Risks hanging over economy

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.