Government feeds banks to discourage real-sector industries

Pitan Daslani Political economy analyst

In defending her policy to increase fuel prices and utility rates, little did President Megawati Soekarnoputri realize -- unless she really meant it -- that she was well on track to crippling Indonesia's real-sector industries.

According to economic theory, the President did the right thing -- that is, she has attempted to pull the nation away from over-dependence on foreign aid and setting the tone for an economic self-reliance yet to be born.

If Megawati deserves the nation's admiration, it is only in that she will not reap the results of the unpopular price rises during her term in office. What she has done, if her actions were faithfully implemented with consistency and support from every sector forming the Indonesian economy, would only bear fruit in about two decades' time when she is no longer President.

Megawati should deserve admiration because only a leader with a particular level of statesmanship would make this daring decision, gambling with the probability of angry reactions from the public.

The subsidy removal could compel economic and business actors to realign strategies by standing on their own feet, rather than by expecting privileges. This would force businesses to promote efficiency in their survival strategies and thereby promote business competitiveness in the international market.

Such would be the assumption of someone innocent, like a foreign observer who arrived in Jakarta only yesterday. Such innocent people are unaware of the prevalence of illegal fees and collusion which are part of Indonesia's politico-business tradition, a lethal virus that kills Indonesia's competitiveness in the world market.

The trouble with this high-profile leap is that Megawati is neither an economist nor a market-friendly politician, who would otherwise refuse to create unnecessary jolts in the economy. And this she did, successfully.

Political and economic observers alike are now wondering whether the President was sufficiently advised before approving the move to hike electricity and phone rates and raise domestic fuel prices at the wrong time, a move that could only be greeted by demonstrations all over Indonesia.

In order to understand precisely what is happening, one needs to trace the domain from which the price hike decision originated. The bottom line is that the government does not have enough in its treasury to feed the bureaucracy and run the state administration. Foreign aid has, for years, constituted a significant portion of the State Budget while the real-sector economy has had difficulty moving forward due to the collapse of the banking sector in 1998.

Banks have now regained confidence following the injection of trillions of rupiah in government bonds but, alas, those alternative investment instruments now comprise a majority of the banking industry's assets instead of performing credits.

At a time when political risk is still high and uncertainty over the continuity of the national leadership looms large, banks prefer to invest in such alternatives rather than channel their loans to the real sector.

One recent example of a tragic policy causing this kind of unfortunate trend was evident at the end of December 2002 and the beginning of January 2003.

Bank Indonesia (BI), the central bank, had announced significant reductions in interest rates by the end of 2002. Bank Indonesia sliced the interest rates on its SBI bonds to 11 to 12 percent and envisaged its M1 to stand at only Rp 138.2 trillion by the end of 2003.

This would have been a very good signal, actually, for business actors to get fresh loans from banks to finance new or expansion projects, if the Cabinet had refrained from killing the optimism.

Only a day after Bank Indonesia had announced its interest rate reductions, however, the government dropped its bombshell on the economy. It hiked public utility rates and the domestic selling prices of fuel, thereby destroying the little spark of optimism that Bank Indonesia had painfully initiated for the revival of the business sector.

How? The frustrated government issued at least Rp 2 trillion worth of T-bonds -- not for the general public and business sector in general -- but for the banking sector again. The fact is that 68 percent of the T-bonds went into the banking industry's portfolios. In addition, the government plans to issue a further Rp 7 trillion worth of such bonds in the near future to generate funds for its treasury. Again, banks would feast on the godsend opportunity to collect more revenue, forgetting their intermediary role in the process.

Worse, the price hike decision vindicates the banking industry's assumption that it is useless to channel credit to the real sector, because industries are now having difficulty surviving and are therefore unable to come up with feasible project proposals.

The biggest irony in Indonesia is that President Megawati's Cabinet is going against the direction that Bank Indonesia is taking. Never before has there been such a tragic collision between fiscal and monetary policies in this country.

Why should banks force themselves to give out loans at a time when there are better and more convincing sources of easy revenue, i.e., government bonds? Why would they perform an intermediary role to feed real-sector industries at a time when the industries themselves are crippled by the extra burden created by increased utility rates and fuel prices? Who could guarantee that the real-sector actors would even be able to complete their own projects, if they should obtain bank loans at a time when political uncertainty continues to grip the nation?

The blunder created by the widely protested decision to raise fuel prices and utility rates is that the government is actually attacking itself. It wants the banking sector to fuel real-sector industries, and to achieve that goal, it has only shown the banks a direction opposite from that in which the banks had been traveling.

It wants real-sector industries to create new employment opportunities to accommodate over 40 million jobless citizens, and to achieve that goal it has only crippled the industries by causing unnecessary increases in their production costs, to the extent that many of them may have to dismiss their workers.

One clear example of the government's lack of sensitivity towards public frustrations is its strange policy to reduce excises on non-clove cigarettes produced by foreign companies, which contribute only 10 percent of total government receipts from the cigarette industry, while producers of clove-blended cigarettes who employ millions of people on their production lines are denied the privilege.

With all these unfortunate developments gripping the nation, are there sufficient reasons for President Megawati to build hopes of occupying the Palace beyond 2004?