RI's recovery is fragile

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.