Buoyed by IMF praise

Buoyed by IMF praise

The government, still rejoicing over the exceedingly positive
market reception of its first global bond offering in over seven
years, got another dose of high praise from the International
Monetary Fund, which completed last week its review of
Indonesia's economic policies and performance under its
surveillance mechanism (Article IV).

The annual surveillance review, which was conducted in
conjunction with the first policy discussion under the IMF Post-
Program Monitoring arrangement Indonesia entered into in January
after the end of the IMF extended facility in December, was full
of commendations for the government for its policy-reform
performance.

The IMF cited significant progress in the implementation of
reform measures, as stipulated in the September 2003 White Paper,
and pointed to the positive economic indicators in key areas such
as low inflation, a steady decline in interest rate, a stable
rupiah exchange rate and the increase in international reserves.

It praised the government's determination to continue its
fiscal consolidation to reduce the budget deficit to as low as
1.3 percent of gross domestic product this year from 2.1 percent
last year. So buoyed was the IMF team with the positive economic
trends that it projected that economic growth this year would hit
4.8 percent, up from an annual average of around 4 percent in the
2001-2003 period.

Different from past policy and economic reviews between 1998
and 2003 when the country was still under the IMF extended
facility arrangement (bailout program), the latest review and
policy discussions were not legally binding because the
assessment was not tied to loan disbursements from the IMF.

However, the findings and recommendations resulting from the
policy review and discussions with the IMF remain greatly
influential in shaping market perception and credibility of the
government and so too, consequently, Indonesia's sovereign risks
and economic prospects.

It is therefore well-advised for the government not to be
lulled into complacency with a lackadaisical attitude, assuming
that the economic crisis is now all over and the country is in
for some robust growth, especially because the IMF qualified its
commendations with a series of policy recommendations.

Take for example, the warning offered by the IMF team at a
meeting with the central bank's board of directors last Thursday.
The IMF expressed great concern that several banks had been
engaged in unsound lending sprees that could threaten the
viability of the whole industry, which is still fragile. The IMF
team also urged the central bank to improve its banking
supervision capability and effectiveness and to be more forceful
in enforcing its directives and rules on banks.

Though many might be surprised by the IMF's strong advice
against overly aggressive lending, but it is because total loan
growth last year remained virtually stagnant vis a vis the 2002
expansion rate of around 19 percent. Additionally, the loan-to-
deposit-ratio within the industry was still very low at about 50
percent, so an early warning is very important to prevent another
debacle in the banking industry.

It is likely that the IMF warning was directed especially at
the "go-go" consumer lending by several banks. The fierce
competition in and the expansion of consumer loans, which
exceeded 66 percent in 2000 and 45 percent in 2001 and remained
inordinately high at 37 percent in 2002 and 32 percent in 2003,
could indeed threaten another upsurge in non-performing loans
within the financial services industry.

Other policy recommendations, as stipulated in the 12-
paragraph press statement issued at the end of the IMF review on
Friday was an urge for the government to tackle weaknesses in
taxation and customs service regulations, enhancing labor market
flexibility and addressing problems with property rights and
contract enforcement. Without significant and quick progress in
these reform measures, Indonesia's growth rate will remain lower
than that of most other countries in Asia.

The press release devoted two paragraphs to policy
recommendations on taxation and customs services. Progress in
these two areas has been seen by most analysts and businesspeople
as far too slow and way short of what is needed to reduce the
costs of doing business and to stimulate investment in the
country.

The amendment of the tax laws are also way behind schedule.
Most businesspeople and analysts are worried that the draft
amendments prepared by the government are far from adequate to
remove uncertainty and minimize corruption within the tax
department.

The IMF team explicitly cited weaknesses in arbitrary tax
assessments, inefficiencies in the refund system for the value
added tax and income tax and burdensome customs procedures as
major barriers to investment.

Failure to make significant progress in the reform of tax and
customs service and labor rules could further postpone the return
of foreign direct investors, even if the upcoming elections go
off without a hitch this year.

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