Indonesian economy muddles through adverse conditions
By Vincent Lingga The Jakarta Post Jakarta
Indonesia's economy entered 2001 amid heightened political uncertainty, the increasingly erratic leadership of then president Abdurrahman Wahid, a decline in the government's credibility and a weakened global economy.
The government's relationship with the International Monetary Fund (IMF) became prickly after the IMF decided in December 2000 to postpone the third US$400 million disbursement of its extended loan facility due to frequent slippages in promised reform measures and several policy reversals.
The World Bank delivered another blow to the market's already low levels of confidence in the country's economic prospects by deciding in January to slash its annual loan commitment from $1.2 billion to a mere $400 million, citing the government's huge existing debt burden as the main reason for the new lending policy.
However, the real reason was the government's failure to keep up with its reform commitments, particularly those related to the establishment of high fiduciary standards in budget management and procurement systems, and its anti-corruption drive.
The cash-starved government received further punishment in April when the World Bank canceled the disbursement of $300 million in social safety net loans due to what it considered the slow pace of meaningful changes in government institutions and the bureaucratic culture. But what really motivated the cancellation was the Bank's heartfelt concern that the funds would be wasted through corruption.
The nasty combination of a weakening currency, growing budget deficit, increasing inflationary pressures and consequently rising interest rates, along with a slump in exports, stifled the recovery process, which began promisingly in 2000, generating a respectable 4.8 percent growth rate.
Predictably, barely three months into the 2001 fiscal year, official assumptions on key economic indicators, including 5 percent gross domestic product growth, inflation of 7.2 percent, an average rupiah rate of 7,800 to the dollar and the central bank's benchmark interest rate of 11.5 percent, were soon rendered irrelevant.
The government and the House of Representatives eventually agreed in June to revise the key economic assumptions to 3.5 percent GDP growth, an average exchange rate of 9,600 rupiah to the dollar, an average interest rate of 15 percent and a 9.3 percent inflation rate.
The GDP growth rate plunged from 5.2 percent in the last quarter of 2000 to a mere 1.81 percent in the first quarter of 2001, and slowed to 4 percent on a year-on-year basis. As market confidence in the economy worsened, the rupiah crashed to 31- month lows of more than Rp 11,500 to the dollar in April.
As the confrontation between then president Abdurrahman and the House grew more intense between April and June, with Abdurrahman resorting to threats, intimidation and political blackmail in a desperate bid to cling to power, the economy entered what the World Bank described in January as a "muddle through" scenario.
The Central Bureau of Statistics came up with an even gloomier picture for the second quarter, putting GDP growth at 0.09 percent on a quarterly basis and at 3.52 percent on a yearly basis.
Muddle through was precisely what the economy did during the year. A modicum of macroeconomic stability was maintained, but economic hemorrhaging continued to weaken the recovery as most reform measures fell behind schedule.
The economic outlook did not improve significantly even after the nation resolved its political crisis peacefully in late July by electing Megawati Soekarnoputri as the new president and Hamzah Has as her deputy.
The third quarter did record a higher growth rate of 2.38 percent on a quarterly basis and 3.47 percent on a yearly basis, thereby bringing the cumulative expansion during the first three quarters to 3.3 percent. This led to a great deal of optimism that annual growth would likely reach the revised projection of 3.5 percent.
But that growth was still far from the minimum 7 percent expansion needed to absorb the 2.5 to 3 million new job seekers who enter the market annually, not to mention the tens of millions already made jobless by the economic crisis.
Moreover, with annual growth of between just 3.3 and 4 percent, the country may need six or seven years to return to the level it was at prior to 1997, given the 14 percent contraction in 1998, almost zero growth in 1999 and an expansion of 4.8 percent in 2000.
The hopes for a more rapid pace of reform that accompanied the election of the new president were soon dashed, even before the Megawati government passed the traditional honeymoon period of its first 100 days in office.
Despite her unanimous election by the People's Consultative Assembly, and even though her political party was the single largest faction in the House, her government failed to secure full legislative support for accelerating the reform program.
The new government did act quickly to mend ties with the IMF with the signing of a new reform agreement in August, followed in September by the third $400 million loan disbursement, which had been held up since January.
But the IMF's endorsement of the government's reform program failed to restore market confidence, as the core elements of the economic crisis management process remained bogged down in politics.
The House simply failed to comprehend the economic logic of a faster pace of asset recovery and privatization of state companies. It instead harbored a misguided nationalistic sentiment against foreign investors acquiring assets in the country, fearing that foreigners would come to dominate the national economy.
The economic outlook became even gloomier after the Sept.11 terrorist attacks on the United States. The tragedy drove the American economy deeper into recession and consequently further weakened global economic conditions.
The country's economy was abruptly deprived of its main driver, the export market, which together with private consumption had become the engine of Indonesian growth last year.
Worse still, inordinately emotional anti-American street demonstrations in several cities in September and October projected such a horrifying image that Indonesia, for some time, appeared to the outside world to be a country controlled by radical Muslims. Even though the voice of reason eventually prevailed, the damage to Indonesia's image had already been done.
Obviously, not only Americans but also quite a number of other expatriates were scared away. Many importers in the U.S., Indonesia's single largest market, abruptly canceled orders, fearing delivery problems.
Sadly, too, many foreign buyers, who had played a vital role in helping Indonesian exporters gain a foothold in overseas markets, decided to cancel their regular visit programs. Consequently, Indonesian exports, which had began to decline in the first quarter due to the weakening of the U.S. and Japanese economies, suddenly plunged, falling by almost 17 percent in September alone.
Minister of Industry and Trade Rini Soewandi estimated early last month that the country would be lucky to record $42 billion in non-oil exports this year, compared to $47 billion last year.
The worsening levels of market confidence drove the rupiah down further, to almost 11,000 to the dollar in October and November. This exacerbated inflationary pressures, making it even more difficult for the central bank to lower interest rates and rendering the overall economic environment increasingly inimical to sound banking operations.
Significantly cutting interest rates amid the severe depreciation of the rupiah, which was called for by many businesspeople and some analysts, would not only have jacked up inflation but would also have prompted a shift to dollar positions.
Even more worrisome were the government's severe cash-flow problems caused by lower than predicted revenue receipts and higher than budgeted spending programs.
Actual revenues are likely to be well below the official target because asset sales, debt restructuring and privatization of state companies have been much slower than expected due to excessive interference from the House and adverse market conditions.
Worse still, foreign creditors have held up almost $1.7 billion of their $2.6 billion program loans pledged to the 2001 budget due to the government's failure to significantly cut interest rates, combined with its low success rate in meeting reform commitments.
Moreover, actual spending may overshoot the budgeted total because the rupiah rate has been much lower, and interest rates much higher, than the levels assumed by budget forecasts.
Hence, the economy has been deprived of sorely-needed investment as the private sector, burdened with bad debts, cannot provide the necessary stimulus, while foreign investors remain jittery about the country's economic, political and security conditions as well as its legal system.
The banking industry, which had been restructured and recapitalized at a total cost of about $65 billion, is still too weak to significantly expand corporate lending.
There is indeed a lot about the short and medium-term health of the economy that should be cause for concern, especially with the deadweight cost of the public sector's debt overhang, which has reached as much as 120 percent of GDP.
It will therefore be almost impossible for the economy to grow even by a mere 3 percent next year in the absence of a new rescheduling package for foreign debts maturing within the next three years and without speedier asset recovery, corporate debt restructuring and privatization of state companies.
Asset sales and privatization are now the most promising source of the new private capital flows that are needed to restore investor confidence in the economy, in view of the overcapacity present in almost all manufacturing industries. And foreign investment, at least over the next two to three years, will be the lifeblood of economic recovery.
But many reform measures have simply failed to materialize, even under strong pressure from the IMF, World Bank and other foreign creditors, which tie their loans to policy reform.
The greatest lesson the government should draw from this utterly inept performance is that a faster pace of reform is the key to a sustainable economic recovery.
However, reform can be sustained only by a strong consensus between the government and the House and not by the force of foreign aid or loans because reform requires changes in coalitions, in ideas and in interests.