has gone from being the "darling" of the international investment community to becoming a virtual "pariah" to be shunned.

This drastic turnaround is especially surprising and perplexing because Indonesia's so-called fundamentals appeared to be very strong.

The government had been maintaining a balanced budget, inflation was under control, and foreign exchange reserves (at US$ 20 billion) were sufficient and growing. The questions on everyone's lips is how and why the drastic downturn happened, and what should be done about it?

The high growth of Indonesia's economy has been supported over a number of years by the "benefit of the doubt" given by the investment community to those managing the country's economy.

Indonesia was given the benefit of the doubt because the investment community bent over backwards to tolerate highly distorted economic management practices and a lack of transparency.

The investment community had closed its eyes to endemic practices of collusion, monopoly and corruption in Indonesia. Then suddenly, unexpectedly, triggered by the economic crisis in Thailand, the benefit of the doubt was withdrawn and vanished.

The investment community felt that the benefit of the doubt given so readily to Indonesia in the past, needed review. The scrutiny imposed by the investment community resulted in strong doubts concerning the quality of the management of Indonesia's economy.

Fueled by jitters and a self-feeding frenzy, the benefit of the doubt enjoyed by Indonesia for years was suddenly canceled. Now, the investment community will no longer tolerate the mismanagement of the past.

The market will also react negatively toward mismanagement and policies which do not adhere to the principles of a market economy.

Several indicators point to the deteriorating quality of economic management:

(1) Inconsistency: Before the IMF was invited to rescue Indonesia from its economic crisis, officials were contradicting themselves right and left concerning the need or not to ask for IMF aid.

Because Indonesia was faced with a financial crisis, in an effort to stabilize the rupiah exchange rate, the government rescheduled multi-billion dollar mega-projects. However, almost immediately, the government permitted the continuation of 15 previously rescheduled, mega-projects valued at US$ 2.6 billion. This reversal occurred despite the fact that Indonesia is in the throes of the most serious economic crisis it has experienced in thirty years.

(2) Vested Interests: State policies governing economics, trade and industry are dominated by conflicts of interest.

(3) No Institutionalized Decision-Making Process: Economic and political institutions are not empowered. The decision-making process for the approval of strategic mega-projects is not conducted openly by competent institutions, but is dictated by nepotism and cronyism. A small group has absolute control over the decision-making process, causing competent authorities to become superfluous. In other words, there is a dysfunctional relationship between defacto power and the rule of law.

(4) Lack of Accountability: Off-budget taxes, illegal levies and fees are so prevalent that they're virtually institutionalized.

(5) No Sense of Crisis: The current account deficit swelled from US$3.1 billion in 1994 to US$7.2 billion in 1995 and increased to US$ 10.5 billion in 1996.

The government should have enacted appropriate measures at that time -- by warning the business community and accelerating the scheduled depreciation of the rupiah against the US dollar.

Instead, the depreciation of the rupiah against the US dollar was purposely kept at a very low rate of 3.6 percent in 1996. Indonesia's high level of foreign debt is another burden on the economy which should have been dealt with a long time ago.

The monetary authorities were negligent for failing to impose sanctions and strict controls on private foreign debt. In fact, the total amount of foreign debt continues to increase at a rapid pace and it is not properly controlled even now.

It is ironic that every year when it is announced that CGI donor nations have increased their loan commitment to Indonesia -- the news that the country's indebtedness has grown is proclaimed by self-serving officials as a wonderful event demonstrating how much confidence the international community has in the Indonesian government's ability to manage the economy effectively.

As a result of the combination of the factors above, exacerbated further by the lack of transparency, the principles of a market economy have been subjected to significant distortions. Market access is determined by one's connections rather than the rule of law.

In this context, Standard & Poor commented, "there is pervasive favoritism throughout the public and private sector".

Consequently, the investment community categorizes the Indonesian money market as high risk, and the financial market as highly politicized. It is difficult for investors to conduct prudent and accurate risk analyses, because risk assessment is increasingly distorted.

This view caused the investment community to give the management of Indonesia's economy a "vote of no confidence," even though economic fundamentals appear to be fairly solid.

The high rate of economic growth in Indonesia in recent years is due to the participation of the Indonesian economy in the global financial market.

The amount of funds invested in Indonesia through the global financial market and equity investments has grown rapidly. The Indonesian economy is now highly dependent on the global financial market, to the point it could be said that the global financial market has become the main constituent of the Indonesian economy.

What Indonesia did not realize is that the market is actually an organized market and not a black market or underground market. An organized market has compulsory requirements for market participants to play an active role. These compulsory requirements are basically (1) transparency, and (2) a level playing field.

As the size of the Indonesian economy grew relatively larger, with its degree of market participation becoming more significant, the global financial market began to force Indonesia to comply with its requirements.

If the public and private sectors in Indonesia are stubborn and not willing to change, the investment community will simply reject Indonesia's participation in the global market.

In other words, Indonesian business entities will not be allowed to take part in the global market. The integrity of Indonesian stock exchanges and money markets will be questioned, and investors will avoid the country.

Besides the deteriorating quality of economic management, another factor contributing to Indonesia's economic crisis is the imprudent, expansive and speculative attitude and short-term orientation of the private business community -- which used short-term foreign debt to finance speculative ventures in non- export sectors that do not generate foreign exchange.

Due to economic mismanagement, marked by a lack of transparency and riddled with vested interests, the private sector has expanded into highly speculative businesses. The real estate sector is an example of this.

Excessive and speculative real estate development was spawned by a lack of prudent public policy regarding land-use and land- clearing. All the developers needed was to get approval from the powers that be, and they had the right to clear the land at will.

To get the "approval", a large up front bribery payment had to be made. Consequently, they were forced to expand on a grand scale to increase the "return on investment" (including the bribe).

These same practices are prevalent in other business sectors as well. Finally, the business community was unable to apply the principles of prudent business management, and Indonesia faced a short term debt overhang which caused investors and lenders to panic. The "benefit of the doubt" was retracted, and the money took flight!

The writer is deputy director at Econit and chief executive officer at ReForm consulting firm, Jakarta.