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.