The `blueprint' of RI's postcrisis economy

Faisal Basri and Gatot Arya Putra, Jakarta

Indonesia's economic problems have reached alarming levels and efforts to solve them have led to improvements in certain sectors. But problems in many other sectors are growing more sophisticated because they have never been addressed, while new problems emerge, making them more complex.

Since the start of the economic crisis in 1997, Indonesia's economy, besides suffering from permanent output losses, tended to grow at a lower rate annually -- below 5 percent per annum.

Low economic growth has been followed by trends of increased unemployment and poverty. Open unemployment increased from 4.7 percent of the total workforce in 1997 to 5.4 percent in 2001, even though disguised unemployment decreased from 37.5 percent to 30.6 percent.

An increase in open unemployment indicates higher unemployment among the middle-class workforce, while a decrease in disguised unemployment shows that employers have been forced to maximize job loads -- or that workers, to cope with increased living costs, were forced to get other jobs.

Either way both efforts appear to have increased income -- as indicated by the doubling of commercial banks' consumer credits from Rp 40 trillion by the end of 2000 to Rp 80 trillion as of the end of 2002. But unfortunately, the increase in workers' incomes were not accompanied by improvements in their productivity. Their productivity even declined.

The low annual rate of economic growth, accompanied by the decline of productivity, has worsened our global competitiveness. Growth competitiveness, for example, declined in rank from 62 among 80 countries in 2001 to 67 in 2002, while the country's microeconomic competitiveness fell from the 59 to 64, according to the Global Competitiveness Report.

Our competitiveness was worse than Asian competitors, such as Vietnam, the Philippines, India, China, Thailand, Malaysia, South Korea, Hong Kong, Japan, Singapore and Taiwan.

The low growth competitiveness was contributed by low technology index (rated 65), public institution index (77) and macroeconomic environment index (53).

Indonesia would be able to improve competitiveness if its companies are restructured. But corporate restructuring has thus far been hampered by government policies related to labor, the capital market and the banking industry.

A government policy discouraging dismissals, for example, makes it difficult for companies to improve efficiency. A policy where creditors cannot force inefficient debtors to be declared bankrupt also hampers efforts to boost efficiency. Hence such policies burden the banking industry and also the economy.

While the Indonesian Bank Restructuring Agency (IBRA) has access to restructure companies under its supervision, it has been too slow, as indicated by the low level of sales of the credit assets under its management.

Out of the sold credit assets, a substantial portion -- worth more than half of banks' total capital -- has been bought again by the banks through third parties. Because the credit assets are of low quality, the purchasing banks will likely run into difficulties if the credit assets go sour in the future.

The restructuring of commercial banks, leading them to have a low ratio of loans against deposits, is also heading to an unhealthy banking industry. Their average loan-to-deposit ratio (LDR) of around 44 percent as of last December indicates that they are not effective in extending credits to businesses. Such a low LDR will make it very difficult for the economy to recover its high growth.

The low LDR has been caused by seven factors. First, banks are trapped to become traders of mutual funds consisting of recapitalization bonds -- whereas the total amount of such bonds accounted for 32.59 percent of commercial banks' total assets by the end of last year.

Second, because commercial banks remain dominantly managed and owned by the same people since before the economic crisis, their operational behavior has never changed. While such banks used to channel major portions of their credits to sister companies, they will therefore find difficulties in efforts to rapidly expand their credits to independent entities, at a time when supervision of legal lending limits is tightened.

Third, expanding the demand for new credits will be hampered by the slow recovery of the real sector.

Fourth, companies' preference to raise cheaper funds from the bond market affects demand for credits from banks, whose intervention is worried by debtors.

Fifth, the higher concentration of the banking industry -- marked by the 70 percent domination of credit extension by 22 banks -- hampers credit expansion to larger numbers of borrowers.

Sixth, Bank Indonesia's plan to include market risks in the calculation of the minimum requirement of 8 percent capital adequacy ratio will hamper credit expansion.

Seventh, the requirement that banks should lower their non- performing loans to a maximum of 5 percent of total credits will force them to be more cautious in channeling credits.

Slow growth in new credit extension was apparent over the past few years. In 2001, for example, new credit extension by banks grew by 11.9 percent and in 2002 by 14.4 percent, far lower than the annual growth rate of 26.05 percent between 1995 and 1997. Moreover, out of the new credits extended in 2001, 38.5 percent came from the acquisition of credit assets from IBRA. The contribution of IBRA's credit assets to commercial banks' new credit extension rose to 51.3 percent in 2002.

Such a slow credit growth will not be able to help facilitate the economy to grow at a level similar to that before the crisis. The banking industry also faces high risks because about half of their new credits are of high risk.

However, commercial banks showed little improvement in their net interest margins -- from an average of 3.69 percent for all commercial banks in 2001 to 4.14 percent in 2002 (meaning that the margins grew by 12.2 percent). But the growth rate of banks taken over by IBRA and that of recapitalized banks were worse than the average growth rate of all banks.

The net interest margins of banks taken over by the IBRA averaged 4.2 percent in 2001 and 4.6 percent in 2002 (meaning that the margins grew by 9.5 percent), while those of recapitalized banks declined from 3.75 percent to 3.74 percent (decreasing by 0.27 percent).

While credits cannot help much to prop up the Indonesian economy, consumption plays its role in supporting economic growth, which is financially integrated. But we cannot rely on consumption alone because consumption in a financially integrated economy is usually supported by foreign debt, whose flow into and out of the country will influence the volatility of consumption. This in turn may cause fluctuation of growth.

A more consistent growth would be gained from the support of foreign direct investment (FDI). However, the FDI inflow can only support higher growth if the country improves its human capital, the depth of its domestic money market, the quality of its governance as well as its macroeconomic policies.

To attract more FDI, the country also needs to liberalize direct investment before portfolio investment and bank loans, trade before the money market and the domestic money market before the external money market.

Faisal Basri teaches at the School of Economics, University of Indonesia. Gatot Arya Putra is a former head of the planning division at IBRA. The above is abridged from the writers' presentation at The Jakarta Post's seminar on Strategy for Indonesia's Economic Development held on April 28.