IMF injection wrong medicine for RI

By Laksamana Sukardi

This is the second of two articles based on a paper presented at a "power breakfast" meeting organized by the International Advertising Association at the Hilton Executive Club on Nov. 21, 1997 in Jakarta.

JAKARTA: The IMF arrived quickly on the scene to rescue the economy. The Indonesian problem, however, is very different from the typical set of problems that the IMF is supposed to solve.

The usual target of the IMF is a government which has financed its budget deficit by printing money at the central bank, which in turn results in high inflation, a currency crisis, and the draining of foreign exchange reserves. Given such a crisis, the IMF generally recommends a contraction of the economy to reduce inflation, the currency is stabilized, and foreign exchange reserves replenished.

Indonesia is not the same. Basically, Indonesia is not experiencing a budget deficit or inflation, and foreign exchange reserves are manageable.

The economic crisis in Indonesia stemmed more from massive private sector short-term debt which was disbursed to speculative non-export sectors.

This resulted in reduced competitiveness of our export goods. Compounding the problem is the fact that Indonesia's exports fail to compete in the global market, in which China is the leader, because of the impact of rising labor costs and the high-cost economy.

The lack of competitiveness, coupled with falling demand for Indonesian products, has reduced the volume of exports. The only way to make the Indonesian economy competitive is to depreciate the exchange rate of the rupiah against the US dollar.

However, a weakened rupiah causes tremendous problems for the private sector, which bears a very heavy load of foreign debt that will be increasingly difficult to service.

Indonesia urgently needs to increase its competitiveness by eliminating its high cost economy and allowing the rupiah to free-float downward. In this way, production costs will drop and exports will rise, so generating foreign exchange which can be used to pay off maturing foreign debt.

Other benefits if Indonesia allows a floating exchange rate for the rupiah are: (1) our foreign exchange reserve will be preserved and not used in a vain attempt to stabilize the rupiah exchange rate by intervening in the financial market; and (2) Bank Indonesia will not need to increase rupiah interest rates to unreasonable levels. It is ironic that the IMF has set Indonesian economic growth at only 3 percent in 1998. This means the IMF is requiring a contraction of the money supply and very limited bank credit expansion.

In fact, the IMF is encouraging bank closures as one effort to restore confidence. But a large scale closure of banks will result in a crisis of confidence instead of restoring it because: (1) the liquidity structure of the Indonesian banking system is very shaky due to the common practice of mismatching assets and unreasonably large liabilities (short-term funds to finance long- term loans -- a practice which stems from the non-existence of a long-term funds market); and (2) very weak law enforcement due to the lack of an independent and impartial legal system. These two determining factors will undoubtedly lead to mass liquidation, resulting in a nation-wide bank liquidity crisis in Indonesia.

The liquidation problem, moreover, will not be settled promptly, but will take years to resolve.

In contrast to the typical IMF case, Indonesia actually needs stable -- or even slightly expansionist -- monetary and fiscal policies to counter-balance the decline in foreign loans.

Interest rates would rise, but only temporarily, and they would not soar to the current outrageously high levels. Strengthening the banking industry should not be accomplished by hasty bank closures, but by pushing weak banks to merge with healthy ones and by pushing the banks to raise their capital base. In the Indonesian case, the majority of owners of the liquidated banks have not gone bankrupt, but are still considered to be very wealthy individuals.

Actually, the liquidated banks could have been rescued by the shareholders who have enormous personal assets. The shareholders were willing to use their assets to reimburse the loans which had been disbursed to them personally.

This confirms that the real problem faced by the Indonesian banking system is a very poor law enforcement system.

Inasmuch as the fundamentals of the Indonesian economy are still considered sound, what is needed is an increase in competitiveness and a rescheduling of foreign debt, so we are able to gradually reduce the level of foreign debt.

The economic crisis in Indonesia is truly the result of a series of policy blunders which occurred due to the systemic and structural impediments which make it impossible to enact prudent economic policies.

Indonesia's economic problems will not be solved until the decision-making process is substantially less influenced by vested interests, nepotism, and lack of "transparency".

The most troubling aspect of the IMF aid package is that the program does not touch the core problems which are responsible for causing the crisis of confidence.

The size of the rescue package has been touted, while little attention has been given to the inability of management to produce sound economic policy, free from nepotism and vested interests.

The additional aid granted by the IMF will add to Indonesia's already perilous foreign debt burden -- which reached US$ 135 billion in early 1997 -- $ 60 billion in government debt, and $ 75 billion in private sector debt.

If Indonesia uses the US$ 10 billion IMF standby facilities in 1998, total foreign debt stock as a percentage of GDP will rise to over 70 percent. This is extremely high compared to the 1995 ratios of other MBA countries such as Brazil, Mexico and Argentina that experienced economic crises and defaulted on their foreign debt payments.

At that time, debt as a percentage of GDP rose to 23 percent in Brazil, 66 percent in Mexico and 35 percent in Argentina.

The income per capita of those MBA nations was much higher at that time than that of Indonesia (Brazil = US$ 3,640 / Mexico = US$ 3,320 / Argentina = US$ 8,030).

The Debt Service Ratio (DSR) in Indonesia in 1998 is projected to reach 42 percent, which is a threatening level that exceeds the prudential limit ratio.

Consequently, Indonesia will be unable to use the stand by facilities provided by the IMF.

The immense commitment on the part of the IMF will serve only to help increase confidence in the Indonesian economy. What Indonesia needs now is stable economic growth, even slight expansion backed by monetary and fiscal policy.

The Indonesian economy must grow by 5 percent per year to be able to provide jobs to an additional 2.6 million new workers entering the labor market each year.

The high rate of new entrants into the work force is due to the fact that 58 percent of Indonesia's 200 million population are under the age of 25.

Indonesia desperately needs to create the infrastructure and a system capable of facilitating a transparent, institutionalized decision-making process.

This is imperative if Indonesia is going to introduce sound macroeconomic management and policies. The severe economic downturn and the dramatic reversal of fortunes were caused by a series of policy missteps.

The decision to bring in the IMF was aimed primarily at luring foreign investors, shoring up market confidence, and overcoming the resistance of vested interests to structural economic reform.

However, the IMF package is tied to orthodox financial conditions, including budget cuts and much slower economic growth, fiscal and monetary contraction and higher interest rates.

The package could very well do more harm than good, transforming a currency crisis into a rip-roaring economic downturn.

Since banks borrow short-term in order to lend long-term, they can be thrown into crisis when a large number of depositors suddenly decide to stage a run on the bank.

If Indonesia is unable to implement structural adjustments, the IMF rescue package will be incapable of restoring confidence.

On a larger scale, the aim of positioning Indonesia as the "circuit breaker" to halt the Asian currency turmoil will fail, and the contagion will spread like wildfire -- and failure to stem the tide in Indonesia will be recognized as the source of instability that threatens the world economy.

The IMF injection is the wrong medicine for Indonesia. Tens of millions of innocent people will suffer from government cutbacks, while those who have reaped enormous benefits from exploiting the system will continue living in the lap of luxury.

Unemployment will skyrocket, creating potential social unrest which could destabilize the political system in Indonesia.

If that happens, it's clear that our only course of action will be to continue living dangerously.

The writer is deputy director of Econit and chief executive officer at ReForm consulting firm, Jakarta.