The good news and the major economic risks are waiting

The good news and the major economic risks are waiting

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

It's always hard to get a perspective on developments in
Indonesia. We're all fixated by the daily turmoil of events, and
rarely take the time to sit back and look at longer-term trends.
Yet, when we do, we see confirmation for what is evident around
Jakarta and even more so in the countryside: Indonesia has come a
long way over the past 30 years.

Four years after the crisis, per capita incomes are back to
the levels of the mid-1990s, and more than three times higher
than in 1970. The distribution of income and key social
indicators have also improved over this period, leading to a
substantial reduction in poverty. Latest data suggest that about
13 percent of the population is below the poverty line -- less
than half the peak levels recorded during the crisis and close to
the pre-crisis lows. Despite the impact of the crisis,
Indonesia's record on poverty reduction over the past 30 years
remains one of the best in the world.

So, if the economy is indeed starting to recover, with
positive benefits for the poor, why do so many still feel
pessimistic? There are several factors:

o First, the crisis has no doubt dashed the high expectations
of the earlier high-growth period. Poor families who were saving
for a TV, motorcycle or schooling for their children saw their
real wealth and income prospects severely eroded. Many middle-
class Indonesians lost their jobs, while new graduates struggled
to find suitable employment opportunities.

o Second, many people are still living just above the poverty
line and feel vulnerable to further shocks. More than half of
the population lives on less that US$2 per day. Many of these
are poor or will become poor if they lose their job, suffer a
family illness, get caught up in local conflicts, or have to pay
more for basic commodities, such as rice.

o Third, Indonesia's prospects have been clouded by the high
levels of debt built up during the crisis. Government debt rose
from only 34 percent of gross domestic product (GDP) at the end
of 1997 to over 100 percent at the end of 2000. Most of this
increase was from domestic bonds, issued by the government to
recapitalize ailing or bankrupt banks. Because of the resulting
debt service payments, the government has limited fiscal leeway
to stimulate the economy or fund pro-poor programs.

o Fourth, political transition and turmoil have left people
feeling uncertain about the future direction of the country.
Lawlessness, corruption, collusion and nepotism (KKN) and
political deals are now much more visible than before. But
people are less sure of the government's capacity to function in
a more democratic and decentralized environment. Some are
despondent about the prospects for reform. While others long for
the strong leadership and greater certainty of the past.

o Fifth, the global environment for development is now much
less favorable than before the crisis. World trade is no longer
providing a strong engine of growth, and much of the regional
focus on trade and investment has shifted to China. Financial
markets are still reeling from a string of bad corporate news in
the United States. And heightened security concerns, both here
and abroad, have damaged Indonesia's tourist industry.

So the current mood has less to do with the impact of the
crisis, even though it has been severe in many parts of the
country, and more to do with changed perceptions about the
prospects for the economy. Gone are the days when growth at 7
percent to 8 percent per annum could be taken for granted. Now
the economy is struggling to grow at 3 percent to 4 percent per
annum -- not bad by global standards, but not enough to absorb a
growing labor force with higher real incomes and lower levels of
poverty.

So how should we assess the economic performance of the past
three years? What are the chances of doing better? And what are
the consequences of continuing to "muddle through"?

First the good news. The government has succeeded in
restoring and preserving macroeconomic stability. This has
required tough decisions to rein in the budget deficit, control
the money supply and implement banking reforms. We have seen
constant setbacks and challenges to the discipline of the program
supported by the International Monetary Fund (IMF).

But, at the end of the day, common sense has prevailed. After
many gyrations, the exchange rate and the stock market are now
back to levels prevailing at the time I arrived. Inflation and
interest rates are substantially lower. And, most importantly,
the burden of government debt has started to decline -- from over
100 percent of GDP at the end of 2000 to around 90 percent at the
end of 2001. The debt to GDP ratio is expected to fall further,
to below 80 percent, by the end of this year.

The short-term burden of external debt on the budget has been
limited by the debt rescheduling agreed with the Paris Club.
This in itself is a reward for the government's good record of
macroeconomic management. Some have argued that Indonesia should
push for more radical debt rescheduling or reduction. But my own
view is that Indonesia should be aiming to graduate from the
Paris Club as soon as possible.

External debt levels are not excessively high -- and are
falling steadily due to net repayments. The government can
access highly concessional loans and grants from the Consultative
Group on Indonesia (CGI) to meet its medium-term financing needs
-- and should be looking to restore its creditworthiness in
international financial markets over the longer term. The real
challenge for Indonesia is how to manage its newly-acquired
domestic debt. While debt is inevitably a highly-charged
political issue, these realities are increasingly recognized in
debt debates and policy decisions.

Good macroeconomic management is essential to restore investor
confidence and reduce poverty. Maintaining fiscal and monetary
discipline is therefore the first economic priority -- and will
become even more important (and difficult) as we head into the
2004 election.

The government will have to repay or rollover a sizeable
amount of domestic debt over the next couple of years. This is
manageable, given the proposed resolution of BLBI debts, the
scope for reprofiling bond holdings in state banks, and with
progress on establishing an effective bond market. But it will
require continued budget discipline.

The draft budget for 2003 is encouraging, as it shows that the
government remains firmly committed to reducing the budget
deficit and debt burden. But will the government be able to
resist the temptation of stimulating the economy heading into an
election year? And will it have enough commitment and
credibility to continue managing the economy well -- without the
added discipline of an IMF program? These are the major
macroeconomic risks that you should follow closely over the
coming two years.

Good macroeconomic management is not enough to sustain high
rates of growth. High growth requires structural reforms to make
the economy more efficient and competitive. In this area,
progress over the past three years has generally been
disappointing. We probably should have realized that reforms
would take time: Given the problems inherited from the previous
regime, the strong vested interests against change, and the weak
public institutions to implement it.

We have to be sympathetic to the major challenges and
constraints facing the government. We also have a responsibility
to point out the importance of reform, and to encourage, cajole
and support the government to move ahead as quickly as possible.
This is essential to reap the full benefits of macroeconomic
stability in terms of higher investment, growth, job creation and
poverty reduction.

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