Policies must put people first

Policies must put people first

This article is based on the executive summary of a report on
the Indonesia Economic Crisis meeting held at the Australian
National University (ANU) in Canberra from Nov. 23 to Nov. 25,
1998. The conference was jointly initiated and designed by Prof.
Anwar Nasution, dean of the School of Economics, University of
Indonesia, and Prof. Ross Garnaut from the ANU.

CANBERRA: The unraveling of the Indonesian economic and
political situation in the past 12 months has been overwhelming.
It has cast a long shadow over the country and its neighbors.

The crisis faced by Indonesia continues to run on parallel and
interdependent tracks of economic and political uncertainty. A
wide range of outcomes is possible, from the optimistic to the
pessimistic.

Progress toward economic stabilization and recovery will be
difficult -- some would say impossible -- to achieve without
resolving vital political issues.

On the other hand, the necessary transition to democracy and
increased participatory processes will also take time, and the
reforms needed to achieve stability, and the beginnings of a
recovery cannot be delayed.

The crisis has also torn, quite seriously, the social fabric
and cohesion of Indonesia. Both the political and economic agenda
must be based on a renewed and explicit social contract, which
addresses systematic inequities and concentration of economic and
political power, and is inclusive of all members of society.

Although it is difficult to forge ahead on economic
stabilization and recovery under conditions of political
uncertainty, there is no real alternative. It has to be realized
that economic stability and recovery will be essential to permit
a reasonably orderly transition process and to ensure that
desirable political outcomes are achieved.

For the restoration of economic growth, it is, therefore,
crucial and urgent that policymakers agree on and prioritize
economic reforms. They will also need to adopt and adhere to
clear and consistent principles for reform and to be aware of the
need to sequence the timing of the policy changes.

It is equally important that the policies adopted should be
mindful of the sociopolitical parameters and challenges facing
Indonesia at the present time.

While the political outlook is still uncertain, 12 months
after a drastic collapse in domestic demand and the financial
sector, there are tentative signs of economic stability and
turnaround by November 1998.

* The exchange rate has improved significantly from the
destabilizing rate of Rp 15,000 per U.S. dollar in June.

* Inflation has eased substantially and expectations were for a
continued decline.

* Nominal interest rates have begun to fall: The rate on one-month
Bank Indonesia promissory notes (SBI) dropped from 70 percent per
annum in the first week of September to 50 percent in the third
week of November.

* The monetary policy has been successful in absorbing liquidity,
and the budget deficit for the current year is expected to be
lower than targeted.

The social impact of the crisis has been great in terms of
falling real wages and incomes, greater unemployment and poverty.

However, recent analysis suggests that initial estimates of
the damage have been overly pessimistic. Increased poverty is
serious but not an insurmountable problem, and some regions
outside of Java, notably Sulawesi and Sumatra, have enjoyed
export booms and better socioeconomic conditions than those of
Java.

These are important and welcome signs. They confirm that there
is potential and a basis for economic recovery in Indonesia. At
the same time, we must not become overly optimistic that the
turnaround will continue without considerable further policy
effort. Large risks and potential fluctuations in economic
conditions still lie ahead.

The most urgent priority is to sustain the recent trend toward
macroeconomic stabilization. This should be achieved in the short
term by continuing the current approach of flexible exchange
rates, targeting of base money and maintaining a stimulatory
budget.

The budget will need to be stimulatory for the next few years
to offset the collapse in private demand and to protect
vulnerable groups through social safety net programs. The
effectiveness of the social safety net needs to be ensured
through well-designed and targeted programs.

These will need to be based on clear priorities of the target
groups, thus minimizing the budgetary burden.

Other components include placing sunset clauses on subsidies
or special treatment, avoiding the entrapments of populist
policies and prioritizing needs for government support for bank
restructuring.

Government spending should remain subject to fiscal
discipline, mindful of potential inflationary effects that would,
in turn, affect the monetary targets.

Some revenue may be raised from the disposal of some state-
owned enterprises, but significant budget deficits are
unavoidable in the next few years. Noninflationary financing of
these deficits will be possible only with substantial external
support.

Significant additional external funding and assistance will be
needed for the next few years. Government revenues will be below
precrisis levels (in real terms) and the funds committed under
the IMF emergency package were front-loaded for this fiscal year.

These will taper off in early 1999. The recently announced $30
billion Miyazawa Plan for East Asia, and the joint commitment of
United States and Japanese leaders to support financial
restructuring in the region, are very welcome developments in
this context. But it also needs to be recognized that Indonesia
will be one of several economies that will compete for such
additional sources of support.

Beyond stabilization, there are two priorities to restore
growth.

First, there is the issue of restructuring of banking and the
corporate sector. It is clear that public funds will be needed to
restructure the banking sector. The most urgent need is to
recapitalize the better banks so that normal banking activities
can be resumed as soon as possible. A range of other issues need
to be addressed in an open and transparent framework, with due
consideration to the principles of justice and distribution.
These include dealing with the problem banks, nonperforming
loans, asset management of owners of the banks and of debts to
pay back the government.

The same principles apply to corporate debt restructuring,
which will need to be backed by effective bankruptcy procedures.

External assistance will also have an important transitional
role by providing funds to alleviate risk. This might be achieved
through guarantees or underwriting to reduce perceived risks and
costs of export financing or bonds issued by the Indonesian
government.

The second priority is to accelerate export growth. The large
devaluation of the rupiah has led to a substantial improvement in
Indonesia's competitiveness, although the export response has
been limited.

More needs to be done to remove administrative problems and to
supply adequate working capital for potential exporters. Exporter
and other producer costs can be reduced by further trade
liberalization.

The large "natural" protection provided by the low exchange
rate makes this a good time to lower trade barriers without a
significant short-term impact on domestic producers.

An acceleration of trade liberalization by Indonesia could
prove very important in ensuring the necessary resurgence of
exports is not blocked by renewed protectionism on the part of
importers.

Economic growth must also lead to a perceived trend toward
improved greater equity. Measures to ensure this can be, and need
to be, economically sound as well as politically acceptable.

While direct subsidies targeted to overcome poverty are an
important part of the policy response to the crisis, the
strengthening market mechanisms is a critical element in the
promotion of equity. Specific initiatives should include:

* maintaining and improving communications and transportation
links;

* dismantling monopolies;

* reducing administrative controls to internal trade; and

* reducing high transaction costs facing small and medium
enterprises.

In the new political environment, it will be difficult, but
important, to ensure that measures which are supposedly designed
to promote equity are not political favors to selected groups.
These can damage economic stability and jeopardize incentives and
growth, without bringing about any real reduction (and possibly
even some increase) in poverty or inequality.

These are the most urgent priorities. But many more issues
will also need to be addressed in the next few years. One
challenge is to ensure that the momentum is not lost in
augmenting social overhead capital.

In addition, there will be a need for substantial investment
in human resources to improve the institutional capacity of
agencies entrusted with implementing and monitoring policies for
recovery and reform.

One of the most important needs for capacity-building is to
ensure that Bank Indonesia (the central bank) and other relevant
agencies are able to safeguard the future soundness of a
restructured financial sector.

Some of the many economic matters that need attention are set
out in the body of this report. The institutional capacity for
reform is limited and prioritization is of critical importance.

However, to sustain economic stability and recovery, it is
important to begin to think through medium-term policy options.

Above all, it is crucial that an equitable policy framework
for economic management be designed by Indonesians, and the
reasons for policy choices be explained to and broadly accepted
by Indonesian society.