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.