Where the Indonesian economy is headed

Where the Indonesian 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.