RI economy in deep water, and it's sink or swim time

RI economy in deep water, and it's sink or swim time

By Riyadi

JAKARTA (JP): The country's economy remains a near hopeless
case. After one and a half years beset by an acute crisis, there
is still no light at the end of the tunnel.

Gross domestic product has plunged this year by 15 percent and
is expected to fall further next year. Inflation has soared
nearly 80 percent this year; projections are for it to remain
high next year.

Resulting widespread mass poverty is so grave that even the
International Monetary Fund -- which normally only provides
bridging finance for current account deficits -- was moved to
arrange additional aid for the hardest-hit Indonesians.

It is more sobering still for a nation praised for decades for
rapid growth, stability and poverty reduction.

"No country in recent history, let alone one the size of
Indonesia, has ever suffered such a dramatic reversal of
fortune," the World Bank said in its 1998 report Indonesia in
Crisis: A Macroeconomic Update.

What a difference a year makes. In 1997, the World Bank's
report on Indonesia was glowingly titled: Indonesia: Sustaining
High Growth and Equity.

"The next years will be difficult and uncertain," the bank
said.

The economic situation remains bleak. At its core is the
massive depreciation of the rupiah against the U.S. dollar,
precipitated by a crisis of confidence.

The rupiah has lost about 65 percent of its value against the
greenback since the start of the crisis in mid-1997, one of the
greatest assaults on a currency since World War II.

Granted, it has gained some ground after the terrible
battering it took earlier this year and interest rates have
fallen significantly. Yet, these are no cause for celebration
because they have not been followed by a surge in real sector
investment.

The rupiah has strengthened to the 7,500 level against the
dollar, from nearly 12,000 in September and 15,000 in July. This
still represents a 65 percent drop in value from the precrisis
2,450.

The rupiah's exchange rate has strong implications for
domestic demand, the banking system, corporate balance sheets,
inflation, trade and balance of payments, government finances and
eventual growth, income, employment, welfare and poverty.

A ravaged rupiah has incurred its own set of victims; domestic
demand has dwindled, inflation soared, balance of payments
lurched into negative territory, the banking system collapsed,
corporations suffered huge foreign exchange losses, and the State
Budget deficit widened.

All those factors combined to lead to negative GDP growth in
1998 and possibly 1999, falling income, diminished employment
opportunities, sorry state of welfare affairs and increasing
poverty.

Meltdown

The brunt of the rupiah's meltdown that began in July 1997 and
the succeeding stagflation in the economy occurred this year.

At the end of 1997, GDP growth was still positive, at about 5
percent, inflation in single digits and the rupiah at around
5,000 to the dollar.

Entering 1998, however, month-on-month inflation suddenly
soared 6.88 percent in January, a 25-year high, and the rupiah
nosedived at one point to hit a historic low of 17,000 against
the U.S. dollar on Jan. 22 -- one week after then President
Soeharto signed a letter of intent with the IMF, pledging to
carry out sweeping economic reforms to end the crisis.

Inflation again shot up by 12.7 percent in February -- another
25-year high -- before moderating at 5.5 percent in March, 4.7
percent in April, 5.24 percent in May, 4.64 percent in June, 8.56
percent in July, 6.5 percent in August, 3.7 percent in September,
minus 0.27 percent in October and 0.08 percent in November.

After dancing dangerously with 17,000, the rupiah strengthened
to below 10,000 in the following months, but the resignation of
Soeharto in May sent it reeling. It's helter-skelter fortunes
slammed it to the 15,000 level on July 8, sliding to 15,250 on
July 10. The rupiah slowly strengthened to 12,000 in September
and mustered more gains to its present 7,500.

In response to the falling rupiah and soaring inflation, Bank
Indonesia tightened the money supply and imposed high interest
rates to soak excess liquidity from the market.

The benchmark rate of Bank Indonesia's one-month promissory
notes reached 40 percent in March, 58 percent in May and 70
percent in late August. It started to fall in September in line
with the improving rupiah and inflation rate, and now stands at
below 40 percent.

The rupiah's slide expanded the country's foreign debt
significantly in rupiah terms. Outstanding foreign debt stood at
$133.7 billion as of Jan. 1998, of which $80.2 billion was owed
by the private sector. Offshore debt enlarged again to $138
billion at the end of March, of which the private sector owed
$83.6 billion.

The government, for its part, successfully restructured part
of the sovereign debt repayment for the 1998/1999 fiscal year.

Private offshore debt payments suddenly became a problem as
most corporations could not service their ballooning debt due to
the rupiah's ruin.

The government attempted to help solve the private debt
overhang by amending the outdated bankruptcy law, a base for the
establishment of a commercial court to settle bankruptcy claims.
It was behind what became known as the Jakarta Initiative to help
creditors and debtors solve their debt overhang and established
the Indonesian Debt Restructuring Agency to bring creditors and
debtors together in finding common ground.

The banking system mirrors that of corporations. Almost all
national commercial banks suffered from the sharp drop of the
rupiah, and most importantly from the diminished confidence in
the banking system following the closure of 16 private banks in
November 1997 at the order of the IMF.

As a result, their foreign exchange obligation ballooned,
their assets crumbled as defaults increased and their deposit
base shrunk as panicked depositors withdrew their money.

The government then moved to stand behind the national banks,
providing blanket guarantees for third-party funds placed in the
banks. This decision forced the central bank to provide liquidity
support to banks in trouble in meeting their obligations. The
assistance kept increasing over time, reaching a staggering Rp
140 trillion at one point.

The government formed the Indonesian Bank Restructuring Agency
to reclaim the liquidity support from the troubled banks. Under
this agency, seven insolvent banks were closed in April and three
more in August.

The government later decided to help recapitalize
undercapitalized banks, including six of the seven state banks,
regional development banks and some private banks.

The ballooning foreign debt servicing, the reduction and even
disappearance of domestic credit availability due to problems in
the banking system and high interest rates have significantly cut
investment.

Domestic demand also dwindled, from 2.5 percent in the last
quarter of 1997 to 7.9 percent in the first quarter of 1998 and
17.6 percent in the second quarter of 1998.

External payments situation is doing no better. Despite the
rupiah's fall which normally would make exports more competitive,
Indonesia has not benefited from higher export revenues this year
due to trade financing troubles.

According to official data, exports fell 5.73 percent to
$37.24 billion during the first nine months over the same period
last year. Imports dropped even more, by 36.6 percent, during the
period to $20.15 billion.

But the core of the problem in the balance of payments lies
not with the current account but rather with the capital account
as private capital inflow has dried up following the rupiah
meltdown.

The only inflow came from official funds, and most of them
were used to service due foreign debts. Despite a boost of $9
billion in loans from the IMF and $1 billion from the World Bank,
gross reserves of Bank Indonesia fell to $22.85 billion as of
Dec. 15 from $28.8 billion before the crisis.

The government budget has not escaped the rupiah's fall. The
fluctuating rupiah and the sharp rise in the inflation rate this
year forced the government to revise the 1998/99 budget no less
than three times: once in January, then in April and finally in
July at the IMF's approval.

The last revised budget projects a deficit of 8.5 percent of
GDP.

The huge projected budget deficit prompted the IMF to arrange
additional aid of $6 billion, on top of the $43 billion bailout
it had assembled for the country. In addition, the World Bank and
donor countries in the Consultative Group on Indonesia pledged a
total of $7.9 billion to finance the deficit.

Macroeconomic indicators -- the rupiah and inflation -- have
shown signs of improvement toward the end of 1999.

The improved rupiah has reduced the projected deficit in the
State Budget to 6 percent of GDP.

However, it is still difficult to predict when the economy
will bottom out and return to the growth path.

Swelling foreign debts and a nearly collapsed banking industry
are two factors which could impede recovery. More importantly,
disruption of the political events scheduled for 1999, especially
the general election, could easily thrust the country into deeper
recession.

Outlook

As expected, the government paints a rosy outlook for 1999. In
the Supplementary Memorandum of Economic and Financial Policies,
signed in November for the IMF, the government forecast modest
economic growth would resume in the middle of 1999, with
inflation for the year to fall to about 10 percent.

Later in December, finance minister Bambang Subianto revealed
that the government, in drafting the 1999/2000 State Budget,
assumed GDP growth of between minus 1 percent and plus 1 percent
for 1999, an inflation rate of between 15 percent and 20 percent
and the rupiah exchange rate of between 7,000 and 8,000 to the
dollar.

But many private analysts have noted that positive growth for
next year is overly optimistic for an economy deserted by
investors.

Mari E. Pangestu, a former executive director of the Center
for the Strategic and International Studies who recently
relocated to the U.S., ruled out the country returning to the
growth track before the year 2000.

She predicted that the country would record negative growth of
between minus 2 percent and minus 5 percent in 1999, provided
there were no outbreaks of massive unrest.

Faisal Basri, a director at the Institute for Development and
Finance (Indef), shared a similarly gloomy outlook, predicting
that the country's GDP would contract further by 5 percent in
1999, inflation should run at about 20 percent and the budget
deficit would likely expand to 10 percent.

Once again, he couched his predictions in terms of an unrest-
free social climate.

Most experts agree that the success of the government's
efforts to reserve political difficulties will be determining
factors in leading the country out of the crisis or pushing it
further into the deep hole of recession.

Looming large is the general election planned for June 7. If
the general election and other political and social reform
agendas pass by peacefully, the economy will continue running on
its recovery path.

But if the general election and other political programs were
not adhered to, economic growth would plunge to minus 6 percent,
inflation would be 35 percent and interest rates would hover at
45 percent, said economist Sri Mulyani Indrawati from the
University of Indonesia.

Rizal Ramli of the Econit advisory group introduced an even
gloomier set of forecasts. He predicted a 5 percent contraction
in the economy next year, even if the general election proceeds
successfully. Unrest, and the economy could contract by another
15 percent.

"If the general election passes satisfactorily, it will mean
that Indonesia still has a future. But if not, Indonesia will
sink."