Risks hanging over economy

Bank Indonesia has predicted only moderate economic growth of 4.5-5.5 percent this year, as against 5 percent last year, but has also forecast an appreciation of the embattled rupiah to a range of Rp 7,750-8,250 against the dollar, compared to Rp 9,500 today, with an inflation rate of 6-8.5 percent.

Some analysts, buoyed by the 5 percent economic expansion that was achieved last year in spite of the prevailing political turbulence, may see the central bank forecast as too conservative. But others, who are worried about the persistently erratic leadership of President Abdurrahman Wahid and his increasingly adversarial relationships with the House of Representatives, may regard the forecast as highly optimistic.

But a better reading of the central bank forecasts requires serious consideration of the risk factors that will loom over the economy throughout this year. Bank Indonesia itself has acknowledged several areas of uncertainty which may affect its forecasts.

Foremost among the risk factors is the lingering political and security instability that could increase Indonesia's country risk, force policy inconsistencies and divert the government's main focus of attention away from economic management. The final conclusions of the House investigations into several scandals that allegedly implicate the President, notably the embezzlement of Rp 30 billion from the National Logistics Agency and a questionable donation from the Sultan of Brunei, will determine whether Abdurrahman's credibility will decline or improve. The way the President-House wrangle over the selection of the new chief justice of the Supreme Court will be resolved will influence the public's perception of the credibility of judicial reform, which is so crucial for the long-term prospects of the economy and for political stability as well. These are just some of the potential sources of political instability, not to mention the risks related to how separatist issues in Aceh and Irian Jaya will be resolved politically.

The pace of corporate foreign and domestic debt restructuring will influence not only industrial capacity utilization, and consequently economic growth, but also the recovery of the ailing banking industry. Companies which have not yet restructured their debts obviously will remain closed to new credit lines, thereby hindering their production operations.

The huge corporate debt overhang is also hindering the recovery of the banking industry as most major banks, which have built up a significant pool of private deposits after their restructuring or recapitalization, still hesitate to resume significant corporate lending. Latest data show that the banks have lent only about one third of the private savings they have attracted due to the high level of business risks, preferring instead to invest their funds in risk-free Bank Indonesia debt instruments. Consequently, their revenues are derived mostly from the slim margin between deposit interest rates and the interest rates paid by the central bank.

Business risks, combined with the uncertainty about the political and security situation, have made it much more difficult and complex for banks to assess credit risks. This situation is quite worrisome because domestic banks still rely on lending for the bulk of their income as their fee-based businesses have yet to develop. Needless to say, in so far as the banking industry cannot resume its financial intermediation properly and efficiently, the economy will remain acutely short of lifeblood.

Another risk looming over economic prospects is related to the capability of provincial and district administrations to exercise their broader political and fiscal autonomy in a business- friendly manner. Too much emphasis on their taxing powers will not only scare away the investments without which the economy will be crippled but also create strong inflationary pressures. Quite a number of local administrations seem unaware that new businesses or investments will increase economic assets, inject new purchasing power and expand the sources of taxes and levies.

The central government's fiscal management, notably its ability to hold the budget deficit at a manageable level amid the huge burden of foreign and domestic debt servicing and the various subsidies, will also affect macroeconomic stability. As tax revenues will remain constrained by moderate economic growth and the carry-forward losses of indebted companies, asset recovery by the Indonesian Bank Restructuring Agency and privatization of state enterprises will play a pivotal role in helping the government to implement its fiscal consolidation.

So all in all, the "fasten your seat belt" sign will likely remain lit throughout this year.