The `blueprint' of RI's postcrisis economy

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.