Slight economic growth spurt faces head wind

Slight economic growth spurt faces head wind

Muhammad Chatib Basri

I was sitting in a small coffee shop in Jakarta when a friend
of mine, a foreign economist, asked me how we reconcile the good
macroeconomic indicators on the one hand with various structural
problems in trade and industry on the other.

This is not an easy question. Over the last couple of years,
we have been haunted by the decoupling of macroeconomic and
industry performance in trade and manufacturing.

Look at the macroeconomic performance: The economy grew by 3.7
percent from the first to the third quarter of 2003; the rupiah
has stabilized at around Rp 8,500; inflation has been
decelerating and it is predicted to hit below 5 percent by the
end of 2003.

Parallel with this, the Bank Indonesia interest rate continues
to decline. In addition, the debt ratio to gross domestic product
(GDP) is steadily declining and the fiscal deficit shows a
similar trend as well.

I think even the most cynical observer of the Indonesian
economy would admit that macroeconomic performance has shown
improvement. In spite of the global conditions that have been
affected by the threat of terrorism, the U.S. invasion of Iraq
and health issues such as SARS, most of Indonesia's macroeconomic
indicators improved during 2003.

However, in contrast, little has been achieved in the trade
and investment sector, particularly in manufacturing. Trade and
investment are the main medium-term issues for the Indonesian
economy.

Although there has been improvement in the non-oil and gas
export growth -- 3.4 percent from January to October -- compared
to 2002, it is still modest and far from the pre-crisis growth.
It is worth noting that despite various concerns about growing
import competition from China, Indonesia's growth in non-oil
exports to China is the highest among other destination
countries.

What is the economic prospect for 2004? Economic growth
continues to rely largely on consumption, while investment is
still lagging and exports remains modest. Food consumption is
expected to continue to increase in 2004 due to positive impacts
of the 2004 elections. In the last elections in 1999, strong
consumption growth was evident, of which food consumption growth
reached around 5 percent.

While economic growth is expected to accelerate slightly next
year, it does not bode much progress in reducing unemployment,
poverty and social conflicts in the near future. Investments and
exports remain slow, showing that serious problems persist in the
manufacturing sector.

The non-oil manufacturing sector only grew 2.3 percent in the
first three quarters. An annual survey conducted by the Central
Statistics Agency (BPS) illustrates the poor condition of the
manufacturing sector, particularly in textile, garments and
footwear. Meanwhile, the percentage of manufacturing firms that
downsized and closed down continued to increase from 2000 to
2002. As a result, the job absorption rate in these sectors also
declined.

On the export front, Indonesia seems to have been shifting
into resource-intensive products since 1995, whereas the
competitiveness of manufacturing is in decline. A study carried
out by Basri and Syahrial from the School of Economics at the
University of Indonesia shows that from 1985 to 1995, most
manufacturing products experienced a rise in competitiveness.

Nevertheless, from 1995 to 2001, the competitiveness of some
of these products -- including plywood, textiles, footwear and
garments -- showed a declining trend. These findings suggest that
export growth was mainly driven by the supply side, or
competitiveness, rather than the demand side from 1985 to 1995,
but not from 1995 to 2001.

To make things worse, the declining competitiveness of
Indonesian exports is combined with creeping protectionism.
Protectionism is not the answer to the hindrances to making
progress at the multilateral level, such as the World Trade
Organization, and does not provide a sustainable basis for
growth.

While there is no conclusive relationship between trade
openness and growth in many countries, there is also no evidence
that trade protection is systematically associated with high
economic growth. This is particularly true for Indonesia. A
protectionist policy will undermine the current open trade regime
that has served the country so well in the past. The continuing
signs of increasing protectionism imply that the government has
tried to overcome inefficiency on the supply side through trade
policy.

But the government does not address the problem of lagging
productivity through increasing efficiency. Instead, it tends to
defend inefficient industries by increasing protectionism, thus
coming out with various ad hoc trade policies.

Since 2001, the protectionist trend has continued to increase,
as evident in the increase in tariffs on wheat flour and trade
regulations, or tata niaga, on textiles, steel, sugar and clove.

More in-depth observation shows that the negative growth of
investment was mainly caused by foreign events, whereas domestic
investment growth remained positive.

One of the possible explanations as to why domestic investment
and foreign investment recorded inverse growth is the
appreciation of the rupiah, which caused imported capital goods
to become more expensive and led foreign investment to decline.

It is true that there is a trend of capital inflow as
reflected by the strengthening of the rupiah, but it is limited
to portfolio investment. As a result, short-term capital inflow
does not have significant impact on investment in the real
sector.

In fact, the government should be aware of the possibility of
reverse capital flow when there is an economic and/or political
shock. It is worth noting, however, that thus far the government
has been able to maintain political stability, and the currency
and capital market is becoming less sensitive to political issues
-- proven in the limited impact of the Bali blast and Marriott
bombing on the exchange rate and stock market.

Looking at the severity of the economic crisis and the
shortcomings in institutional reform, immediate recovery is not
to be expected in the short term. In addition, other factors,
such as political uncertainty, have also hampered economic
recovery during the last five years.

The investment climate remains bleak due to various labor and
institutional problems. Looking at government performance and the
obstacles faced in implementing good governance, it certainly is
difficult to expect that the climate will improve soon.

The implication, therefore, is that foreign investment will
not return unless significant reforms are made in politics as
well as the judiciary. Coupled with business uncertainty, labor
problems and local taxes, these factors will influence economic
growth during 2004. The University of Indonesia's School of
Economics predicts that the economy will grow by an average 5
percent per annum until 2007. Under such conditions, the road to
economic recovery is still long and bumpy, although it is not
unpromising.