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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