Economic pump priming

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.