Open letter to the next President of Indonesia

Open letter to the next President of Indonesia

Kahlil Rowter, Jakarta

I congratulate you on becoming the leader of the fourth most
populous country on earth and the third largest democracy in
history. As the first president to be elected directly, you carry
the mandate and the hopes of more than 230 million on your
shoulders. I do not envy you in this regard. History will judge
you harshly, and the media even more so. But your taskmaster is
not the press, nor history, but the plight of your people -- even
those who did not vote for you.

Your election could not come at a more critical time.
Indonesia has only begun to recover from its severe economic
downturn. It is undeniable that the worst phases of the crisis
are over, as attested to by most economic indicators. In fact, we
are now well into the recovery phase. But as regards sentiment or
climate, I still hear people talk about and breathe the air of
crisis.

Perhaps that is just how we Indonesians go about it: We never
really collapsed during the worst phases of the economic crisis,
but we never really -- at least, not yet -- seem to shake off the
feeling of being in a crisis.

This may be your greatest challenge: How to imbue the average
Indonesian with enthusiasm. If you fail, a ceiling of about 4 to
5 percent will be created over our economic growth. At this rate,
job growth would be inadequate to absorb annual entrants into the
labor market, thus resulting in rising unemployment. The
unemployment figure as of August 2003 was 8.5 percent,
significantly higher than just 9 months earlier in November 2002
at 8.1 percent. Although the statistics are not robust, the trend
is undeniable: Unemployment is rising fast.

Until now, the unemployed could rely on the culture of
familial support peculiar to Indonesia, in which parents still
welcome grown children to live at home. Even married couples with
children can count on immediate and extended family support --
one contributing reason for the rise in the educated unemployed.
But there has to be a breaking point sometime.

Why is enthusiasm so important? The future is a product of
effort and circumstances combined, and projections of the future
drive how much effort to invest in the present. Hence, optimism
plays a key role. The more optimistic one is, the more effort one
can make now for a better tomorrow; the more effort made in the
present, the better the chances for a positive outcome.
Conversely, less effort will stultify the chances for success in
the future, as if to justify the pessimism that was its cause.

Investment, as with any other risky venture, is crucially
determined by expectations of future outcomes. Take the price of
equity, for example -- once the market is convinced that a
particular firm will grow above a certain threshold, its price
rises. But if this hope is betrayed, punishment is swift, and it
will take more effort in convincing the market that the firm will
reassume an upward growth trend. The same logic also applies to
other endeavors in investment.

One particularly vexing problem that harms raising
expectations has been corruption, especially in the legal justice
system. More broadly, this has resulted in a perception of legal
uncertainty and problematic contract enforcement.

This is just one of the issues raised in a recent post-IMF
program assessment on the existing economic policy. Two other
important issues are revamping the tax system and increasing
labor market flexibility.

It is well known that the tax office, with its rather
arbitrary assessment methods and cumbersome refund system,
creates unnecessary business uncertainties. Try asking how many
of your frequent-flyer friends have recently received tax returns
on their "fiscal" charge, payable by residents each time they
leave the country.

The need to revamp the tax system also stems from the
constraints that the government budget faces. For example, 29
percent of total revenues are allocated to just three main
expenditures: Domestic debt interest payments (14 percent),
overseas debt interest payments (7 percent) and fuel subsidies (9
percent).

These three are also the most sensitive to market
fluctuations, domestic interest rates, the exchange rate and
global oil prices. To be specific, a 1 percent rate increase in
the 3-month Bank Indonesia promissory note will incur an
additional interest payment of about Rp 2.3 trillion (US$270
million). In addition, to refinance maturing domestic debt in the
next three years, the government is relying on market absorption
of bond issuances.

Hence, future growth in expenditure rests crucially on the
ability to increase tax revenues without simply raising taxes --
an unwise recourse in an economy recovering from recession.

It should be noted that the government's debt burden in
relation to its GDP has fallen dramatically from its peak in 2000
of almost 100 percent to below 70 percent in 2003. This was
mainly accomplished by paying off loans at a faster rate than
borrowing.

But the still-high debt-to-GDP ratio, plus scheduled
refinancing needs and the sensitivity of expenditures on market
conditions, create a constraint on future fiscal expenditure,
further compounded by the requirement to share revenues with
regional governments. All in all, this means that the degree of
freedom at the central government is limited. For instance, pump
priming or the use of government budget as a stimulus -- mostly
by resorting to deficit financing -- is severely limited.

At the same time, the currently improving economic environment
also places constraints on the future path of key variables. This
is because the existing environment and subsequent reaction by
economic agents create a particular dynamic path from which it
will be difficult to deviate in future.

Take the historically low interest rate environment, which has
induced agents to increasingly finance automobile and motorcycle
purchases as well as property purchases by multiyear loans.
Therefore, any adverse movement in interest rates would hit them
hard. Another case in point is the increasing exposure of
institutional investors to the government bond market.

In the past, any interest movement, especially upwards, would
be reflected instantly in a higher income, due to their exposure
to time deposits. But now, the movement along the yield curve to
longer-term instruments also means higher sensitivity to interest
rate fluctuations.

An increase in the liquidity of government bond trading and a
wider spectrum of investor types also brings with it a
responsibility on the part of the government -- which benefits
from lower issuance costs -- and the central bank -- which will
soon cut costs in monetary management through using government
bonds as an instrument for open market operations -- to maintain
market stability.

These are just a few examples of the constraints that you will
face once you start to formulate your economic plan.

Mr(s). President, the economic problems are well-known. The
key issues and the constraints that you will face have been laid
out here. Therefore, what your economic policy should accomplish
is quite clear. Beyond this, I hope it is equally clear that we
need your leadership to uplift our spirits. What we want to see
now is your positive and swift response.

Please remember that the challenges you face are numerous and
difficult. If they were not, a less capable leader would have
solved them by now. I hope you have the necessary stamina and
patience -- stamina to tackle the multidimensional challenges
facing Indonesia, and a healthy dose of patience toward us.

We are a rowdy bunch, but basically good at heart.

The writer is Head of Research at Mandiri Sekuritas. The views
expressed in the article are strictly personal.