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.