Macroeconomic condition remains fragile

Macroeconomic condition remains fragile

The panel of economists' verdict was unanimous. Indonesia's
economy, deprived of its external locomotive, would likely expand
by only 3.1 percent or, at best, by 4 percent in 2002.

That growth, while still respectable compared to other
countries in East Asia, except China and Vietnam, was
nevertheless far from sufficient to accommodate the 2.5 new job
seekers entering the market every year, not to mention the almost
6 million fully unemployed and 32 million underemployed.

Growth below 5 percent was considered far from adequate to
repair the damages inflicted by the economic contraction of
almost 14 percent in 1998 and zero growth in 1999.

The tasks ahead would not be easy even though the political
condition would be much more stable than during the first seven
months of this year. The reform agenda itself was long and
cumbersome as it had to be implemented in a much more difficult
environment.

Managing the far-reaching damages of the Sept. 11 terrorist
attacks on the United States would impose additional burdens. For
the first time since the onset of the crisis in late 1997, the
huge domestic risks that Indonesia faced have now increased by a
new layer of equally dangerous external risks, with a more
prolonged and deeper downturn in the global economy.

One panelist came with three scenarios of growth (in terms of
gross domestic product) ranging from 3.1 to 4 percent for 2002.
First scenario: GDP growth would reach only 3.1 percent, lower
than the 3.5 percent estimated for this year, if the American
economy contracted by 0.3 percent and the Japanese economy
declined by 1.3 percent, the international oil price hovers at
US$21 per barrel and the rupiah rate against the dollar averaged
10,000.

Second scenario: GDP growth will be 3.4 percent if the U.S.
and Japanese economies were flat with 0.6 percent and 0% percent
growth, respectively, the international oil price averaged $22
per barrel and the rupiah rate against the dollar averaged 9,500.

Third Scenario: GDP growth would reach 4 percent if the
assumptions in the second scenario materialized and the
government could increase its investment by 10 percent in real
terms (adjusted for inflation).

"But I think the best the economy can do next year will be
continuing to muddle through the adverse domestic and external
environment," the panelist added.

All panelists agreed that the unenviable financial situation
the government inherited imposed severe constraints on what could
be realistically achieved. Strong vested interests, weak
institutions, and a turbulent political transition with ill-
defined boundaries between the three branches of government and
the ongoing ambitious decentralization process made the task
unusually difficult.

A too adversarial attitude on the part of the House of
Representatives was blamed for the delay of many reform measures
as legislators had tended to intervene in almost any deal the
government intended to make.

Indonesia's dire economic straits demanded fast decisions on
asset recovery, privatization, legal reforms, civil service and
judicial reform. However, a democratic and decentralized system
required new decision-making procedures that implied a more
complex and demanding environment for policy making.

The panelists shared great concerns about the severe lack of
government funds as its revenues would continue to be much
smaller than its spending, which had risen steeply due largely to
debt service burdens.

The high government indebtedness certainly rendered the
economy highly vulnerable to rupiah and interest rate movements
and severely restricted the government's ability to respond to
new shocks.

"What makes things even more formidably challenging is that
the biggest spending items in the state budget, interest on
domestic debts and installments on foreign debts, are inflexible
in that the expenditures provide no room for retrenchment,"
another panelist noted.

Domestic and foreign debt service burdens alone would take up
Rp 128.5 billion ($12.2 billion) or almost 45 percent of the Rp
289.4 trillion domestic revenues expected next fiscal year. As
the central government personnel costs would total Rp 40.6
trillion, subsidies for fuel and other basic needs Rp 46.6
trillion, grant allocations for the regions Rp 90.3 trillion and
goods procurements Rp 11.5 trillion, there would be a shortfall
of about Rp 28.5 trillion to cover even just the current
spending.

Only proceeds from asset sales, including privatization, and
new foreign loans would enable the government to allocate Rp 47.1
trillion for investment. But this investment budget would be a
mere 4 percent nominal increase from that budgeted this year.
In real terms (adjusted for the 12 percent inflation estimated
for this year), the public sector investment would decline by
about 8 percent.

But even the assumptions of revenues from the asset sales were
highly vulnerable because, for the current fiscal year for
example, only about Rp 3.5 of the Rp 6.5 trillion expected from
privatization could be realized. Worse still, $1.7 billion of the
$2.6 billion in foreign program loans budgeted this year could
not be disbursed due to the government's failure to meet policy
reform targets.

For the next fiscal year, the disbursement of $1.3 billion of
the $3.1 billion in new foreign loans pledged by the Consultative
Group on Indonesia creditors would also be contingent upon policy
performance, an area where the government's performance had
always been poor.

In the absence of any fiscal stimulus, the private sector
investment should become the locomotive. The problem, though, was
that these investors remained jittery about the business
environment in Indonesia due to unstable security conditions and
weak law enforcement.

"No amount of tax holiday and other fiscal incentives will
help woo investments if the risks of doing business in the
country remain unusually high as they are now due to unstable
security condition and law uncertainty," a panelist asserted.

Foreign investors would not bring their money to Indonesia if
rich Indonesians themselves still preferred to park the bulk of
their financial assets overseas.

"Foreign investors usually comment that if your people
themselves are still afraid of bringing their money back to
Indonesia, why should they," one panelist noted.

A conducive investment climate also depended on progress in
bank and corporate debt restructuring, monetary stability and
good governance and smooth fiscal decentralization within a
framework of overall fiscal consolidation.

Macroeconomic performance would remain weak and unstable as
long as the asset sale program and privatization remained at
their current slow pace since the government, notoriously known
for its pervasive corruption and collusive practices, now
controlled or managed almost 80 percent of business and banking
assets.

The panelists also were worried about what they saw as
disharmony between fiscal and monetary management, lambasting the
persistently tight monetary policy imposed by the central bank.

They warned that Bank Indonesia's political independence did
not mean that the central bank was free to design its monetary
policy apart from the fiscal management. They should instead sit
down together to design fiscal and monetary policies in the
direction of mutually agreed objectives.

The recapitalized banks were not yet able to resume financial
intermediation due to the combination of high business risks and
the 17 percent benchmark interest maintained by the central bank
since the middle of this year.

Small and medium-scale enterprises (SMEs) were cited as saving
the economy from total collapse. As most business conglomerates
remained in the hospital that is the Indonesian Bank
Restructuring Agency (IBRA), negotiating their debt
restructuring, SMEs had proven their resilience and flexibility.

They could have expanded more robustly had it not been for the
credit crunch, stifling bureaucratic red tape, regulatory
barriers and an unpredictable policy environment.

One panelist specifically pointed out the discriminatory
treatment still accorded to Indonesian Chinese in spite of the
onset of the reform and democratization era, while their high
entrepreneurial spirit and high propensity to take risks could
have been harnessed to fuel the economic recovery.

"The crisis has crippled only the big conglomerates, while the
SMEs remain alive and kicking. Unfortunately though, the SMEs
owned by Indonesian Chinese continue to face adverse conditions,
such as being harassed by the authorities," the panelist noted.

He questioned how the Indonesian business sector would be able
to survive in the upcoming ASEAN Free Trade Area if the business
environment remained as inimical as it was now.

So all in all, macroeconomic conditions remained highly
vulnerable to risks due to the fragile banking and corporate
sectors and the precarious condition of the government's
finances.

However, a faster pace of asset recovery, corporate and bank
restructuring and privatization, supported by a more stable
security and political condition, would generate a stronger,
sustainable recovery.