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.