Indonesia's future economic challenges

This is the first of two articles by Dr. Emil Salim, professor of economics at the University of Indonesia and chairman of the former National Economic Council. The article is based on a presentation at an international conference on Indonesia held last month in Tokyo. The event was hosted by the Ministry of Finance.

TOKYO: Indonesia's development performance in 2000 had an economic growth of close to 5 percent and an inflation rate below 10 percent per annum. This performance was received with pleasant surprise, given the numerous demonstrations, conflicts in the provinces, frequent replacements of Cabinet members, and the tug of war between the President and the legislature.

The first quarter of 2001, however, has raised concern because of the following indicators:

* a sharp depreciation of the rupiah from Rp 7,800 as assumed in the 2001 budget, to Rp 10,250 to the US dollar in March;

* a fall in the composite share index in the capital market;

* the drop of Moody's rating from positive to stable and Standard & Poor's long-term rating from stable to negative;

* the slowdown in major export markets, such as in the United States and Japan and reduced oil prices in the world market;

* increased interest rates, as revealed in one month promissory notes, from 11.5 percent in June 2000 to 15.58 percent in March 2001.

The declining trends shown by these indicators were influenced by economic, social and political factors.

First, the market has sensed strained ties between the International Monetary Fund (IMF) and the government. The review of the implementation of the Letter of Intent scheduled last year has been frequently delayed. It should be possible for agreement to be reached rather soon, however, on the remaining issues:

1. Amendment of the Central Bank Law, specifically on the notion of independence and accountability. There is also the concern that the legislature wants more political control on monetary policy. A panel of four eminent persons has been assigned to assess and review these issues;

2. Fiscal decentralization, which allows local governments to borrow from external as well as domestic sources. With the current huge debt burden, it is irresponsible to allow further borrowing by local governments. A government decree postponing the implementation of foreign borrowing has been issued;

3. The divestment of Bank Central Asia and Bank Niaga, which has been agreed by the government and the House of Representatives. Privatization of state enterprises is also forthcoming;

4. Principles for corporate debt restructuring under the Indonesian Bank Restructuring Agency (IBRA), to create transparency that maximizes recoveries for the government and is applied in a non-discriminatory manner to all large debtors. These are in the process of fine tuning.

With these issues satisfactorily solved, negotiations may resume this April.

A second major issue is the 2001 budget. With the sharp rupiah depreciation and increased interest rate, the budget requirement for debt servicing has increased; likewise spending of activities with foreign exchange components.

Furthermore, the delay until October 2001 in cutting the fuel subsidy requires more spending for subsidies. Also, funds for autonomous districts are apparently insufficient.

Fewer economic activities have dampened initial optimistic estimates of revenue, while the percentage of Indonesian taxpayers is the lowest among countries of the Association of Southeast Asian Nations. In brief, the estimated budget deficit for 2001 of fewer than 3.8 percent of gross domestic product needs further adjustment.

Third, Indonesia is still struggling with weak institutional arrangements, such as good governance, law enforcement, implementation of competitive policies, elimination of corruption, collusion, nepotism, etc. Quite a number of the bankruptcy cases submitted by foreign firms to the commercial courts have failed to receive fair and honest hearings. The Minister of Justice and Human Rights is aware about this situation and has replaced several judges.

Fourth, the issue of security becomes increasingly important as seriously demonstrated by the temporary closure of ExxonMobil's production facilities in Aceh. A number of other foreign mining companies are also complaining about lax security in the field.

Wildcat strikes, more demands for land compensation that were settled years ago, and thefts of mining equipment in the open are disturbing mining operations. There is the impression that responsibility for security has been shifted by the central to local governments -- while local administrations still expect the central government to take responsibility.

Fifth, decentralization of economic decision-making to the regions is politically desirable but economically difficult. The rules on fiscal responsibilities need to be intensively introduced. Most local governments complain about the lack of funds and are therefore eager to introduce local income sources. The risk of fragmenting the provinces into individual economic compartments are high and real.

In the past, too much emphasis was placed on taxation by central government, to be distributed later to the regions as subsidies, which the regions considered unfair. The central government is now suffering a backlash, as local administrations are shifting many budgeted spending items to the center while claiming more revenues for themselves.

Centralized management by a strong central government was initially justified for creating and assuring unity in a country that stretches the equivalent distance as from London to Egypt. However when unity is stressed too long at the expense of diversity, the reaction of the regions becomes stronger and stronger, until it bursts into the open and releases the energy for demanding freedom.

Decentralization then becomes important. This brings us to the social factors behind declining economic performance.