Where the economy is headed

Umar Juoro Jakarta

The optimism about a better economy has suddenly been confronted by the reality that even macroeconomic stability cannot be taken for granted. It is widely understood that macroeconomic stability alone cannot produce the sort of high economic growth that is essential for employment creation.

As a result of Bank Indonesia being slow to anticipate higher inflation and the increase in the U.S. Fed funds rate by keeping its benchmark interest rate low, the rupiah depreciated quite sharply recently. Macroeconomic stability was again threatened. Only after the central bank raised its short-term promissory note (SBI) rate to 7.81 percent was the rupiah stabilized at around Rp 9,500 per dollar. Similarly, inflation can now be better controlled even though it is still running at more than 8 percent year on year.

The rise in the SBI rate led to an increase in the time deposit rate to between 6 percent and 6.5 percent, but banks for a time maintained their lending rates at around 13-15 percent. A further rise in the SBI rate, which is likely due to high inflation and a further increase in the Fed rate, might cause the SBI rate to go much higher than the average of 8 percent assumed for the whole year, and this in turn will prompt the banks to raise their loan interest rates, thereby dampening the prospects for high economic growth.

From the financial side, banks in general are continuing to concentrate on consumer and commercial (small and medium enterprises/SME) lending, while tightly controlling corporate lending. As regards consumer banking, the aggressiveness of the banks, especially in extending motorcycle loans, has reduced the supply of credit for other retail borrowers.

There is no indication as yet of an improvement in the real purchasing power of consumers. Higher inflation means higher household expenses. For many households, especially in urban areas, it is better to buy a motorcycle and sacrifice other expenditure, as this is more economical due to higher bus fares and unreliable public transportation. Moreover, buying a motorcycle is an investment rather than being just consumption.

As regards corporate banking, the alleged lending scam at Bank Mandiri, with all of its political ramifications, reveals once again how risky corporate lending is, both from the business and prudential point of view. Furthermore, it reminds us of how vulnerable the banking sector is to abuses and litigation. In general, the corporate sector in Indonesia is still weak with low equity, high leveraging, and weak cash flows. Only a few blue chip companies have relatively strong fundamentals.

The banking sector is still wallowing in excess liquidity. However, there are not many opportunities with reasonable risks that would allow the banking sector to expand. The country's banks are competing in severely restricted areas, namely, the consumer and blue chip corporate markets.

In the real sector, investment growth is encouraging. However, since investment lending is a high risk business for the banks, growth could well prove to be limited. For a higher level of investment, foreign direct investment (FDI) must quickly recover. But this will requires quicker economic reform, including reform in the areas of taxation, decentralization, and the legal system.

The oil, gas and mining sectors, which should be able to benefit from high prices, remains sluggish because of the same old problems. It is difficult to understand why the government has been so reluctant to extend tax incentives to the oil and gas sector in particular. There is also a need to amend the Oil and Gas Law if this sector is to act as a catalyst for increased FDI.

Recently, the President issued a decree designed to facilitate land acquisition for public infrastructure projects. This was certainly a step forward. But the main issue is whether the government will acquire the land for public infrastructure projects, or still let the contractors do the job themselves -- a task that is not only very costly financially, but also time consuming.

On a sectoral basis, we can still expect the construction sector to grow at a high rate, spurred by the construction of apartments, housing and selected infrastructure projects. The transportation sector, however, might grow at a slower rate because of the impact of higher fuel prices.

The manufacturing sector will grow moderately as various manufacturing activities, except probably car and motorcycle production, are still facing endemic problems concerning labor and tough competition from imports, notably from China. The retail sector might level off due to the stagnant or even declining purchasing power of consumers. Meanwhile, the agriculture sector remains stuck in low growth mode.

Judging from these observations, we can still expect economic growth of around 5.5 percent, as estimated by the government. But the problem is that macroeconomic stability is eroding, and limited investment might not bring about significant employment creation.

Despite all the economic challenges, Indonesia actually has the potential to grow sustainably at a much higher rate. But the fundamental issue is the difficulties faced in creating synergies and putting the public interest above vested interests. If the policies of the Ministry of Finance, especially on taxation, could synergize with those of other ministries, and the financial sector could synergize with the real sector, the economy would be able to grow robustly.

Unfortunately, the government needs to do a lot of work to realize all these potential benefits.

It would be wise for the government to set itself an appropriate scale of priorities. Also bear in mind the fact that the government's instruments and resources are very limited. The right set of priorities would provide direction to the private sector to expand in particular business areas with a high level of confidence.

Catch-all policies, such as the setting of ambitious targets without providing much detail, only end up confusing people.

We cannot jump from one problem to another without seriously addressing the first problem, or only come up with ad hoc solutions to fundamental problems, while all the time engendering unreasonable expectations in the public. This is a recipe for frustration.

Good intentions, compassion, and persuasive overtures to both the public at home and foreigners are necessary, as exemplified by the President himself, but these are far from sufficient to generate real economic activities. What we urgently need are actions that produce actual results within a given period of time. This is what the government is supposed to be doing.

The writer is the chairman of CIDES (Center for Information and Development Studies), and a senior fellow at the Habibie Center.