The costs of habitual fudge

The costs of habitual fudge

The best lesson the government can draw from its macroeconomic
management this year is that political stability, policy
consistency and good rapport with multilateral development
agencies are key prerequisites to maintaining the momentum of
economic recovery.

When then president Abdurrahman Wahid was preoccupied with his
political fight with the House of Representatives during the
first six months of this year and the government picked a fight
with the International Monetary Fund, the economy bled more
profusely as the rupiah fell sharply and interest rates rose
steeply.

The rupiah's steady fall to as low as 11,500 to the dollar in
June from 9,500 in January precipitated a vicious circle within
the economy as foreign debt service payments increased, business
risks rose and corporate debt restructuring became much more
difficult.

The stronger inflationary pressures fueled by the falling
rupiah prompted the central bank to tighten its monetary policy
by raising interest rates, thereby stifling bank lending,
severely hurting business operations and increasing the
government's domestic debt service payments.

The adverse developments made the situation detrimental to
reform measures, causing longer delays of sorely-needed programs
to support the recovery process.

As the government continued to backtrack on its reform
commitments, the IMF extended facility, put on hold in December
2000, remained mothballed. This in turn prompted the World Bank
and Japan, the largest creditors, to cancel or postpone their
loan disbursements.

The end result of all this was the loss of whatever remaining
vestiges of confidence the market still had in Indonesia's
economy.

President Megawati Soekarnoputri's Cabinet made the right
strategic move when it acted firmly, less than three weeks after
its installation in early August, to mend ties with the IMF and
put in place a new package of reform measures.

The economy immediately regained market confidence and the
rupiah strengthened to almost 8,000 to the dollar, thereby
fueling a virtuous circle (rather than a vicious one).
Unfortunately, though, an external shock hit the country after
the Sept.11 terrorist attacks on the United States pushed the
global economy into a deeper recession and deprived the
Indonesian economy of its external locomotive.

Worse still, an anti-American campaign that raged almost
uncontrollably between September and October inflicted more
damage on the country's economic outlook and once again sent the
rupiah into a tailspin, thereby setting off another vicious
circle. The rupiah has since been languishing at around 10,500 to
the dollar.

Most international and local economists agree that the current
rupiah rate does not reflect the real economic fundamentals,
arguing that the local unit should have been much dearer.

But that is the rate accepted by the market, the blunt reality
emanating from how the market perceives the Indonesian economy.
One may argue that this adverse development was the work of
greedy market manipulators.

But in so far as the country pursues a market economy and an
open capital account, and the economy continues to depend
significantly on the international commodity and financial
markets, the government cannot simply ignore market perceptions,
however imperfect the market has traditionally been.

The market perception is formed by what market players see,
read and learn from analysts regarding developments in Indonesia,
notably those related to political and security conditions, the
legal framework, regulatory environment and reform policy
performance, which all influence macroeconomic conditions.

It is therefore imperative that the government makes its
policy-making process as transparent and as predictable as
possible, and its decision-making process as accountable as
possible, to enable the market to form a more accurate perception
of the economic outlook.

The timely completion by the government of a new package of
reform measures for the next fiscal year, as stipulated in its
Dec. 13 letter of intent to the IMF, is one good step towards
attracting a favorable market perception.

But the most important thing the government can do is to go
all-out to implement each of the measures pledged in the package.
The World Bank has warned that the government has only six months
to prove it is really serious about sorting out the economy.
Another fudge or further delays would condemn the economy to
continue on its "muddling-through" path and could even derail the
recovery process if the market stopped giving the government the
benefit of the doubt.