Economic pump priming

As with the government's budget this year, its budget proposal for 2003, currently under deliberation by the House of Representatives, is facing sudden and radical changes in the external and internal environments.

Four days after the 2002 budget proposal was submitted to the House, the external factor, on which Indonesia's ailing economy depends a great deal for its recovery, was abruptly damaged by the September 11, 2001, terrorist attacks on the U.S., the world's largest economy.

However, the impact of the October 12 bomb blast in Bali is much more devastating for the country's economy because the tragedy adversely affected both the external and internal factors, which are more influential on economic growth.

First of all, the increased security risks and negative repercussions of the bomb attack on the domestic political situation will further delay the restoration of foreign investor confidence. Even existing investors are highly likely to be moving into a holding pattern until basic questions around the terror bomb are resolved.

All of this is certainly increasing business risks at the expense of business confidence and banking operations, cutting tax revenues and consequently forcing the government to review the key assumptions used for its budget aggregates.

The assumption for economic growth, for example, may have to be revised down from 5 percent to at least 4 percent and this change will obviously lower tax revenues, making the target increase of 18.8 percent in tax receipts next year extremely doubtful.

The rupiah exchange rate may have to fall from the original estimate of Rp 8,700 to the U.S. dollar to a range of Rp 9,000 to Rp 9,200, and this, in turn, may increase inflationary pressures and consequently raise interest rates, with all the consequences on the burden of domestic debt servicing.

It is not clear yet as to how the government will cope with these worsening external and internal conditions but these issues are surely the main agenda of the informal meeting of Indonesia's international donor community, the Consultative Group on Indonesia (CGI), opening in Jakarta on Friday (today).

Finance Minister Boediono's pronouncement, that the government would pick up the slack caused by a weakening private sector by increasing its development (investment) spending on job- generating activities to provide a stronger stimulus to the economy, is theoretically appropriate.

However, the policy statement does not have any credibility without explanations as to how the government will go about pump priming in view of the anticipated lower-than-estimated tax revenues. Boediono simply said the government would increase its deficit spending from the original target of 1.3 percent of gross domestic product.

As the government is unlikely to be so misguided as to cover deficit spending by printing money, the only alternative is larger loans from CGI. Given the severely limited budget capacity to provide counterpart funds, the government may have to ask for larger amounts of quickly disbursed program loans, instead of project aid.

BUT CGI creditors will not readily fulfill Indonesia's request, however sympathetic they are to our plight. Their pledges will still depend on the government's policy performance or its determination to execute reform measures already agreed with the International Monetary Fund. Last year, for example, $1.3 billion of their $3.1 billion loan pledge was tied to policy performance.

Just witness how the World Bank and Asian Development Bank, which both usually provide more than one-third of CGI's total aid pledge, recently stopped disbursements of their loans to urban development projects in Sulawesi and North Sumatra due to suspected bidding fraud in the tendering for procurements.

It is therefore most imperative for the government to speed up the implementation of its structural reform measures. Simply sustaining policy performance achieved so far is no longer enough as the Bali bomb blast has damaged many of the macroeconomic gains that were hard won over the past year. Moreover, pump priming alone is not adequate to offset the setback caused by the tragedy. Private sector activities should be stimulated as well to fuel recovery.

Accelerated reforms, such as those in the banking system, the judiciary, public sector governance, corporate debt restructuring, asset recovery and privatization, are vital to improve overall economic efficiency and business confidence.

Perceived greater security and business risks have increased the cost of doing business in the country, in terms of transactions with foreign parties and impaired export competitiveness. These additional costs should be offset by higher efficiency through trade-facilitation measures in expediting regulatory and licensing procedures, transportation, port handling and customs services.