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.