Economic growth?

Praise from the International Monetary Fund (IMF) for the significant improvement in Indonesia's economic situation could further strengthen market confidence, both in the economic outlook and the government's credibility. The government deserves some credit for the steady progress made over the last few months in the implementation of sorely needed reforms to remove the woes that have dogged the economy.

Several confidence-building deals and developments, including the completion of the government's divestment from Bank Central Asia, the IMF's disbursement of the fifth tranche of its extended facility, the Paris Club's decision to reschedule official debts maturing between April and the end of 2003 and decreasing inflationary pressures, have all improved market sentiment. The most evident signs are the steady, yet small, appreciation of the rupiah and the increasingly bullish state of the stock market.

The IMF's commendation, as made by IMF senior executive Daniel Citrin on Monday, should provide stronger confidence and a better sense of determination for the government, enabling it to believe that most of its policies have thus far been on the right track and what it has so far painstakingly worked on has started to heal the economic ills.

It is nonetheless entirely misguided for the government to let the IMF's praise go too deeply to its head, let alone sit back and relax in a spirit of complacency.

The blunt reality is that as the economic crisis is now entering its fifth year, the economy is still in dire state, strikingly different from the robust recovery already gained by other crisis-ridden Asian countries such as Thailand, South Korea and Malaysia. That is because Indonesia has often backtracked on its reform commitments since November, 1997, and even made policy reversals, thereby nullifying the positive impact of previous measures.

So poor had been the government's performance that the IMF postponed its program in the country in December, 2000, and reopened its extended facility only in August, 2001, soon after the election of President Megawati Soekarnoputri. Take, for example, the two factors -- the rupiah and banking -- that were the main causes of the panic in 1997 and 1998 that set off the economic crisis. The rupiah has indeed stopped depreciating and has now strengthened to the range Rp 9,300 to 9,500 to the U.S. dollar. But that is still almost 80 percent below the precrisis level of Rp 2,500, weaker than the Rp 7,100 achieved in December, 1999, and the Rp 8,800 in August, 2001, one month after Megawati took over.

The banking industry remains fragile even after its bailout in 1998 and 1999, which cost the taxpayer more than Rp 640 trillion ($67 billion). The industry has yet to resume its proper function of pumping lifeblood (credit) into the economy. Lending by the largest banks is still very low, or less than 30 percent of their third-party deposits.

In fact, the sixth-largest bank (Bank International Indonesia), already recapitalized twice by the government, with Rp 21 trillion, is now insolvent again, with negative capital of more than 47 percent. The bank will have either to be recapitalized again or be liquidated, but either alternative will cost the taxpayer at least another Rp 4.3 trillion.

Equally discouraging is the interest rate. Even though the central bank's benchmark short-term interest rate has, of late, been declining steadily to 16.20 percent now, it is still much higher than the average 14 percent assumed for the current fiscal year. The rate is even higher than the 13.74 percent achieved in October, 2000 and 12 percent in December, 1999. The relatively high cost of money not only stifles economic activity but also threatens to increase the state budget deficit, as the government has estimated that every one percentage point rise (over the assumed rate) in the benchmark interest rate will increase the interest charge of its bonds issued in 1999 to recapitalize banks.

Yet more challenging is the backlog of several other reforms essential to a sustainable recovery, including asset recovery, corporate debt restructuring and the reform both of state enterprises and tax and customs administration. The resolution of Rp 131 trillion in bad debts owed by the 33 largest debtors, scheduled to be completed last month, is likely to suffer another delay of two months to three months. The government pledge to work out Rp 40 trillion in bad debts owed by 414,000 small- and mid-sized businesses has yet to be realized.

Equally worrisome is the huge domestic and foreign debt overhang that has maintained the country's risk and sovereign risk at damagingly high levels and discouraged private capital inflows. Contingent liabilities related to the banking industry and the blanket guarantee on bank deposits and claims are similarly horrendous. Around Rp 13.5 trillion of government bonds will mature next year and bond redemption will more than quadruple, to an annual range of Rp 52 trillion to Rp 70 trillion starting in 2004.

So fragile still is the economy that there is virtually no margin of error for even minor policy mistakes or reversals, without the risk of plunging it again into a deeper crisis. What is urgently needed now is a quickening of reforms to strengthen the virtuous circle that started early this year.