Indonesia's inflation culprits

Indonesia's inflation culprits

By Mohammad Sadli

JAKARTA (JP): The Indonesian economy is growing well. The
official figure last year was 7.3 percent, but the Central Bureau
of Statistics has recalculated the time series for the 1988 to
1993 five year development plan with respect to real economic
growth and produced the astonishing figure of an average of 8.3
percent. The previous figure was 7.1 percent.

The same growth figures were used but the base year for
relative prices was shifted from 1983 (earlier time series) to
1993. Such a change in base year is appropriate and legitimate as
time progresses. What influenced the outcome was the fact that
oil prices in 1983 were two times higher than in 1993. What
prices should be regarded as normal now? Those in 1983 or 1993?

For the 1990s, the 1993 prices should definitely be regarded
as normal. But Indonesian economists are still at a loss to
explain the high growth achieved during the five year development
plan. This new average growth figure approaches the performance
of our neighbors, Malaysia (9 to 10 percent a year) and Thailand
(8 to 9 percent), and we know that their higher growth has been
the result of higher savings (over 30 percent of GDP) and
investments. The Indonesian saving rate is estimated at 27
percent and the normal current deficit is 2 to 3 percent of GDP.

A 8.3 percent growth rate with about 30 percent of GDP is
pretty impressive. With an implicit Incremental Capital Output
Ratio (ICOR) -- the ratio of investments over growth in
percentages GDP -- of 3.6. Professor Sumitro Djojohadikusmo and
others have lamented the inefficiency of our investment and
growth process because the then perceived ICOR was well above
four and exceeded five at times.

The trend in this investment-to-growth ratio has declined
since the 1968 to 1973 five year development plan. This period
was one of economic reconstruction and necessary frugality but
those early investments produced an 8 percent growth rate.
Economic growth rates dropped in the second five year development
plan to 7 percent, 6 percent and then 5 percent, although the oil
boom and the Inter-Governmental Group on Indonesia aid -- not yet
burdened by high debt-service payments -- allowed the government
to engage in heavy spending for infrastructure and large scale
industries (steel, refineries and petrochemicals).

Since the middle of the 1980s this investment pattern has
changed drastically. Deregulation made the economy more
competitive and non-oil exports began to grow. Government
investments slowed and private investment soared. Visible
evidence is the skyline along Jl. Sudirman and in Kuningan.

Since the mid 1980s the economy has gained new, structural
strength. The high growth sectors, such as manufacturing and
modern services, are overtaking traditional agriculture (not
horticulture and the new plantations which are growing fast). If
these new sectors hit double digits while the old sectors only
manage 3 percent a year, the overall growth could be in the 8
percent range. Base year prices of 1993 will give the relative
size of the non-oil and non-food sector an additional boost.

Hence, the economy is on a new growth trajectory and can
continue to grow at a speed of 8 percent a year. But the
government appears less confident and has upped the new target
rate for the sixth five year development plan from 6.5 percent a
year to 7.1 percent.

Conservatism is a virtue, but can sometimes mislead policy.
The case of cement is an illustration. The old estimates of
growth of consumption have proven wrong: Too conservative? But
licenses for new investment were given on this basis, in an
effort to protect the industry from over capacity. The results
have been periodic shortages, accentuated by efforts of price
control under inflation.

Everybody was unhappy: the contractors, the public, the House
of Representatives, even the government. And every one had their
own favorite scapegoats: the public and House blamed the poor
conglomerates, the conglomerates blamed the wholesalers and
distributors, the government blamed the speculators, while the
minister of industry at one point confessed that the previous
statistical figures were unreliable.

If the economy really has gained new strength, why is there
often a lack of confidence inside and outside the country?

First, every one was jittery because of the non-oil exports
growth rate decline, primarily for plywood and textiles. On the
other hand, imports kept rising. In June 1995 there was even a
deficit. Structurally, merchandise exports should show a surplus
to compensate for deficit in services. Fortunately, the latest
figures for July indicate a surplus again. Alarmingly the surplus
is shrinking.

The normal current account deficit of US$ 2 to 3 billion will
be exceeded by 100 percent this year. Are lights turning red? Or
only blinking yellow? For a single year, or maybe two, a current
account deficit of US$ 5 billion may not be a sign of impending
danger if it is a reflection of large inflows of productive
investments.

This may well be the case, but the flow of footloose non-
equity funds attracted to "emerging markets" and the high
interest rates in Indonesia give the central bank a big headache.
Because of the completely free foreign exchange regime these
flows cannot be censored and sterilizing them through Bank
Indonesia's Deposit Certificates carry a heavy interest burden,
under which a normal commercial bank would collapse. The large
capital inflows tend to appreciate the rupiah, but on the other
hand the close to ten percent domestic inflation requires
depreciation of the currency to keep non-oil exports competitive.
If Bank Indonesia tries to outsmart the currency speculators it
could put itself into a bind.

High international indebtedness is another source of weakness.
Malaysia, Thailand and even China, can afford larger current
account deficits because they still do not have a high debt
overhang. Indonesia does not have much leeway. The last World
Bank Jakarta office chief economist, Hanson, and the recent
Pacific Economic Cooperation Council conference in Beijing,
warned that Indonesia should control its international debt.

Monetary authorities, the finance minister and the governor of
Bank Indonesia, understand this too well: But what instruments
should be used? The main instrument deployed by Bank Indonesia is
high interest rates, but critics (Mari Pangestu for one) warn of
overuse. On the other hand, even private sector mega-projects are
still sanctioned in high government circles. The proposed 500
meter television tower is the latest example.

External debt management therefore needs real political
commitment and the monetary authorities can't only resort to
traditional monetary policy means; effective arm twisting of the
private sector is also in order.

Lastly, the near double digit inflation is an additional
weakness in the economy. Because the economy is growing fast on
the strength of investments and consumption, the management of
inflation becomes much more crucial. Otherwise pressure on the
balance of payments will assume crisis proportion.

Like in China, where inflation is even higher, the culprit may
be bottlenecks in the system. Some of these are non-physical and
can only be removed by deregulation, although the effect may take
some time. That is why the sooner deregulation is implemented the
better. Food distribution and the agriculture sector should come
first.

The traditional culprit of high inflation is unrestrained
money supply expansion. Money supply should not expand by over 12
percent a year. It has been at 20 percent in Indonesia. The
government's budget already contradicts itself. Therefore the
inflation culprits are the private banks and extra-budgetary
spending.

The writer has been a cabinet minister several times.