Brittle confidence

Brittle confidence

Finance Minister Boediono chartered out a much brighter
economic outlook for next year but the macroeconomic assumptions
he proposed in the preliminary deliberations with the House of
Representatives on the state budget plan for 2003 still very much
reflects the brunt of the five-year old economic crisis.

Boediono ventured a high estimate of 6 percent growth in terms
of gross domestic product (GDP), as against 4 percent this year,
largely on the back of an improved political and security
condition and a global recovery which would help bolster
Indonesian exports.

He was especially buoyant about the strong (10 percent)
appreciation of the rupiah against the American dollar in the
first five months but his low and high estimates of the local
unit for next year, Rp 8,500 and 9,500 respectively, are still
over 70 percent lower than the pre-1997 crisis level. They even
reflect a significant depreciation from the Rp 7,100 level
already reached in December, 1999, Rp 8,025 in 1998 and Rp 7,900
at the end of 2001.

These developments show how fragile the macroeconomic
condition still is and how the economic-crisis management has
often swerved off the right track due to backtracking on and
reversal of reform measures. This policy inconsistency resulted
in one step forward being followed by two steps backward within
the economic reform and caused high volatility in market
confidence.

A similar trend took place in the developments of interest
rates. The 12.50 percent to 14.50 percent benchmark interest
rates estimated for next year, compared to almost 16 percent
now, are even still much higher than the average 11.50 percent
already achieved in the first six months of 2001, let alone the
pre-crisis level of 10 percent. True, like the rupiah which
significantly strengthened this year, the projected interest
rates are considerably lower than the 17 percent prevailing
between July, 2001 and January, 2002. Yet, they do not really
bear out improvement from what had actually been achieved in
previous years.

We deliberately cite the two indicators not only because the
rupiah and interest rate are highly sensitive to market
sentiment. They are two variables which are greatly influential
to macroeconomic stability and to the state budget. The rupiah
rate manifests the extent of wealth destruction after the crisis,
affecting both foreign debt service burdens and the
competitiveness of the manufacturing sector that still depends
largely on imported materials, intermediate inputs and
components.

Likewise, the interest rate level influences the domestic debt
service burdens and the costs of business operations and, most
damaging of all, could stifle a sound recovery of the banking
industry.

These developments make it crystal clear that what is vital
for regaining and maintaining market confidence to generate a
sustainable recovery is a steady, if small, progress within the
economic reform drive as this creates certainty about the
direction of the economic management.

Boediono's GDP estimate of six percents seems too high, except
if the recovery of the distressed assets held by the Indonesian
Bank Restructuring Agency, corporate debt restructuring and
privatization of state companies can be accelerated. Without
significant progress in these three programs, the real sector
will remain feeble, new investors will remain on the sideline,
many industries will continue to operate below designed capacity
and the banking industry will remain fragile, exposed to
unusually high risks.

Only new investors can bring back the distressed assets and
state companies to higher productivity with a stronger
competitive edge either through technology improvement or product
diversification. Corporate debt restructuring is surely a key to
reinvigorating economic activities. Companies that are hostage to
their bad debts will remain closed to credit lines, thereby
unable to raise operation rates. This condition will deprive
banks of creditworthy borrowers to plough their excess liquidity
and will prolong their reliance on the interest revenues from
their government bonds

The government is well advised to realize that it is now
extremely difficult to woo new investment to green-field
projects in the manufacturing sector due to the excess capacity.
The most prospective avenue for capital inflows now is the
acquisition of the distressed assets and sale of viable state
companies. This is something that politicians should also be
highly aware of, especially because the situation next year will
predictably be highly politicized in the run up to the 2004
general elections. Whipping up narrow-minded nationalistic
sentiment against foreign investors to gain popular support would
only damage the economic outlook.

So all in all, the challenge ahead remains uphill. The
government should capitalize on the progress achieved in the
first five months of this year to maintain the momentum of market
confidence by accelerating confidence-building measures. But the
government should also realize that the overall condition is
still highly brittle and under this situation, when things start
going wrong they could easily descend into a new bout of panic
and a deeper crisis.