Indonesia to keep on muddling through in the next few years

Indonesia to keep on muddling through in the next few years

Dr. Hal Hill is a professor of Southeast Asian Economics,
convener of Southeast Asian Economies Program at the Economics
Division, Research School of Pacific and Asian Studies (RPAS) at
the Australian National University.

He teaches Southeast Asian economic policy and development.
His recent publications are, Indonesia's New Order: The Dynamics
of Socio-Economics Transformation (1994), The Indonesian Economy
since 1966 (1996) and Indonesia's Industrial Transformation
(1997).

Below is an excerpt of a telephone interview with him
conducted by The Jakarta Post's Melbourne-based contributor Dewi
Anggraeni, on the state of Indonesia's economy and its prospects.

Question: You have published at least three books on the
Indonesian economy, in which you project Indonesia as Southeast
Asia's emerging giant and extol the industrial transformation.
What happened then?

Answer: It might be worth making the point somewhere that it
is hard to think of any other country that has experienced such
an extraordinary fluctuation in its economic fortune as
Indonesia.

If you think back to the early and mid 1960s, Indonesia's
economy was in a terrible state. Quite catastrophic in fact.
Benjamin Higgins in his book called Indonesia a "chronic
dropout". It had a couple of good years then it was wiped away
quickly. Then a couple of decades later, in 1993 the World Bank
was calling it "a miracle".

And in 1997 to 1998, Indonesia experienced by far the sharpest
economic crisis of all the crises in the region. Coming out of
the crisis, it is also the slowest to recover. So it has had a
roller-coaster ride in the last four decades, and it's hard to
think of any other country that has had such an experience.

Q: If it collapsed so easily, was the growth Indonesia
experienced genuine?

A: I think it was genuine growth. What I am going to say might be
politically incorrect, but I think for much of the Soeharto
period, Indonesia had a broad-based and sustainable economic
development.

It seems to me that if Soeharto had stood down in the early
1990s, he would have been remembered as one of the great leaders
of the 20th century, in terms of economic development. Obviously
in terms of human rights, political freedom and democratic
process, he wouldn't have scored so well.

In the first 25 years of his rule, he did preside over a
really important socioeconomic transformation on the Indonesian
economy. And it is not just economic growth.

It is important to emphasize that this was fairly broad-based.
If you look at all the indicators which we think were important
for development, there were financial improvements.

In education, in health, in poverty reduction. In virtually
every indicator, it was really an impressive record. So the first
25-year record was quite good. And it was mainly in the 1990s
that the record was eventually undone.

Q: So where do you put the blame for the crisis?

A: This is a very good question and everyone is debating it
endlessly. It was by and large unexpected. Nobody really saw it
coming. The International Monetary Fund, the World Bank, most
economic analysts did not. Certainly financial markets did not.
And there was no one single explanation for it. Different people
have different theories.

Some say corruption, collusion and nepotism or the KKN factor,
some say the greedy Soeharto regime, others say international
capitalism, George Soros and the like.

No one single factor is adequate. The key to understanding it
was the coincidence on at least four or five factors that were
happening at once.

Q: You mean the political crisis had an important role in it as
well? But the economic crisis hit in 1997 and the political
unraveling did not really begin until 1998.

A: It should be considered that Soeharto's legitimacy rested on
his government's economic performance. You couldn't really say
that he had widespread support through the ballot box. So as the
economy began to unravel, all the other grievances quickly began
to surface.

And really, only as long as the economy performed well was it
possible to push those grievances aside. It is interesting to
compare the mid 1980s with the late 1990s.

In the mid 1980s there was a very serious crisis caused by the
crash of the oil prices, yet Indonesia came out of it quite
successfully. And when you think about it almost every major
parameter was largely positive in the mid 1980s and largely
negative in the late 1990s.

The international donors were mostly behind Indonesia in the
mid 1980s, yet they split rather publicly in the late 1990s.
Soeharto and the technocrats were largely in control in the mid
1980s, while in the late 1990s they had almost been pushed aside.

Q: Did the international donors and investors give credence to
Soeharto or to Prof. Widjojo Nitisastro's team?

A: To both. The fact that the team was largely in control,
Soeharto's regime was thereby enhanced. Whereas by in 1997 to
1998, most of the team had been pushed aside. Unfortunately, in
the key economic policy area, they couldn't have the cohesion or
the international recognition that they'd had earlier on.

The other important aspect to compare in the mid 1980s and the
late 1990s was that the kind of rent seeking and KKN in the mid
1980s were much more amenable to direct control than in the late
1990s. The roles of the Soeharto's children were hardly in
existence in the mid 1980s. The main opposition to reform then
was from the bureaucracy and the state enterprises. They were
easily pushed aside.

By 1997-1998 there was a different kind of business sector
altogether. So even if we know that Indonesia has had problems
with corruption for 30 years or more, the KKN factor only became
crucial in the 1990s. It was no longer so much corruption as
being on the take for money as such, but it was a corruption of
economic policy making political processes, hence the inability
to reform on the spot.

Q: So it was also pushed by Soeharto's own deterioration in the
1990s?

A: Yes, it was. If you think about the mid 1980s, when the oil
crisis hit hard, there was a prompt and effective response,
whereby in the six months from October 1997 to April 1998, in
every turn there was a major mistake made. I think that was the
key contrast.

The other important point is, of course, during the 1980s and
before Indonesia had quite large debts, but they were almost all
long-term official debts to different international agencies and
countries. In the late 1990s most of the debts were actually in
the private sector, therefore they became much more unpredictable
and much more difficult to manage.

Q: If we come back to the present time, foreign investors are
still keeping a distance from Indonesia. Some say they do not
like the political instability. Do you agree?

A: Yes. If you look at most East Asian crisis, with the exception
of the Philippines, and to some extent Thailand, foreign
investments came back quite quickly. In Indonesia they haven't. I
suspect they will not for quite a long time, until the political
situation becomes more predictable, and until they see a little
more progress with the debt workout through the Indonesian Bank
Restructuring Agency.

In the next few years, I suspect, one of the big challenges
will be to find a way of separating the economic and commercial
world from the political world.

The next few years will most likely see continuous political
uncertainties, so there has to be some mechanism that will
protect the economy from the political upheavals. Otherwise
Indonesia's economy will be stunted as a result.

Q: How come they were able to do that in Korea and Thailand?

A: It is interesting to look at countries where they successfully
delinked the economy from the politics. The two countries which
come to mind would be Thailand before the mid 1990s, and Italy.
Both Italy and Thailand, postwar, have done very well, most of
the time. And both countries have had very frequent political
changes.

The secret is, there has to be an assurance that the economic
policy parameters are going to be largely undisturbed by the
political instability. We know that was the case in Thailand. For
a long time they have had very strong institutions, such as the
Bank of Thailand, their central bank and the Ministry of Finance.

Politicians and governments could come and go, but these able
technocratic institutions were essentially running the economy
very well, independent of the government. So there needs to be
economic policy predictability.

Indonesia needs strengthened bureaucracies in some of the key
areas, especially in National Development Planning Agency
(Bappenas), Bank Indonesia and Ministry of Finance.

At the moment in Indonesia, not only is there political
instability, but also institutional demoralization and
unpredictability. So you need to put on a cordon sanitaire around
these core economic institutions.

Q: So the President's tendency to intervene in all sectors does
not help?

A: No, certainly not. It would be good if he could a find a way
of protecting these departments. The evidence so far is that it
is not happening. Indonesia has been moving along those lines,
towards having strong institutions. But my impression is that it
has been largely unraveled in the past two or three years.

Q: The Consultative Group on Indonesia has approved US$4.8
billion new loan and a US$500 million grant to Indonesia. In the
meantime, the old loans are still not performing. According to
the state budget projections for the next year, there will be a
Rp 52 trillion deficit. Will Indonesia sink further and further
into debt?

A: Yes, it will sink further into debt.

Q: In the short term or long term?

A: You have to look at this in the short term and in the long
term.

Short term tends to dominate our thinking. And in the short
term things are going to be very difficult. There are so many
things to tackle.

That is an obvious weakness in retrospect, of the Soeharto
regime. It didn't prepare the country for the challenges which
they suddenly have when they have this massive political
transformation and institutional challenges.

On the particular issues of overseas aid and debts,
Indonesia's public debt is going to increase, there is no way
around that. Partly because the government has a particularly
conservative fiscal policy. It began to run a deficit in 1998 for
an entirely commendable reason that if the economy collapsed then
they would need a kind of fiscal stimulus to try to revive it.
That made sense in 1998-1999, simply because the debt was almost
entirely funded by foreign aid.

The challenge now is going to be, to get back to the old days
of being rather more cautious fiscally, of not adding to the
debt. In the next couple of years, it is going to be manageable.
Indonesia can expect to get a high level of foreign aid, some of
it in loans with low interest rates, some in grants. But that can
only help in the short term.

Beyond 2002 things will have to change. The longer term,
unfortunately is going to begin pretty quickly. Things are going
to get very tight. There needs to be a much more clever, much
more efficient government. Social services will have to be
targeted to those who really need them. The rich are going to pay
their way in taxes, because by and large they haven't done that.

Indiscriminate subsidies like electricity subsidies will have
to be reduced, maintaining them just for those who really need
them. So the government will face big tasks, there is no other
way but to address them.

It is going to be complicated by the fact that somehow a lot
of private debt is going to be, in a sense, assumed by the
government, and we know that a lot of this debt will not be
compensated. So the government is going to be picking some of the
damage from it.

Q: And paying interest on the bonds?

A: That is right, which effectively will translate into an
increase of public sector debt.

However, it does not matter that much, provided they have
recovery. The real danger is, since the foreign investors are
going to stay away, Indonesia is not going to have a durable
economic recovery, and will be left with these large debts. That
is why economic recovery is the key.

Q: Does it have to depend on foreign investment?

A: If there is enough national savings, it does not have to. But
the experience of other developing countries in a similar
situation is that they do need foreign investment to supplement
the shortfall.

There are various kinds of foreign investment, long term PMA
(foreign investment), short-term portfolio investment, then long-
term debt. It seems to me that Indonesia does need long-term PMA
or long-term debt. Whether Indonesia needs the short-term
portfolio investment is debatable.

In the next couple of years, it is probably going to be
Indonesian investment. I expect a lot of the Indonesian capital
that went out (of the country) in 1997, is going to return in
some way as foreign capital, because it is going to be somewhat
protected by having a foreign capital form.

Q: So what do you personally think will happen?

A: I think Indonesia is going to muddle through in the next few
years. It is going to be buffeted by this constant political
uncertainty. The general economic policies, I suspect, won't be
too bad. If you've got inflation under control, fiscal policy is
more or less under control, if you have a fairly open economy,
which Indonesia has, you can actually do quite well.

It is going to be a mixed picture, but it will muddle through.
It won't go back to the halcyon days of 7 percent or 8 percent
growth for a while. Probably 5 percent. People will have to lower
their expectations.

Q: As you know legal certainty is very important for business
entrepreneurs, as they would be reluctant to conduct any business
if they were not confident of the protection provided by the law...

A: In Indonesia the law seems to have been used selectively in
protecting certain business interests, such as in the cases of
Tommy Soeharto and Bank Bali. Can you comment on this?

The way I see it is, Indonesia's legal structure is extremely
complex with a mixture of Dutch law and adat (traditional) law,
sometimes sitting uncomfortably together.

As a result, the courts have been used rather daringly. They
are unpredictable in their outcomes, often of course rather
corrupt.

In the Soeharto period, the legal system became defined by the
connections one had in a legal case. So those who were connected
to the Soeharto family for instance, were more sure of an
outcome. Then suddenly there was a dramatic political change in
1998-1999, the beginning of an evolution toward a modern system.

I believe the process will take years to start to take effect.
In the meantime Indonesia is going to be faced with a very
uncertain legal system, not only in a political sense, but also
in a commercial and economic sense.

If this uncertainty continues, and legal cases have very
uncertain outcomes, the implementation of those cases is going to
be unpredictable. So the Tommy Soeharto, Texmaco and Bank Bali
cases have to be seen in this light. This will be a pattern for
quite a long time.

Q: There are indications that government intervention still
occurs. Do you think that will go on for a while?

A: There is no doubt. It is intervention not just in the cases
themselves, but also in the follow up of the cases. Even if there
is a finely developed legal system, but no capacity by the police
to implement it, then the legal system is not all that useful.

I think it will take a long time before Indonesia has legal
predictability. Then the danger is people overloading the legal
system with expectations they cannot deliver.

Q: How will this unpredictability have an impact on business
investments?

A: I think Indonesia will be seen as a somewhat risky country.
Unfortunately, unlike in the Soeharto era, the rules of the game
are somewhat much more uncertain. At least under Soeharto there
was a kind of predictability in the operation of the legal
system.

What may happen now is that investors, both foreign and
domestic, will build in substantial risk premiums when they make
their business calculations. Unfortunately that is going to have
an impact on Indonesia. It will only attract investors who have
short-term orientations.

It is also important to note that in the whole question of
property rights and land tenure, especially for mining companies,
there is an added dimension, because investors will have to see
the situation not only at a national level, but much more on a
provincial level. They are uncertain about how to handle the
problems with illegal miners, for example.

Q: Will it make Indonesia immensely uncompetitive?

A: Probably not immensely uncompetitive, but certainly it is a
negative factor in the perception of investors. It makes
Indonesia far less attractive than countries with more legal
predictability.