'Conditionalities' choke RI's recovery

By Sidhesh Kaul

This is the first of two articles on the relationship between international institutions and Indonesian government.

JAKARTA (JP): Brazil, Peru, India, Somalia, Rwanda, Bangladesh, Vietnam, Bolivia, Russia, Turkey, Bosnia-Herzegovina and, of course, Indonesia.

This is a list of some of the selected and prize medals that decorate the International Monetary Fund's proud chest.

The hand of an IMF-driven recovery has touched all of them and a comparative study reveals a familiar pattern. It appears that there is indeed some method in IMF's madness.

The pattern of economic subjugation prescribed by the IMF-led International Financial Institutions (or IFIs) foretells a bleak picture for Indonesia whose sovereign obligations far outstrip the capacity to repay.

Recently, in the wake of the new wave of politico-economic instability, the IFIs have joined voices in a chorus urging the embattled government of President Abdurrahman Wahid to stick to the several "conditionalities" that the several IFIs have prescribed for the country.

Subservience to the demands of the IMF is well worth the effort. The choice is between getting Indonesian assets to perform productively and efficiently overnight, a task of Herculean proportions given the current chaos, and agreeing to a few conditions.

The vital tools in the hands of IFIs, led by the IMF, for reigning in an economically embattled country are broadly described as "conditionalities".

These "conditionalities" come attached to the loan agreements and ostensibly serve the purpose of re-directing macro-economic policy but in fact serve the narrow interests of the IFIs.

For a developing country, which has borrowed from the IFIs, there is little choice but to synchronize the nation's debt management policy with the IMF-driven macro-economic reform that is warranted under the strict "conditionalities" regime.

The straitjacket of the "conditionalities" ensures that the country continues to abide by its' financial obligations.

Debt management typically comprises deferring principal payments and swapping of debt for equity whilst keeping the interest payment current. Often the country has to borrow "new monies" to pay interest arrears (so that the country can avoid a default). This new burden of borrowings comes along with stricter conditionalities.

The cycle carries on and very soon the crippled nation reaches a state where it becomes a net exporter of capital, that is the country pays more in terms of interest than the "new monies" that flow in.

Bowing to the dictates of the "conditionalities" opens the doors to the Paris and London Clubs, commercial banking institutions and bilateral donors whilst non-compliance brings in its wake obstacles in rescheduling the debt, difficulties in obtaining new developmental assistance and blockages in short- term credit (that would have the effect of crippling exports and paralyzing debt servicing capacities even further). An errant borrower would soon face isolation.

The IMF-World Bank's "conditionality" driven remedy begins with a short-term macro-economic stabilization process (read as devaluation, price liberalization and budgetary austerity) that is followed up with a dose of more fundamental and structural reforms.

The country's exchange rate is an important instrument of macro-economic reform and the IMF-World Bank's short-term macro- economic stabilization programs play a key political role in pushing for devaluation.

Devaluation brings into play the supply-demand interactions within an economy and affects the real prices paid to direct producers as also the real value of wages and leads to a real contraction in those industries and sectors that are heavily reliant on imported inputs (including capital) but whose markets are domestic.

Earnings are compressed and the dollar value of government expenditures falls drastically and which in turn facilitates the release of state revenues towards external debt servicing.

Then there is the social cost to bear. With the contraction in the domestic sector and the subsequent effect this has on real prices for consumer goods, the common man finally begins to feel the pinch. Demands for an increase in real wages to counter this effect fall on deaf ears.

The first symptom after a round of devaluation is spiraling inflation and the "dollarisation" of domestic prices and at this stage the IMF is quick to prescribe its standard "anti- inflationary" program -- at best a diversionary tactic.

The program has little to do with the devaluation (the actual impetus for the inflation and an aspect that has met with staunch denial from the IMF historically) but instead focuses on a contraction of demand -- reduction in public expenditure, cuts in social sector programs and de-indexation of wages.

Decreases in government expenditure, as a direct consequence of these measures, succeed in diverting state revenues towards debt servicing.

In addition, the IMF prescribes a tight control on money supply as a means of combating inflationary pressures.

The IMF's tight control over money supply would be impossible without a pliant Bank Indonesia. The IMF's constant refrain for "independence of Bank Indonesia from political power" (Is it more than a coincidence that Bank Indonesia's senior officials are former staff members of the IFIs?) is actually an effort at shoring up their tactics to control money creation.

The government thus has very little control over domestic monetary policy and the implication is that the country would have little choice but to depend on international sources of funding for real economic development.

Traditionally, the IMF is not going to settle for anything other than total control over a country's monetary policy.

The domain of public finances too is subjected by the IFIs to across the board austerity measures. The social sectors are also not spared and the IFI's advocate programs on the basis of economic feasibility (read as cost recovery) and the gradual withdrawal of state funding from basic health and educational services. Social sector funding is limited to targeted "vulnerable groups".

The entire thrust of the IFIs is to ensure that the government's cuts in public expenditure can bolster the repayment scheme to international creditors. State investment in public infrastructure projects is curtailed thus leading to a slowing down of the rate of capital formation. The government is basically denied the right to muster its' domestic resources for deployment in any major project.

Concessions are made by the IFI's for "essential" projects in the form of soft loans and under the watchful aegis of a set of binding procedures.

The new rules of the game ensure that whilst the state's burden increases, the interest payments keep flowing back to the IFIs.

The explosion of social problems that follow the curtailment of public expenditure has another important side effect -- the ensuing destabilizing forces erodes the legitimacy of the government in the eyes of the public and makes it even more dependent on IFI-driven quick fixes.

The government is pressured to lift subsidies on fuel and utilities. The net effect is a foregone conclusion -- domestic prices spiral upwards in the market and the effect is sharpened by the fact that there is a squeeze on real income. Cost structures for both productions as well as distribution get affected and domestic producers find that their local markets have been surgically incised.

The Indonesian government is under severe pressure to forego the subsidy on fuel and that too at a time when the country is being wracked by social and political instability.

Whilst the government has managed to stave off increases in fuel prices for the common man till later in October of this year, industries (the major consumers of fuel) have been hit by the increases immediately -- the increased costs in a market that is experiencing a second round of currency devaluation is detrimental to growth.

Whilst this situation is an impetus for industries to seek export markets it spells death for those industries that cater exclusively to the domestic market.

Indonesia has little choice but to swallow the bitter pill of an IMF-driven regime of "macro-economic stabilization" policies.

But this is only the first phase of remedies and the treatment does not end here. What follows next is a phase that entails the implementation of "necessary" structural reforms.

The writer is a commentator on regional economic and political issues based in Jakarta.