IMF may not offer all the answers

By Peter Sheehan and David Ray

MELBOURNE (JP): With the resignation of former president Soeharto and the establishment of the Habibie government, Indonesia has a major opportunity for renewed economic and social progress.

After the suffering which the country has undergone and the substantial nature of the political change that has been brought about by the popular will, Indonesia now has a very high level of international support on which it can draw.

While the new government is faced with many critical decisions, none will be more important than the key choices made in the first week about the economic crisis.

It is essential that the government consider at this time its options for dealing with this crisis, rather than immediately recommitting to the existing International Monetary Fund (IMF) reform package or to negotiations with the IMF of a new package. In particular, recommitting to the existing IMF package will soon lead the Habibie government back into the economic and political problems of recent months.

This is not to dispute in any way the need for most of the reforms in the IMF package, nor the need to deal with global financial markets in a credible way. But many qualified observers, both in Indonesia and in the United States, Europe and Australia, share the view that the IMF package is badly flawed. Nor does the official view that the IMF programs are working elsewhere seem to be correct. For example, the real gross national product (GNP) in South Korea was 5.3 percent lower in the first quarter of 1998 than a year earlier, and is clearly continuing to fall. The new Indonesian government should think very seriously before it takes on board this heavy burden.

There are four main issues to be looked at in this process of reconsideration.

* Many observers believe that a key aspect of Indonesia's economic crisis has been a premature opening to short-term global capital flows, and that some temporary respite from these pressures is necessary for the crisis to be resolved.

There are a number of different ways by which this respite can be achieved: Controls on short-term capital flows and a fixed exchange rate for trade transactions (the regime which was applied in developed countries in the long boom of 1950 to 1973); a dual exchange rate, with different rates for trade transactions and capital flows respectively, and others. These options are worthy of consideration.

* Indonesia's real economy is the key victim of financial crisis.

Production, employment and prices have all been adversely effected by the recent dramatic fall in the rupiah, engendered by Indonesia's prematurely open position in world capital markets.

The current IMF package seeks a number of long-term objectives within the context of a floating exchange rate and open capital markets. It provides little in terms of restimulating the (otherwise healthy and dynamic) real economy in the short run.

Coupled with a fixed exchange rate and capital controls, a comprehensive investment program (a potential minimarshall plan) is required, which draws upon a coordinated effort from international aid institutions, the governments of Australia, Singapore, Japan, the United States and others, and private investors (both local and international). Such a program should have as its main objective the short-run stimulation of the real economy, so that it can continue to provide employment and incomes for Indonesia's large and growing population.

* There is no doubt that continued reform of economic institutions and structures is necessary in Indonesia. But this needs to proceed in a way driven by Indonesian values and in a realistic time frame determined by the Indonesian authorities, rather than one determined by financial markets and their agents.

The new government has the opportunity to put in place a reform timetable which is more realistic and more achievable than that dictated by the IMF in its various packages, and which can garner international support for such a revised timetable.

* Negotiations with international banks are necessary. The dollar-denominated debt held by private firms in Indonesia to international banks and other creditors remains a major constraint on the economy. Removal of this overhang is a vital precondition for economic recovery.

The basic principle behind any government-facilitated resolution of such private-to-private debts should be that the outcome mirrors that which would have occurred through the operation of market forces alone.

Most international banks would have largely written off their debts to private firms in Indonesia, and without official support would be unlikely to recover much of their money. Thus a rapid resolution, on terms favorable to the Indonesian economy, might be achievable as part of a broader package, perhaps with the involvement of the governments of the main creditor countries.

In particular, the Indonesian government should establish an urgent process for consideration of its economic options, drawing in not only leading Indonesian figures but also influential and respected figures from abroad, who have been critical of the IMF approach. Examples of such figures include Joseph Stiglitz, chief economist at the World Bank, Prof. Jeffrey Sachs of the Harvard Institute for International Development, and the governor of the Reserve Bank of Australia, Ian Macfarlane.

The writers are specialists at the Center for Strategic Economic Studies of the Victoria University in Melbourne.