Economic growth?

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.