Too rosy forecast

Too rosy forecast

Bank Indonesia's latest forecasts of key economic indicators
for the rest of the year and next year could generate a sense of
optimism, a precious commodity sorely needed by the business
sector, and bolster consumer confidence which is the main
locomotive of the nascent recovery.

The central bank foresaw an economic growth (gross domestic
product) of four to five percent next year, compared to an
estimated three to four percent this year.

Inflation was projected at almost eight percent this year,
higher than the previous estimate due to the anticipation of
stronger inflationary pressures when the planned increase in fuel
oil prices, already delayed for more than five months now, is
effected in October.

Bank Indonesia forecast its benchmark interest rate to
gradually decline to as low as 11 percent later this year from
slightly over 13 percent today. It also estimated a one to two
percent expansion in investment this year and 5.5 to 6.5 percent
next year, as against minus 20 percent in 1999. The rupiah
exchange rate against the American dollar was foreseen to
strengthen into the Rp 7,780-8,200 range in the July-September
period, compared to Rp 8,300-8,500 in the May-August period, and
to further appreciate to Rp 6,500-7,000 next year. The current
April-December 2000 state budget envisages an average rupiah
exchange rate of Rp 7,000.

Even though the sovereign risk has now been minimized after
President Abdurrahman Wahid survived the annual session of the
People's Consultative Assembly (MPR), we still see the
projections as too optimistic. The government would be well
advised to remain extra careful about the formidable challenges
ahead and not to be lulled into complacency, let alone adopting
an attitude of "business as usual". There is a string of caveats
that could easily upset the projections, making things even
worse.

Several issues that have to be taken into account when
considering the rosy forecast include the formation and
credibility of the next Cabinet, the pace of asset sales, bank
restructuring and the privatization of state companies, the
public's reaction to higher fuel prices in October and the
credibility of the 2001 state budget, which is to be proposed to
the House in October. Most crucial too is the reception by local
administrations of the rules on the decentralization of fiscal
authority (inter-governmental fiscal relations) which will be
implemented in January.

How the market will vote on the new Cabinet will go a long way
in determining investor confidence and the rate of the rupiah.
This will in turn influence bank interest rates. It will be a
very positive indicator if the introduction of the higher fuel
prices later this year does not cause social instability and
excessive inflationary pressures. The phasing out of fuel
subsidies is quite pivotal in the effort to prevent the budget
deficit from exploding into unmanageable levels.

The resolution of the $65 billion in foreign corporate debt
overhang and more than Rp 230 trillion ($27 billion) in non-
performing domestic bank loans is also quite crucial for
restoring investor confidence and determining the success of bank
restructuring.

If debt and corporate restructuring remain at their current
snail's pace, foreign investors and foreign banks will continue
to shun the country. Likewise, domestic banks will remain weak if
they cannot expand lending operations. The situation now is that
banks find it extremely difficult to get medium and large-scale
businesses viable for new loans as most of them are still buried
under bad loans that have yet to be restructured. A persistent
credit crunch may sabotage the budding recovery and this in turn
will lead banks into another bout of financial distress. No
wonder, the MPR annual session included accelerated debt, bank
and corporate restructuring among its recommendations to the
President.

Yet more worrisome is the utterly poor performance of the
Indonesian Bank Restructuring Agency in asset sales and loan
recovery. As of this month, only Rp 7.5 trillion of the Rp 18.9
trillion it has been tasked to raise for the 2000 state budget
has been collected. Similarly disappointing is the privatization
of state companies which has been set to generate Rp 6.5 trillion
for the state budget. None of the 19 state enterprises scheduled
for privatization this year have been sold.

The way the central government is managing the process of
devolving political and fiscal authority to regional
administrations is also causing jitters among investors. The
uncertainty in the transition to stronger regional autonomy has
been hindering new investments in resource-based ventures, which
are actually the most promising area for new investment right now
as the manufacturing sector is still suffering from excessive
capacity due to the 14 percent economic contraction in 1998.

All these issues, in addition to weak legal enforcement and
security problems in several provinces, are the main determinants
of a sustainable economic recovery and should therefore become
tasks of top priority for the new Cabinet.