RI country risks remain high

RI country risks remain high

Johanes L. Sitanggang, Jakarta

A modicum of political stability has returned to Indonesia.
However, the long-term outlook remains clouded in uncertainty as
the country's transition to a transparent and stable democracy
faces numerous obstacles, ranging from powerful vested interests
of the previous and current regimes to an immature party system
and the centrifugal forces of separatism.

The specter of religious militancy looms ever larger over the
country, despite the fact that the vast majority of Indonesians
are moderate. Deadly terror attacks in Bali and Jakarta provided
tragic evidence of the potent security risks potentially faced by
U.S. and Western interests.

Investor confidence has also been dented by a persistent
corruption problem at all levels of officialdom and severe
deficiencies in the legal system.

Economic reforms have been followed up slowly and unevenly,
with Indonesia failing to realize its true growth potential to
absorb the over 2.97 million new entrants into the labor market
yearly, which has increased the number of unemployed to over
11.66 million in 2004, plus another 40 million who are
underemployed.

More effective policies on infrastructure development and
poverty reduction for the more than 39 million officially
classified poor people and 25 million near-poor are urgently
needed, in line with the UN Millennium Development Goals on
Poverty Reduction. In addition, the country's legal framework
requires an overhaul and the tax framework is in need of reform.

Indonesia is still recovering from the financial crisis of
1997/1998, with per capita income now at US$710, far from the
$1,110 before the crisis. There has been some progress in terms
of consolidation, but the structural problems that precipitated
the crisis have not been sufficiently addressed. Political and
legal uncertainty continue to deter the return of foreign
investors.

A conspicuous lack of deregulation and financial transparency
have combined with political issues and the weak legal framework
to hamper growth, despite an extremely rich endowment of natural
resources.

High levels of domestic corporate debt exposure obstruct
investment and the resurrection of a viable financial sector.
Vested interests and corruption impede progress on economic
reform and development. However, Indonesia's geostrategic
importance ensures the commitment of donors, despite the failure
of successive governments to make good on their promises of
reform. Donors are unable to control corruption by central,
provincial and district government officials, despite improved
procurement procedures.

Indonesia's legal framework did not keep pace with the
improvements in the economic environment prior to the financial
crisis and it is a difficult country in which to do business. The
regulatory and legal environment can be tangled, incoherent and
time-consuming. After a long period of vacillation, the
government has finally prioritized the modernization of the legal
system, and numerous elements of the legal framework are likely
to undergo a major overhaul.

However, entrenched business practices and deficiencies in law
enforcement could be much harder to remedy than weaknesses in the
fabric of the legal system.

The tax system was already failing to keep pace with economic
developments before the crisis. Reforms in early 2001 were a
tentative first step toward an urgently needed overhaul of the
system, but further reforms are required. Corporate tax rates are
high by regional standards. The system relies quite heavily on
withholding taxes, reflecting the government's difficulties in
tax collection. Decentralization since 2001 has resulted in a
greater risk that extra taxes will be levied at the provincial
and district levels.

Endemic official corruption continues to blight business
activity in Indonesia. Overall government attitudes toward
foreign investment are positive, but the same cannot be said
about all key political figures and the bureaucracy, which --
particularly at the provincial and district levels -- can be
anything from cumbersome to antagonistic.

The quantity and quality of infrastructure in Indonesia lags
behind other Asian countries, and is in urgent need of
development. The August 2003 car bomb attack on the JW Marriott
hotel in Jakarta provided tragic evidence that the terror threat
in Indonesia has not receded since the October 2002 Bali
bombings.

Several unresolved small-scale attacks in the Jakarta area
have also highlighted persistent dangers to foreigners. The
majority of Indonesians are moderate, but the scope of terrorist
cells is uncertain and Islamic militant groups may have shifted
their focus away from local conflicts to economic terrorism. The
risk of further terrorist attacks on the interests of the U.S.
and its allies must therefore be taken seriously due to mounting
anti-U.S. and probably anti-Western sentiments. Several provinces
are experiencing secessionist violence.

Politically motivated violence could erupt in Jakarta and
other large cities. The police force and the legal system are
stretched thin. Indonesian waters have the highest frequency of
piracy in the world and the Strait of Malacca is thought to be a
potential target for bin Laden's terrorist networks in Indonesia.

The writer (kljs@indo.net.id) is an economic and financial
analyst at KLEMENS Economic Development and Corporate Advisory.