Indonesia Business Review 2001- Part 3

Economy muddles through adverse conditions Friday, December 28, 2001
Friday, December 28, 2001 Vincent Lingga, The Jakarta Post, Jakarta

Indonesia's economy entered 2001 amid heightened political uncertainty, the increasingly erratic leadership of then president Abdurrahman Wahid, a decline in the government's credibility and a weakened global economy.

The government's relationship with the International Monetary Fund (IMF) became prickly after the IMF decided in December 2000 to postpone the third US$400 million disbursement of its extended loan facility due to frequent slippages in promised reform measures and several policy reversals. 

The World Bank delivered another blow to the market's already low levels of confidence in the country's economic prospects by deciding in January to slash its annual loan commitment from $1.2 billion to a mere $400 million, citing the government's huge existing debt burden as the main reason for the new lending policy.

However, the real reason was the government's failure to keep up with its reform commitments, particularly those related to the establishment of high fiduciary standards in budget management and procurement systems, and its anti-corruption drive. 

The cash-starved government received further punishment in April when the World Bank canceled the disbursement of $300 million in social safety net loans due to what it considered the slow pace of meaningful changes in government institutions and the bureaucratic culture. But what really motivated the cancellation was the Bank's heartfelt concern that the funds would be wasted through corruption.

The nasty combination of a weakening currency, growing budget deficit, increasing inflationary pressures and consequently rising interest rates, along with a slump in exports, stifled the recovery process, which began promisingly in 2000, generating a respectable 4.8 percent growth rate. 

Predictably, barely three months into the 2001 fiscal year, official assumptions on key economic indicators, including 5 percent gross domestic product growth, inflation of 7.2 percent, an average rupiah rate of 7,800 to the dollar and the central bank's benchmark interest rate of 11.5 percent, were soon rendered irrelevant.

The government and the House of Representatives eventually agreed in June to revise the key economic assumptions to 3.5 percent GDP growth, an average exchange rate of 9,600 rupiah to the dollar, an average interest rate of 15 percent and a 9.3 percent inflation rate. 

The GDP growth rate plunged from 5.2 percent in the last quarter of 2000 to a mere 1.81 percent in the first quarter of 2001, and slowed to 4 percent on a year-on-year basis. As market confidence in the economy worsened, the rupiah crashed to 31-month lows of more than Rp 11,500 to the dollar in April.

As the confrontation between then president Abdurrahman and the House grew more intense between April and June, with Abdurrahman resorting to threats, intimidation and political blackmail in a desperate bid to cling to power, the economy entered what the World Bank described in January as a "muddle through" scenario.

The Central Bureau of Statistics came up with an even gloomier picture for the second quarter, putting GDP growth at 0.09 percent on a quarterly basis and at 3.52 percent on a yearly basis.
Muddle through was precisely what the economy did during the year. A modicum of macroeconomic stability was maintained, but economic hemorrhaging continued to weaken the recovery as most reform measures fell behind schedule.

The economic outlook did not improve significantly even after the nation resolved its political crisis peacefully in late July by electing Megawati Soekarnoputri as the new president and Hamzah Has as her deputy.

The third quarter did record a higher growth rate of 2.38 percent on a quarterly basis and 3.47 percent on a yearly basis, thereby bringing the cumulative expansion during the first three quarters to 3.3 percent. This led to a great deal of optimism that annual growth would likely reach the revised projection of 3.5 percent.

But that growth was still far from the minimum 7 percent expansion needed to absorb the 2.5 to 3 million new job seekers who enter the market annually, not to mention the tens of millions already made jobless by the economic crisis. 

Moreover, with annual growth of between just 3.3 and 4 percent, the country may need six or seven years to return to the level it was at prior to 1997, given the 14 percent contraction in 1998, almost zero growth in 1999 and an expansion of 4.8 percent in 2000.

The hopes for a more rapid pace of reform that accompanied the election of the new president were soon dashed, even before the Megawati government passed the traditional honeymoon period of its first 100 days in office.

Despite her unanimous election by the People's Consultative Assembly, and even though her political party was the single largest faction in the House, her government failed to secure full legislative support for accelerating the reform program. 

The new government did act quickly to mend ties with the IMF with the signing of a new reform agreement in August, followed in September by the third $400 million loan disbursement, which had been held up since January.

But the IMF's endorsement of the government's reform program failed to restore market confidence, as the core elements of the economic crisis management process remained bogged down in politics.

The House simply failed to comprehend the economic logic of a faster pace of asset recovery and privatization of state companies. It instead harbored a misguided nationalistic sentiment against foreign investors acquiring assets in the country, fearing that foreigners would come to dominate the national economy. 

The economic outlook became even gloomier after the Sept.11 terrorist attacks on the United States. The tragedy drove the American economy deeper into recession and consequently further weakened global economic conditions.

The country's economy was abruptly deprived of its main driver, the export market, which together with private consumption had become the engine of Indonesian growth last year. 

Worse still, inordinately emotional anti-American street demonstrations in several cities in September and October projected such a horrifying image that Indonesia, for some time, appeared to the outside world to be a country controlled by radical Muslims. Even though the voice of reason eventually prevailed, the damage to Indonesia's image had already been done. 

Obviously, not only Americans but also quite a number of other expatriates were scared away. Many importers in the U.S., Indonesia's single largest market, abruptly canceled orders, fearing delivery problems.

Sadly, too, many foreign buyers, who had played a vital role in helping Indonesian exporters gain a foothold in overseas markets, decided to cancel their regular visit programs.

Consequently, Indonesian exports, which had began to decline in the first quarter due to the weakening of the U.S. and Japanese economies, suddenly plunged, falling by almost 17 percent in September alone.

Minister of Industry and Trade Rini Soewandi estimated early last month that the country would be lucky to record $42 billion in non-oil exports this year, compared to $47 billion last year. 

The worsening levels of market confidence drove the rupiah down further, to almost 11,000 to the dollar in October and November. This exacerbated inflationary pressures, making it even more difficult for the central bank to lower interest rates and rendering the overall economic environment increasingly inimical to sound banking operations.

Significantly cutting interest rates amid the severe depreciation of the rupiah, which was called for by many businesspeople and some analysts, would not only have jacked up inflation but would also have prompted a shift to dollar positions. 

Even more worrisome were the government's severe cash-flow problems caused by lower than predicted revenue receipts and higher than budgeted spending programs.

Actual revenues are likely to be well below the official target because asset sales, debt restructuring and privatization of state companies have been much slower than expected due to excessive interference from the House and adverse market conditions.

Worse still, foreign creditors have held up almost $1.7 billion of their $2.6 billion program loans pledged to the 2001 budget due to the government's failure to significantly cut interest rates, combined with its low success rate in meeting reform commitments. 

Moreover, actual spending may overshoot the budgeted total because the rupiah rate has been much lower, and interest rates much higher, than the levels assumed by budget forecasts.

Hence, the economy has been deprived of sorely-needed investment as the private sector, burdened with bad debts, cannot provide the necessary stimulus, while foreign investors remain jittery about the country's economic, political and security conditions as well as its legal system. 

The banking industry, which had been restructured and recapitalized at a total cost of about $65 billion, is still too weak to significantly expand corporate lending.

There is indeed a lot about the short and medium-term health of the economy that should be cause for concern, especially with the deadweight cost of the public sector's debt overhang, which has reached as much as 120 percent of GDP. 

It will therefore be almost impossible for the economy to grow even by a mere 3 percent next year in the absence of a new rescheduling package for foreign debts maturing within the next three years and without speedier asset recovery, corporate debt restructuring and privatization of state companies.

Asset sales and privatization are now the most promising source of the new private capital flows that are needed to restore investor confidence in the economy, in view of the overcapacity present in almost all manufacturing industries. And foreign investment, at least over the next two to three years, will be the lifeblood of economic recovery. 

But many reform measures have simply failed to materialize, even under strong pressure from the IMF, World Bank and other foreign creditors, which tie their loans to policy reform.
The greatest lesson the government should draw from this utterly inept performance is that a faster pace of reform is the key to a sustainable economic recovery. 

However, reform can be sustained only by a strong consensus between the government and the House and not by the force of foreign aid or loans because reform requires changes in coalitions, in ideas and in interests.

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Managing Bank Indonesia: An insider's look at the crisis

Sunday, December 02, 2001 Vincent Lingga, The Jakarta Post, Jakarta

Mengelola Bank Indonesia Dalam Masa Crisis (Managing Bank Indonesia During the Crisis); By J. Soedradjad Djiwandono; PT Pustaka LP3ES Indonesia, 2001; 398 pp

What was the main cause of Indonesia's economic crisis, which many analysts have described as the most dramatic reversal of fortune the world has seen over the past 50 years?

The crisis was not precipitated entirely by the financial panic in Asia that eventually set off in Indonesia the worst implosion of a financial system seen in the world in recent history. Nor could it be blamed solely on Indonesia's macroeconomic structural weaknesses, according to a former governor of Bank Indonesia, Soedradjad Djiwandono.

Rather, the crisis was brought about by the cascading impact of the two factors, says Djiwandono in his latest book, Mengelola Bank Indonesia Dalam Masa Krisis (Managing Bank Indonesia During the Crisis). 

The structural weaknesses in Indonesia's banking and real sectors made the nation's economic resilience so vulnerable to self-validating panic, that the fallout from the Asian financial debacle (triggered by the crisis in Thailand in mid-July 1997) quickly triggered an overall economic crisis. This calamity immediately spread to the social and political sectors, which were also structurally very weak. 

This book explains blow-by-blow how the contagion from the regional financial panic set off a devastating feedback loop in Indonesia that destroyed market confidence and started a vicious cycle of financial and economic collapse.

The external shock laid bare all the structural weaknesses and inefficiencies caused by rampant corruption, collusion and nepotism, thereby setting off self-fulfilling speculative attacks on the rupiah and massive runs on the banks and triggering a self-fulfilling crisis. 

Many foreign economists and institutions, notably the International Monetary Fund and the World Bank, have analyzed the Indonesian economic crisis. However, Djiwandono's book is the first well-documented chronology of events by a leading member of the "fire squad" that attempted to cope with the conflagration, which is now popularly known as a multidimensional crisis. 

As Djiwandono was the governor of the central bank from March 1993 to mid-February 1998, when he was summarily fired by then president Soeharto about a month before his tenure officially ended, his account of events leading up to and into the early days of the crisis is enlightening and provocative. 

The book discloses many new things about the crisis, validates and disproves rumors about his working relationship with Soeharto and reveals the severe handicaps he faced because the central bank was still a tool of the government; not yet politically independent as it has been since May 1999.

He describes how the government finally abandoned the managed floating system in mid-August 1997 to protect foreign reserves because speculative attacks on the rupiah continued unabated even after the central bank poured more than US$1.5 billion into the market between the third week of July and Aug. 13 alone.

Foreign market players and fund managers, who got burned in the foreign exchange markets in Bangkok, Singapore, Manila and Kuala Lumpur, rushed to convert their rupiah assets into dollars, as they did not believe that Indonesia's managed floating system would hold much longer. 

The self-fulfilling speculative attacks on the rupiah became much stronger after national players joined the rupiah-dumping stampede.

The steep depreciation of the rupiah immediately hit the corporate sector which, lulled by the 3 percent to 5 percent annual depreciation over the past decade, had built up unhedged external debts between 1992 and early 1997. As their debt service payments skyrocketed in rupiah terms, many debtors defaulted, creating giant shocks in the banking industry.

Another blow hit the banking industry after the central bank suddenly tightened its money policy, doubling and then tripling interest rates in a desperate bid to curb speculative attacks on the rupiah.

These shocks in turn exposed the structural weaknesses, inefficiencies and many other basic flaws in the banking industry, which were previously camouflaged by robust economic growth. 

The book, however, fails to acknowledge that the crisis also revealed the technical incompetence and ineffectiveness of the central bank's supervisory system, and Bank Indonesia's powerlessness to deal firmly with bad bankers who were either Soeharto family members or Soeharto cronies. 

As many banks fell into financial distress, panicky depositors began withdrawing deposits, forcing the central bank to pump in liquidity support to prevent the national payment system from collapsing.

However, the liquidity loans did not help much as rumors began to fly and depositors, who had never been informed about the real condition of banks due to a lack of transparency and low disclosure standards, began pulling out of other banks supposed to be still financially sound.

A panic run on the banks started at full speed.

Next the Jakarta Stock Exchange was hit, its composite index falling from as high as 612 in mid-August 1997 to 475 in early September, and most foreign banks closed out Indonesian banks.

As things rapidly worsened and the public's confidence in the government's ability to handle the financial crisis declined sharply, the government decided in early October to ask for IMF assistance.

The IMF immediately demanded that 16 insolvent banks, including two partly owned by Soeharto family members, be closed down immediately as a prerequisite to any agreement.

However, strong protests and litigation proceedings launched by Soeharto family members against the central bank governor, and the ease with which Soeharto's son Bambang Trihatmodjo acquired another bank to replace his bank which was closed on Nov. 1, further damaged market confidence in the government's seriousness and capability in handling the crisis. 

The absence of a blanket guarantee (launched only in early February 1998) on bank deposits caused even greater concern among people about the safety of their deposits in national banks, thereby prompting both massive flight to quality (shifting money to foreign banks) and flight to safety (converting rupiah savings into dollars).

The book also discloses how joint market intervention with the Monetary Authority of Singapore, the Government of Singapore Investment Corporation and the Bank of Japan initially succeeded in strengthening the rupiah from 3,600 to the dollar to 3,200 in November 1997.

However, the Singapore and Japanese monetary authorities abruptly halted their market interventions, apparently due to a request from the IMF, which was disappointed by the Indonesian government's backtracking on many of the reform measures stipulated in the first reform agreement signed with the IMF in mid-November 1997. The rupiah eventually plunged to as low as 15,000 in January 1998. 

The book, however, does not shed much light on the alleged misuse of about $13 billion in emergency liquidity support from the central bank, as uncovered by the Supreme Audit Agency.

Djiwandono instead blames the controversy on the fact that since the government has long been seen as a vast ocean of corruption, the central bank, as part and parcel of the government, is also seen as corrupt.

He also blames the misperception on the misunderstanding of the role of liquidity support, arguing that if such a misperception did not exist the public would accept the cost of the liquidity support.
Moreover, he argues, the parameters applied to assess normal conditions cannot be used to evaluate such a critical situation as took place during the height of the crisis. 

Djiwandono asserts that the massive liquidity support was required to prevent a total collapse of the national payment system and not to protect bank owners and depositors.
Is Djiwandono really so naive as to believe that Bank Indonesia was an island of incorruptibility in the middle of an ocean of corruption?

The book also fails to enlighten the public about the technical competence and integrity of Bank Indonesia officials, notably those in charge of bank supervision, who had come under increased suspicion after audits in 1998 and 1999 disclosed how egregious the banks' violations of almost all prudential regulations had been.

Detailed explanations in the book about the central bank's supervisory system, its resources, accountability of bank supervisors and internal controls could have helped straighten out the issue.

How could violations of prudential rulings of such magnitude have occurred without the collusion of a number of Bank Indonesia officials?

Djiwandono's book is nevertheless a valuable new trove of information on Indonesia's economic crisis, because it not only provides a factual account of events, but also ventures analyses of what should and should not have been done and why similar IMF programs in Thailand and South Korea were more successful.

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Media distortion hurts Indonesia's image

Friday, November 02, 2001 Vincent Lingga, The Jakarta Post, Hong Kong

Indonesian officials, businessmen and analysts attending the three-day East Asian Economic Summit appeared uncomfortable and occasionally frustrated about the negative image that had been projected about their country to the hundreds of participants who had come from around the world.

The anti-American street demonstrations, emotional outbursts against the U.S., staged by a few hundred people in Jakarta and several other cities over the last two months, seemed to have earned Indonesia the image of a country controlled by millions of radical Muslims. 

The steady stream of stories and prominent displays of photos about demonstrators with slogans bashing the U.S. and its allies for the attacks on alleged terrorists in Afghanistan and television interviews with people registering as volunteers to fight in Afghanistan were presented as if the world's largest Muslim-populated country was about to erupt.

"I painstakingly explained to them that the group, which threatened to use violence to express their support of and solidarity with Muslims in Afghanistan, was negligible compared to the hundreds of millions of moderate Indonesians," Minister of Trade and Industry Rini Soewandi told The Jakarta Post after giving an interview with CNN.

Rini conceded that even though the voice of reason now prevailed among public opinion, the damage had already been done to Indonesia's image.

She confirmed that a number of importers overseas had canceled orders from Indonesia due to security concerns.

"Scenes of people demonstrating on the streets are normal, especially in democratic countries. But when such scenes are disproportionally displayed in photos and repeatedly zoomed in on television screens, the resulting perception is misleading," she added.

Did the Indonesian and foreign mass media go over the top in their coverage of anti-American sentiment, especially between late September and the first two weeks of October?

"Yes, I think many newspapers and television news broadcasters went overboard in the treatment of those events," said Jusuf Wanandi, Chairman of the Jakarta-based Centre for Strategic and International Studies.

Jusuf, who was a panelist at two sessions during the summit, went into great length to assert that what people overseas read in newspapers or saw on television did by no means represent Indonesian public opinion.
"But the way the mass media treated the events created the impression that radicals sometimes control public opinion in Indonesia," he said.

Garment businessman M.Manimaren also seemed frustrated about the negative image his buyers had of Indonesia.

"I didn't come here primarily to attend the economic summit but to meet my buyers as they did not want to come to Indonesia. "I have to continue our exports, otherwise I would not be able to pay my employees. Therefore, I have to go wherever my buyers are willing to meet," Manimaren said.

Some foreign analysts, who are based in Jakarta or regularly visit Indonesia, said their perception of Indonesia was not in anyway distorted by the overblown stories about the recent wave of anti-American demonstrations.

But they admitted that people overseas, notably those who had never visited Indonesia, could have been scared by what they had read in the print media and saw on television.

They said Indonesia had inherited problems, which it is now encountering in its transition to full democracy and local autonomy, from more than three decades of authoritarian and centralized government, the nation was not fanatically anti-American.

Arwin Rasyid, president of Jakarta-based Bank Danamon, acknowledged that despite the myriad of problems Indonesia is facing, people need uplifting stories, news about kindness, compassion amid the torrent of bad news.

Rasyid was also disturbed about how some of the mass media in Jakarta tended to disproportionately emphasize the bad aspects of events.

"Since you have already heard all the bad news, negative things from the mass media, I will present to you the positive developments currently going on in the banking industry," he said at an Indonesian session during the summit.

Speaking as a panelist at the session, Rasyid cited the restructuring efforts that had been implemented in the banking industry and the progress already made in the process of rebuilding a sound financial system in Indonesia.

He added that, despite the seemingly gloomy outlook of the economy, one should not live in constant worry, waiting for the next series of bad news.

Does Rasyid expect too much, given the liberal mood of Indonesia's press, the preoccupation of many print media with expanding circulation and the fierce competition among TV broadcasting stations for a higher rating?

That depends on the mass media themselves. But like the Americans who are now at war against terrorism, Indonesia seems in need of another kind of fight, which is a campaign against pessimism.

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RI told to speed up reforms to cope with slump

Tuesday, October 30, 2001 Vincent Lingga, The Jakarta Post, Hong Kong

Indonesia had no alternative but to stay on course and speed up reforms and structural measures to cope with the likely full-blown global economic recession exacerbated by the impact of the Sept. 11 terrorist attacks on the United States, international analysts asserted in Hong Kong on Monday.

"The market punishment for poor policies is likely to be harsher and quicker than before," warned Shigemitsu Sugisaki, deputy managing director of the International Monetary Fund (IMF) at the East Asia Economic Summit 2001 organized by the Geneva-based World Economic Forum.

Sugisaki predicted that the economic growth of East Asia, excluding China, would plunge to a mere 1.2 percent this year from 6.5 percent last year, as the world's largest economic locomotives, the U.S. and Japan, would be pushed deeper into recession.

Hubert Neiss, formerly Asia Pacific director of the IMF, concurred that governments in East Asia should accelerate restructuring to restore confidence.

"The markets will take very badly any retreat from reforms or attempt to tinker with control or regulating mechanisms already in place," cautioned Neiss, who from 1997 to 2000 was in charge of supervising reforms in Indonesia under the IMF bailout program.

Neiss warned that if, for example, Indonesia significantly eased its monetary and fiscal policies now to generate economic pump priming, market confidence in the country could collapse altogether.

The opening day conference of the summit, which consisted of four individual plenary sessions, two parallel plenary meetings and one business luncheon, was occupied almost entirely with analyses on the impact of the gloomy global economic outlook on East Asia.

Even though the dozen analysts who acted as panelists at the sessions agreed that the current recession in East Asia was qualitatively different from the slump in 1997, they charted out a much more difficult period for the next one to two years.
 

President of the Philippines Gloria Macapagal Arroyo was also bearish about economic prospects, saying that the global economy now seemed to have been pushed over the edge into a full-blown recession.

"It is therefore imperative that East Asian political leaders seize the opportunity to take the bitter pill of oft-postponed reforms," President Arroyo asserted in a keynote address to the meeting.

Businesspeople and analysts seemed to be worried about the latest situation in Indonesia, especially after the U.S. attacks on Afghanistan, asking how the backlash would affect political stability and President Megawati Soekarnoputri's political survival.

Jusuf Wanandi, chairman of the Jakarta-based Centre for Strategic and International Studies, however, assured participants at the meeting that the situation in Indonesia was not as bad as they might have read in the print media or saw on television.

After initial confusion over the action taken by the U.S., the mainstream Muslim community had now been more assertive in their condemnation of terrorism and any form of violence such as "sweeping" against Americans.

"However, the U.S. should work hard to build up a supportive environment of public opinion in the fight against terrorism and encourage more regional and national initiatives for the campaign against terrorism," added Jusuf, who became a panelist at two plenary sessions in the morning and the afternoon.

He acknowledged, though, that the short wave of anti-American demonstrations in Indonesia had done some damage to Indonesia's image, blaming what he saw as the overblown treatment of the event by the mass media, which gave the perception that a small group of radicals controlled the national agenda.

Theo F. Toemion, chairman of the Investment Coordinating Board, also assured foreign businesspeople and analysts that the political and security condition in Indonesia was not as fragile as many might have perceived from what they read in newspapers or saw on television. 

"Many right policies have been put in place and we are now preparing a new investment law to replace the 1967 foreign investment law, which would provide equal treatment to both domestic and foreign investors," Toemion added. 

Toemion acknowledged that if things seemed not to progress as fast as they should be at the moment, it was because the country was learning democratic practices.

However, Adam Schwarz, senior consultant at McKinsey Company in Jakarta, noted that Indonesian country risk premium had been rising due to the backlash from the U.S. attacks on Afghanistan. Foreign investors, Schwarz added, although still interested in Indonesia, seemed worried about inadequate policy direction and weak policy implementation.