Boom and bust: Natural cycle hits Indonesia hard

By Sri Pamoedjo Rahardjo

JAKARTA (JP): The monetary fiasco in Indonesia is proving to be a complicated situation. Heads of states and directors of international organizations have visited our shores offering all kinds of solutions and financial assistance.

The value of the rupiah has dropped sharply causing private sector overseas debt, when measured in rupiah terms, to quadruple. Surprisingly, the government and the central bank were unaware of the exact magnitude of these loans. In theory, all flows of currency to and from Indonesia should be detected by monitoring apparatus at the central bank.

Measures taken to alleviate the crisis could have been more effective had analyses referred to historical events in addition to recent trends. However, few analysts are interested in using this historical approach since it requires large amounts of time series data on social and economic forces.

The world experienced a major economic crisis in early part of this century, but this event has no place in the conscience of the current generation in Indonesia. In 1929, massive poverty descended on the western world, coming hard on the heels of record breaking economic growth. Is Indonesia now facing a similar situation?

This question arises because the crisis has followed a period of time during which the country enjoyed its best ever economic performance. Only a few months ago the economy appeared robust, unemployment was low, inflation in single figures and growth rates around 9 percent. Indonesia was seen by the international community as the next tiger in Asia.

Impetus for this pleasing economic performance came from deregulatory policies which the government introduced to assist the business community. Indonesia became a nirvana for foreign investors and the national economy expanded tenfold within a decade. Per capita income also rose and was predicted to reach US$1,000 by the turn of the century. Business boomed, then warning signs of overheating in the economy emerged.

However, some observers believed the economy would not overheat since its structure was better than Mexico, another country which had recently fallen victim to an economic crisis. There was a danger that slowing down development would hinder progress. Pride also held a stake -- an overheating economy was taken to imply an inability to transcend to a higher plain of development.

But this is mistaken and the government needs to pursue a strategy which will enable the country to adapt to a naturally fluctuating economic cycle.

The economic cycle consists of four phases, recession, depression, recovery and boom. When output and employment decline, the economy moves into recession. When all sectors in the economy are in crisis, the economy is in a state of depression. When employment and productivity are rising, the economy is in recovery. Finally, when employment and productivity are near the optimum capacity, the economy is booming.

Policy makers must strive to implement policies which dampen the impact of this boom-bust cycle and, if possible, exert some control on the upswing and downswing of the economy. Appropriate interventions can be prepared in anticipation of hardships encountered during the economic cycle.

Also of importance is the way in which policy makers react. They must not be prematurely intimidated by a downswing in the cycle as this may lead to the imposition of inappropriate policies, at a heavy cost to the economy.

The current downswing in our economy was triggered off when the rupiah devalued against the U.S. dollar. Attempts to correct for this failed because the downturn had already gained strong momentum. The government then sought assistance from the International Monetary Funds (IMF), who urged reforms, including the closure of 16 badly managed commercial banks. Despite taking these steps, the rupiah continued to slide against the dollar causing ordinary depositors to lose confidence in the national banking system and currency.

In a second attempt to restore market confidence the IMF and the government drew up a 50 point reform plan to be implemented in exchange for a multi-billion dollar rescue package. Although the package addressed fundamental issues such as the distribution of income, the more immediate problem of a weak rupiah remained unsolved.

The national currency's predicament has paralyzed much of the country's private sector. The failure of the IMF backed reforms to address this situation have rendered the interventions superficial since they do not strike at the heart of the matter in hand.

Wealth in Indonesia is concentrated in the hands of a select few. However, even this imbalance has been beneficial to society. New openings in the economy are created to meet the growing demand for services and consumer goods stemming from the new wealth at the top of society. In turn, further complementary and related niches develop in the economy and bring further jobs in services and trades. This is known as the multiplier effect.

This process, which was given impetus through the accumulation of wealth at the top of Indonesian society, has wrought change on the structure of Indonesia. The resultant new market opportunities made Indonesia very attractive to foreign investors. However, should the proposed reforms succeed in securing a more equal distribution of wealth in the country, one of the major stimuli to foreign investment will be wiped from our economy. A move which may prove unwise.

Are we now experiencing a depression? The answer is yes and no.

No, because the underlying cause of the troubles is the difficulties the private sector are having in repaying debts. An inadequate supply of dollars in the market has pushed the value of dollars up in rupiah terms. Rumors tempered with political overtures have caused pandemonium in the economy and even healthy private sector firms have been unable to plan and implement business strategies.

The national economy has been floored by a single blow, the unexpected and swift depreciation of the rupiah. The U.S. dollar shortage was interpreted as a crisis by the public and initial analyses of the situation only served to exacerbate the fraught situation.

Yes, because despite the underlying cause, we do seem to be entering a phase of depression and the national economy has begun to show signs of stagnation. All sectors face liquidity problems and planning and operational difficulties. Prices are rising and companies are trying to survive by holding on to their hard cash. Some have laid off employees, while some have temporarily stopped production. Some have inevitably closed as a result of a rise in production costs of up to 80 percent.

The depreciated value of the rupiah has had an enormous impact on local production and exporters are even experiencing credibility problems in international trade.

While a more equitable distribution of wealth is desirable, the task of redistribution should be handled with great care. Wealth is concentrated with a small number of private companies who no longer have expanding market opportunities. The government should therefore ensure that the private sector can continue to operate while reforms are being instituted.

The Foreign Debt Settlements Team recently announced that private sector debt is smaller than had been feared -- Indonesian companies have a debt of approximately US$23 billion. However, the debt task force stops short of providing rescue measures to save the ailing companies. It is essential for the government to guarantee private sector debt while introducing reforms. The government should utilize the committed dollar loans to selectively pay private sector debts, particularly for those companies that have the greatest impact on the lower niches and smaller cogs in the economy. The dollar assistance could be converted into specially designed rupiah loans, where the private sector would pay the government back in rupiah, including a measure of devaluation. This would prevent overheating in the economy and help keep the rupiah relatively stable.

In conclusion, the IMF rescue package was not designed to account for the unavoidable cyclical movement of the economy. To retain control of the economy, the government should avoid superficial interventions, including the introduction of a currency board system and should instead consider the interrelated nature of economic agents and economic growth. Failure to do so will further distort the natural cycle of the economy and plunge it into deep depression.

The writer is a social and economic observer and former regional development bank officer.