The good news and the major economic risks

The good news and the major economic risks

Mark Baird, World Bank, Country Director for Indonesia, Jakarta

At the heart of the structural agenda is restoring the
integrity and credibility of public institutions, especially in
the civil service and justice sector. Problems of corruption,
collusion and nepotism are now much more visible. But
improvements in accountability have not kept pace.

This credibility gap between transparency and accountability
generates much frustration. Some would like to go back to the
good old days -- when you knew who to pay, with well defined
costs and benefits. But this is inconsistent with the new
democratic ideals, and incompatible with the demands of a more
open and competitive global economy.

Indonesia will have to reform its public institutions -- to
serve its people and to improve the investment climate.

I would highlight five items for the coming years:

o Improve tax and customs administration. The government needs
to raise revenues to finance its budget, in a way that doesn't
distort or deter investment decisions. The recent establishment
of a large taxpayer office in Jakarta is a promising start.

o Develop balanced labor market policies. Private investors
complain about the negative impact of recent sharp increases in
minimum wages, generous severance packages for workers, and
growing labor disputes. To some extent, these trends reflect the
emerging power of labor within a more open and society.

The challenge will be to find ways to balance workers' rights
and investor interests, while the institutions for arbitration
and settlement of disputes are being developed. No one gains when
factories shut down and investment moves to other countries.

o Avoid excesses of decentralization. It has not led to the
breakdown in public services. But it has created added
uncertainties and risks for private investors (in the mining
sector, for example). New taxes and regulations are adding to the
costs of business and, in some cases, restricting the free
movement of goods around the country.

Local government demands for ownership and management control
of enterprises are often at odds with national policies (and
common sense). The central government has the authority to step
in and nullify conflicting policies and illegal rulings by local
governments. This authority should be exercised more forcefully.

o Push ahead with IBRA asset sales and privatization. These
are important to finance the budget deficit and to put productive
assets back into the private sector. Because of the crisis,
Indonesia has one of the world's largest public sector. In some
areas, this may be justified.

But there is no justification for keeping many manufacturing
firms, banks, hotels and shops under public control. Progress on
IBRA asset sales is encouraging. But privatization of state owned
enterprises continues to be very slow. A return to the masterplan
of several years ago could revitalize privatization.

o Improve the regulatory framework for investment. Substantial
investment in infrastructure such as power and telecommunications
will be needed over the next few years. However, the scope for
public investment is limited.

Efforts to attract private investment paid too little
attention to sound market structures and regulatory arrangements;
many of these projects had to be shelved or renegotiated. This
contributed to the drying up of investment flows. Progress on
these policy and regulatory issues would help attract the private
investment needed to support infrastructure development and
stronger economic growth in the future.

With progress in these areas, macroeconomic stability and a
credible start on institutional reforms, Indonesia can attract
the investment needed to sustain growth rates of at least 5
percent to 6 percent per annum. This would be good to reduce
debt, create jobs and lift people out of poverty more quickly.

But what if this doesn't happen? Will Indonesia continue to
muddle through at 3 percent to 4 percent growth? This is
possible, provided the macroeconomic situation stays under
control. But this might not happen, as pressures to stimulate the
economy build up before the election. I don't expect a blow-out
in budget spending. But I do fear growing pressures for more
trade protection and less privatization.

Such populist measures are likely to further erode investor
confidence. Hence the importance of pushing the reform agenda, so
that policies can be locked in and results achieved; before the
political pressures become too great.

(Meanwhile) at the World Bank we have had to confront our own
legacy problems, while trying to readjust to the rapidly changing
and uncertain realities. Our new Country Assistance Strategy
(CAS), released in early 2001, is based on the assumption that
Indonesia will slowly recover, with macroeconomic stability but
halting progress on economic reforms. But just because we were
right, doesn't mean we're satisfied.

We have tried to keep the reform agenda before the government
and the public, working closely with the IMF on budget and
banking issues, while stressing on more basic structural and
legal reforms. We have also continued to open up to public
scrutiny. Much of our policy advice is on our website, along with
the proceedings of the Consultative Group for Indonesia.

What we haven't done is provide a lot of financial assistance
over this period. New commitments from the Bank have averaged
only $310 million per annum over the past three years -- less
than a quarter of the levels of the previous decade. More than
one third of this new assistance has been on highly concessional
IDA (International Development Association) terms, mostly used to
finance social services and basic infrastructure for the poor.

This lending program is consistent with the base case program
laid out in our CAS -- and Indonesia's capacity to service debt.
We could do more, if there is more rapid progress on improving
public resource management and developing a new poverty reduction
strategy. Developments are encouraging. But the government will
have to decide how much it wants to borrow -- taking into account
debt levels, the cost of funds from alternative sources, and the
need to maintain basic expenditures on social services and anti-
poverty programs.

Our biggest challenge over the past three years has been
corruption. Having learnt that we cannot isolate projects
financed by the World Bank from systemic corruption, we have
concentrated our anti-corruption efforts on working with the
government to put in place better procurement and financial
management systems.

However, we have also stepped up efforts to improve the design
and supervision of our projects. Complaints about corruption are
now investigated by experts from our Institutional Integrity
Department in Washington. Firms proven to have participated in
corrupt practices will be barred from future contracts financed
by the World Bank.

We have also started to be more pro-active at looking for
corruption in Bank-financed projects through our own supervision
efforts. The results of the first review, on the Sulawesi Urban
Development Project, are now available on our website. The sample
of contracts was small, yet we found compelling evidence of
collusion among bidders and inadequate project oversight.

Our Institutional Integrity Department has launched
investigations and the government has indicated that it will ask
us to cancel the balance of unused funds. We have also agreed to
prepare a joint action plan to address these problems -- before
we move ahead with any new lending in the urban sector.

The biggest challenge here will be decentralization. Past
problems will be even more difficult to manage when working with
more than 350 local governments. But by channeling our money to
reform-minded local governments, we can help reinforce commitment
to good economic policies, the proper use of public funds and
poverty reduction.

Ultimately, this is how most aid money should be allocated.
The central government has to use its general grants (DAU) to
give every region the means to provide minimum public services --
which means reducing the large fiscal inequities in Indonesia.

But the center can use its special grants (DAK) in much the
same performance-based way as aid should be allocated. In this
way, we can help build a better environment for private
investment, more responsive and accountable local governments,
and more effective anti-poverty programs.

The above article is abridged from the writer's address to the
Jakarta Foreign Correspondents Club on Aug. 27.