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.