The Indonesian economy in 2006

Ross H. McLeod Canberra

Indonesia's economic performance next year is likely to be similar to that in 2005. Output growth -- the key determinant of changes in individuals' incomes -- should remain around 5.5-6 percent per annum. Inflation is likely to decline steadily, with significant reductions in the year-on-year rate in March and October as the impact of the 2005 fuel price increases disappears. There is no reason why inflation should not be reduced below 5 percent, although past performance of the central bank suggests that it will be happy with a less ambitious target, probably between 5-10 percent.

Of key importance will be the degree of emphasis given to micro, as distinct from macro, policy. Macroeconomic policy is crucially important in that poor policy can have a devastating impact on the entire economy. Such was the case in Soeharto's last year in office (characterized by strongly negative growth), as it was in Sukarno's (characterized by hyperinflation).

But the policy mistakes at those times reflected concurrent severe political instability that made it almost impossible for the governments of the day to take the tough policy decisions needed. By contrast, the political climate heading into 2006 is benign. With the exception of a handful of religious fanatics bent on depriving Indonesia of its newly won democracy through terrorism, it seems widely accepted that political calm offers the best opportunity for the government to make progress on the economic front.

The problem is that sound macroeconomic policy is a necessary but not sufficient condition for a return to sustained and rapid economic growth. Soeharto's technocrats quickly delivered a stable macroeconomy in the late 1960s, but it was the OPEC- induced world oil price increases in the 1970s that allowed his government to spend heavily on infrastructure, education, the family planning program and so on, which in turn delivered rapid increases in average incomes.

By contrast, in its first year in office the President Susilo Bambang Yudhoyono (SBY) government frittered away Indonesia's new oil price windfall. It was not until last October that it finally found the courage to implement a significant reduction in domestic fuel subsidies, in principle allowing budgetary revenues to be reallocated from wasteful and regressive subsidies for the consumption of fuels to expenditures in forms that would have a positive and long-lasting impact on well-being of the general public.

To achieve a high economic growth rate will be much more difficult than it was for Soeharto 40 years ago, starting with an economy ripe for modernization. This time around it can only come from a significant improvement in the contribution the government sector makes to the functioning of the economy.

More will need to be done to facilitate the conversion of assets in the ground (hydrocarbons and minerals) to new assets on the ground: Better road networks, larger and more efficient harbors and airports, improved supply systems for electricity and water, more extensive flood mitigation measures, more and better education and health care facilities, and so on. More will need to be done to encourage exploration for, and exploitation, of oil and gas and other mineral resources, and to cut back on illegal logging and mining.

More will need to be done to reform the judiciary, the legal bureaucracy and law enforcement agencies -- and to improve economic legislation itself -- in order to create a legal environment in which there is security of property and person.

While it is easy to highlight the areas in which poor government performance is holding back the economy, progress in these areas presupposes a well functioning and properly motivated bureaucracy. But this does not exist in Indonesia at present, and almost nothing has been done by any of the post-Soeharto governments to make a serious start on reform of the public sector in general, and the bureaucracy in particular. For this reason, a return to Soeharto era sustained high growth rates is unlikely in the near term.

The SBY government has certainly been far more active than its predecessors on the anti-corruption front, but the number of wrongdoers caught, prosecuted and jailed is negligible in comparison with the tens of thousands -- perhaps hundreds of thousands -- involved in corruption. This anti-corruption drive can be predicted to run out of steam before achieving much more. Corruption is endemic, and there is no more prospect that the crime detection and punishment approach will defeat it than there is that it will eradicate organized crime in forms such as prostitution and the supply of drugs: it never has, and never will. Putting a criminal or a corruptor in jail simply opens up the opportunity for someone to take his place, and as long as these activities remain highly lucrative, this is exactly what will happen.

The big question about Indonesia's economic future, therefore, is whether the government can find a more effective approach to public sector reform. From this perspective, the key to the nation's medium-term future will be the recent cabinet reshuffle.

The new Coordinating Minister for the Economy, Dr. Boediono, is one of Indonesia's most highly respected economic policymakers. Coming from an academic rather than a business background there is no concern on the part of knowledgeable observers about any conflict of interest. His previous positions in National Development Planning Agency (Bappenas), Bank Indonesia, and the Ministry of Finance have provided him with a wealth of experience in managing the economic affairs of state, and he has two fine economist allies in the cabinet in Dr. Sri Mulyani Indrawati (as minister of finance) and Dr. Mari E. Pangestu (as minister of trade).

Boediono's commitment to sound macroeconomic policy is clear, and for this reason there is little reason to fear any loss of stability in the near future. Of greater interest is whether he will satisfy himself with the task of keeping the macro economy on track, or whether he and his colleagues will also push for a significant emphasis on microeconomic reform -- especially in the government sector itself.

His published work suggests that he would like to see the state cutting back on its presence in business activity, such as banking, where this is often counterproductive and serves no useful purpose. And it shows clearly that he is aware of the need for the government to do much better in fields where the private sector needs its assistance -- particularly in the provision of a reliable legal infrastructure. Technically this is outside his authority as coordinating minister for the economy, but if the President were of a mind to do so he could well allow Boediono to push for, and perhaps guide, such reforms within the cabinet.

In his previous position as finance minister Boediono also dabbled in civil service reform, attempting to build up the Large Taxpayers Office as an island of efficiency and probity in the sea of indifferent performance and corrupt behavior that is the civil service.

It is to be hoped that he will now build on this land reclamation experiment, and that the president will lend his fulsome support. In the medium to long term this could be of great benefit to Indonesia. But for the next year at least, the return of Boediono's steadying and unifying influence is something for which to be grateful.

Ross H. McLeod is the editor of Bulletin of Indonesian Economic Studies, Canberra.