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.