The economy: Between muddling through and a strong recovery

The economy: Between muddling through and a strong recovery

By Vincent Lingga, Senior Editor

Optimists are looking forward to a more democratic Indonesia built on a stronger, better local autonomy five years down the road. In their hopeful vision, provinces will compete with each other to woo investment, with new businesses creating jobs which will pay wages to generate consumer demand and propel the production machineries of goods and services. This process will develop new major economic centers in the outer islands, notably Sumatra, Kalimantan, Sulawesi, Riau archipelago and Papua, and provide local administrations with broader and bigger sources of tax revenues to enable them to expand and improve public services and public welfare as well. Are these optimists simply dreaming? The pessimists think so: Their various versions of doomsday scenarios for the years ahead have been shaped by the daily turmoil of events during the learning process of democracy and local autonomy. They are nervous about the first experiment with the direct election of the president and vice president next year, seemingly hopeless about any significant improvement in the quality of governance and national leadership with the new crop of political leaders emerging from the 2004 elections likely to be as bad as their predecessors. An air of pessimism seems unavoidable in view of the steady increase in unemployment and under-employment that is now estimated at more than 40 million. Even though the incidence of absolute poverty has declined to about 15 percent from as high as 27 percent in 2002, the almost 50 percent of the population hovering on the verge of poverty are still highly vulnerable to the slightest decline in the economy. Worse still, the political transition and turmoil have left many feeling uncertain about the future direction of the nation, especially as law enforcement against corruption is perceived to be extremely lacking. But, given the problems inherited from the previous regime and the achievements made over the past years, the best course for assessing the economic outlook within three to five years is neither inordinate pessimism nor blind optimism, but cautious confidence. It may be cold comfort for the pessimists to be reminded of how the nation has often flirted with disasters over the past five turbulent years, only for common sense to prevail. Macroeconomic stability has been strengthening with a stabilizing rupiah exchange rate (although still losing more than 60 percent of its 1997 value), inflation under control, interest rates falling steadily and the government's debt ratio to gross domestic product down from more than 100 percent to 70 percent at present. These gains are no reason for undue complacence as the overall condition is still fragile because many structural reforms -- vital to fuel sustainable, strong growth -- have yet to be implemented. There are several major factors that will determine whether the economy will continue to muddle through at annual growth of 3-4 percent or will be able to expand at the pre-1997 crisis level of 6-7 percent. The first risk is related to the government's ability to keep up the pace of its reform programs this year and to resist political pressures for populist, yet misguided, policies in the run up to the 2004 election. Failure in this area would erode the little confidence the international market still has in the economy and undermine the foundations of a sustainable recovery. Bleaker still would be the prospects if opponents of the International Monetary Fund-supervised reform program win their campaign against any extension of the IMF facility after its expiration later this year, while the government possesses no credibility nor discipline to push through structural reforms. Even now under the tight supervision of the IMF and the World Bank, in their capacity as the opinion leaders among Indonesia's international creditors, the reform drive has often floundered under resistance from entrenched vested interests. Macroeconomic stability, though very important, is not by itself sufficient to fuel robust recovery. A long agenda of structural reforms has yet to be implemented to make the economy more efficient and competitive. The formidable challenge is that state institutions have yet to build up adequate competence and credibility to facilitate a self-sustaining reform drive, while institution-capacity building is a long-time process as improvement is incremental at best. Then there is the sovereign risk related to the government's capability in reducing the service burdens of its almost Rp 650 trillion (US$72 billion) in domestic debts through refinancing with the placement of treasury bonds, debt buy-back or bond reprofiling. All these debt-reduction measures will depend on the strength of the macroeconomic condition, which in turn is highly influenced by the pace of structural reforms and fiscal consolidation. The government will risk derailing its fiscal consolidation if its reform-agreement with the IMF is not extended after this year because the rescheduling of foreign debts to sovereign creditors will have to be negotiated on a bilateral basis outside the auspices of the Paris Club. The quality of the 2004 elections of the president and vice president and members of the House and regional assemblies will also make or break market confidence in the economy. If the polls are seen as fair and credible the democratic exercise will reinvigorate investor confidence. But the economy will continue to plod along if the quality of the national leadership in the government and legislative branch remains as mediocre as it is now. Obviously, the country cannot afford to continue the low growth (below 4 percent) course as it did in 2001 and 2002 without risking huge unemployment exploding into massive social unrest and the incidence of poverty rising at the expense of political stability. And muddling through will remain the economy's course if growth continues to depend mainly on domestic consumer demand, now increasingly losing steam. Investment has to be reinvigorated to generate higher growth. Analysts estimate investment should increase from around 18 percent of GDP now to at least 30 percent to generate 6 percent growth. Investment, especially foreign, is unlikely to materialize unless political stability strengthens and legal and regulatory certainty improves. Investors fully realize that many of the structural reforms, especially those in the judicial sector and civil service (good governance), will take a long time. They simply want to see a firm commitment to reform, supported by concrete and consistent measures to allow for a reasonable calculation of business risks. The government is actually aware of the importance of restoring investor confidence, as can be noted from the high priority that has been given to areas of greatest concern to businesses: improving tax and customs service, creating more conducive labor- market policies, minimizing the excesses of decentralization, speeding up asset disposal and divestment of nationalized banks. Achievements in these areas have not only been very slow but also have often been reversed by policy inconsistencies caused in part by adversarial relations between the government and the House of Representatives. Progress in these reforms could be quicker and more consistent to accelerate the process of regaining investor confidence, provided the government demonstrates a stronger and more effective leadership, and the government and the legislative branch are united in a stronger determination to push ahead with the reform agenda. But it is almost impossible to create these preconditions in the run up to the 2004 election. President Megawati Soekarnoputri seems to be preoccupied with her political ambition to win the 2004 presidential election and the House seems too divided by factional interests. Nevertheless, politicians would be well advised to realize that they share common interests in restoring strong growth. Whoever takes over the government must be aware that their days in power will be numbered if adverse economic conditions persist.

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