Economic reform without misery?

By Omar Halim

This is the first of two articles examining the prospects for Indonesia's economy in light of the signing of a reinforced economic program mid this month by President Soeharto and the International Monetary Fund (IMF) managing director Michel Camdessus.

JAKARTA (JP): President Soeharto signed on Jan. 15 an agreement revising and strengthening an earlier economic program with the IMF.

The basic aims of this program are to:

* Restore confidence in the Indonesian rupiah as quickly as possible.

* Include all extra-budgetary resources in the budget and bring transparency into the budgetary process.

* Rationalize public expenditure, limiting it to "those items that are of vital importance to the country".

* Take the initial steps toward undertaking reforms to strengthen the long-term competitiveness of the Indonesian economy.

Before commenting on this program, it is imperative to comment on the need for Indonesia to seek the assistance of the international community.

In seeking assistance to resolve a major problem, which it could not fix on its own, a country should be prepared to cede part of its sovereignty, since in return for obtaining outside resources and support it has to undertake certain corrective measures that it could not, or did not want to, take on its own.

But it should not have to undergo the humiliation of having the managing director of the IMF glaring down, with folded arms, on the head of state signing the agreement to obtain that assistance.

Unlike other ASEAN countries, such as Thailand -- and as Sumitro Djojohadikusumo and Mohammad Sadli have concluded -- the tremendous lack of confidence is no longer a reflection of the economic problem alone -- it is rooted in the political foundations and other problems faced by the country.

The IMF package alone is therefore no longer sufficient to restore confidence.

As the performance of the rupiah -- after the President had indicated his willingness to run for another term and implied the type of person he would like to have as vice president -- recently showed, it is where the country and the economy are heading in the next five years that will determine whether confidence will return.

It is therefore imperative that a regime which could elicit full trust, be elected to lead the country in the next crucial five years.

This regime should comprise leaders who are widely accepted and respected, by the different groups and layers of Indonesian society, and supported by technically competent people. They should be able to undertake essentially three types of reform:

* Economic and financial reform (to be undertaken immediately).

* Political reform

* Reform of the judiciary.

With the prospect of such reforms in the next five years, the country would be turned into one that would be governed more transparently, rationally and with fairness. There seems to be no doubt that confidence, especially among Indonesians, would return.

Capital flight would stop and new capital, local and foreign, would flow into the country. The rupiah would strengthen considerably in expectation.

Economists and financial traders have been attributing the collapsing rupiah to the US$65 billion corporate debt overhang.

It has no doubt been putting a lot of pressure on the rupiah, but, it is argued here, that it is a supplementary influence in the free fall of the Indonesian currency.

The lack of confidence has substantially decreased the supply of U.S. dollars to be exchanged for rupiah, and the need for U.S. dollars to service corporate debts and, presumably, small-scale capital flight, has resulted in the increasing volatility of the thin U.S. dollar market.

The magnitude of capital flight is hard to determine, but a political change would no doubt assuage capital owners.

With regard to corporate debt, a moratorium and other arrangements have been proposed.

Despite the understandable reluctance of the government to assume these debts, it is imperative that it acts immediately to calm the situation.

For example, the government could bring together the Indonesian debtors to assess the extent of their indebtedness and to strengthen their collective bargaining position.

In this way, they could be brought together with the creditors in order to arrange for possible rollover, moratorium, discount or other mutually acceptable solutions.

This should alleviate considerably the need to purchase foreign currencies. Then the rupiah might strengthen further to levels closer to Rp 4,000 or Rp 5,000, and remain stable.

The high interest rate policy would not, under this condition, be required to stabilize the exchange rate. Reasonable interest rate levels could be used, at an appropriate time in the future, to stimulate investment, and consumption, which would in turn be sources of economic growth.

This stability would enable the economic agents to plan their activities, particularly the manufacturers who produce goods for export.

At present, it is conceivable that exports have decreased because of the uncertainties caused by the huge swings in the exchange rate.

With a significantly depreciated rupiah -- as long as the import content of their products is relatively low -- they should have a considerably strengthened competitiveness in international markets.

But exports would not increase sharply overnight, especially those whose markets were other ASEAN countries. Exports should, in the long-run, be a crucial demand component for Indonesian manufacturers as an engine of growth.

Consumer demand, in light of the sharp deceleration of the economy anticipated for this year, will no doubt decrease substantially.

Investment demand, in light of decreased consumer demand, should also plummet, and there could even be a disinvestment.

The decrease in consumer demand and investment will particularly be exacerbated by the banking sector being in a shambles.

The writer is a research fellow at the Center for Strategic and International Studies. He retired from the United Nations two years ago.