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.