Letters of Intent frustrate Soeharto to Megawati

M. Sadli, Emeritus Professor of Economics, University of Indonesia, Jakarta

Part 2 of 2

In the end, it was Megawati Soekarnoputri as vice president, who in May, 2001, took an initiative to invite back the International Monetary Fund.

The IMF replied that it was ready to do so on three conditions: First, there should be a review of the government budget for the year 2001; second, the efforts of the government to change Bank Indonesia's Governor, Syahril Sabirin, should be reconsidered in respect to the Law upholding the independence of the central bank; and third, the idea of assets backed securitization should be discarded. Then vice president Megawati succeeded with the cooperation of the legislature, and Anoop Singh of the IMF came in June 2001.

On Aug. 27 this year a new Letter of Intent was signed. The environment was more friendly this time because Megawati was President and the new economic team was much more IMF-friendly.

The IMF also discarded the old "micro-management" approach whereby many items covering a lot of areas were made specific targets with deadlines for execution, in matrix-like time table. The IMF shifted more to "macro (economic) management".

The current IMF program will end in 2002. But the government needs further bilateral debt rescheduling after 2002 through the Paris Club. That requires the country having an IMF program, a current Letter of Intent (LoI) and good relations with the IMF. Hence it is pretty sure that there will be an extension of the IMF program for another three years.

Will the end of such dependence on the IMF occur in the medium term? South Korea and Thailand have graduated out of that. The prospect for Indonesia is still uncertain. Thirty years ago it took from 1967 to 1974, i.e., seven years, to cut this umbilical cord.

Again, upon recommendation of the IMF, the budget deficit is being contracted. From some 5 percent of gross domestic product in 2000, this tolerable deficit is put at 3.7 percent of GDP for 2001 and should go down to 2.5-2.7 percent in 2002. Of this shortfall only one-third could come from net foreign aid.

Gross foreign aid is much bigger but the largest part will go back for repayment of principals. Hence a long round of debt rescheduling is required to lessen the burden of total external debt equal to GDP and more than twice of exports of goods.

In 1969 the country received 30 years of debt rescheduling without amortization costs through the intermediation of Dr. Hermann Abs, a German banker. On top of that, the Paris Club gave seven years grace, the amounts to be added to the last seven years of repayment.

Today the country desperately needs a similar break. The role of the IMF may be important for finding such a resolution, but debts to the multilateral institutions are far more difficult to reschedule or to be accorded forgiveness. For the time being, this major foreign debt overhang is weighing as a heavy albatross around Indonesia's neck.

From a fiscal standpoint there is ample room for improvement of the government budget, but this requires painful measures and a good doses of political will. If and when the large subsidies for domestic fuels and electricity rates can be phased out, the savings can be some 5 percent of GDP.

The prices of kerosene and diesel oil are only a fraction of those in Singapore with the result of extensive smuggling. Domestic tax revenues are also some 4 percent of GDP below what is current in neighboring countries.

Hopefully the high savings rate prevailing in South and East Asian countries can return in Indonesia. That will solve part of the problem, but not quite for the balance of payments gap. That will require return of normal flows of external capital, which is not forthcoming as yet.

At the present time the IMF, World Bank and Asian Development Bank, have still a lot of complaints about unresolved problems with respect to the restructuring of the Indonesian economy.

The old complaint is that so many reforms, committed in LoIs since 1999, are still tepid in execution, such as banking restructuring, privatization of state enterprises, sale of IBRA held assets, overhaul of the judiciary system, and stemming corruption.

Disbursement of Asian Development Bank and Japanese co- financing is being stalled because he passing of new laws to meet conditionalities, like for money laundering and the basic law on the state electricity board, are proceeding very slowly in parliament.

The numerous conditionalities imposed by the multilateral institutions are not quite in line with the political mood and will of the country embroiled in a messy political process towards greater democracy.

That begs the question as to whether the IMF, the World Bank, etc., are severely overasking, or whether such external pressures are constantly needed, but do not expect smooth and expedient accommodation.

All of the required reforms are badly needed, but more time is required for implementation. In the end the IMF has shown flexibility and more patience, but that differs from time to time according to the quality of the government counterpart. With Megawati Soekarnoputri the international goodwill and patience is certainly greater than with B.J. Habibie and Abdurrahman Wahid.

Lastly, with the Bank Indonesia there is also something of a running battle about monetary policies. The IMF regards the management of the volume of base money (amount of money in circulation attributable to the central bank) too lax, resulting in a higher inflation (10 percent per annum and up) than is good for economic recovery.

Bank Indonesia's defense is that it has to accommodate the increase of demand for liquidity as a result of severe depreciation of the rupiah and the consequent rise in import prices and others related. It is kind of a chicken-and-egg phenomenon.

The above was the writer's presentation at the one-day Joint Public Forum on Indonesia. It was held in Singapore on Nov. 1 by Singapore's Institute of Southeast Asian Studies and Jakarta's Centre for Strategic and International Studies.