Jakarta Post Anniversary Article

Jakarta Post Anniversary Article

Is it time to bid goodbye to the IMF?

I was honored and pleased when I was requested to contribute to this special anniversary supplement. I thought I could most usefully take advantage of the space offered to me by commenting on one of the most controversial aspects of Indonesia's efforts to recover from the devastation of the Asian financial crisis, namely Indonesia's relationship with the International Monetary Fund (IMF). The public debate is highly politicized and accurate descriptions of the true nature of the relationship between Indonesia and the IMF are few and far between. I will try to provide such a description here. While many people are aware that the current IMF program in Indonesia ends on Dec. 31 this year, few are aware that, under the rules of the IMF, the program cannot be extended. It is actually up to Indonesia to request a new program if it so desires. Indonesia must decide whether the country 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 that the program should end, particularly from officials who dealt unsuccessfully with the IMF in previous governments, there has been little discussion of the pros and cons of the IMF relationship. 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 government of Megawati Soekarnoputri has been exemplary over the past 18 months, much to Indonesia's benefit. The major criticism today seems to be that the program forces Indonesia to follow inappropriate economic policies in trying to meet the standards set by the IMF so it can approve balance of payments support program. This criticism seems short on specifics and long on emotion, the major emotion being that it is inappropriate for any non- Indonesian institution to have so much influence on the country's economic policy. On the other side of the coin, one of the major benefits of having Indonesia involved in a program with the IMF is the credibility the execution of the program brings to the country in its relations with third parties, like the members of the Paris Club, negotiating program aid with member countries of the Consultative Group on Indonesia (CGI) 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. Many 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 positions in debates with politicians over programs that may be politically attractive but financially disruptive. One reason rating agencies and the market in general tend to look favorably upon a country that it is seriously trying to implement a program in cooperation with the IMF is the notion that the government's financial officials are limited to a "corridor" of acceptable policies, so it is very unlikely that damaging policies will be put in place. 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 US$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 deficit target is 1.8 percent of GDP for this year 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 and is certain to be hurt further by the economic ravages of the SARS epidemic. Nevertheless, 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 of about 1 percent of GDP as its target without a Paris Club agreement, 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 (DPR) which is frequently well beyond the control of the administration. A third area which is often ignored in the public debate on the IMF 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. 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 why it is paying commercial rates for finance when they would be giving up World Bank and ADB money which at 2 percent interest is by far the cheapest money available. Without 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 rates will be lost and much harder to regain. Without an IMF program, a vital safety net is removed. The absence of the program will bring substantial costs and risks that deserve more thoughtful public debate than they have received thus far. The Jakarta Post, as always, will continue to play an important role in facilitating this debate.

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1 James Castle