Growth with caveat

Growth with caveat

All projections point to continued high growth of the
Indonesian economy. The economic expansion, in terms of real
gross domestic product, is estimated at a range of 7.3-7.5
percent this year and the same robust growth is foreseen for the
next two years.

However, the rosy projections are qualified by notes of
caution. The main caveat is related to the widening deficit of
the current account in the balance of payments. The problem lies
not only in the size of the deficit, which is expected to more
than double from last year's deficit of US$3.4 billion, but also
the underlying developments which have been causing the deficit.

One of the most worrisome trends is the sharp decline in the
merchandise trade surplus due to the steep increase in imports
and the virtually stagnant level of export growth. During the
first seven months, for example, the trade surplus amounted only
to $2.3 billion, or a mere 30 percent of last year's surplus. In
fact, for the month of June, the trade balance, including oil and
natural gas, showed a deficit of $205 million, the first deficit
in the past decade. In the past, the merchandise trade surplus
usually checked the current account deficit at a comfortable
level, despite the big deficit in the service account.

The 30 percent growth of imports would not have caused such
great concern had the import composition remained dominated (with
a 95 percent share) by capital goods and industrial materials as
it had been until 1993. But the import of consumer goods has been
expanding rapidly over the last two years, indicating the rising
demand of the expanding high and middle-income people for a wide
variety of goods not locally produced. We don't expect any
decline on consumer goods imports due to the continued trade
liberalization and the steady increase in the purchasing power of
the middle and top-income people in line with robust economic
growth.

True, as Bank Indonesia's Governor Soedradjad Djiwandono has
stated, the current account deficit, though increasing to twice
last year's level, will still be manageable due to the capital
flows through direct and port-folio investments. But dependence
on portfolio capital is not sound, as shown by the speculative
attack on the rupiah early this year which was set off by the
Mexican financial crisis.

What makes the situation rather delicate is the fact that
there is little chance of curbing the widening deficit within the
next two to three years. Merchandise imports will obviously
continue to increase partly due to the dramatic rise in the sums
of new foreign and domestic investments licensed this year.
Moreover, since most of the export-oriented industrial companies
depend largely on imported basic and intermediate materials,
their imports also will surge along with any expansion in the
production for the export market. The central bank's recent move
to increase banks' reserve requirement from two to three percent
of third-party funds would have only a slightly contractive
impact on domestic aggregate demand. In fact, this measure will
further tighten the money supply, thereby maintaining bank
interest rates at a high level.

The service account, which has always been in deficit, cannot
either be expected to decrease significantly in view of the big
servicing burdens of the official and private-sector foreign
debts and our heavy dependence on foreign freighters. The only
sector that has a realistic chance of curbing the service-account
deficit growth is the tourism industry.

Given the severely limited options for curbing the widening
current account deficit, we should focus attention on export
promotion once again. The fusion of the trade and industry
ministries into a single ministry could help improve coordination
of the export drive. But that is only the first of numerous other
measures essential to bolstering exports. Our problem now is not
only the declining competitive edge of Indonesian export goods
but also the numerous barriers faced by export flows.

Even though a great portion of our growth has so far been
generated by domestic market demand, the call for a more
concerted export promotion has now become much more urgent. A
persistently widening deficit would put our external balance in a
very precarious position, highly vulnerable to devastating
monetary instability, since short-term capital flows, attracted
by the present high interest rate differentials, could suddenly
fly out at the drop of the wildest, most nonsensical rumor.