The $35b retrenchment

The $35b retrenchment

The government deserves high commendation for immediately
delivering some of the drastic measures it promised early this
month to cope with the currency turmoil and its far-reaching
implications. Minister of Finance Mar'ie Muhammad told the
plenary session of the House of Representatives yesterday that Rp
3.27 trillion (US$1.1 billion) worth of development projects
covered in the current 1997/1998 state budget had been postponed.
In addition, almost $24 billion worth of investment projects by
state companies and private firms were rescheduled or reviewed.

The retrenchment will surely improve market sentiment,
strengthen investors' confidence in economic prospects and
consequently help stabilize the rupiah at its equilibrium market
rate. First of all, as Mar'ie himself acknowledged, the spending
cut aims at keeping the state budget from a Rp 9.2 trillion
deficit. Fiscal deficit not only effects investor confidence in
the rupiah but is also against the law which stipulates that the
government shall run a balanced budget.

The postponement of private sector and state company projects
with large import requirements will help check the current
account deficit at a sustainable level. This again is conducive
for further strengthening the stability of the rupiah because an
excessive current account deficit will put the rupiah under
strong pressure. Even though most of the rescheduled projects are
basic infrastructure such as toll roads, power generation and
port facilities, they will not adversely affect business
operations as the capacity of the current infrastructure is
fairly adequate, at least for the next two to three years.

Mar'ie also announced retrenchments in budget spending on
official travel, meetings, office buildings, land appropriation
and equipment procurement. Given the government's poor track
record regarding this kind of spending, we hope that this time
the government will be able to instill high budget discipline at
all its offices.

It is both economically and politically understandable, in
view of the Presidential election in March, that the government
did not raise domestic oil fuel prices but decided instead to
subsidize fuel prices with an estimated spending of Rp 2.2
trillion for the whole fiscal year. Higher fuel prices would
further worsen the business climate, which has been in a dire
condition due to tight monetary measures, and would further heat
up the inflationary pressures, which are already very strong as a
result of the 23.5 percent depreciation of the rupiah. All this
may still threaten macro-economic stability.

Spending cuts in the public and private sectors are, however,
only part of the crisis management to cope with the currency
turmoil. They serve only to address the currency crisis but are
not effective by themselves in coping with the structural
weaknesses of the economy. Other reform measures are needed to
strengthen the economic fundamentals which have been shaken by
the rupiah depreciation and the credit crunch.

Mar'ie did promise at the House session that other measures
would be launched soon to curb imports of consumer goods and to
strengthen the banking industry. Hopefully, the market will not
have to wait too long for these additional measures, although we
know these structural adjustments are the hardest part of the
necessary reform package.

Mar'ie did hint at several incentives for exports such as pre-
shipment financing for exporters and lower import tariffs for
basic materials but the technical details have yet to be worked
out.

We are also concerned that Mar'ie did not mention anything
about measures to minimize market distortions such as
monopolistic practices and various other obstacles to open, fair
market competition. Hopefully, these anti-market practices will
also be included in the upcoming package of reform measures.

The government and the private sector should use the currency
turmoil and its wide-ranging implications as a momentum to
consolidate the national economy through deep structural
adjustments. After all, the rupiah crisis and the damage it has
incurred on our economy in such a short period of time clearly
show that the fundamentals of our economy are not as strong as we
like to assume. Our economy has structural weaknesses which are
highly vulnerable to external pressures.