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.