Economic rise snags on political turbulence

Vincent Lingga , Jakarta Mon, 12/21/2009 11:28 AM Review & Outlook

It is impossible to chart the economic outlook for 2010 without factoring the Bank Century debacle into the equation.

The nationwide controversy over the Nov. 21, 2008, bank bailout is not simply a temporary distraction, as several analysts say, insofar as the economic prospects for next year are concerned.

The manner and speed in which the parliamentary inquiry committee will complete its investigation will determine the magnitude of the political and financial market turbulence facing the nation within the next few weeks or even months.

Even more worrisome is that whatever the conclusions and recommendations from the committee, they will have an adverse impact on the economy, the government’s economic team and its policymaking credibility.

What an unfortunate development it was. Instead of riding on his landslide re-election with stronger confidence, President Susilo Bambang Yudhoyono has remained a diffident and indecisive president unwilling to take firm action.

He allowed his administration to be besieged by the tussle between the police and the Corruption Eradication Commission (KPK) for nearly 50 days before he finally decided to intervene with some recommendations, however weak they seemed.

The public’s attention and the national media will again be consumed by the parliamentary investigation over the next six weeks when vice president Boediono several ministers, the central bank governor and scores of other senior central bank and government officials and expert witnesses will be summoned to testify.

This political furor and the intermittent wave of street demonstrations set off by the findings of the political inquiry will continue until February, when the committee is scheduled to submit its conclusions and recommendations to the President.

This means Yudhoyono’s government has virtually lost or wasted the golden chance during what was supposed to have been the political honeymoon period for his second administration to take painful reform measures that are badly needed to kick-start new investment and the construction of badly needed infrastructure.

Put another way, the government simply did not take any benefit early on from the almost 61 percent of votes garnered by Yudhoyono in his re-election last July.

The President instead came out weaker from the legal tussle between the corruption busters and the police. His position could become even more beleaguered by the bank debacle, and his coalition government much weaker.

The worst impact on the economy is the huge erosion of the government’s policymaking capacity and credibility, resulting in a very slow pace of reform sorely needed to overcome obstacles to investment, without which the economy will never be able grow robustly.

Due to the impact of the two big cases, the Yudhoyono administration now has neither the mandate nor the capacity to fix quickly the problems caused by corruption, regulatory risks and weak legal framework (civil service and legal reforms).

The government is scheduled to launch several bold programs during its first 100 days, including a stronger legal framework for expediting land acquisition for infrastructure, streamlining investment licensing and comprehensive bureaucratic and legal structural reforms.

But all these top-priority programs will likely fall behind schedule because it is now extremely difficult to have the Yudhoyono Cabinet, dominated by political representatives from his coalition partners, to work strongly in a united and well-coordinated manner.

Likewise, the government coalition in parliament seems in disarray now due to different stances regarding the legal and policy issues related to the bank bailout.

True, the controversy over the Century bailout is the only cloud looming over political and macroeconomic stability next year, but this cloud could turn into a devastating storm.

Putting aside what is now often referred to as “Century gate” and its adverse impact on the economy next year, Indonesia’s medium- and long-term economic outlook is bright.

The country posted a fast, strong recovery this year, and is internationally praised as the third-highest growing economy after China and India, with an estimated expansion of 4.3 percent.

The US$500 billion economy, supported by the steady improvement in the financial and banking system and the green shoots in the world economy, could accelerate to a growth of 5.5 to 6 percent next year.

The country has a sound fiscal policy, strong balance of payments and sharply declining government debt to as low as 30 percent of gross domestic product.

But again all the estimates for next year will depend on the magnitude of the political and financial turbulence caused by the political process of resolving the bank debacle, notably the fate of Finance Minister Sri Mulyani Indrawati and Vice President Boediono, both nationally and internationally respected as icons of reform.

Barring any immediate devastating fallout from the parliamentary inquiry into the bank debacle, the Jakarta stock exchange will likely end the year with growth of more than 85 percent, the rupiah gaining an appreciation of 15 percent and inflation staying below 3 percent.

The low inflation rate will enable Bank Indonesia to keep its benchmark interest rate low, currently at 6.5 percent, and this in turn will bring down borrowing costs for businesses and consumers.

But whether the central bank will be able to check inflation next year will depend on the rupiah’s stability and improvements in infrastructure.

Significant improvements in infrastructure are essential because unusually high logistics costs — caused by inadequate infrastructure, regulatory barriers, bureaucratic inertia and corruption — are one of the main causes of the economic inefficiency.

Inflation will be manageable next year, within the target range of 4 to 6 percent, if the expansion on the demand side of the economy is accompanied by adequate expansion in the domestic capacity on the supply side.

Domestic consumption will continue to be the main driver of growth, as investment and exports are expected to expand only modestly at 5 percent.

Direct investment, which this year remains cautious despite the resilience of the overall economy, is expected to accelerate next year, but a slower-than-expected pace of reforms to remove major barriers to businesses may stand in the way of robust investment.

Foreign capital turned in big inflows, increasing the foreign reserve holding of the central bank to more than $65 billion or more than five months of imports.

But instead of helping bolster the economy’s real sector, this short-term hot money makes the country vulnerable to sudden shocks as capital flight could happen at the slightest hint of trouble.

This vulnerability should cause great concern in view of the political turbulence likely to be set off by the finding of the parliamentary inquiry into the bank bailout.

Given the downside, at best the economy will likely muddle through the political turbulence with growth of 5 percent next year.

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SBY economic team may lose trust and market confidence

Vincent Lingga , Jakarta Thu, 12/03/2009 12:22 PM

Who in the government can we trust if then Bank Indonesia governor Boediono and Finance Minister Sri Mulyani Indrawati turn out to have compromised their policy decisions in bailing out Bank Century in late November 2008?

That was one of the great concerns expressed by most businessmen I talked to during an Indonesian-Australian business conference in Yogyakarta last week.

They were worried about all the possible findings or conclusions of the investigation into the medium-size bank’s rescue to be made by the House of Representatives and the Corruption Eradication Commission (KPK), not to mention the political and financial market turbulence arising during the process.

The Supreme Audit Agency (BPK) already issued early last week a very damaging report after an investigative audit that lasted more than three months, blaming the central bank and the now-defunct Financial System Stability Committee, chaired by Mulyani, for negligence and incompetence in deciding on the bailout.

The more devastating impact would be if the upcoming investigation by the House concluded that Boediono (now the Vice President) or Mulyani, or both — though quite a remote possibility — had deliberately compromised their policy decisions for political gain.

Another possible compromise solution would see Boediono and Mulyani made the scapegoats, taking the fall for the sake of political stability but at the risk of causing suspicions about the implication of Yudhoyono and/or members of his family in the bank debacle.

Whatever the final outcome, it will adversely affect the public’s trust and market confidence in the government, especially its economic team.

Many, if not most, remain in great doubt that either technocrat, with such impeccable integrity and high financial competence, would have risked their reputations for financial or political gain by deciding on a bank bailout that was not necessary.

Boediono, in his capacity as chief economics minister and later the BI governor, and Mulyani as the minister of finance, made up the bedrock of President Yudhoyono’s economic management during his first term in office.

They had been perceived nationally and internationally as personalities who had the courage to stand up to even the President when it came to maintaining policy-making credibility.

If the verdict of the House inquiry is policy incompetence, both Boediono and Mulyani — the leaders of the economic reform — must resign for moral and ethical reasons, even though their “honest mistake” was caused by wrong or incomplete input from their subordinates.

There is an inherent risk of an honest mistake being made in a bank bailout, given the time pressures and rapidly worsening problem, even after all the standard procedures for decision making have been fulfilled, as Boediono and Mulyani claim to have done for Bank Century.
That is because different from other businesses, banks may sometimes — often based on nothing more than rumor — face a run. And a bank that faces a run by depositors, lacking the cash to meet their demands, may go bust even if the rumor is false.

Bank runs can also be contagious as depositors at other banks are likely to get nervous too, setting off a chain reaction like that in 1997-1998.

But the caveat of debating now whether Bank Century then (November 2008) posed a systemic risk to the whole banking industry or not is the big difficulty in reconstructing the precise national and international economic and financial condition prevailing when the bailout was decided.

True, Indonesia’s financial sector was rather fragile between September and December last year due to the fallout from the global financial crisis, which was triggered by the bankruptcy of Lehman Brothers investment bank in the US.

Some of the indicators:
• In early October 2008, the capital market management and regulator stopped trading at the Jakarta stock exchange for a few days after the benchmark index, which had fallen steeply since September, crashed to 1,451, losing almost 50 percent of its capitalization from early that year.
• Even when the central bank kept reassuring the people that our banking system was sound and its fundamentals were much stronger than back in 1997, the government decided on Oct. 12 to increase the ceiling amount of bank deposits covered by the Deposit Insurance Agency 20 times, from Rp 100 million (US$10,000) to Rp 2 billion.
• Three days later, the government proposed to the House a regulation-in-lieu-of-law on the establishment of the framework of a financial safety net that would authorize the finance minister to lead the management of a financial crisis, indicating an emergency condition.
• The problem was then made more difficult by the virtual stoppage of inter-bank lending as big banks, awash with liquidity, were reluctant to lend to others on fear that their money would not be repaid.

However Boediono’s and Mulyani’s points of argument for defending the Bank Century rescue were made very weak after the discovery of the massive cost overruns, the questionable massive withdrawal of deposits a few days before and after the bailout, and the discovery of banking crimes by the bank’s owners and management.

All this led critics to suspect that both Boediono and Mulyani had put aside their professional judgment in assessing the systemic risks posed by Bank Century

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