Prospects for RI's recovery

The following article is taken from a presentation at the Indonesia Next: Politics, Business and The Impact of Change Conference in Bali on Friday.

By Mar'ie Muhammad

JAKARTA (JP): After a long political struggle, the People's Consultative Assembly succeeded in electing Abdurrahman Wahid as the fourth president of the Republic of Indonesia, the third largest democratic country.

A milestone has been laid for a long, arduous journey. Now society is in waiting, generally with mixed feelings and opinions. The core of the issue, a formidable task to resolve, is restoring confidence. For this we need urgently to build a credible government, fully committed to the reform program, including to rebuild good governance.

It is obvious that the government, in collaboration with civil society, has to reunite Indonesia's highly fragmented society. Furthermore, it is the duty of the nation to restore trust in society as a main social element that has continued to deteriorate.

Restoration of peace and order should become the first priority of the new government, with active support from all citizens. The government should secure strong support from political parties, professionals, civil society and the regions, and should be welcomed by the international community.

To achieve this objective, the new Cabinet should be a sort of grand coalition which is able to accommodate various interest groups, including the minorities.

While other regional economies have begun to recover from the economic crisis, Indonesia's recovery has occurred at a slower pace. Thailand, for example, is expected to attain a real gross domestic product growth rate of 3 percent to 4 percent, and the Korean economy is expected to grow by more than 5 percent.

Indonesia, in contrast, is unlikely to achieve a 1.5 percent to 2 percent increase in real GDP.

However, it should not be forgotten that the greater severity of the economic crisis in Indonesia compared to other regional economies is at its root a reflection of political instability, a devastated and dysfunctional banking sector, a deeply indebted corporate sector and pervasive corruption.

Some signals of economic recovery are quite encouraging. One is inflation with an annual rate falling to less than 6 percent in August. The one-month interest rate has dropped below 13 percent per annum. The rupiah has strengthened to about 7,000 to the U.S. dollar although it is still highly volatile.

Share prices on the Jakarta Stock Exchange rose by 120 percent between October 1998 and June 1999 and are still more than 80 percent above their level of a year ago.

This said, I still do not mean to belittle the magnitude of the economic difficulties that we face. The bank restructuring program, for example, has made enormous progress, with insolvent banks having been closed, most remaining banks recapitalized and much of the bad debt moved to an asset management agency.

Nonetheless, our banking system remains dysfunctional. Although banks continue to perform one of their two critical functions -- absorbing savings from households and businesses -- they are not performing the other function, which is to channel these savings into productive investments in the real economy.

Bank lending is still at a standstill and is unlikely to recover anytime soon. Similarly, some progress has been made in corporate debt restructuring. More than 280 companies with over US$23 billion in outstanding foreign debts have begun negotiations under a program supported by the World Bank, and 27 of these debtors have reached agreements in principal involving more than $3 billion.

However, most corporate debt is still uncertain and the Indonesian bankruptcy law and its enforcement are still weak. The bank restructuring agency has taken about Rp 230 trillion of bad debt but very little of this has been successfully restructured. In this regard, it is critical to strengthen the Indonesian Bank Restructuring Agency (IBRA) and its operations, and for this IBRA needs strong political support. Until the banking and corporate debt problems are resolved, Indonesia's economic recovery will remain anemic.

Another obstacle that Indonesia will face over the next few years will be the fiscal burden created by the crisis. Before the economic crisis, Indonesia did not have a significant fiscal problem. In fact, the government had been running surpluses for several years. The crisis created enormous new spending obligations for social safety nets, food and energy subsidies, and most importantly the enormous cost of financial sector restructuring. At the same time, with the slowdown in economic activity, domestic revenue as a share of GDP declined.

Consequently, Indonesia is expected to experience a deficit of 4 percent to 5 percent of GDP during the current fiscal year. For the time being these fiscal deficits are being financed by foreign borrowing but this is obviously not a viable long-run solution. The government's foreign debt has already risen by more than $15 billion during the crisis, creating a larger burden on future generations, and the willingness of the international community to provide official assistance to Indonesia will diminish with time.

While the soundness of future economic policy cannot be guaranteed simply on the basis of past performance, there are several reasons to believe that the fiscal difficulties can be overcome. First, there is considerable scope for raising tax revenue. In recent years Indonesia's non-oil tax receipts have amounted to only 10 percent to 12 percent of GDP.

This is far less than the share of GDP collected in other economies. Thailand and the Philippines, for example, collect more than 15 percent of GDP in tax revenue. Second, there is some scope for reducing spending, particularly with respect to fuel and energy subsidies, although removing these subsidies will be painful.

Third, the government has acquired a great number of valuable assets as a consequence of the financial sector restructuring program. These assets, including some of the largest private banks and industrial companies, will be sold back to the public over the next few years, creating an income stream to offset the cost of bank restructuring. Government banks and state-owned enterprises will also be privatized over the next few years.

Of course, the government's political will to divest these assets in a fair and transparent manner must remain firm. Maintaining firm political support for this process is highly essential, particularly if the participation of foreign investors is needed.

In sum, where do we go from here?

* Equitable development through pro-poor policy and empowerment of the small scale business.

* Export-led growth, push for foreign investment and continuous deregulation.

* Sale of banks and other IBRA assets and the privatization of state-owned enterprises.

* Monetary policy that focuses on attaining and keeping low inflation and interest rates.

* A neutral and more effective tax collection system.

We can only realize the above agenda with the support of the international community, including international financial institutions. We firmly believe that democracy is an essential foundation for the establishment of a more favorable nation that is capable of carrying out fair and transparent activities in all aspects of society. Maintaining international support for Indonesia is highly critical, based on mutual interest and respect.

The author is a former finance minister and a founder of the private Indonesian Transparency Society.