Seize momentum, ensure change in right direction

Seize momentum, ensure change in right direction

By Mari Pangestu

SHANGHAI (JP): We will soon enter a new millennium. As the
rest of the world debates how to anticipate and respond to new
technologies and the new economy -- the "bits" economy -- we in
Indonesia are still facing the basic issue of how to rebuild our
basic economic structure, or the "bricks" of our economy. As the
20th century approaches its end, we need to take stock of what
has happened, review the challenges and prospects and reflect on
the future.

Taking Stock: Modest Recovery and Continued Ambivalence.

Despite the ups and downs faced throughout the year, the good
news is that Indonesia has experienced a modest recovery, one
that began in the latter part of 1999. Growth up to the third
quarter of 2000 reached 5 percent per annum and is expected to
reach the targeted 4 percent or higher this year.

Indonesia's recovery has been much slower and at a much more
modest rate than other crisis-hit Asian countries such as
Thailand, Malaysia and Korea, which have experienced growth rates
above 5 percent.

The main sources of growth were initially consumption followed
by exports. A rebound in consumer demand has occurred since the
last half of 1999 and can be expected after the extent of
contraction experienced in 1998.

There was also the realization of consumption deferred during
1998, especially of consumer durables, and consumers choosing to
spend rather than keeping their funds in deposits as the interest
rates drastically declined from the high levels in 1998 and the
first half of 1999.

Whereas export growth has been partly driven by high oil
prices, with oil and gas exports, which still account for close
to a quarter of exports, growing at 57 percent per annum by
September 2000.

Non-oil export growth has also been robust at 26 percent per
annum by September 2000 and this has been caused by a combination
of strong external demand, including recovery in the Asian
region, greater macro and political stability, and
competitiveness due to the large depreciation of the rupiah.

Imports have also picked up with the increase in exports and
some initial increase of investment; however, the level of
capital goods imports still remains much below precrisis levels.
The situation has led to a trade surplus for Indonesia and rising
foreign exchange reserves.

Other good news is that higher oil prices have provided the
necessary buffer for now and possibly into next year to finance
the government budget deficit. Progress has also been achieved in
the formal completion of the bank recapitalization program and
the Indonesian Bank Restructuring Agency (IBRA) appears set to
meet its revenue target from asset sales for this year. Recently
IBRA sold four major assets worth at least US$300 million.

Reviewing challenges

However, the modest recovery is subject to many challenges and
the prospect for continued or higher growth remains very fragile.
One major worry is sustaining the sources of growth. Growth in
private consumer demand has slowed down throughout 2000 and this
trend is supported by a decline in consumer confidence recorded
by recent consumer confidence surveys conducted by the central
bank. Whereas, the prospect of non-oil export growth will be
affected by the expected soft, or even worse, hard landing of the
U.S. economy.

The increase in production to meet consumer and export demand
has been possible despite a nonfunctioning banking sector and
continued political uncertainties, because of existing excess
capacity. Firms have been able to fund their working capital
needs by using internally generated funds, especially retained
earnings.

Some exporters and prime domestic companies such as the kretek
(clove cigarette) producers have also issued rupiah-denominated
bonds to raise funds, and some are still able to borrow abroad.

Many of the domestic firms taking advantage of increased
export opportunities are also the more medium-sized firms, which
did not experience the debt crisis of the larger conglomerates
and they are a new segment of the Indonesian private sector which
must be nurtured.

There has been little by way of new investments to replace
needed machinery and equipment, to restructure companies, or to
expand existing capacity. Therefore, while businesses appear to
be more resilient to political developments, their growth is and
will be constrained without any new investment inflows and
resumption of lending and/or financing from the financial sector.

Thus, without resumption of investment, restoration of
consumer confidence and continued robust exports, growth will be
positive but continue to be modest. The government assumption is
for growth of 4.5 percent in 2001. The obvious implication of a
scenario of low or modest growth is that it will take Indonesia
much longer to get back to the precrisis per capita level of
incomes.

In other crisis-hit countries, Malaysia and Korea which have
experienced rapid recovery, their real GDP surpassed precrisis
levels by the beginning of 2000. Indonesia's real GDP is still
currently around 10 percent below precrisis levels, and per
capita income even lower. At a modest rate of recovery of 4
percent, the World Bank has estimated that it will only be 2007
before the real per capita income of precrisis is reached. The
cost of slower growth will be borne by the poor, and the
unemployed and underemployed.

Maintaining confidence and macro stability will continue to be
a challenge for Indonesia. Despite improvements compared to 1998
with the rupiah strengthening to Rp 7000 per U.S. dollar when
President Abdurrahman Wahid came in as the first democratically
elected president in October 1999, and the stock market index
rising for a number of quarters, the indicators have fluctuated
throughout 2000 and deteriorated for the last quarter.

Since August 2000 the rupiah has weakened to around Rp 9,500
to the dollar and higher more recently. The stock market index
has declined since mid-year and has hit an all-time low. No doubt
the weakening of the rupiah is partially due to the strengthening
of the U.S. dollar and the rise in U.S. interest rates, and the
seasonal year-end needs.

However, it has also been due to the deterioration of
confidence in the government's ability to provide a clear
direction with regard to policy; lack of implementation of rule
of the law; delays in reforms; security issues with the spate of
bombings and regional unrest; and continued political
interference in major economic issues such as delaying action on
large debtors.

Investor confidence is at a low point with concerns about
security, political and economic uncertainties, and most
importantly lack of clear direction on investment policy and its
implementation. The latter is illustrated by how the Manulife
case was handled and the change in the terms of Cemex investment
in Semen Gresik after nationalist pressures.

Inflationary pressure has also been rising due to a loose
monetary policy and the depreciation of the rupiah so that
inflation can be expected to be about 9 percent to 10 percent for
this year. Monetary policy authorities have to depoliticize
monetary policy and focus on price stability as a target and
allowing interest rates to rise if needed. Monetary policy should
not be concerned with considerations of the rising cost of
servicing the government debt at the cost of price stability; the
issue of servicing the debt is the purview of fiscal policy
management.

Fiscal sustainability remains looming large on the horizon.
While high oil prices have provided the buffer in the fiscal
situation at least for this year and possibly into next year, in
the near future fiscal sustainability is still a major issue
facing Indonesia. The expenditure side should be a great source
of concern given the cost of servicing interest payments and
principal (which begins in 2003 and 2004) on government bonds
issued for bank restructuring; the unpredictable costs of
decentralization; and the vulnerability of the fiscal situation
to exchange rate and interest rate changes.

The way out of the fiscal situation is to "grow" out of the
debt. That is, growth and recovery of confidence is important for
tax revenue targets to be met, for a secondary market to develop
in government bonds, better prices and prospects for asset
recovery and privatization proceeds. Again the cost of slow
recovery will be that the fiscal burden will be borne over a much
longer period by taxpayers and with less expenditures being
allocated to social needs.

The banking restructuring program is still fraught with
problems despite the formal completion of the recapitalization
program. Given current economic uncertainties and the need to
maintain capital adequacy, banks are still channeling funds into
Bank Indonesia promissory notes (SBI) and thus on the asset side
banks are holding high levels of SBI and government bonds, and
subsequently they have experienced low spreads and earnings.

The growth of new loans is limited since recapitalization has
been through bond issue and not through cash injection. There are
also limitations on selling the bonds in the secondary market.
Despite the restructuring on the loan side, there are also still
nonperforming loans, which could rise further with slow economic
recovery and slow progress on corporate debt restructuring.

It would appear that without an increase in capital, it would
be difficult for banks to increase their lending. Furthermore,
even if banks wanted to increase lending, there are a limited
number of viable corporations without successful restructuring of
corporate debt. The problems related to the lack of "stick" to
push recalcitrant debtors such as ineffectiveness of the
bankruptcy procedures, weak legal enforcement and political
interference with the influential groups are still with us,
despite attempts to make progress.

Therefore, while it appears we have moved ahead compared with
the situation at the height of the crisis -- most would agree we
have still some way to go. This government continues to send
ambivalent signals and despite hopes for change under a reform-
minded government, blatant cases of political interference in
economic decisions also persist.

The most formidable challenge remains for the government to
restore confidence by providing a clear direction in policy and,
most importantly, implementing the policy.

Without a clear signal that necessary actions will be taken
such as addressing corruption, taking debtors to task, asset
recovery and privatization, completing bank restructuring and
upholding rule of law, it is difficult to see a sustained
restoration of confidence and that the much needed investments
will flow back.

The Future

The statement above sounds familiar. It is not dissimilar to
ones made under the Habibie government. The hopeful statements
made at the end of last year and into the first few months of
2000 have gone; the tune has increasingly changed to the familiar
one we concluded on above.

It is distressing that we are still faced with many of the
same problems and challenges, indicating the slow progress. The
main problems as noted above, for sustained economic recovery
remains that growth is important for all aspects of the recovery
program, ranging from bank restructuring, fiscal sustainability
and poverty reduction.

The cost of slower growth is all too evident, especially for
the poor and vulnerable. Furthermore, effectiveness of one part
of the recovery program hinges on progress in other parts of the
recovery program. For instance, corporate restructuring is
important for bank restructuring and vice versa and so on. This
of course emphasizes the importance of coordination and a
comprehensive approach, which has sorely been lacking.

The lack of progress as we all know is not for lack of knowing
what to do. The litany of recommendations of how to move forward
is also by now too familiar: speed up reforms; accelerate the
sale of assets and divestment of government ownership of banks
and corporations; strengthen institutions; good governance;
transparency and address corruption; rule of law and so the list
goes.

Sadly we also come to the same old conclusion. Lack of
implementation is still the crucial bottleneck and we should not
be so naive as to ignore the political realities; inadequacies of
the political, social and legal institutions of our new democracy
to address many divisive issues that tend to slow down or even
block implementation; and that the real changes can only happen
in the longer term.

Given these considerations, economic recovery and the
requisite policy and institutional changes to sustain recovery is
most likely to progress at its current slow and muddling pace.
Six months back most would still agree that this was acceptable.
The solution was not to revert back to a strong government or
person scenario under the pretext of restoring confidence and
order.

Most of us still felt that the muddling through solution was
still the one that would safeguard democracy, and to some extent
worth the social and economic costs once one took a long-term
view of a better outcome in the future. The hope is that
eventually, the present leadership and government shape up and
should be pressured to do so, and if still found wanting, then we
have the option to change the leadership and government.

At present, it is unclear how many still support the muddling
through scenario. Furthermore, the situation has become more
complicated than anticipated. While we have the ability to change
the leadership and government when they are found wanting, we are
unfortunately still experimenting with the process so that
whatever happens it seems that we are in for a rough ride --
which can be expected to last some time. Again, this is not a new
conclusion, yet it unfortunately still holds.

How should we then reflect on the future? In the spirit of the
new millennium we should not throw up our hands in despair. I do
not want to end on a gloomy note, so let me reflect on some
priorities on the economic front of what can then be done in the
meantime, to at least prevent a worsening of the situation and
prepare for the time when change and action can really begin to
be meaningful. I would prioritize the following.

First focus on what is working in the economy and ensure that
they can continue to function and facilitate their growth. This
comprises the less indebted small- and medium-sized corporations,
many of which are involved in exporting or producing basic
consumer goods, which have successfully substituted for the
unaffordable imports.

For example, the steps taken ranges from ensuring minimum
government intervention, facilitating removal of bottlenecks
wherever they are, such as access to credit and administrative or
other barriers associated with exports or the functioning of
their business.

The natural resources sector should also be safeguarded to
yield much needed government and export revenues, and national
policies, investment and the decentralization process must be
mutually supportive to prevent any serious disruption to this
sector.

Second, the non-oil export boom currently experienced should
not be seen as sustainable. This is not just an issue of the need
for new investment. The export boom currently experienced is a
"catch-up" due to the improved competitiveness provided by the
real exchange rate depreciation. The high growth rates will come
down and more normal growth rates will resume.

More importantly, the issues of competitiveness of exports
faced precrisis will soon emerge again, such as moving out of the
unskilled labor intensive exports to more semi skilled and human
capital intensive exports; the need to have a competitive supply
of inputs and increase added value; and to be part of the
regional production networks which have come about and continue
to develop.

To be competitive in exports, countries need to be flexible in
product and factor markets to continuously respond and change to
external and internal changes. This will involve the usual
policies of openness to trade and foreign investment, flexible
factor markets, efficient supporting services and infrastructure;
but increasingly it must involve human capital development and
formation in anticipation of changing comparative advantage and
technology.

The crucial policy is education policy in the widest sense;
something that has not been integrated well with our development
policy and which has focused too much on universal primary
education. The policy has served the first stage of unskilled
labor intensive exports well; but it will not take us to the next
stage without further skill development of our labor force.

Enhancing human capital is important not only for export
competitiveness, but is also crucial to address poverty and
equity by creating assets for people to be employable and
upwardly mobile. Since education and training impacts on the
labor force with a lag, we have to begin to focus now on an
education policy with a long-term vision which focuses not just
on quantity but on quality, creativity, development of specific
skills and anticipates future needs.

Third, rebuild national consensus with an open and informed
debate on the contentious issues which continue to plague major
resolutions of our economic problems, especially with regard to
asset sales, privatization and bank restructuring. The necessity
to go toward an open market system, with the requisite laws,
regulations and institutions to ensure fair competition and
protection of consumers and so on is explicit in the
International Monetary Fund program which the government has
signed on to.

However, we know from the slow progress on economic
restructuring, the polemic which has developed, and the more
dispersed decision-making process due to decentralization, that a
number of basic issues have to be revisited and reformulated.

These include issues such as the role of the state versus the
private sector in general as well as in particular sectors such
as banking, natural resources and public goods. Since the state
owns around 80 percent of the banking sector and private sector
corporations through the debts of bank owners, this is not a
trivial debate.

Furthermore, the debate is not confined to the issue of state
versus private ownership, but also how much the state should
intervene in industrial structure or restructuring as the case
may be. There is also a revival of nationalism and the role of
foreign investment in the economy. Finally there is the issue of
the structure of ownership within the domestic private sector,
whether it is between big corporations versus medium- and small-
sized corporations or between ethnic groups.

One cannot and should not easily dismiss the polemic as
ideological baggage, perceptions not based on fact and
politically motivated to respond to popular pressure. It is
imperative that the issues are addressed in a sensible and open
way; otherwise in fact they will be politicized or utilized to
suit different needs.

It is easy to stir up nationalist fervor to divert attention
from our real problems, but it really does not get us anywhere.
There must be an open and sensible debate involving all the
stakeholders and a national consensus on these issues forged.

At the end of the day this may mean slower progress on some
areas of reforms, and it could also mean special policies will be
needed for specific groups or areas in the economy which either
need to be compensated for change or boosted to balance
inequities which are destabilizing.

Special policies are acceptable as long as we learn from our
past mistakes. That is they should be limited to specific
targeted groups, policies are designed to meet the target group
as directly as possible, are implemented in a transparent and
objective way, subject to good governance, supported by capable
institutions and are phased out over a clear time period.

At the end of the day, the most important thing to do is
perhaps not to be too preoccupied with speed, but to keep the
momentum of change going and ensure that it at least moves in the
right direction by focusing on a number of priorities. It will
then still be up to all of us to ensure that we do not lose this
focus.

The writer is an economist at the Jakarta-based Centre for
Strategic and International Studies.