Indonesia commits to economic reforms

Indonesia commits to economic reforms

Reza Y. Siregar examines Indonesia's success with its various
economic reform programs.

From the end of the era of the oil price boom in the early
1980s up to 1994, Indonesia has attempted about 23 economic
reform packages. This, plainly, is an impressive showing of
commitment to economic liberalization. More remarkably, within a
span of five years (1985-1990), roughly 12 reform proposals were
announced and implemented, transforming Indonesia into one of the
most dynamic developing economies in the world. As a result of
these efforts, despite the country's still modest per capita GNP,
Indonesia has been well distinguished as a part of the East Asian
Miracle in the World Bank's 1993 special report.

However, in an April 1995 Economic Conference, commemorating
the country's Golden Jubilee, a number of participants referred
to the phenomenon of "reform fatigue" of the past four years.
From 1991 to 1994, nominal unweighed average tariffs on imports,
for instance, still stood at 20 percent, compared with just over
25 percent tariff reductions implemented between 1989 and 1991.
Therefore, the tariff reductions on more than 6,000 items,
announced on May 23 this year, was a long-awaited deregulation
package, registering another significant move to integrate the
domestic economy with the international economy.

The results of this latest reform move remain to be seen. Yet,
one thing is for sure: the most urgent issue now has to do with
the effectiveness of this reform to tackle the "grassroots" of
the high-cost economy, which has been hampering the
competitiveness of the country. To address this issue, a review
of the achievements of the previous reforms, and an evaluation of
the still-existing obstacles, is necessary.

Most commonly used statistics to highlight the outcome of a
deregulation program are still the growth rates of domestic and
foreign investment in an economy. For Indonesia, the rates of
growth of approved domestic and foreign investment for 1983-1994
were estimated at 245 percent and 860 percent respectively.
Unfortunately, those inspiring numbers fail to address the most
fundamental concern -- how competitive is the domestic market
vis-a-vis the international market after the reforms? To shed
some light on this question, one needs to assess the success of
the deregulation process not in terms of the size of either gross
or net capital inflows, but by the extent to which expected
returns are converged to a competitive level between domestic and
foreign assets/investments of a comparable type.

In a recent study, several comparisons between real interest
rates (nominal minus inflation) offered by the Indonesian
monetary authorities and by its banking sector with the rates of
their counterparts in United States, were made for the period
1984 to 1993. The objectives were to analyze the policy and the
competitiveness of the domestic monetary authorities' and the
country's financial sector respectively. From the findings, it
was apparent that Bank Indonesia has been fully committed to the
international integration of its domestic financial market, which
was clearly evidenced by its spontaneous response in realigning
its rates to adjustments made by the US Federal Reserve over the
past two years.

Interestingly, the findings did not arrive at the same
conclusion for the banking sector rate, represented by the three
month time deposit (TD) rates. The prevailing market rate in
Indonesia's banking sector has not been integrated at all to U.S.
rates, even when the domestic central bank has repeatedly made
efforts to integrate its key rates with Federal Reserve rates.
This outcome is not difficult to understand, given the fact that
these TD rates are strongly affected by numerous changes in
different market fundamentals, especially those of the domestic
sector, in addition to the targets predetermined by the monetary
authorities.

With oil revenues continuing to decline as a percentage of
GDP, the previous deregulations have successfully attracted high
rates of capital into the economy. Yet, the fact remains that the
average spread between the Indonesian real TD rate and its U.S.
counterpart is still large, at about 9 percent for the 1984-1993
period and, presumably, higher for lending rates. Even after
accounting for 3 to 5 percent annual depreciation of the rupiah
against the U.S. dollar, an estimated 4 to 6 percent gap still
prevails per annum. This illustrates the essential problem of
high domestic cost of capital, where more concrete deregulation
packages are urgently needed.

During early reform programs, the authorities had rightly
targeted the macro-financial sector of the economy to swiftly
liberalize and attract required foreign capital and to repatriate
domestic funds. Recent challenges, however, are demanding much
more comprehensive micro/real sector reforms to target existing
high tariff barriers and, more importantly, the practices of
monopoly or other types of market barriers. These grassroots of
imperfectly competitive market structures are inherent
infrastructure problems, which largely explain the speculative
distortions in the economy. Initial research has found that,
surprisingly, more than 90 percent of the variance of the real TD
spreads is generated through this speculative factor.

With respect to the tariff reductions, the May 1995 reform
proposal is undoubtedly an important package. However, it could
also be argued that it is just another "timely-recommended"
package, in terms of meeting recent challenges but lacking long
awaited breakthroughs. This deregulation has guaranteed a gradual
process for the country in its preparations for more competitive
environments as set by APEC and the Asean Free Trade Area. Yet,
some of those vital industries, affecting not only a majority of
the domestic industries but also daily household consumption, are
not included in the list of deregulated items. Without the
political will to seriously address some of these grassroots, any
reform package would only have a marginal effect.

Dr. Reza Y. Siregar is a Fellow at the Institute of Southeast
Asian Studies, Singapore.