By Laksamana Sukardi

By Laksamana Sukardi

This is the second of two articles based on a paper presented
at a "power breakfast" meeting organized by the International
Advertising Association at the Hilton Executive Club on Nov. 21,
1997 in Jakarta.

JAKARTA: The IMF arrived quickly on the scene to rescue the
economy. The Indonesian problem, however, is very different from
the typical set of problems that the IMF is supposed to solve.

The usual target of the IMF is a government which has financed
its budget deficit by printing money at the central bank, which
in turn results in high inflation, a currency crisis, and the
draining of foreign exchange reserves. Given such a crisis, the
IMF generally recommends a contraction of the economy to reduce
inflation, the currency is stabilized, and foreign exchange
reserves replenished.

Indonesia is not the same. Basically, Indonesia is not
experiencing a budget deficit or inflation, and foreign exchange
reserves are manageable.

The economic crisis in Indonesia stemmed more from massive
private sector short-term debt which was disbursed to speculative
non-export sectors.

This resulted in reduced competitiveness of our export goods.
Compounding the problem is the fact that Indonesia's exports fail
to compete in the global market, in which China is the leader,
because of the impact of rising labor costs and the high-cost
economy.

The lack of competitiveness, coupled with falling demand for
Indonesian products, has reduced the volume of exports. The only
way to make the Indonesian economy competitive is to depreciate
the exchange rate of the rupiah against the US dollar.

However, a weakened rupiah causes tremendous problems for
the private sector, which bears a very heavy load of foreign debt
that will be increasingly difficult to service.

Indonesia urgently needs to increase its competitiveness by
eliminating its high cost economy and allowing the rupiah to
free-float downward. In this way, production costs will drop and
exports will rise, so generating foreign exchange which can be
used to pay off maturing foreign debt.

Other benefits if Indonesia allows a floating exchange rate
for the rupiah are:
(1) our foreign exchange reserve will be preserved and not used
in a vain attempt to stabilize the rupiah exchange rate by
intervening in the financial market; and
(2) Bank Indonesia will not need to increase rupiah interest
rates to unreasonable levels. It is ironic that the IMF has set
Indonesian economic growth at only 3 percent in 1998. This means
the IMF is requiring a contraction of the money supply and very
limited bank credit expansion.

In fact, the IMF is encouraging bank closures as one effort to
restore confidence. But a large scale closure of banks will
result in a crisis of confidence instead of restoring it because:
(1) the liquidity structure of the Indonesian banking system is
very shaky due to the common practice of mismatching assets and
unreasonably large liabilities (short-term funds to finance long-
term loans -- a practice which stems from the non-existence of a
long-term funds market); and
(2) very weak law enforcement due to the lack of an independent
and impartial legal system. These two determining factors will
undoubtedly lead to mass liquidation, resulting in a nation-wide
bank liquidity crisis in Indonesia.

The liquidation problem, moreover, will not be settled
promptly, but will take years to resolve.

In contrast to the typical IMF case, Indonesia actually needs
stable -- or even slightly expansionist -- monetary and fiscal
policies to counter-balance the decline in foreign loans.

Interest rates would rise, but only temporarily, and they
would not soar to the current outrageously high levels.
Strengthening the banking industry should not be accomplished by
hasty bank closures, but by pushing weak banks to merge with
healthy ones and by pushing the banks to raise their capital
base. In the Indonesian case, the majority of owners of the
liquidated banks have not gone bankrupt, but are still considered
to be very wealthy individuals.

Actually, the liquidated banks could have been rescued by the
shareholders who have enormous personal assets. The shareholders
were willing to use their assets to reimburse the loans which had
been disbursed to them personally.

This confirms that the real problem faced by the Indonesian
banking system is a very poor law enforcement system.

Inasmuch as the fundamentals of the Indonesian economy are
still considered sound, what is needed is an increase in
competitiveness and a rescheduling of foreign debt, so we are
able to gradually reduce the level of foreign debt.

The economic crisis in Indonesia is truly the result of a
series of policy blunders which occurred due to the systemic and
structural impediments which make it impossible to enact prudent
economic policies.

Indonesia's economic problems will not be solved until the
decision-making process is substantially less influenced by
vested interests, nepotism, and lack of "transparency".

The most troubling aspect of the IMF aid package is that the
program does not touch the core problems which are responsible
for causing the crisis of confidence.

The size of the rescue package has been touted, while little
attention has been given to the inability of management to
produce sound economic policy, free from nepotism and vested
interests.

The additional aid granted by the IMF will add to Indonesia's
already perilous foreign debt burden -- which reached US$ 135
billion in early 1997 -- $ 60 billion in government debt, and $
75 billion in private sector debt.

If Indonesia uses the US$ 10 billion IMF standby facilities in
1998, total foreign debt stock as a percentage of GDP will rise
to over 70 percent. This is extremely high compared to the 1995
ratios of other MBA countries such as Brazil, Mexico and
Argentina that experienced economic crises and defaulted on their
foreign debt payments.

At that time, debt as a percentage of GDP rose to 23 percent
in Brazil, 66 percent in Mexico and 35 percent in Argentina.

The income per capita of those MBA nations was much higher at
that time than that of Indonesia (Brazil = US$ 3,640 / Mexico =
US$ 3,320 / Argentina = US$ 8,030).

The Debt Service Ratio (DSR) in Indonesia in 1998 is projected
to reach 42 percent, which is a threatening level that exceeds
the prudential limit ratio.

Consequently, Indonesia will be unable to use the stand by
facilities provided by the IMF.

The immense commitment on the part of the IMF will serve only
to help increase confidence in the Indonesian economy. What
Indonesia needs now is stable economic growth, even slight
expansion backed by monetary and fiscal policy.

The Indonesian economy must grow by 5 percent per year to be
able to provide jobs to an additional 2.6 million new workers
entering the labor market each year.

The high rate of new entrants into the work force is
due to the fact that 58 percent of Indonesia's 200 million
population are under the age of 25.

Indonesia desperately needs to create the infrastructure and a
system capable of facilitating a transparent, institutionalized
decision-making process.

This is imperative if Indonesia is going to introduce sound
macroeconomic management and policies. The severe economic
downturn and the dramatic reversal of fortunes were caused by a
series of policy missteps.

The decision to bring in the IMF was aimed primarily at luring
foreign investors, shoring up market confidence, and overcoming
the resistance of vested interests to structural economic reform.

However, the IMF package is tied to orthodox financial
conditions, including budget cuts and much slower economic
growth, fiscal and monetary contraction and higher interest
rates.

The package could very well do more harm than good,
transforming a currency crisis into a rip-roaring economic
downturn.

Since banks borrow short-term in order to lend long-term, they
can be thrown into crisis when a large number of depositors
suddenly decide to stage a run on the bank.

If Indonesia is unable to implement structural adjustments,
the IMF rescue package will be incapable of restoring confidence.

On a larger scale, the aim of positioning Indonesia as the
"circuit breaker" to halt the Asian currency turmoil will fail,
and the contagion will spread like wildfire -- and failure to
stem the tide in Indonesia will be recognized as the
source of instability that threatens the world economy.

The IMF injection is the wrong medicine for Indonesia. Tens of
millions of innocent people will suffer from government cutbacks,
while those who have reaped enormous benefits from exploiting the
system will continue living in the lap of luxury.

Unemployment will skyrocket, creating potential social unrest
which could destabilize the political system in Indonesia.

If that happens, it's clear that our only course of action
will be to continue living dangerously.

The writer is deputy director of Econit and chief executive
officer at ReForm consulting firm, Jakarta.