Indonesia in for another year of sluggish growth

Indonesia in for another year of sluggish growth

Vincent Lingga, The Jakarta Post, Jakarta

Indonesia is likely to end its fifth consecutive year of
economic crisis with moderate growth but is in for another
slowdown in expansion in 2003 as the country grapples with
adverse internal factors and an unfavorable external environment.

The nation missed a number of growth opportunities generated
by strengthening political and macroeconomic stability in the
first half of the year, because of lagging policy reforms and an
often adversarial relationships between the House of
Representatives and the executive branch of the government.

The overall condition worsened after the Oct. 12 bomb attacks
in Bali that created a new uncertainty as it revealed the
country's vulnerability to terrorism, increased the country's
risks and, consequently, business risks, and further slowed down
the process of regaining foreign confidence in the economy.

Most analysts predict this year's economic growth (in terms of
real gross domestic product) at 3.2 percent to 3.5 percent, lower
than the government target of 4 percent, or about similar to the
3.3 percent posted in 2001, but much lower than the 4.8 percent
expansion in 2000.

The World Bank is similarly downbeat about economic prospects
in Indonesia. In its latest assessment after the attack, the
World Bank predicted economic expansion of 3.2 percent this year.

The government revised down its growth target from 5 percent
to 4 percent for 2003 after the Bali bomb blast but even this
expansion is considered by most economists as too optimistic.
Most analysts predict the economy will muddle through in 2003 at
this year's moderate pace at the most, unless the government
strengthens its leadership of the reforms with the full support
of the House.

Though the growth is very modest by the country's pre-crisis
performance, some economists still consider the increase
respectable for a country grappling with the complications caused
by its transition from an authoritarian, centralized government
to a democratic, decentralized administration.

However, the expansion is far from enough to cope with the
problems of unemployment and under-employment, which are
currently estimated at 40 million people, let alone to absorb the
2.5 million new job seekers entering the labor market annually.

Nor will an economic expansion of less than 4 percent be able
to significantly reduce the incidence of poverty. Such moderate
growth will ensure the economy remains fragile.

Consumer demand has and will remain the main driver of growth,
especially in 2003 when spending by political parties geared up
for the 2004 election will increase.

The contribution of external demand to growth will, however,
remain weak because the economic upturn in the United States
seems likely to be slower than expected, while Japan will still
be mired in recession and the recovery in Europe will be sluggish
at best.

Economic weaknesses in Latin America will continue to cast a
pall over the emerging markets in Asia while the possibility of
armed conflict in the Middle East threatens to add a further
element of uncertainty.

Worse still, the competitiveness of Indonesian exports, which
is already suffering from adverse business conditions due to
mounting labor strife, inimical regulatory and judicial systems,
inefficient and corrupt customs and tax service and crumbling
infrastructures in many provinces, has further been eroded by
increased security and business risks in the aftermath of the
bomb blast in Bali.

Not much can be expected from private investment spending as
most big business groups are still struggling to restructure
mountains of bad debts while small and medium-scale firms are
hindered by the fragile banking industry.

Mining and agro-based industries, including fisheries and
plantations, which are supposed to be the most promising among
resource-based businesses, are unfortunately embroiled in
complications in the learning process after regional autonomy
implementation in 2001.

Foreign investors will continue to stay away due to the poor
business condition, higher risks and anticipated political
turbulence in the run up to the 2004 general elections.

The most prospective avenue for capital inflow now is the
acquisition of the distressed assets and sale of viable state
companies. But this prospect cannot be fully realized because
narrow-minded politicians often resort to whipping up inordinate
nationalistic sentiment to gain popular support.

Yet more worrisome is that this negative sentiment will likely
continue in 2003 when the national agenda will be highly
politicized before the 2004 election.

Privatization, another alternative to woo capital, will
continue to be debilitated by the lack of government leadership
in gaining political consensus for the program, which is sorely
needed to finance the state budget and improve state companies'
competitiveness.

Strong opposition from vested-interest groups, including
politicians and senior officials who often collude with trade
union leaders to maintain state companies as their cash cows, has
virtually stalled divestment.

The uncertainty about Indonesia's relations with the IMF after
the current extended facility agreement ends in December 2003
will make investors jittery since, in spite of its past mistakes
and shortcomings, this multilateral institution is still an
opinion leader on Indonesia for international creditors.

The international market will most likely feel more
comfortable if Indonesia remains under the oversight of the IMF,
especially in the run up to the 2004 elections when pressure for
more populist policy measures usually mounts.

The end of the IMF program will, however, increase market
confidence if it is based on Indonesia's good policy performance
that enables it to leave the IMF's crisis management unit.

The public sector is not in a financial position either to
pick up the slack in private investment spending. Overburdened
with foreign debts of about $74 billion and a similarly huge sum
in domestic debts, the government has little leeway to provide
stimulus to the economy. Moreover, as business performance will
remain weak at least until 2004, the government cannot
significantly increase tax receipts.

Even though the government has planned to extend its bonds
maturing in 2003 and 2004 through reprofiling programs or the
issuance of treasury bonds, it needs to have a stronger
macroeconomic environment to be able to refinance or restructure
these bonds on market-based terms.

Foreign debt service burdens will again threaten to undermine
its fiscal consolidation in 2004.

Since the Paris Club III agreement rescheduled only foreign
debts and interest payments due by the end of 2003, the
government will have to begin fully servicing its debts maturing
in 2004 and in subsequent years, unless it renegotiates another
rescheduling agreement. But such a deal is contingent upon
Indonesia remaining under the IMF program.

Unless the economy is able to regain annual growth of 5
percent to 6 percent, it will be impossible for the government to
reduce its stocks of debt. Hence, its domestic and foreign debt
service burdens that now already siphon off more than one third
of Indonesia's fiscal revenues will continue to severely limit
the public sector's investment capacity.

Asset recovery and loan restructuring by the Indonesian Bank
Restructuring Agency, the most important instrument created to
manage the economic crisis, have made faster progress, though
often in a controversial style due to allegations of corruption.

Next year will also pose another challenge for Indonesian
businesses as the ASEAN Free Trade Area will start full
operations in January. At a time when most local industrial
companies are already hard hit by higher business risks and
consequently the rising cost of doing business, they will
experience tougher competition from suppliers in Malaysia,
Thailand, Singapore and the Philippines.

Yet still more worrisome is the capability of the customs
service to accurately verify the minimum 40 percent ASEAN
content, the basic requirement to make products traded within
AFTA eligible for the preferential tariff arrangements of 0
percent to 5 percent.

Even now producers of garments, electronics, footwear,
electric appliances and food commodities have been adversely
affected by imports and smuggled products, compelling the
government to roll back its trade liberalization policy by
imposing non-tariff barriers and raising import tariffs.

However, any measures against market mechanisms are vulnerable
to failure and often cause new problems as they provide
discretionary power to government institutions, most of which are
either incompetent or hopelessly corrupt.

All these risks make it even more imperative than ever for the
government to exert a stronger leadership of its structural
reforms to offset the setbacks caused by the impact of the Bali
bomb blasts on political, security and economic stability.

Higher economic growth is urgently needed to reduce poverty
because, as more than half the people still live on the brink of
poverty, even the slightest economic deterioration could plunge
these unfortunates into absolute poverty.

Next year is a crucial moment for attaining stronger
macroeconomic stability before the impending political turbulence
surrounding the 2004 elections.

The risks of political upheaval are high as competition
between political parties (there are now more than 200 parties
registered to take part in the elections) will escalate.

However, a robustly growing economy with stronger
macroeconomic stability will be able to weather the turbulence.
Middle- and high-income earners will likely be more capable of
rationally responding to political campaigners, who may resort to
emotional, narrow-minded themes to gain popular support even at
the cost of the long-term economic good.

Indonesia's major economic events and market performance throughout
2002

Jan. 2: The rupiah ends its first day of trading of the year
at 10,380 against the U.S. dollar, while the Jakarta Composite
Index closes at 383.45 points.

Jan. 29: The International Monetary Fund (IMF) approves the first loan
tranche of the year worth US$341 million for Indonesia, signaling
continued support for the government. The move fails to
significantly lift the Jakarta currency and stock markets.

March 14: The government sells a 51 percent stake in the country's
largest private bank, BCA, which is regarded as a milestone
toward restoring foreign investor confidence in the country.

April 26: The IMF approves a US$347 million loan tranche for Indonesia,
the second of the year, but urges the country to push ahead with
reform warning there is no room for complacency.

Aug. 26: President Megawati Soekarnoputri officially submits to the
House of Representatives the draft 2003 state budget, which
features a sharp cut in subsidies and hikes in tax revenues.

Oct. 12: Massive explosions rock two nightclubs in the country's
popular resort island of Bali, claiming close to 200 lives and
leaving hundreds injured. On the next trading day, the Composite
Index plunged 10.35 percent to 337.48, its lowest level in four
years, while the rupiah dropped 3.55 percent to 9,330

Nov. 8: IBRA sells a controlling 51 percent stake in Bank Niaga to
Malaysia's leading financial group, Commerce Asset-Holding Berhad
(CAHB).

Nov. 27: All factions of the House of Representatives unanimously pass
the government-proposed draft 2002 state budget into law during a
plenary session. The approved budget includes revisions of
various economic assumptions to better reflect the impact of the
Bali bombings.

Dec. 7: The IMF approves its latest loan tranche to the country. The
loan amounts to US$365 million.

Dec. 15: Singapore Technologies Telemedia (STT) is named the winning
bidder for the government's 41.9 percent stake in state-owned
telecommunications firm PT Indosat at a price of Rp 5.6 trillion
(about US$610 million), marking the largest sell-off to date in
the country's privatization drive.

Dec. 23: The rupiah closes at 8,885 per dollar, while the stock index
ends the year on 425.60 points.