THE INDONESIAN ECONOMY UNDER WAHID

By : Hadi Soesastro
[ CSIS and ANU ]

Introduction

The honeymoon period following the election of Abdurrachman Wahid as President under a more democratic system was only a brief one. It ended with the announcement of the National Unity Cabinet. Wahid’s cabinet is a great disappointment to many. Firstly, it does not reflect the spirit of “reformasi” because it is not free from individuals that have been associated with the status quo forces. Secondly, it is regarded as a “political” cabinet rather than a cabinet that can deliver the reforms because it incorporates all major political parties with diverse interests and agendas. Thirdly, the capability of the economic team is highly questioned as it consists of politicians from different parties (and some military officers) with no technocratic background.

Abdurrachman Wahid, known as Gus Dur, is fully aware of these shortcomings. He has consciously made a political “trade off” between effective government on the one hand and national unity and reconciliation on the other hand. Gus Dur has been of the view, even before assuming the Presidency, that national unity and reconciliation should be given highest priority. He has been deeply concerned with the political polarization in the country. This has motivated him to run for the Presidency himself in order to prevent a deepening rift within the nation between the nationalists, represented by Megawati, and the Muslims that are organized into different groups and factions that initially rallied behind Habibie. He has been worried about the weakening of the nation’s social fabric. He is of the view, for example, that to punish Soeharto would tear apart this already fragile social fabric.

It is somewhat puzzling that the problems of Aceh, Irian Jaya and Maluku did not initially figure prominently in Gus Dur’s agenda although they pose a serious challenge to national unity. Gus Dur has delegated the task of resolving the problems of Irian Jaya and Maluku to Vice President Megawati and reserved Aceh for himself. They both moved only slowly and gave the impression that they do not know what to do. However, this could have been a calculated move. On Aceh, Gus Dur successfully kicked the ball back to the Acehnese court as the ball was to hot for him to handle. He would only burn his hands and there was not much that he could do unless the Acehnese themselves can come up with a credible representation to engage in serious negotiations with Jakarta. While the problem remains unresolved, Gus Dur has been able to defuse one of the many “time bombs” that were left by the previous governments. To further improve the situation in Aceh the military must restrain itself. Gus Dur appears to have taken over from Megawati the task of dealing with Irian Jaya and Maluku. On his trip to Irian Jaya on New Year’s day he appears to have responded to the psychological demand of the Irianese by agreeing to adopt the name Papua. This could open up the way for a peaceful resolution of the problem. The problems of Aceh and Irian have been (temporarily) defused by Gus Dur. Since late January the situation in Maluku also appears to be under control, especially following Gus Dur’s successful move to change the leadership in the army. This suggests that there may be some truth in the allegations that elements in the army have been responsible for the outbreak of hostilities in Maluku.

The task of Jakarta now is to seriously and substantively tackle the problem of regional autonomy that involves a smooth devolution of power from the center to the regions and a more fair sharing of resources between the center and the regions. If these tasks are handled satisfactorily there is a great chance that Aceh and Irian Jaya will not break away from the Republic. It remains to be seen how well Gus Dur can handle this difficult problem. His political skills are well recognized and people still have great confidence that he will be up to this task. Yet the issue is not merely one of political skill of the leader but one of effective government that is necessary to resolve the on-going economic crisis and to rebuild the economy and the society. This paper sets out the main challenges that the Wahid Administration faces in the economic field. This will be followed by an examination of the institutional setting and the policy agenda of the new government. It then discusses the economic prospects for the year 2000.


The Economic Setting

The deep economic and political crisis in Indonesia is clearly indicated by the dramatic deterioration in economic indicators. The value of the currency fell from about Rp 2,500 per US$ at the onset of the crisis to Rp 17,000 in January 1998 following a series of events of political significance, namely Soeharto’s illness and the nomination of Habibie as Soeharto’s Vice President. The economy shrank by about 14 percent in real terms in 1998 and inflation during that year reached almost 80 percent. This was Indonesia’s worst economic performance over the past 30 years. However, the most serious problem that emerged was the loss of confidence on the part of the populace and international investors in the economy and the government. This led to the huge outflow of capital and a series of bank runs. In an attempt to make an end to panic witdrawals of funds by depositors the government instituted a blanket guarantee. This has cost the government thus far about Rp 54 trillion or US$ 7.5 billion at the exchange rate in January 2000. However a much larger amount of emergency liquidity assisstance to banks was provided by Bank Indonesia as a lender or last resort. It remains a matter of dispute between Bank Indonesia and the Ministry of Finance as to how large that emergency liquidity was, but it is estimated to be in the order of US$ 25 to 30 billion at the exchange rate in January 2000.

Banks have been the hardest hit by the crisis. On the one hand depositors withdrew their money. On the other hand, their corporate borrowers ceased to pay interest or to repay their debt. Non-performing loans increased rapidly from around 14 percent at the onset of the crisis to perhaps 50 percent at the height of the crisis. In some state banks, the proportion of non-performing loans is estimated to have reached 70 percent. A program of bank and corporte restructuring was introduced as part of the agreement with the International Monetary Fund. A major component of this is bank recapitalization. The plan is to recapitalize all state banks, all regional development banks with a capital adequacy ratio (CAR) of less than 4 percent, and so-called Category B private banks, namely those with a CAR of between minus 25 and 4 percent if they have a sound and realistic business plan and if the owners and management have passed a fit and proper test. The cost of bank recapitalization is huge. A major part of the cost is borne by the government and is financed by issuance of government bonds. This could amount to about US$ 45 to 50 billion at the exchange rate in January 2000. Hence the total cost of bank restructuring of about US$ 90 billion, which includes the cost of bank recapitalization, issuance of bonds to cover the emergency liquidity and government blanket guarantee. This is about the same amount as the cost of bank restructuring in Mexico. In Mexico this accounts for about 25 percent of GDP, but in the case of Indonesia the cost of bank restructuring that is borne by the government accounts for about 85 percent of GDP. This is a staggering amount. On top of this, the government has an external debt of about 60 percent of GDP. The total public debt now amounts to about 145 percent of GDP. The burden to the government is enornmous. Total public debt service payments in fiscal year (FY) 1999/2000 (ending 31 March 2000) is about Rp 55 trillion, which amounts to 26 percent of total expenditures or 4.5 percent of GDP. In the year 2000 budget (1 April to 31 December 2000), total public debt service payments increased to Rp 59 trillion, which amounts to 32 percent of total expenditures or 6.5 percent of GDP.

The restructuring and rehabilitation of the banking sector is entrusted upon the Indonesian Banking Restructuring Agency (IBRA), an institution established under the Ministry of Finance with a lifetime of 5 years. IBRA has acquired assets from failed banks and banks that have been taken over as well as non performing loans of state banks and recapitalized banks. It has been estimated that over 50 percent of corporate assets are now in the hands of the government. In a sense it is “nationalization by default”. Since the government does not intent to control these assets it will have to dispose of them. In addition to restructuring banks, IBRA task is to help recover government funds that have been used to restructure the banking sector. Maximizing asset recovery is thus a major objective of IBRA. The Asset Management Unit - Credit (AMC) arm of IBRA manages about Rp 207 trillion of loan protfolio which consists of approximately 170,000 debtors. Most of the value is concentrated in the large corporate loans. There are 1,339 corporate debtors (0.8 percent of debtors) with loans above Rp 50 billion with a total loan of about Rp 172 trillion (82.8 percent of loans). About 40 percent of the loan portfolio is in manufacturing.

Disposing of the assets of these large corporations is not an easy task. Many of the large debtors are related to Soeharto. They have not been cooperative, and the Habibie government did little to help IBRA recover the assets from Soeharto’s related companies. IBRA also face resistance from the original owners or the management as in the case of the sale of Bank Bali and Astra. IBRA has estimated to achieve an asset recovery rate of about 32 percent. Its plan is to dispose of the assets at a rate of about Rp 40 trillion per year from 2000 to 2004. Less than half of this amount will be contributed annually to the budget to help finance the cost of interest that accrue from issuance of government bonds to restructure the banks.

Restructuring of the banks is key to economic recovery, but its huge cost creates a major drag to the economy and raises the longer-term issue of fiscal sustainability.


The Institutional Setting

When installing the National Economic Council (Dewan Ekonomi Nasional) at the beginning of December 1999, President Wahid stated the Council’s main task is to advice him on economic matters, specifically to provide him with a “second opinion”. He further stated that this was deemed necessary because his cabinet was the result of “horse trading”. He revealed that he wanted to have a smaller cabinet of 18 ministers, doing away with the coordinating ministers that characterized Soeharto’s cabinets, in order to be effective. Yet he ended up with a 33-person cabinet and retained the structure of the three coordinating ministers, one for political and security, one for the economy, finance and industry, and another one for social welfare. This large cabinet resulted from his own initiative to invite other political forces to have respresentatives in the cabinet. It is not a coalition government in the usual sense. Rather, Gus Dur tries to accomodate the interests and to gather support from other political parties by having their representatives in the cabinet.

The problems with the cabinet is not so much its large size but that many of its members are in at the sponsorship of political parties (and the military). More precisely, they are being “guaranteed” by leaders of those political parties. Gus Dur does not personally know a number of the candidates but accepted them under that guarantee. It has become clear from the outset that these ministers have difficulties working together unless there is strong leadership from the President himself or from the coordinating ministers. In the first 100 days Gus Dur did not try to exert any leadership on economic matters, entrusting this to the coordinating minister, Kwik Kian Gie. This may be because Gus Dur’s priority is in the political field, but it may also be because he feels less competent about economic affairs.

Minister Kwik was Gus Dur’s own choice. He is in the cabinet not because of Megawati although he has been with PDI-P for many years and as one of the chairpersons of that party he has been in charge of research and planning. He has some experience in business but left it since joining politics. He has been one of the founders of one of the oldest graduate business schools in Indonesia and is still active in managing an under-graduate business school. With him in the economic team from the same party is Laksamana Sukardi, who is a state minister in charge of investment and state enterprises. Laksamana is Megawati’s man in the cabinet. Another key person in the economic team, the minister of finance, Bambang Soedibyo, is from Amien Rais’ PAN and is said to be the intellectual author of the Central Axis, the political alliance among a number of Muslim parties. The minister of industry and trade, Jusuf Kalla, is from Golkar, but he has been suggested to Gus Dur as a person to represent South Sulawesi by the former Defense Minister, M. Jusuf, who is also from that region. The background to the importance of having a representative of this region is to appease people from that region that have been disappointed by Habibie’s defeat. The minister of mines and energy as well as the minister of transportation, which traditionally are also under the coordinating minister of economic affairs, are both from the military. It is possible that their inclusion in the cabinet is to remove Wiranto’s competitors from the armed forces as a price to get Wiranto in the cabinet or out of the cabinet.

The media is full of reports about the lack of cooperation and coordination among members of the economic team. This is clearly demonstrated by two recent events. The first is the resignation of the President Director of PLN (Perusahaan Listrik Negara), the state electricity company, because his policy of dealing with the foreign independent power producers (IPPs) was not supported by the new government that prefers an out-of-court settlement. Had there been better communication and coordination in the government the negotiations involving court procedures already set in motion by PLN, which would have guaranteed a fairer outcome for Indonesia, need not be terminated. The damage to the government is that it appears to be caving in to pressures by the U.S. government that acted in the interest of the foreign power producers. Ironically, the U.S. government is seen to be backing those that allegedly were engaged in corrupt practices. The point here is that the government did not consult PLN in resolving the problem. The second is the issuance of a government regulation to ammend another government regulation that was issues only 5 days before. At issue is who should be in control of state banks, the state minister for investment and state enterprises or the minister of finance. The media exposed this struggle between the two ministers as a struggle between the two political camps that ecah minister represent. Coordinating Minister Kwik admitted that there is a struggle for control, but he argued that it is based on technical rather than political grounds. Despite this statement observers believe that the struggle for the control of resources by political parties for the next general elections (in 2004) has already begun. These developments have not helped to create confidence on the part of the public in the ability of the government, the economic team in particular, to resolve the country’s grave economic problems.

Gus Dur was given 100 days by opinion makers to prove that his “political” cabinet can deliver. This is a kind of pressure without any constitutional implication. He has been legitimately elected by the People’s Consultative Assembly (MPR) and constitutionally only the MPR can unseat him. It is true that instead on meeting every five years the new MPR has decided to meet every year. A meeting is scheduled for August 2000. This means that the MPR need not call for an extraordinary session to change the president. There are speculations that the chair of MPR, Amien Rais, will make use of this opportunity if indeed the Gus Dur cabinet turns out to be totally incompetent. This “threat” of a constitutionally legitimate change of government before the term of the president is over may well provide an incentive for the Wahid Administration to shape up. On his part Gus Dur has also given his ministers 100 days to get their act together, threatening to remove those that fail to do so. The coordinating minister for social welfare has already been replaced, perhaps largely for political reasons. Talks about an imminent cabinet reshuffle continue to feed the rumour mill, but this is not likely before the end of the first six months, not the 100 days. The 100 days ended on 5 February 2000 without much debate about Gus Dur’s record. This has been overshadowed by tensions that developed between the President and Wiranto. On 31 January the National Human Rights Committee, based on the findings of a special committee, published its report on human rights abuses in East Timor that implicates the Coordinating Minister for Political and Security Affairs, General Wiranto. The President, who was abroad, suggested that Wiranto should resign, but the latter ignored the suggestion. Two weeks later, after returning to Jakarta, Gus Dur decided to non-activate Wiranto from his cabinet post and installed a care taker. This episode is regarded as an important one in Indonesia’s political development as it is unprecedented for a civilian leader to be able to remove a four-star general from a high official posititon. It is unlikely that Wiranto will come back. His removal cleared the way for reforms in the armed forces in the direction of a more subdued role of the military in society, and in the short term it possibly will also put a stop on the sudden outbreaks of disturbances in the regions. The people and international markets welcome this development. However, investors’ confidence will not be fully restored until Gus Dur shapes up his cabinet, his economic team in particular.

Seemingly, Gus Dur does not intent to do so as yet. After returning from his trip to Europe, he has decided to take charge of the economy himself, acknowledging that economic leadership will not come from within his cabinet. In doing so he may want to rely more on the advise from the National Economic Council (or DEN) and the National Council for Business Development (or DPUN). DEN is to advise the President on ways to recover the economy and to enhance Indonesia’s economic position in international competition. The President has also asked DEN to formulate a new framework for the Indonesian economy. DPUN is to advise the President on how to revive the real sector. There are concerns that the existence of these different institutions could lead to conflicts that would further weaken the effectiveness of the government. DEN is conscious of this danger and has made it clear that while it is a body advising the President it will maintain open communication with members of the cabinet and other government institutions, such as the Central Bank (Bank Indonesia).

It is too early to assess whether DEN and DPUN can be effective. Even if they can become effective advisory bodies, they cannot and should not be involved in the execution of policies. Gus Dur has also strengthened his inner circle in the Palace. In addition to the Presidential Secretariat and the State Secretariat he has instituted a Secretariat for the Management of the Government and a Cabinet Secretariat. It is likely that the governing of the state and policy making, including economic policy making, will be in the hands of this group rather than the cabinet.

In the final analysis, it is the executing agencies that are most important in the successful implementation of policies to revive the economy. In resolving the crisis the previous government has established new institutions. These include the Indonesian Banking Restructuring Agency (IBRA), the Indonesian Debt Restructuring Agency (INDRA), and the Jakarta Initiative Task Fore (JITF). Together with Bank Indonesia, the Ministry of Finance, the State Minister for Investment and State Enterprises all those “crisis” institutions are involved in the gigantic task of credit restructuring, which is key to the recovery of economic activities. Coordination amongst these institutions and agencies is at best very weak and of an ad-hoc nature. This explains why banking and corporate restructuring has been very slow. During the Habibie Administration there was a lot of political intervention towards those “crisis” institutions, IBRA in particular, with the aim of mobilizing financial resources for political purposes. The Bank Bali scandal is a case in point. There was also intervention towards state banks to conceal huge non-performing loans of politically connected companies. The Texmaco scandal is believed to be just one of many similar cases that await to be revealed.

During the very first few days of the Wahid Administration there were attempts by certain political groups to gain control over IBRA, the institutions that is now in control of a lot of assets of banks that have been taken over and failed companies that owed to those banks. Gus Dur and the government initially gave conflicting signals as to what they want to do with IBRA. However by late November it became clear that the government is serious in strengthening IBRA. The empowerment of IBRA is stipulated in the new three-year IMF-supported program. There have been suggestions to further strengthen IBRA by making it a fully autonomous agency. Under an ealier IMF-support program, Bank Indonesia has become an independent institution since 17 May 1999.
It remains to be seen whether the independence of these institutions would help expedite the process towards banking and corporate restructuring by insulating them from political interests. The political environment under which these institutions have to operate has become more complex as the political system opens up. Insulating them political influences becomes a necessity but these institutions must also increase their transparency and accountability.


The Economic Agenda

The economic agenda of the Wahid government I still being crafted. It will be guided by the Broad Outline of State Policy (or GBHN) that has been formulated by the MPR in October 1999. In essence it instructed the government to take steps to accelerate the recovery of the economy. Some critics have said that the government is too preoccupied with dealing with problems of KKN (corruption, collusion, and nepotism) and has not given sufficient attention to tackling the more urgent problems of reviving the economy. Others are of the view that the government has done nothing on the KKN problems. The government will have to find the right balance between tackling KKN and concrete efforts to revive the economy. KKN problems in the widest sense of its meaning should include efforts to improve public and corporate governance.

In practice, the government already has an economic agenda for the next three years as formulated under the new three-year program supported by the IMF. It incorporates a medium-term agenda that has four components, namely a medium-term macroeconomic framework, restructuring policies, rebuilding economic institutions, and improvements in natural resource management. The medium-term macroeconomic framework aims at recovery while maintaining price stability. The targets are likely to be set for a 5 to 6 percent growth over the medium term with inflation below 5 percent. Other targets include gross international reserves at about six months of imports, and a gradual reduction of public debt to GDP from the high level today to 65 percent by the year 2004.

The core of the restructuring program remains financial system and corporate reforms. In addition, new reform programs have been introduced that are aimed at strengthening the agricultural sector, increasing opportunities to SMEs, improving targeted spending programs, upgrading human infrastructure, and sustained poverty reduction. These new programs have been accorded a high priority by Gus Dur. The third component of the medium-term agenda, namely rebuilding of economic institutions, places the priority in the public sector (fiscal management, fiscal decentralization, and civil service reform), the financial sector (IBRA, state-owned banks, regulatory and supervisory institutions), the judiciary, and institutions responsible for corporate governance. The fourth component involves policy and institutional framework for natural resource management. This framework has three objectives, namely: (a) greater consultation and stakeholder participation in decisions affecting natural resources; (b) developing a pricing structure for natural resources that reflects true value; and, (c) improving forest management and ensuring a sustainable production of goods and services from forest resources.

The short-term economic agenda of the government has two main components, namely macroeconomic policies and structural reform programs for the year 2000. The macroeconomic targets for 2000 are as follows: a 3 to 4 percent growth rate, single-digit inflation, and a fiscal deficit of up to 5 percent of GDP, which will be financed about equally from domestic asset recovery and foreign sources.

The government appears to be reluctant to adopt even a slightly expansionary fiscal policy. The Finance Minister stated that the budget “will not be too contractive”. The government has set a constraint to the budget by limiting foreign borrowing. Initially it started out with a policy to significantly reduce foreign borrowing, but later on decided to adopt this policy in a pragmatic manner. Minister Kwik has announced that the government will seek to maintain a level of foreign borrowing as deemed necessary.
Comparing the budget for 2000 (for 9 months) with estimated realization of the FY 1999/2000 budget for 9 months suggest that total expenditures would increase by about 30 percent. However, about two third of this increase will be due to increased debt service payments on domestic debt. As discussed ealier, the huge jump in domestic debt resulted from the issuance of bonds to recapitalize banks. It is estimated that the cost of servicing these bonds would amount to about Rp 45 trillion a year. Each 1 percent increase in interest add about Rp 6 trillion in domestic debt service payments. This is the reason why the government targets a low inflation rate.

Three other issues deserve mentioning. First is the raise in civil service salaries. Official civil service salaries have always been low and they have been frozen since the crisis. However, income of government officials is not necessarily low as they are many ways to earn additional income such as through involvement (nominal or real) in the execution of development projects. A 20 percent raise in salaries has been proposed by the government , but the increase will not be across the board. The government is of the view that in the first instance substantial increases should applied to the salary of the ministers and first escelon bureaucrats. The theory is that the top should be made clean first in order to be able to clean the system from the entrenched corruption. However, in addition to raising salaries definitely there is need for civil service reforms and improving governance in general in order to be able to fight corruption effectively. It remains to be seen whether the Parliament (DPR) subscribes to this theory and approves the huge increase in salaries at the top or would opt for an across the board increase.

Second is the problem of subsidies. Total subsidies in the current budget (FY 1999/2000) are estimated to reach to about Rp 50 trillion, or about 25 percent of total expenditures. Of this amount more than 60 percent is accounted for by fuel subsidies. Fuel prices in Indonesia have been highly distorted for many years for social and equity reasons. The price of kerosene has been kept low and is currently only about one fifth of the cost of production. Automotive diesel oil (ADO) is also highly subsidized. Together, kerosene and ADO account for about 75 percent of total fuel subsidies. Various studies have shown that these subsidies are mostly received by those that do not need them. Yet the government continues to be cautious and will gradually reduce these subsidies gradually as it is politically not readily acceptable. In the 2000 budget fuel subsidies will be reduced by 15 percent. The government has not decided on how to increase fuel prices. This is a politically sensitive issue. Student demonstrations in 1998 that led to the fall of Soeharto were triggered by the decision of the government to raise fuel prices. Other subsidies (food and electricity) will also be reduced. However, there will be a significant increase in interest subsidies for small credits.

The third issue relates to fiscal decentralization. The two decentralization laws (No 22/1999 and No 25/1999) that have passed the parliament in May 1999 will not be in force until May 2001. However, demands for implementing them earlier have forced the government to begin with fiscal decentralization in the 2000 budget. About 60 percent of development expenditures from domestic sources will now be managed by the regional governments directly.

The second component in the short-term agenda that deals with structural reforms is essentially a continuation of the programs that have been stipulated in the earlier IMF-supported programs but these programs will be strengthened. Key to the success of implementing these programs is strengthening of the institutions responsible for undertaking the programs and a better coordination of these institutions as identified earlier.


Prospects for 2000

Indonesia can expect a modest recovery in 2000. Economic growth will be about 3 to 4 percent. More optimistic projections suggest a growth rate of 4 percent or more. It will be difficult for the government to maintain a low inflation rate below 5 percent. With the increase in fuel and electricity prices and the raise in civil service salaries, inflation is likely to be higher but still below 10 percent.

Institutional changes and shaping up of the economic team will help accelerate banking and corporate restructuring in the year 2000 that is key to the recovery and sustained growth in the future.

The government is facing an enormous task. It has to defuse a host of time bombs that have been left by the previous governments. There are demands on all fronts, economic, political, social, and even cultural. It has yet to develop an effective government to be able to deal with them. Fortunately, there is still a lot of goodwill left on the part of the people to give this government a chance to succeed. There is also a lot of goodwill shown by the international community. But goodwill may run out if the government does not deliver.

The risk to this forecast, however, remains largely political: will Gus Dur be able to maintain national unity and make progress on the democratization front. The chances are good. His political skills will help him manage the frail democratization process, but he must recognize as well that a significant improvement of the economy will make that task more manageable.

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