Is it soon to be party time in Indonesia?

David J. Green, Country Director ADB Indonesia Resident Mission, Jakarta, dgreen@adb.org

In many circles in Indonesia there is a sense of confidence that has not been present in years. True, the economy is hardly booming at 3 percent-4 percent growth each year and unemployment is unlikely to go down. But the stock market is one of the better performers in Asia, the rupiah has appreciated, inflation is under 10 percent, and money is coming back into the country after years of capital outflow. If this were an American TV situation comedy, someone would yell "party time" and we would fade into a commercial.

It is not quite party time, but there are some reasons for satisfaction -- reasons for looking forward and, in emotional terms at least, leaving some of the ugly experience of the Asian Crisis behind us.

Not convinced? Let's try what we called in school a thought experiment. Suppose we were sitting together 10 months ago and I told you that Indonesia would face a horrific terrorist bombing in Bali that would bring tourism to a halt (at least temporarily), a war in Iraq that would bring thousands of demonstrators to the streets of Jakarta, and an unknown disease that would sweep out of China to scare off travelers in Asia. You would have sold rupiah.

Indonesia has weathered these shocks without serious setback to macroeconomic stabilization. There are some very positive reasons why. The country has garnered a solid track record in fiscal policy. The Minister of Finance doesn't promise to spend more than he has, and usually doesn't even spend what he does have. Fiscal deficits have been smaller repeatedly than budgeted, with the difference easing the debt management problem.

Although the total public debt hasn't shrunk much; because of a growing economy, an appreciating currency, and lower interest rates, the burden of the debt is easier to bear. Monetary policy, after several years of uneven performance, finally appears to be keeping inflation in single digit terms.

Money is coming back, partly because the government is selling solid assets under its privatization program. Indonesia is divesting decades old holdings in plantations and firms as well as the banks and other assets accumulated during the late-1990s Crisis.

So, why not party? For one, life isn't a situation comedy -- there is no commercial break from long-term problems. More importantly, what we are seeing in Indonesia is as much a product of weakness as it is real strength.

Government actions helped insulate Indonesia from the recent shocks -- especially good police work after the terrorist attacks in Bali and astute political maneuvering during the Iraq war. But Indonesia was not buffeted by the recent shocks partly because it was not at risk of capital outflow. After several years of capital outflow there was little room for panic to move markets.

What is happening reflects some real accomplishments, but also a cyclical upturn after a long trough. The bounce in capital markets, in the foreign currency exchange, and in investment behavior is a bounce from the bottom and is not a solid indication that long-term trends are improving.

This is particularly important with respect to investment. Indonesia's growth over the last few years has been in the 3 percent-4 percent range. There is some reason to believe this underestimates real growth by failing to track an informal economy that may be more robust. But there does not seem to be the level of growth needed to create jobs with wages significantly above the poverty level. Growth has been limited because real investment has been almost non-existent. In real terms last year, business spending on plant and equipment was less than 70 percent of the pre-Crisis peak.

It doesn't have to be this way. Indonesia needs to take advantage of this period of "market good will" and take the steps that would bring longer-term growth. Encourage investment by reforming the investment climate -- treat foreign and domestic firms equally, remove unnecessary licensing, minimize scope for corruption in investment incentives, and provide clarity in the business environment in the regions.

Aggressively continue to privatize banks and establish a credible financial sector regulatory agency. Most importantly, look for opportunities to diminish the perception that corruption is present.

I have been told that the agenda above is impossible in an election year. But I disagree. Reforms can be politically attractive. Over the last few years, Indonesia has managed to take difficult actions in difficult times. We are seeing some of the benefits. The key is to take credit for this and make the argument that the next steps are equally good. I think we'll see politicians recognize that good policy is a vote getter.

The opinions expressed are those of the author and do not necessarily represent those of the ADB.