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."