RI economy continues to muddle through

Rizal Ramli, Economist, Jakarta

From an economics perspective, two important facts emerged during 2003. First, Indonesia's exit from the IMF program did not trigger an economic collapse, as predicted by conservative economists.

Over the past year these commentators had conjured up a doomsday scenario in Jakarta-based newspapers, in which the conclusion of the IMF program was seen as precipitating a collapse in the country's credit rating, loss of confidence among foreign investors, capital flight and economic isolation.

Fortunately, the doomsday scenario proved to be little more than pro-IMF propaganda. Recent events have confirmed the view, long held among colleagues associated with the Indonesia Bangkit group of economists, that Indonesia's credit ratings would improve following the conclusion of the IMF program. The view that only the IMF could forestall economic collapse in Indonesia has been revealed as nothing more than scare-mongering.

Second, during and after the IMF program the government adopted a minimalist approach to economic recovery. The approach is minimalist in the sense that economic targets set by the government, particularly for the real sector of the economy, are decidedly unambitious and far below that which could be achieved given existing opportunities.

There is a tendency to confuse targets and trends. For example, if the economy is predicted to grow at x percent, then the target is also set at x percent. But trends are not targets. Great national ambitions can only be achieved on the basis of a marked break from existing trends. Japan in the 1960s, Taiwan, Malaysia, Korea and China set their economic targets well above prevailing trends and worked hard to achieve them.

The performance of the economy was unimpressive in 2003, particularly from the perspective of economic growth and job creation. The only meaningful improvements appeared in financial indicators such as the exchange rate, inflation and interest rates. Despite these advances the financial system is still vulnerable. The Bank BNI and BRI scandals demonstrate that, even after the massive bank recapitalization totaling Rp 650 trillion, the conduct and behavior of Indonesian bankers has not changed much. Meanwhile, exports increased by only four percent to five percent in 2003, to US$62 billion, still below the figure of $65 billion recorded in 2000.

At present financial stability is externally driven. First, the weakening of the U.S. dollar since early 2002 against all of the major world currencies has led to an apparent strengthening of the rupiah. The rupiah's rise has reduced imported inflation as prices of imports priced in dollars have stabilized, thus creating space for interest rate reductions. Second, IMF loans to augment foreign exchange reserves give the illusion of financial stability, reducing pressure on policy makers to stimulate exports and domestic efficiency. This is reflected in the slow rate of export growth of 4 percent to 5 percent. Third, low U.S. dollar interest rates have encouraged short-term capital inflows. American interest rates are at their lowest levels since the 1950s. Moreover, interest rates in Japan, Singapore, Malaysia, Hong Kong and Thailand are extremely low, at present 0.07 percent, 0.5 percent, 3 percent, 0.28 percent and 1.31 percent, respectively.

Domestic factors contributing to financial stability include the political consensus among the major parties that Megawati should not be challenged prior to the 2004 elections. Political stability is of great importance to financial stability because it reduces political risk premiums. Yet this period of relative political stability has not been used to accelerate the resolution of the country's economic problems.

Other domestic factors include the sale of state-owned corporations and state assets held by IBRA at fire sale prices. The financial burden from the fire sale of state assets ultimately falls on the national budget and the Indonesian people. Privatization policy has not been oriented toward improving the performance of state-owned firms and increasing value added, but instead has been driven by the desire to mobilize political and personal resources.

There is a significant difference between the nature of capital flows to Indonesia and those to China and Thailand. Capital flows to Indonesia over the past year were largely directed to the acquisition of IBRA assets by former owners of these assets, and for speculative portfolio investments. Speculative capital flows have responded to the decrease in sociopolitical risk as the main parties refrained from overt attacks on the government prior to the 2004 election campaign.

By way of contrast, capital flows to China and Thailand largely represent long-term investments attracted by the bright economic prospects of these countries. The main difference, therefore, relates to the attitudes of overseas investors in Indonesia versus China and Thailand: Until now, investors have viewed Indonesia only from the perspective of risk minimization and not yet as a dynamic, growing economy and economic engine for the region as a whole.

Investors' responses will change only when stability is achieved on the basis of internal factors. Indonesia will be more attractive to investors when, for example, capacity utilization approaches 90 percent (at the moment it is about 41 percent), when Indonesian goods are more competitive and law enforcement improves. Strong and stable economic prospects are what draw in long-term investors.

Efforts to achieve internally driven stability are more difficult because they require the formulation of viable strategies and policies as well as strong political and economic leadership.

Aside from the apparent financial stability of recent months, has the economy really improved? What economic indicators are most appropriate to answer this question? It is often said that if unemployment is on the rise the economy cannot be said to be improving.

Across the globe it is considered a huge contradiction to claim that the economy is performing well when unemployment is increasing. The level of unemployment is the single-most important indicator of economic performance. But then why does the Indonesian government claim that the economy is recovering as unemployment rises? The reason is that the government's chosen indicators of economic performance are the exchange rate, inflation and the interest rate.

But these are intermediate rather than ultimate objectives of economic policy. Moreover, responsibility for stabilizing the exchange rate, the inflation rate and interest rates rests primarily with Bank Indonesia, according to the Central Bank Law 1999. The government plays only a supporting role in these areas.

The contradiction between financial stability and rising domestic unemployment over the past two years is explained by the sources of Indonesia's apparent stability. If the origins of financial stability were domestic then it is unlikely that improvements in financial indicators would be accompanied by rising unemployment. For example, if Indonesian export earnings had surged by more than 20 percent because of efficiency improvements and greater competitiveness, then the rupiah would strengthen and employment would increase.

Internally driven stability is thus more sustainable than externally driven stability resulting from the weakness of the U.S. dollar and low international interest rates, which have a minimal impact on the labor market. Moreover, at the moment the volume of dollar transactions is less than $200 million per day, as compared with $4 billion before the crisis. Little wonder that such a thin foreign exchange market has such a small impact on the real side of the economy.

The current situation can best be described as vulnerable financial stability combined with a jobless recovery. Layoffs continue unabated and factories are still closing. Even more pathetic is the growing number of Indonesian producers reduced to buying goods from China and relabeling them "made in Indonesia" for both domestic and foreign markets. Indonesia has entered the early stages of a process of deindustrialization and the economic recovery must be characterized as partial (only financial), lacking the dynamism required to generate employment.

According to most economic forecasts we should not expect momentous change in 2004. We should expect politically driven fluctuations in financial indicators such as the exchange rate, but there will be little change in the economic fundamentals.

The upcoming elections will use a more complex system. The likelihood of error estimated on the basis of field simulations is as high as 10 percent of all votes cast. Uncertainties surrounding the elections represent an important and dynamic factor in 2004, and these uncertainties are likely to increase the volatility of financial indicators.

In general, however, we should not expect meaningful progress because economic policy is only oriented towards stability. Stagnation will continue throughout 2004. Based on such considerations, economic growth will be about 4 percent.

Developments in 2003 and forecasts for 2004 suggest that the Indonesian economy is still just "muddling through": In other words, continued stagnation. Economic improvements are partial in that they are limited to the financial sector. Even these improvements are very fragile because of the absence of significant changes in behavior and conduct in the banking sector.

Stagnation and deindustrialization have resulted in a jobless recovery in which layoffs and factory closures continue unabated. Indonesia finds itself at the crossroads in 2004. What happens this year will determine whether the country continues along the current path of stagnation and decline until 2009. The costs of doing so will be immense. Unemployment is a time bomb that, if allowed to increase over time, will give rise to huge social, economic and even political problems.

But 2004 could also be the starting point of a new period of revitalization and progress for the Indonesian nation. Indonesia has the potential to become a prosperous country and to take its rightful place as one of the leading countries of the Asian region. We can only achieve these ambitions on the basis of better and more effective leadership than we now have from the "pseudo-reform" regime in power at present.

Our nation is at the crossroads between stagnation and decline versus reconstruction and progress. We urgently need quality leaders who possess an ambitious, but realizable vision of the country's future. Indonesia deserves better leaders.

The writer is former Coordinating Minister for the Economy.