RI needs market control
By Peter Sheehan and David Ray
MELBOURNE (JP): In the months since the fall of the Soeharto government, Indonesia has begun a remarkable political transformation, and a new democratic nation is slowly beginning to take shape.
But at the same time the economy has deteriorated sharply, in spite of strenuous efforts to implement the International Monetary Fund (IMF) program and substantial foreign support.
The food situation is very dangerous; most firms are still paralyzed by debt; inflation is likely to top 100% in 1998; GDP will probably drop 20% this year and unemployment is surging. Decisive action is necessary to address these issues, or economic collapse will overwhelm political progress.
Earlier this year (The Jakarta Post March 16) we put forward a set of proposals to tackle the emerging crisis in Indonesia. These proposals were based on the premise that Indonesia needed a period of respite from open capital markets to take control of its own affairs and to put its house in order. On this basis, the key elements were restrictions on the capital convertibility of the rupiah, a fixed exchange rate for current account transactions, steps to resolve the corporate debt crisis and a more expansionist policy.
In our view, events since March 1998 have confirmed that broad approach, as the East Asian crisis has deepened in many countries with open capital markets and has spread beyond the Asian region. Many distinguished economists, such as Paul Krugman, Jagdish Bhagwati and Joseph Stiglitz of the World Bank, have come to a similar view.
Continued growth in China, which has a fixed exchange rate and limited capital convertibility, has demonstrated that there are viable alternatives to the IMF route, and recently Malaysia has embarked on such a course of action.
The purpose of this article is to make some revised proposals along these lines to meet the desperate economic situation which now confronts Indonesia.
In our judgment there are four key issues that must be given priority, although all the economic issues are now intertwined with one another.
Food Supply. The most fundamental problem confronting the nation is the supply and distribution of food, in particular rice. There are increasing numbers of reports of hoarding and smuggling of desperately needed food stocks.
Famine is now a very real possibility in certain parts of the archipelago.
Many economic studies of famine have shown that the problem is usually not a shortage of food, but weaknesses in distribution systems and economic incentives which stop the available food getting to those who are starving. This seems to be clearly the case in Indonesia now.
In particular, with the fall in the rupiah, the import parity price of rice has risen nearly fivefold over the past year.
Hence, with the present exchange rate, efforts to get food to the needy at reasonable rupiah prices provide massive opportunities for corruption and smuggling.
Inflation. Few things are more destructive of economic and social development than high inflation. For example, sharp increases in the price of food and other necessities have led to significant erosion of the purchasing power of incomes, and are fueling social unrest. Getting inflation down must be a key priority.
Corporate Debt. The corporate sector in large part remains crippled by the combined effect of high interest rates, higher prices for imported inputs, falling revenues and asset values and a huge debt overhang. In particular, virtually no progress has been made on the US$80 billion debt hanging over Indonesian companies.
This is in spite of the fact that foreign lenders have already been required to make massive provisions for losses on these loans in their consolidated accounts. The present stand-off benefits neither Indonesian firms nor the foreign lenders.
Interest Rates. Even though inflation is high, interest rates of 60 percent to 80 percent are destructive for both companies and individuals, especially when neither incomes nor asset values are rising commensurately. Much lower interest rates are vital for economic recovery.
It is now surely clear that Indonesia needs to take decisive action to take back control of its own affairs from the IMF and the international markets, and to meet the desperate needs of its people. Waiting for the markets to work, or for confidence to return of its own accord, will be waiting in vain.
Nevertheless, this action needs to be taken in full recognition of the difficulties and of the market realities. It should also be market conforming as far as possible, providing a respite from, rather than a rejection of, international market forces.
The world climate in which such concerted national action would be taken is quite different from that of six months ago. The deficiencies of the IMF approach are now widely recognized, as is the depth of the problems facing Indonesia. Appropriate action on alternative policies, carried out carefully and professionally, could receive widespread support from foreign governments and agencies.
In addressing these problems the Indonesian government needs to concentrate on a few key points. Our suggestion is that the following five steps should be given priority.
1. Fixed Exchange Rate for Current Account and Foreign Direct Investment (FDI) Transactions. The government should put in place a fixed value for the rupiah, applying to all bona fide current account and FDI transactions, including letters of credit and other instruments directly related to Indonesia's goods and services trade and all income and capital movements directly related to FDI.
This value should be fixed at above that deemed necessary, given expected outcomes for inflation and economic activity, to ensure a current account surplus for Indonesia. As a working premise we suggest something of the order of Rp7,000 to the U.S. dollar. This rate would be supported by Indonesia's existing foreign exchange reserves, but not in the form of a currency board.
2. Restricted Capital Account Convertibility: Controls on Capital Flows. The government should, for a period of no longer than three years, reintroduce controls on other capital flows and restrict the convertibility of the rupiah for capital transactions. Exceptions should include small transactions and all repayments by Indonesian firms or individuals of foreign currency debt, which should be convertible at the fixed exchange rate. In the case of firms this should be subject to an agreed debt rescheduling package with the lender.
3. Use the New Regime to Reduce the Foreign Currency Debt Overhang of Indonesian Firms. In the context of restricted capital convertibility and a lower exchange rate, the government would be in a much stronger position to force a resolution of the debt position of companies as a matter of urgency. This could be done by compulsory tripartite negotiations bringing together companies, lenders and expert officials.
Participation in such negotiations should be a condition for any Indonesian firm to receive government support, and for any foreign lender to receive approval to convert any interest or debt repayment proceeds into foreign currency.
The aim of these negotiations should be to resolve the problem by an agreed process of debt rescheduling and loan write-offs, at the new exchange rate. In limited cases, the government might offer, through the Indonesian Debt Reconstruction Authority (IBRA), to take over part of the foreign currency debt of viable Indonesian firms in return for equity.
This might be applied particularly to key export-oriented firms, or as one part of an overall package which includes a substantial write-off of debt by the lender. Firms which are clearly nonviable should be allowed to fail, and in these cases international lenders should incur normal commercial losses.
4. Controlling Inflation. A central goal of policy must be to reduce inflation from the expected 1998 figure, on present policies, of over 100 percent to 15 percent to 20 percent in 1999. While both a higher rupiah and lower interest rates will contribute substantially to this, IMF-mandated measures which contribute to rising prices, or perhaps more importantly to expectations of rising prices, should not be implemented at the present time. The immediate priority must be the control of inflation rather than the reduction of the cost of subsidies, although this will be reduced by the effects of the higher value of the rupiah on the cost of imports.
5. Lower Interest Rates. With capital flows controlled and the exchange rate pegged, there will no longer be a need for high rates of interest to protect the currency. Interest rates should be reduced substantially, and should be set having regard to a realistic estimate of the rate of inflation achievable in 1999, rather than the expected rate for 1998.
Nevertheless, monetary policy should be held firm, to ensure that the present burst of inflation is halted, and is not allowed to be transmitted into a continuing period of high inflation.
Indonesia's problems are much deeper than they were six months ago, and the case for urgent, innovative action is consequently more pressing.
They also deeply interrelate with one another, so that individual issues, such as the food crisis, are unlikely to be resolved without broader economic action. Nevertheless, the aim of each of our proposals has been to address the urgent problems facing Indonesia, rather than to remove it from open participation in the world economy.
As soon as current problems are stabilized and appropriate structures and controls are in place, Indonesia should return to the world of free capital flows and floating exchange rates.
Prof. Peter Sheehan is director of the Center for Strategic Economic Studies at Victoria University in Melbourne. He was Director General of the Department of Management and Budget in Victoria (1982/1990) and adviser to former Prime Ministers Hawke and Keating. Dr. David Ray is an economist specializing on Indonesia at the Center.
Window: Indonesia's problems are much deeper than they were six months ago, and the case for urgent, innovative action is consequently more pressing.