The Indonesian economy in 2006

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.