Thu, 27 May 2004

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 ( is an economic and financial analyst at KLEMENS Economic Development and Corporate Advisory.