Boom and bust: Natural cycle hits Indonesia hard

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.