Is it time to bid goodbye to the IMF?

Wed, 16 Apr 2003, 00:00 WIB

Many people are unaware of the fact that the current
International Monetary Fund (IMF) program in Indonesia ends on
Dec. 31 this year and cannot, under the rules of the IMF, be
extended.
It is actually up to Indonesia to request a new arrangement if it
so desires. The choice for Indonesia is to decide on whether it
still needs the exceptional international support a special IMF
program provides. The decision on whether or not to do so and
the steps the government must take in support of that decision
will have a major impact on Indonesia's medium and long-term
economic future.
While there has been a great deal of public comment, particularly
from officials who dealt unsuccessfully with the fund in previous
governments, that the program should not be renewed, there has
been little discussion of the pros and cons of not doing so.
Even if one accepts the arguments of IMF critics like Joseph
Stiglitz and Kwik Kian Gie (which I do not) that IMF policies
somehow caused or exacerbated Indonesia's financial crisis in
late 1997, the cooperation with the Megawati government has been
exemplary over the past 18 months, much to Indonesia's benefit.
The major criticism seems to be that an IMF program forces
Indonesia to follow inappropriate economic policies in trying to
meet the standards set by the fund so it can approve balance of
payments support program. This criticism seems to be short on
specifics and long on emotion, the major emotion being that it is
inappropriate for any non-Indonesian institutions to have so much
influence on the country's economic policy.
On the other hand, one of the major benefits of having Indonesia
involved in a program with the fund is the credibility the
execution of an IMD program brings to the country in its
relations with third parties like the members of the Paris Club,
negotiating program aid with Consultative Group on Indonesia
(CGI) member countries or seeking to improve its international
credit rating with groups like Moody's, S&P and Fitch.
The market is reacting cautiously to Indonesia's potential exit
from the program. One reason rating agencies and the market in
general tend to look favorably upon the country that it is
seriously trying to implement a program in cooperation with the
IMF is the notion there is a "corridor" of acceptable policies
that the government's financial officials are limited to, and
thus it is very unlikely that damaging policies will be put in
place.
There are many who believe that the existence of a program with
the IMF provides an extremely useful policy framework and
analytical support. External evaluation of the government's
budget and the policies through which the budget revenues and
expenditures are established provides good discipline in budget
development and policy implementation.
It also provides economic and financial professionals with
expertise to support their personnel in debates with politicians
over programs that may be politically attractive but financially
disruptive.
The policy framework argument is, of course, one of the most
hotly debated and politically sensitive aspects of an IMF program
in any country. There are, however, also serious financial
considerations which are more easily quantified and subjected to
objective evaluation.
In Indonesia's case, this immediately relates to the Paris Club
which will provide external finance of over US$3 billion in 2003.
This is equivalent to about 20 percent of non-interest current
spending. The Paris Club relies heavily on the imprimatur of the
IMF in deciding the terms under which it will provide this
funding. If there is no IMF program, there will be no Paris
Club, so the financial planners have to ask themselves how they
will replace this $3 billion in 2004.
If this money cannot be replaced, what would be cut from the
budget? This is not an easy question because Indonesia's budget
is already relatively austere even though it provides a deficit
equal to nearly 2 percent of GDP. There is really no room to
increase this deficit. The target for this year is 1.8 percent
of GDP and 1.3 percent next year.
These targets will not be easy to meet in an economy which is not
yet operating at full capacity. One can argue that the budget
needs to give some support to demand so it will be virtually
impossible to eliminate the deficit in the next several years.
If in 2004, an election year, the government were to set a fiscal
deficit target of about 1 percent of GDP as its target, it would
probably have to implement tax increases or spending reductions
or some combination of the two equal to about 0.5 percent of GDP.
How can this be done in an election year when both tax hikes and
subsidy reductions will be extremely difficult to accomplish?
Indonesia can still turn to the CGI but even here there are
problems. In 2002, the CGI promised budget support of about Rp
33 trillion, of which the government was able to use only Rp 20
trillion. Some of the shortfall in utilization was due to
conditionalities of program financing where financing is offered
in exchange for specific reforms.
In recent years, the government has often been unable to get
policies in place to utilize available funds. These
conditionalities often relate to the passage of legislation in
the House of Representatives which is frequently well beyond the
control of the administration.
A third area often ignored in the public debate on the IMF's
program is the domestic debt market. This is important because
if the government is going to give up the $3 billion of external
finance provided through the Paris Club, then it will need to
raise that much money domestically.
The situation is made even more serious because recapitalization
bonds will start to mature in increasing amounts next year. In
fact, depending on the pace of government buy-back plans this
year, nearly Rp 30 trillion of recap bonds mature next year.
A large amount of this is going to have to be financed in the
domestic bond market. The government planned to start building
this market several years ago but parliament only passed the
government securities law late last year. This enabled the
government to place Rp 2 trillion in bonds very successfully last
December and it plans to place another Rp 7 trillion to Rp 8
trillion this year. The specific amount needed in 2004 is yet to
be determined, but it will be a multiple of this year's figure.
If the government is to have any chance of success of raising
such a large amount of money in the domestic market, it will face
a real market test. The market will ask many questions. Is
macroeconomic policy on track? What is the prospect for
increased inflation? Are reforms going forward? Is new
investment coming in?
In the absence of very clear and positive answers to such
questions, the market will only take this enormous amount of
domestic debt at very high interest rates which could well
destabilize the budget. So if the IMF program is not in place,
the government will have to successfully implement an even more
rigid reform program than it has been committed to, but unable to
implement, in the past several years.
The government might also have to explain to the public of why it
is paying commercial rates for finance when they would be giving
up World Bank and Asian Development Bank (ADB) funding which, at
2 percent, is by far the cheapest money available to Indonesia.
Save for compelling political or policy reasons, the government
should ensure that it is utilizing all other forms of financial
assistance before resorting to these more expensive financial
mechanisms.
Most importantly, will the absence of the IMF program in 2004
threaten the success of the economic reforms and debt reduction
already accomplished?
The worst possible outcome would be for the government to subject
itself unnecessarily to an extremely tight budget with no margin
for error, and then suffer some external shock which it cannot
absorb, causing it to go back to the IMF in a year or 18 months
for a new program.
If this were the case, the credibility the current financial team
has earned by reducing debt, stabilizing the currency, reducing
inflation and lowering interest rate would be lost and prove much
harder to regain.
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