Polls reassure market

The financial market performed last week in very much the same way as it did following the April 5 legislative election.

The Jakarta Stock Exchange (JSX) composite price index gained more than 2.7 percent on April 6 and the rupiah strengthened between the Rp 8,200 and Rp 8,700 band, which the central bank then considered its comfort zone

Likewise, the JSX index jumped 3.1 percent to 768.25 the day after what the public saw as a peaceful and fairly clean presidential election. Similarly, the rupiah exchange rate firmed up to Rp 9,000 from Rp 9,135 against the dollar.

If we can learn lessons from our immediate past, it is important to note that on April 12 the JSX lost 1.5 percent on negative sentiment. This was triggered by a joint political statement from 19 political parties, which rejected the results of the legislative election and demanded a repeat poll.

Upbeat sentiment returned to the market only after the protest turned out to be a bluff, driven by politicians disillusioned with the poor showings of their parties in the election. Many of the parties later watered down their stance, especially after public opinion turned against them and they were seen as bad losers.

Whether a similar protest will emerge this time around will depend on how the final process of vote counting proceeds during the next two weeks.

As the experiences from the legislative election show, a credible election process will promote confidence in the economy, as reflected in the steep rise in the JSX index to 810.85 on April 20, the highest level ever reached by the JSX since its revamp in August, 1977.

The high probability incumbent President Megawati Soekarnoputri will contest the election runoff on Sept. 20 is likely to help assure the market that the machinery of government can continue to run smoothly during this transition period.

However, this is not enough. The Sept. 20 runoff must also be seen to be peaceful, clean and credible, otherwise whatever gains the financial market has made thus far in recouping investor confidence will disappear.

Restoring confidence is crucial to fostering economic stability that can weather the heightened political emotions likely to arise in the final stage of the presidential election.

While macroeconomic stability has been strengthening since late 2001, the economy is still highly vulnerable to domestic and external shocks. The rupiah exchange rate has lost almost 8 percent and Bank Indonesia's foreign reserves have decreased by more than US$2.5 billion in just one month, between mid-May and mid-June, due to uncertainty then about an imminent rise in the benchmark U.S. Federal Reserve lending rate and the steep rise in international oil prices to an excess of $40 per barrel.

The rupiah and stock prices did recover last month after the Fed decided to increase its rate by only 0.25 of a percentage point, lower than the market expected. However, the damage had been done and the significant progress made earlier was lost. The rupiah is now hovering between Rp 8,900 and Rp 9,100, as against Rp 8,200 and Rp 8,700 before mid-May, with the JSX now at much lower than the 810 points it reached in April.

We are therefore most encouraged by the central bank's announcement last week that it will continue to focus on controlling inflation. This commitment was made more credible after Bank Indonesia and the government agreed earlier this month to set up a team to implement a comprehensive inflation targeting framework that would provide a better anchor for the public's inflation expectations.

A better coordination of monetary and fiscal policies, as reflected in the steady easing of the credit crunch and the continued fiscal consolidation, is vital to maintain stability and smoothen the transition period until the new government elected in September begins work.

In this context, it is most important the House of Representatives and the government accelerate the preparations for the draft 2005 state budget because the new government would have little time to prepare the budget from scratch.

Although the budget will still have to be approved by the new House to be inaugurated in October, a detailed spending plan would at least give the market an idea of the likely fiscal direction next year, decreasing the uncertainty factor.