RI's recovery is fragile

Rizal Ramli, Former Finance Minister, Jakarta

The last few weeks have seen the appearance in the press of an excessive euphoria regarding the progress of Indonesia's economic recovery. The basis of this optimistic evaluation is the recent strengthening of the rupiah on foreign exchange markets and the rise of share prices on the Jakarta Stock Exchange.

To some extent a euphoric press is a good thing, since positive statements about the economy help build confidence in the markets. But an excessive euphoria can be dangerous as it creates conditions for a sudden shock or surprise that is disadvantageous to all of us.

The strengthening of the rupiah and share prices are the result of several factors that do not reflect an improvement in the fundamentals of the economy.

The first factor is economic recovery throughout Asia, in which all of the Asian currencies have been strengthening over the past few months. The strengthening of Asian currencies is reflected in the first instance of the appreciation of the Japanese yen from levels of about 140 per U.S. dollar to levels approaching 120 per dollar over the past few weeks.

Asian currencies have also been supported by the emergence of a more bullish outlook on growth prospects in eastern Asia based largely on the realization that the economic impact of Sept. 11 would not be as grave as earlier predicted. The rupiah has strengthened and share prices have firmed up to a greater extent than in other countries because these indices started from such a low base and the markets for the rupiah and Indonesian shares are still relatively thin.

For example, the daily value of U.S. dollar trades in the Jakarta foreign exchange markets reached US$4 billion before the crisis. Now, however, only $200 million is traded daily. The same can be said for volumes on the on the Jakarta Stock Exchange, which in dollar terms are now one-fourth of the levels recorded before the crisis.

The second factor is the leadership of President Megawati Soekarnoputri. Her relatively uncontroversial leadership has given rise to a comparatively stable political environment, which has helped to reduce political risk premiums. The opposition parties have also shown restraint, contributing to the overall perception that the political climate has begun to settle down.

Yet it is not certain that this conducive environment will last as we approach the Annual Session of the People's Consultative Assembly (MPR) in August 2002 and as disappointment with the trajectory of reform deepens among students and other activists.

The third factor is the sale of assets of the Indonesian Bank Restructuring Agency (IBRA). The act of selling IBRA assets such as Bank Central Asia and the privatization of state-owned firms such as Indosat and PT Telkom have contributed to the strengthening of the rupiah. These asset sales have increased the domestic supply of U.S. dollars in our very thin domestic foreign exchange market. Yet boosting the strength of any currency on the basis of asset sales is a risky proposition, especially when the asset sales in question are "forced" sales below market prices.

Unfortunately our macroeconomic policies, particularly fiscal policy, have not led to an improvement in the economic fundamentals. For example, the budget deficit in the first quarter of 2002 increased more than two-fold to Rp 5.6 trillion as compared to the planned target of Rp 2.7 trillion.

In general, economic indicators that are related to perceptions have improved the most. But other indicators more closely related to the fundamentals of the economy have in fact worsened, and in some cases the deterioration has been significant.

Statistics published by the Central Bureau of Statistics indicate that the economy grew in the first quarter of 2002 by only 2.15 percent on an annual basis. This is far below the rate of 4.8 percent recorded in 2000 and 3.4 percent in 2001.

Year on year economic growth in the first quarter of 2002 was only 2.47 percent, much lower than year on year growth in the first quarter of 2001 of 4.08 percent.

Moreover, growth forecasts for 2002 are in the range of 3 percent to 4 percent, which is insufficient to absorb the predicted growth in the labor force. In Indonesia, as in other countries, the most important economic indicator is the growth of employment and recorded unemployment, not the exchange rate or the share index.

Jobs are what give people dignity and hope for greater prosperity in the future. With growth in the range of 3 percent to 4 percent, the economy can only absorb 1.5 million new workers each year, while over the same period 3 million people will enter the labor force. The result is chronic unemployment -- a personal tragedy for every unemployed person and a waste of the nation's human resources.

Other declining indicators of the economic fundamentals include the investment rate. The rate of foreign direct investment (FDI, as opposed to portfolio investment in equities) fell by 60 percent in the first four months of this year compared to the first four months of 2001. FDI declined from $3.4 billion in the first four months of 2001 to $1.4 billion in the first four months of this year. Domestic investment during the same period fell by 30 percent from Rp 11 trillion to Rp 7.5 trillion.

These figures are striking given that the political situation has stabilized, which, in theory, should stimulate new investment. Yet this has not happened because the conservatism of the monetary authorities has resulted in macroeconomic policies that do not encourage investment.

Another worrying indicator is the drop in non-oil exports. The decline in non-oil exports has continued in the first quarter of this year, falling 9.6 percent compared to the first quarter of 2001.

On the consumption side, demand has begun to soften in the retail sector. Sales growth in the retail sector was only 15 percent in the first quarter of 2002, or half of the growth rate of 32 percent recorded in the first quarter of 2001. Moreover, profitability in the retail sector declined by 50 percent, mostly because of increases in the prices of fuel, electricity, wages and rents.

The softening of demand in the retail sector is worrying because the economic recovery has to date been driven by consumption and domestic demand. Another important indicator is the weighting that international fund managers attach to Indonesian assets. Weightings for most countries in Asia have risen compared to last year, but so far there has been no change in fund managers' expectations concerning the performance of Indonesian assets.

Of course demand for Indonesian bonds has begun to increase, but this is mostly because interest rates in U.S. dollars are very high. If we are not careful these high interest rates could become a serious cyclical problem in the future.

These negative trends in the fundamental indicators of economic performance are a warning to all of us that we must all do our best to come up with new initiatives to achieve a breakthrough on the real side of the economy. The government's economic team needs to change from its current passive stance in which no new initiatives are taken and the decision-making process is inordinately slow. A more proactive stance is needed to reverse these negative trends, and mechanisms must be created to ensure that decision-making is more rapid and effective.