New hope in Indonesia's economy

Andrew Steer, Country Director Indonesia, The World Bank, Jakarta

This week the government has published its eagerly awaited economic policy package for the next 18 months. This crucial document constitutes the government's policies for the period after the financial assistance of the International Monetary Fund (IMF) runs out in December, and throughout the election year 2004.

The package seems to have been well worth waiting for. It lays out an impressive time-bound program of economic reforms that, if implemented, would ensure continued macroeconomic stability, lower interest rates and risk premiums, and higher investment and growth.

In the words of Minister of Finance Boediono, the package also serves to fill the "credibility gap" that the end of the IMF supported might cause -- especially in an election period, when it is often hard for any government to hold the line on spending. That the package is in the form of a Presidential Instruction to the ministers enhances the standing of the package, and increases the likelihood that it is implemented.

The package aims to achieve three goals: To build on the macroeconomic progress since the crisis of 1998; to further strengthen the financial sector; and to improve the climate for investment. These measures are expected to create jobs, and lead to more exports and growth, and further reductions in poverty.

Macroeconomic management has been Indonesia's strength over the past three years. The budget deficit has declined systematically (from a budgeted 4.8 per cent of gross domestic product in 2000 to a 1.8 percent in 2003), as has public debt (from 100 percent of GDP in 2000 to 72 per cent today), and inflation (from 60 percent in 1998 to around 6 percent today).

The announced policies will continue these trends. This is good news for Indonesia, and good news for the poor. Macroeconomic stability is a precondition for more rapid growth, and the stability achieved since 1999 brought down poverty from 27 percent of all Indonesians to 16 percent.

The aim now is to reduce the fiscal deficit to zero by 2006, and the government debt to GDP to "safe levels" (the state finances law specifies a level below 60 percent of GDP -- equal to the "Maastricht" norms prevalent in the European Union).

Measures to increase efficiency in spending include revised procedures on government procurement, establishment of a separate treasury and a treasury single account, and implementing regulations for budget preparation and government accounting standards. The plan calls for further reductions in untargeted fuel subsidies -- and limiting these to household kerosene, a fuel mainly used by the poor.

The program includes privatization of 10 state enterprises -- an ambitious target for an election year -- and a revamp of the intergovernmental fiscal relations, including limitations on the type of taxes and levies the regions can raise. These taxes have become a major nuisance for businesses, and they have depressed farm-gate prices for agricultural goods. Controlling them is likely to improve business conditions and farmers income.

The financial system was at the center of the 1997-1999 financial crisis, which cost Indonesia cost some Rp 450 trillion (over US$50 billion) in recapitalization bonds. Much remains to be done to restore the function of the financial system as a safe intermediary and financier of growth. Plans for deeper reform include polices to solidify a financial sector safety net, continue bank restructuring, strengthen state bank governance, and improve capital market supervision.

A "white paper" on the financial safety net would be prepared, a deposit insurance law submitted to the legislature, and the "lender of last resort" role of Bank Indonesia would be amended. Specific actions on bank restructuring include further sales of banks and assets under the Indonesian Bank Restructuring Agency, and introduction of risk-adjusted capital adequacy rules.

Capital markets would be placed on a firmer footing by enforcement of capital adequacy standards, regulation of the mutual funds business, and consolidation and improved regulation in the insurance and pension sector. The anti-money laundering law would be revised to abide by the guidelines of the Paris- based Financial Action Task Force and an anti-money laundering task force would be created.

Indonesia's investment climate has been its weak suit in recent years, as the rate of investment has remained at around 20 per cent since the crisis, in contrast with more than 30 percent prior to 1997. The package thus rightly gives a high priority to restoring confidence in the investment community -- whether large corporations or the millions of small farmers and household enterprises.

The measures draw from extensive consultations with the business community, and seek to begin to address deep seated constraints, such as corruption, the lack of a trusted legal system, and the lack of adequate physical infrastructure as well as more immediate regulatory and labor issues.

Toward this end, the government intends to set up an Investment and Trade Team to identify and address constraints and monitor progress. Specific actions include a revision of the investment law, a review of the negative list of sectors barred for foreign investors, and acceleration of tax refunds for exporters. Implementing regulations for the recently passed labor law will be issued, and the industrial dispute law will be finalized.

The Anti-Corruption Commission will begin operation, a judiciary commission in charge of the appointment of judges will be established, the law on the attorney general's office will be revised, and the law on freedom of information will be promulgated. The bankruptcy law will be revised, and the commercial court in charge of application of that law will be strengthened.

To improve investment and management of physical infrastructure, additional public funds will be allocated, and private investment will be facilitated through revisions to the Transport Law, and the creation of an independent supervisor for the electricity market.

The government commits to improving service delivery to the public by improving tax and customs administration, and by requiring all agencies with services to the public to publish service delivery standards. Finally, the government commits to more equitable growth by expanding several successful programs, and will issue a national poverty reduction strategy by mid 2004.

The policy package is not perfect. It will thus be vital to focus on the truly important measures. Any failure to implement a critical mass of the proposed measures would be costly, since broken promises are worse than no promises.

But such imperfections are minor in comparison to the potentially positive impact of this package on Indonesia's future. Each of the above actions has a date and a responsible party for its implementation, marking an important self-imposed discipline and transparency to the program.

The Presidential Instruction sets up a monitoring team under the leadership of Coordinating Minister Dorodjatun Kuntjoro- Jakti, and supported by a strong secretariat, that will also seek regular inputs from the investor community. Private investors, together with academic institutions and international agencies, will monitor progress, and lobby for progress when slippage occurs.

This package is then an encouraging step towards accountable government -- as well as towards a brighter economic future for Indonesia's citizens.

The Indonesian version has been published in Kompas daily.