INDONESIA’S ECONOMY POST – IMF: RECOVERY IN AN UNCERTAIN ENVIRONMENT@

Oleh : J. Soedradjad Djiwandono
Gurubesar tetap Ilmu Ekonomi, Universitas Indonesia


THE ISSUES

What I would like to do is sharing with you the seemingly continuing surprises transpiring from Indonesia’s economic performances since the 1997 financial crisis. For sometimes I have been in a habit of offering my assessments on why and how an economy that at the start of the crisis possessed similar or better economic fundamentals than other crisis countries in Asia, and could claim to have a decent and prudent policy responses initially, ultimately turned into a basket case.

Recently, when most economies have been suffering from weak economic environment, Iraq war and Sars outbreaks, Indonesia received some accolades of being one of the best performers in stock market, in its currency’s (Rupiah) appreciation. Standard and Poor and other rating agencies have even raised Indonesia’s ratings, both in sovereign as well as a number of corporations.  

Are we observing a process of Indonesia’s economic recovery? Or is this an aberration? These seem to be transpiring with the backdrop of the government’s resolve to end the IMF- supported program by end of 2003. These have been developing in spite of the facts that Indonesia will soon enters into a lengthy process of general election next year, in addition to threat of facing a weak world economy.

I would like to discuss the meaning and implications of these surprises and offer my interpretations. With a view to controversies arising from the IMF prescriptions in the fight against financial crisis in Indonesia, what seem to be the differences and similarities as compared to other crisis countries like Thailand and Korea I would discuss the policy for ending the Fund’s involvement. What seem to be its implications?   Aren’t there any alternatives for other types of IMF arrangements? These are questions that I would like to address in my presentation.

PUZZLE ABOUT THE CRISIS

It is still relevant to discuss the past crisis, especially to explain the Indonesian experience of becoming a basket case:

  • Pre-crisis vulnerable indicators, like the ratios of debt to GDP, corporate debt to equity, property loans to total banking loans, short-term debt to reserves and figures of non performing loans, Indonesia’s were similar to Thailand and Korea
  • Export growth and current account figures were better than the two countries, while concentration of company ownership was worse
  • The early policy responses against the onslaught of the currency of Indonesia were lauded by all creditor countries members of CGI (Consultative Group on Indonesia), the IMF, WB and ADB
  • All the three went to the IMF for help, Thailand in August, Indonesia in October and Korea in December, all in 1997.

After the crisis went for sometime in became clear that in comparison to Thailand and Korea, the two other Asian crisis countries asking for IMF help, Indonesia turned into a basket case. Indonesia experienced for having the worst in currency depreciation, worst in the decline of stock prices, increases in interest rates, increases in poverty, and worst social dislocations. In politics the crisis triggered the toppling of an authoritarian regime that rules the country for more than three decades and changes in governments, which occasionally went along with social unrests and dislocations.

In 1999 Thailand and Korea had succeeded in leaving the crisis behind when Indonesia threw away a golden opportunity to join the others to say good- bye to the crisis. Indonesia instead experienced a deeper dependence on the IMF, at least in terms of how market perceived. Cancellations or postponements of fund disbursement from the IMF seemed dictated the movement of Rupiah exchange rates.

As we know there are different theories aiming at explaining the Asian crisis. It seems that the basic difference arises from one’s believe whether it originates from internal factors (unsustainable exchange rate system due to domestic (bad) policies, and the bad practices of ersatz capitalism), and the believe that crisis arises from financial panic due to herd instinct that creates self fulfilling prophecy that basically external from the system. The first one is known as first generation (current account) crisis while the latter, second generation (capital account) crisis.

It has been my contention that Indonesia’s crisis is a combination of the two that works like a contagion: It started with external shock in the financial market, but due to the domestic structural weaknesses (weak banking system coupled with cronyism, on top of weak social and political systems) the external shocks served to unravel domestic weaknesses that were dormant during the good years, and a contagion developed from financial shock to economic, social and finally political crises.  Indonesia’s crisis is multi dimensional and home - grown, albeit not home alone.

The public debate on who is at fault and who to blame for causing the crisis or the turning of Indonesia into a basket case has been coupled with criticisms against the IMF role in advising Indonesia. It’s my contention that it has been very difficult to be specific in this matter. It is too simplistic to say either the blame should go to the government or to the IMF. Since IMF has been involved in designing and monitoring the programs it is difficult to argue that IMF is free of the blame from the failures. However, the governments of Indonesia from Soeharto to the present one must have contributed a lot to the problems or failures of the program implementations as well.

I could go into more specifics, but in general inconsistencies in implementation of the programs, but to a certain degree also in their design have been the main reason of how Indonesia’s crisis become a basket case. The inconsistencies have arisen from the governments, the private sector (banking sector and corporations), and the IMF as well, either in the policy designs or implementations.

Lately the IMF just completed an independent report prepared by the Independent Evaluation Office (IEO), which was established by the new management under MD Horst Kohler. The study was done for three crisis countries received IMF facilities - the stand-by arrangement (SBA) and Extended Fund Facility (EFF) -, Indonesia, Korea and Brazil.  It is interesting indeed to look at the IMF role in addressing the crisis in different cases by tracing the pre-crisis surveillance activities (the well known article IV consultation), the design of program and its conditionality and the monitoring of program implementation for each crisis economy. 

ANOTHER PUZZLE?

The recent performance of the Indonesian economy has also created some surprises or even contradictions in the eyes of those making casual observation. Negative assessments that one would hear in seminars or read from the media about weak Megawati presidency, lack of policy consistency, ineffective parliament, failure of decentralization policy, corrupt government and judiciary system, etc, have gone hand in hand with reports about the relatively mild effects of the Bali bombing, the mild reaction on the Iraq war and encouraging development in some indicators, the strengthening of rupiah and the bullishness of the capital market.

Bert Hofman, Lead Economist of the World Bank in Jakarta and James Castle a business consultant that has been operating in Indonesia for more than 15 years recently provided a positive assessments on the recent development of Indonesia’s economy, which include:

·        Solid macroeconomic management and declining vulnerability by showing some statistics confirming a stronger Rupiah (about 10 per cent appreciation against US dollar since March). The sock index has climbed nearly 22 per cent in Rupiah and 32 per cent in dollar terms, interest rates have been down, and so has inflation rate. Budget deficit has gone down to 1.6 per cent of GDP, and the ratio of public debt to GDP has also gone down to around 80 per cent from 100 per cent a year before.

·        Standard and Poor has raised sovereign rating from CCC+ to B-, and corporate bank loans from B- to B

·        FDI approvals have increased, banks have started to increase their loan portfolios while maintaining good capital adequacy ratio (CAR)

·        Privatisation and the sale of IBRA assets, including some banks have made some progress

·        Capital outflows have turned into inflows, albeit a trickle.

·        Growth estimate has only slightly reduced to slightly below 4 per cent

In an uncertain environment due to weak world economy, Bali blast, Iraq war, Sars, and Aceh problem, this development seems to defy logic just like my point about the basket case in a reverse order.

Due to some encouraging development in the above macro indicators some have step up their optimism about the economic outlook of the Indonesian economy. “Indonesia’s sunnier economic outlook’ and “…the glass is half full, instead of half empty”, “Indonesia no longer a ‘basket case’, “Indonesia is Asia’s exception”; these are some statements from economic and finance observers on Indonesia’s recent economic performance.

However, a more careful observation on the development, whether to search for answer on specifics, or to get a longer-term outlook one would immediately encounter caveats. Optimism declines and even evaporates and more problems seem to appear:

·        The prospect of less than 4 per cent growth rate of the economy is bad news for employment opportunity – the conventional wisdom says that to address the problem of employment creation and reducing poverty the economy should grow at leat 6 per cent. Both Thailand and Korea have been registering more than 6 per cent economic growth since their recovery that started in late 1999

·        To achieve a higher growth Indonesia has to resume its higher rate of investment. But, this has to be supported by foreign investment, which has been eluding Indonesia for sometime. The recent bullishness in capital and money markets are mostly short terms, which bear some risk of flying out fast with changes in market sentiment. This is the hard lesson from the Asian crisis in the first place.

·        Foreign direct investments are still avoiding Indonesia, due to problems that include labour disputes and labour law that seems to be business-unfriendly, bad socio-political image, sharp increase in wages while productivity remains low, money politics, weak and corrupt judicial system (questionable court decisions), messy decentralization policy, deteriorating infrastructures, and still fragile financial sector.

·        Declining competitive position, number 47 out of 49 ranked by the World Economic Forum. Indonesia is no longer attractive in terms of its low wage rate. Kinoshita, a member of Japanese expert group to Indonesia said recently that Indonesia’s wage is similar to Shenzhen, China, but the average labour productivity is much lower.  This, plus other problems mentioned before have caused exodus of foreign companies, including those that have been operating in Indonesia for long time, like Johnson and Johnson, Sony, some textile and garment companies and many others. Aside from losing to China, Indonesia has been out competed by Vietnam and Cambodia.

UNCERTAIN OUTLOOK

A closer look has to be made to the relative smoothness of the recent Indonesia’s economic performance when one looks into a longer- term outlook. Is a sustainable recovery developing within the Indonesian economy? Could one claim that Indonesia is out of the woods for resumption of sustainable economic growth of the pre crisis level? The answer is no or at least not yet The need for an annual growth rate of at least 6 per cent to meet additional labour force and poverty reduction is already a problem with the recent path of development. If the recent path continues the growth itself cannot support the targets of job creation and poverty reduction.

As it was stated before the most important requirement for achieving a higher growth rate is the resumption of investment expenditures whereby foreign investment is very crucial. During the recent CGI (consultative group for Indonesia, a group of 30 creditors comprises of countries and multilateral institutions under the coordination of the World Bank) meeting, the World Bank director in Jakarta Andrew Steer stated that “If Indonesia could make genuine progress on the investment climate, governance and legal reform – as it has on macroeconomic policy – it could again become one of the brightest performers in East Asia”.   It is a big if indeed.

In addition, the political pressures create additional constraints for economic policy that could support development objectives. For sure national elections, one for members of parliaments in April 2004 and another one for president in July 2004, with a possibility of another one in September 2004 if no clear majority results from July election, would absorb most of national preoccupation such that implementation of economic reforms, which have been muddled through so far would take a back seat until new government is formed in late 2004.

Even at present the government policy seems to cater to nationalist agenda that pushes the decision for the government to resort to military solution to Aceh problem and the likely decision to exit from the IMF program.

THE IMF FACTOR

Political pressure has been mounting for the government not to renew the present IMF-supported program, which will end toward end of this year. The program, which started as a stand-by arrangement (SBA) in November 1997 has been undergoing changes and renewals in its development. But, lately together with other nationalist sentiment that has become stronger in the privatisation policy and other matters, stronger voices have been herd from different sectors that the government should get out of the IMF program in conducting its economic management. Indeed, the People’s Consultative Assembly had issued a resolution in its meeting last year that Indonesia should exit from IMF program.

The concern has been that an exit from IMF-supported program would among others means that Indonesia could no longer seek for debt rescheduling through the Paris Club for its official debts. This would immediately mean, if no substitute is available that a bigger deficit in the budget would ensue. And, in general the decision to exit from the IMF program could risk the loss of credibility from the business community, which would put the already weak investment climate more precarious.

There is also some possibility of other loss of confidence with respect to restructuring of government debts to the private sector, the so - called London Club. In fact, Minister of Finance Boediono has been quoted for stating that the consequence for Indonesia to exit from the IMF program is the widening of the financial gap and credibility gap. The first gap implies a bigger budget deficit, while the second one implies higher cost of banking credits for the private sector.

What are the available alternatives? Of course one is a renewal of the program. The others include entering into a precautionary arrangement and a scheme, which is known since 2000 as post program monitoring (PPM). What are they and what are the features of each arrangement? And what would be the benefits from each?

Of course public sentiments against foreign investment and foreign influence that go with foreign loans and aids have been historical in Indonesia. President Soekarno was known with his statement ‘go to hell with your aid’ in early 60s.

However, the more recent experience for Indonesia has been the IMF role in the crisis through the IMF-supported programs that have been going on for over five years. As it was stated at beginning of this presentation Indonesia became a basket case after a prolonged crisis and muddle through process of creating a turn around for a sustainable recovery. 

As the crisis and the efforts to fight against it has gone for over five year with the IMF involvement through policy design as well as monitoring it is difficult to exonerate this institution, and certainly not the governments as well as the private sector in Indonesia from the blames and the success of the efforts to address the crisis. Following the development of the policy design and the conditionality of the Indonesian program one could say that even IMF could learn and make new adjustments in the advised it gives to adjustment policies in the face of the balance of payments cum banking crisis, in fact a multidimensional crisis, at least in the case of Indonesia.

And, for Indonesia the question remains could the economic management without IMF and in the midst of uncertain environment produce a sustainable recovery?  


@ Guru Besar Tetap Ilmu Ekonomi, UI dan Senior Visiting Fellow, IDSS, Nanyang Technical University.
** Draft of a paper/pointers for presentation at a Brown Bag Lunch discussion, IDSS, June 11, 2003