The virtuous circle

Improving macroeconomic stability, the steady, significant progress in the implementation of reform measures over the past 18 months and several hugely positive developments in the past two months have accelerated the process of the virtuous circle within the Indonesian economy.

This in turn has markedly improved the market perception of the country's economic outlook, and assured investors and creditors that the process of Indonesia's economic recovery will accelerate despite the risk of political turbulence during the 2004 election year.

There have been several new developments, especially over the last two months, that have contributed to the speeding up of the virtuous circle that started last year.

First of all, the market reacted positively to the white paper on Indonesia's new reform agenda that was unveiled last month. This means that the market sees the new reform programs, which will replace the International Monetary Fund program that ends later this year, as fairly credible.

Many analysts had been concerned that the complete termination of the IMF program would upset market confidence in the country, especially ahead of the 2004 elections, when almost all political leaders, from the president on down to district chiefs, would be preoccupied with campaigning.

Fortunately, the impressive policy performance over the past two years has significantly improved the credibility of the government in designing and implementing reform programs.

Late last month, rating agency Moody's Investors Service upgraded Indonesia's sovereign rating in light of improvements in its external balance and a significant decrease in its government debt ratio.

Moody's said Indonesia's international reserves had risen to levels that reduced the country's vulnerability to external shocks, and that its international debts had fallen. This higher rating will certainly decrease the costs of Indonesia's borrowing overseas.

Last week, Standard & Poor's Ratings Services also raised its long-term foreign and local currency ratings on Indonesia, reflecting the country's good fiscal performance backed by improving macroeconomic stability.

A stable rupiah exchange rate and increases in foreign investment in banks and corporate assets (through asset acquisitions) have improved international liquidity in the country despite the termination of the IMF program later this year, which will increase Indonesia's foreign debt service burden.

Also last week, the IMF executive board in Washington completed its 10th review of Indonesia's performance under its US$5.2 billion extended fund facility arrangement, thereby releasing a further $493 million to strengthen Indonesia's international reserves.

The IMF praised Indonesia's economic performance, pointing out that inflation continued to decline, the rupiah was stabilizing and interest rates were on a downward trend.

However important these achievements may be for strengthening the economic ability to weather any political turbulence next year, complacency is out of question.

Finance minister Boediono cautioned at a seminar on Monday that despite all the impressive progress, Indonesia was still only half-way through the first of four stages of development the country must pass through in order to achieve sustainable growth of more than 5 percent, which is needed to absorb the unemployed.

Boediono said further concerted efforts were required to strengthen basic institutions (good governance), and additional reforms of microeconomic policies and their supporting institutions were necessary to reinvigorate investment.

Bank Indonesia Governor Burhanuddin Abdullah shared Boediono's message of caution, saying on Monday that banks had yet to fully return to their function of providing lifeblood (credits) to the economy. Most banks remain overcautious in new lending and are hesitant to lower interest rates due to the persistently high risks in the business sector.

The string of impressive achievements should not lull the government into complacency, as the overall economic condition of the country is still vulnerable to internal or external shocks.

Yet the accelerated process of the virtuous circle will hopefully strengthen the confidence of the government and the House of Representatives in taking on tougher reforms, especially governance and judicial reforms.