Several major risks affect prospects

JAKARTA (JP): The World Bank foresees several major risks that could adversely affect Indonesia's economic prospects in the short and medium term, including the economic slowdown in the U.S., huge foreign and domestic debts, fragile political environment.

The World Bank said in a report released here on Friday that the expected slow down in the U.S. economy and consequently the weakening of global economic and trade would certainly affect Indonesian export expansion.

"The expected decline in oil prices-- from US$28/barrel in 2000 to under $20 in 2003-- will further reduce Indonesia's current account surplus," the report on the World Bank Group's country assistance strategy for Indonesia added.

While the report does not expect a rise in international interest rates, it warns that Indonesian risk premium-- at present more than 700 basis point over the U.S. Treasuries-- reflects continued negative sentiments of international investors towards the country.

Moreover, the World Bank added, the high domestic and foreign debt, a weak banking and corporate sector, and a growth rate that is much lower than before the 1997 crisis make Indonesia particularly vulnerable to such risks.

"The key risks are a more rapid decline in oil prices, a further depreciation of the rupiah, and an increase in domestic interest rates," it noted.

According to the report, the largest macroeconomic risk stems from the government's high domestic debts (more than Rp 650 trillion), which are largely in the form of floating-rate bonds.

"Higher domestic interest rates-- triggered by, for instance, political turmoil could cause fiscal havoc as a one percentage point rise in real interest rates would cost the government some 0.3 percent of gross domestic product or the equivalent of $500 million," the World Bank warned.

The report draws three case-scenarios for Indonesia's economic outlook, ranging from a crisis, base-case to high-case scenarios.

The worst projection-- crisis-scenario--assumes a breakdown in the government-IMF agreement that could lead to a further erosion of market confidence and deterioration in economic condition.

"A similar outcome could result from political instability or a widespread deterioration in law and order as in both cases, the turmoil would be reflected in a further worsening in financial markets, especially interest rates and exchange rate," the World Bank warns.

Another crisis-scenario could result from external shocks such as a more rapid decline in oil prices, a more rapid slow down of the global economy and global trade growth or a rise in world interest rates, which all could trigger renewed macroeconomic imbalances, according to the report.

The World Bank predicates its base-case scenario on a fragile political environment and its associated risks to the ongoing reform program.

According to the report, this base-case scenario is the most likely situation in Indonesia whereby the economy will muddle through with a growth of only 4 percent for the next three years.

This scenario assumes Indonesia remains under the IMF bailout program but the implementation of its structural reforms will be very slow with frequent slippages and some policy reversals. Investor confidence and private investment will revive barely enough to keep GDP growth at about 4 percent a year.

The World Bank's high-case scenario assumes a greater political stability and a more aggressive implementation of structural reforms.

Under this scenario, economic growth is projected at 4 percent this year, but rising to 5 percent in 2002 and 6 percent in 2003.

Other major assumptions for this scenario include an acceleration of bank and corporate restructuring, careful management of the ongoing fiscal decentralization program, and appropriate monetary and exchange rate policies, as well as key actions in legal and judicial and civil service reforms.

The report, however, warns that Indonesia's external financing position remains fragile under any of the three scenarios because oil prices will decline and export-growth will slow down while new private equity flows through direct or portfolio investment will likely remain modest.

"Moreover, Indonesian companies' access to new external private borrowing is likewise expected to be limited as long as their debts are not resolved and their balance sheets remain weak," the World Bank said.

The report notes that in any of the scenarios there is likely to be considerable political uncertainty, stop-go policies on reforms and capacity constraints impeding the government's ability to carry through on its commitments.

"But the probability is high that Indonesia will muddle through. The challenge for the government and Indonesian development partners will be managing this uncertainty and helping reduce the associated risks," the World Bank added. (vin)