Broader-based recovery

The 5.12 percent economic growth in the third quarter, as reported by Indonesia's Central Bureau of Statistics on Wednesday, is thoroughly amazing. This is not only because the expansion surpassed most analysts' expectations, but the growth, previously fueled mainly by private consumption, has become broader based, with exports becoming the main locomotive.

One may argue that the year-on-year growth only looks impressive compared to the third quarter of 1999, when the economy contracted by 1.7 percent. But even on a quarter-on- quarter basis, the July-September growth was still a respectable 1.97 percent.

What makes the third consecutive quarterly growth even more surprising is that the expansion took place amid heightened political uncertainty and stronger opposition to President Abdurrahman Wahid before and during the August Annual Session of the People's Consultative Assembly and persistent violence in several provinces.

The trend certainly points to a strong pickup in the real sector (manufacturing and agroindustry) even though the weak banking industry has yet to resume significant lending and a large number of businesses remain preoccupied with debt-workout negotiations.

But different from the robust real sector, the financial market greatly suffered from the political uncertainty and security disturbances in several provinces. The rupiah was driven down to between 8,700 and Rp 9,000 against the American dollar in the third quarter from an average of Rp 8,400 in the second quarter. The rupiah's depreciation has forced the central bank to steadily raise its benchmark interest rate from as low as 11.50 percent in June to as high as 13.65 percent in September and 13.90 percent today to reign in inflationary pressure caused by the higher costs of imported goods. The Jakarta Stock Exchange composite price index also bore the brunt, falling from 515.11 in June to as low as 407 in September.

However, as the bureau noted, the weakening rupiah has been a a blessing in disguise for the export sector. As the value of the rupiah is now still more than 70 percent lower in terms of American dollars, compared to its rate at the outset of the financial crisis in late 1997, Indonesian manufactured goods are much more competitive on the international market. Export indeed became the engine of growth in the third quarter, expanding 4.54 percent from the second quarter, while private consumption grew a mere 0.80 percent and government consumption even contracted 5.75 percent.

Exports could actually be increased further if many debtor companies which have been denied access to new credit lines could obtain working capital in the form of loans to raise capacity utilization. But newly recapitalized banks, still traumatized by mountains of bad credits and being overzealous to maintain their capital standards, have shunned debtors who have not reached debt solutions with the Indonesian Bank Restructuring Agency even though they could show firm import contracts from overseas buyers to prove their creditworthiness.

But again the basic question is whether the recovery will be sustainable without significant growth in new investment to expand the production capacity and improve manufacturing technology in order to increase the value of industrial goods. The bureau's report shows that fixed gross capital formation in the third quarter still contracted 0.92, compared to a 2.64 expansion in the second quarter. That means investors remain on the sidelines, spooked by the unusually high risk of doing business in the country.

Hence, while the numbers for economic growth should generate a sense of confidence, concerted efforts are still needed to resolve the huge corporate debt overhang and improve political and legal certainty in order to reduce to a reasonable level the economic and political risks of doing business here.

As long as these risks remain unusually high, the financial market will continue to be highly volatile, a condition inimical to the corporate debt restructuring process and recovery of the newly recapitalized banking industry, as well as damaging to the nascent economic recovery process.