Inflation the worst problem of the economic crisis

News of the recent pledges of US$6 billion and $7.9 billion in fresh aid from the International Monetary Fund (IMF) and members of the Consultative Group on Indonesia (CGI) respectively failed to substantially strengthen the rupiah. Economist Sri Mulyani Indrawati from the University of Indonesia discusses why and looks to the future for the economy.

Question: Why has the rupiah remained weak to this day?

Answer: The money market should have taken the aid announcements as a good sign for the rupiah, but in fact the announcement had a very small psychological impact and received a very cool reception from the market because many believe the country has lost momentum in its efforts to promote economic recovery.

Indonesia is also considered as having failed to make headway on political reform conducive to establishing a strong platform for economic recovery. There is a feeling that political support for President B.J. Habibie and his government is so thin that he cannot launch an adequate agenda for political and economic reform. Meanwhile, consolidation in the Armed Forces (ABRI) has failed to impress the general public.

Q: Do you think the rupiah will strengthen?

A: Assuming that the demand for dollars decreases in line with declining imports and the rescheduling of official and corporate debt, while at the same time the dollar supply rises as a result of the disbursement of aid from the CGI and the IMF, then we would expect the rupiah to strengthen to about Rp 11,000 to the dollar in August or September. The rupiah may then strengthen further to Rp 10,000 by the end of the year if the banking sector becomes fully operational and exports are rise, providing we have no further political upheavals.

The increase in demand for goods prior to the Idul Fitri holiday early next year and social mobilization ahead of the general election in May might cause the rupiah to weaken again in the first half of 1999.

Q: What do you think about the surge in inflation?

A: High inflation is the most critical problem facing the government. The government will never be able to restore the credibility of the rupiah while inflation continues to rise. High inflation is partly caused by increases in the aggregate demand for goods and services at a time when production and distribution have been disrupted.

Aggregate demand is being increased by Bank Indonesia's monetary expansion policy, which is providing capital (worth about Rp 139 trillion or $10.7 billion) to commercial banks facing liquidity problems, and by the government's expansive budget (with a budget deficit of Rp 127.8 trillion, which will be financed by foreign aid).

Judging from these factors, inflation is likely to reach between 80 percent and 90 percent in 1998.

Q: Do you agree that the recession has yet to bottom out?

A: Indicators like inflation and employment show that the economy has not reached the bottom of the crisis. It's now very difficult for us to stop the economy from deteriorating even further because of the government's negligence when the crisis first broke.

Inflation has the potential to worsen in the coming months because the prices of imported goods have yet to adjust to their projected levels and the government is still providing huge subsidies for fuel, electricity and food consumption. Unemployment is expected to rise until the end of the year, while commercial banks are quite vulnerable to increases in non- performing loans. I think the economy will contract by 15 percent this year and will continue to contract until the first months of 1999 at the earliest.

Q: Do you expect private capital to return to the country?

A: If officials and politicians fail to create a business environment conducive to investment, Indonesia will experience a lost decade marked by sharply rising prices and the absence of synchronization between monetary and fiscal policies.

Q: How do you foresee economic developments in the coming years?

A: If Habibie regains power next year and continues with his current policies he will in all likelihood fail to improve the economy.

Habibie has sent out conflicting signals. For example, he said he would eradicate corruption, collusion and nepotism but he has not introduced any legislation to achieve this end. Abolishing such practices is very important because they are merely the tip of an iceberg of structural problems that include a poor bureaucratic system, an excessively close relationship between the government and business, and the societal role played by the military. These structural problems drove Indonesia into the current crisis. (riz)