Structural reform lagging

Structural reform lagging

Indonesia has come a long way in reforming its economy, which has
been battered since 1998 by the multidimensional crisis amid the
transition from a centralized, authoritarian government to a
decentralized, more democratic one.

A more consistent implementation of reforms has been
strengthening macroeconomic stability, as can be seen from the
steady decline in both interest rates and inflation. Fiscal
consolidation is continuing and the ratio of government debts to
gross domestic product was down to as low as 72 percent from more
than 105 percent in 2001, plus the rupiah has kept its strength
against the American dollar.

The economy has reduced its vulnerability to both domestic and
external shocks, such as the terrorist bombings in Bali last
October and the recent war in Iraq. Banks have been decreasing
their nonperforming loans, while financial restructuring has cut
down the gearing ratios in business enterprises.

Unfortunately, though, there are few signs that the stronger
macroeconomic stability has been fueling higher growth. In fact,
growth this year is widely predicted to be less than 4 percent,
as it was in 2001 and 2002. This is way below the minimum 6
percent expansion needed to absorb the estimated 2.5 million new
job seekers entering the labor market annually, let alone the
millions of others who lost their jobs at the height of the
crisis in 1998 and 1999.

Moreover, most people do not have strong confidence in the
long-term outlook of the economy and are concerned that the
current stability is still fragile. Just witness how almost 50
percent of the Rp 833.4 trillion (US$93.6 billion) in private
savings in the banking system as of March consisted of time
deposits of one- to three-month duration, and almost all of the
capital that has begun to flow in was portfolio investment that
could immediately fly out simply at the first hint of any
trouble.

What fundamentally went wrong?

Analysts and businesspeople blame the persistently low growth
on the long backlog in structural and legal reforms that has kept
the environment inimical to new investment, while private
consumption, which has been the main locomotive of the economy
since 2000, has been losing steam due to lack of savings and
mounting consumer debts.

Most structural reform has largely been behind schedule due to
a combination of strong resistance from vested interest groups
within the government, poor leadership within the executive
branch, adversary relations between the executive and legislative
branches and inadequate institutional capacity to execute reform.

Most damaging is the miserable failure in corporate
restructuring due mainly to the bombed-out system of bankruptcy
proceedings under the prevailing Bankruptcy Law.

Unreliable bankruptcy proceedings have distorted market
competition as errant firms that have simply stopped servicing
their debts have an advantage over those that painstakingly
endeavor to service their debts.

Yet more damaging to the long-term foundation of sound
economic growth is the loss of opportunity created by the
economic crisis to clean up the corporate sector from the
inefficient businesses that in the past thrived mostly on the
benefits of corruption or collusion and nepotism.

Consequently, most banks remain highly averse to new lending,
which is badly needed to fuel a higher pace of economic
activities.

The political environment for making decisions about the
remaining reform measures has become increasingly tough as the
House of Representatives has always insisted on delving into the
nitty-gritty of every executive action. This is actually expected
in a democratic and decentralized Indonesia. Gone are the days
when policies could simply be decreed and implemented under the
sole command of the president. Decision- and policy-making should
now be based on a national political consensus. That is what
democracy is all about.

The problem though is that a balancing act is badly needed to
accelerate the pace of structural measures to stimulate
investment, because the nation cannot afford a few more years of
low growth without risking the huge unemployment figure exploding
into social and political instability and the incidence of
poverty rising again.

The next 18 months will be even more challenging insofar as
government discipline and leadership to implement structural
reform are concerned.

First, because most of the remaining reform measures are much
more difficult as they involve institutional-capacity building in
taxation, customs service, the legal system, local autonomy and
other components of good governance that all require the
transformation of old minds, culture, work habits.

Second, because the government will no longer have a reward-
punishment mechanism for its reform program with the scheduled
termination of the International Monetary Fund extended facility
later this year.

Third, because during the 2004 election year, both the
executive and legislative branches will tend to favor populist
measures at the expense of the long-term good of the economy.
It is therefore most imperative for both the executive and
legislative branches of government to realize that without
steady, significant progress in structural reform the economy
will never return to the path of high growth, but will instead
become highly vulnerable to a new bout of crisis.