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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James Castle