Strong political mandate, weak economic performance

Strong political mandate, weak economic performance

Vincent Lingga, Jakarta

Judged against the strong political mandate Susilo Bambang
Yudhoyono obtained in last September's presidential election,
Indonesia's economic performance during the first year of his
administration has been quite disappointing.

His government failed to make best use of its significant
political capital to quickly regain investor confidence in
Indonesia's economy through bold reforms in priority areas of
greatest concern to businesspeople.

Early on during his first week in office last October, Susilo
made the right remarks. He signaled quick action in the top
priority areas of his programs by making working visits to the
Attorney General's Office, and the directorate generals of
taxation and customs. He demonstrated his understanding of the
formidable economic challenges the nation is facing by
immediately holding meetings with Bank Indonesia's board of
governors and with business leaders.

The market initially gave the benefit of the doubt to the
uncomfortable mix of technocrats and politically-connected
businessmen in Susilo's Cabinet,

He promised to resolve high-profile disputes with foreign
investors -- the Cemex company of Mexico, Karaha Bodas, Exxon
Mobil and Newmont of the United States. None of them has been
settled, further validating the notion that Indonesia is an
unpredictable place to do business.

Susilo made a strategic decision to proceed with the plan to
hold an infrastructure summit in January, less than three weeks
after the devastating earthquake and tsunami in Aceh province and
Nias island, North Sumatra.

Infrastructure deficit has indeed become one of the biggest
hurdles to investment in Indonesia as poor infrastructure impairs
the competitiveness of the economy as production and distribution
costs are made much higher than those in other countries. The
prospect of imminent power shortages hangs over many provinces.

Economic performance during the first six months (October,
2004 to March, 2005) was fairly impressive with gross domestic
product growing by 6.65 percent on a yearly basis in the fourth
quarter of last year and 6.35 percent in the first quarter of
this year. The quality of growth also increased significantly
with a much stronger foundation as the prime movers shifted more
to investment and export. Investments (mostly domestic) grew by
15 percent, as evidenced by a 40 percent robust increase in
capital goods imports, and exports expanded by 13 percent.

However, promises and symbolic moves, though needed, are not
enough to maintain the momentum of market confidence. Investors
require concrete, consistent measures because only consistent and
effective implementation can give credibility to government
policies. Unfortunately, it is these two factors that are acutely
lacking in the Susilo government.

Most foreign investors remained on the sidelines, waiting for
consistent policies and strong evidence of credible decision-
making. Some foreign investment did flow back into the country
but mostly in portfolio capital, which is skittish and can fly
out any time at the slightest sign of problems.

Only about five of the around 90 infrastructure projects
offered during the summit were eventually taken up by private
investors because the government failed to enact more than a
dozen rulings badly needed to strengthen legal certainty,
straighten out taxation issues, improve the commercial viability
of investment in infrastructure and set up a viable tariff
system.

Economic growth slowed down to 5.54 percent in the second
quarter, the balance of payments prospects worsened amid the
steady decrease in foreign reserves caused by the huge need for
oil imports and the lack of political courage to reduce the fuel
subsidy. Most analysts now foresee a growth of 5.5 percent to 5.7
percent this year, still respectably higher than last year's 5.1
percent.But this year's economic expansion could have been much
faster.

When the government finally decided to bite the bullet in
March, it seemed too little, too late. The 29 percent price hikes
were rather meaningless in controlling fiscal deficit and fuel
export smuggling and the market became increasingly jittery about
fiscal sustainability.

The worsening economic conditions forced the government to
amend the 2005 budget twice, while most of the reform agenda
Susilo promised in such important areas to investors as customs,
taxation, logistical arrangements and other basic infrastructure
remained mere declarations of intent.

The entirely unrealistic budget for 2006 that Susilo proposed
to the House of Representatives in mid-August was the last straw.
Even though the draft budget was immediately revised, the damage
had been done as the market lost trust in the government's
ability to meet economic challenges.

The market immediately and severely punished the government,
attacking the rupiah and pushing it down at one time to a five-
year low of Rp 12,000 to the dollar in early September, thereby
unleashing enormous inflationary pressures from imports. This
forced Bank Indonesia to raise interest rates to as high as 11
percent now.

Worse still, only about 18 percent of the 2005 development
(investment) budget had been spent as of last month due to
bureaucratic inertia, thereby further tightening the contractive
impact of the already austere budget.

The market hailed the bold Oct. 1 decision to double fuel
prices in order to bring them closer to their economic costs.
However, this long-delayed measure could be too bitter for the
economy to swallow if the government is not able to cushion the
shock impact of the inflationary pressures within the next few
weeks.

One may argue that it is not fair to judge the Susilo
government by ordinary yardsticks, given the devastating natural
disasters in northern part of Sumatra late last year that
preoccupied the government for almost two months early this year.
The steady rise in international prices to historical highs is
also completely beyond his control.

Investors, however, don't expect instant results in all areas.
What they really want to see is a steady progress in the right
path of a consistent reform process. Everything does not have to
be fixed at once.

It is also well advised for the government to realize that an
economic policy cannot be sold in a vacuum. The environment
should support the credibility of the policy and the government,
notably its economic team.

No one doubts Susilo's integrity. But the market now has low
trust in his economic team and several economics ministers have
perceived conflicts of interest. The first anniversary of his
administration seems to be opportune for a reshuffle of his
Cabinet.

The writer is a senior editor at The Jakarta Post.