Broader-based recovery

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.