Volatility threatens Indonesia's progress

Even in today's economic climate, most Indonesians are in better shape than they were in 1998, reports Philip Bowring.

It seems an improbable proposition. Few countries generate more bad news than Indonesia. The Government is in turmoil, the President seriously threatened with impeachment, bloody civil strife exists in at least two provinces, and separatist insurgencies in two more.

The banks are barely solvent and government debts threaten to rise to unserviceable levels. To cap it all, the currency has recently taken another nosedive and insurgents have cut off one of its major exports.

So it may seem absurd to propose that Indonesia's economic growth rate this year could be 4.5 to 5.5 per cent, which would put it into the top half of the east Asian league. That forecast is from the central bank. It is 1 per cent higher than the expectations of the World Bank and International Monetary Fund (IMF) or what is possible assuming there is neither a new political nor financial crisis.

But Indonesia did better last year than most had forecast, and could do so again.

The first reason is the rather obvious one that daily street demonstrations in central Jakarta do little other than disrupt traffic. They do not have much impact on the industrial areas on the outskirts.

The violence-racked Maluku islands are of scant economic importance, and strife has done little to slow resource exploitation in Irian Jaya, also known as West Papua, or Kalimantan. Indeed, in the case of the latter, illegal logging has probably increased. It was only last week that gas production from Aceh's Arun field was disrupted.

Indonesia has many flashpoints, but so does India. Like elephants, huge countries have momentum and thick skins. Economic life goes on, driven neither by politics nor that ephemeral and inaccurate barometer of prosperity, the stockmarket. So what are the drivers?

First, agriculture. There is no guarantee Indonesia will not be hit by another devastating drought like that of 1997-98, which was far more serious for most Indonesians than the Asian currency crisis. But weather aside, an average 3 per cent growth can be expected in this sector. Other disruptions and price changes may have negative implications but gradual increases in productivity are well embedded.

That is not to ignore future problems, such as a collapse of new investment due to land ownership disputes and lack of capital.

Next comes devaluation itself. Indonesian costs were already highly competitive before the currency fell back 20 per cent during 2000.

Exporters' rupiah earnings have been rising faster than inflation, now around 9 per cent. This benefits at least some rural producers, which feeds through to domestic demand for basic manufactures and consumer durables like motorcycles. In the short term it shifts demand from imports to local products. The cheap rupiah has also produced a surge of manufactured exports.

Many companies may be deep in debt and many investors reluctant to put more money into Indonesia. But there is no shortage of working capital for those who have export orders and plenty of dollars available to fund raw-material imports. In some cases the lack of progress in debt restructuring may be helping businesses continue to operate, painful though this may ultimately be for the taxpayer. There is plenty of spare factory capacity in most sectors, so new commitments are not often needed.

Last year exports rose by 28 per cent, mostly the result of expansion in non-oil volumes. That's close to the top of the Asian league. This year, with world growth slowing, the nation may be lucky to get close to 10 per cent. But even 5 per cent could prove as good as the Asian average.

Indonesia has a good spread of resource-based and labour-intensive industries, and should be least hurt by the demise of the tech bubble.

Tourism is being hurt by the nation's image, but Bali has held up fairly well.

Some economists maintain that Indonesia's recovery since 1998 has been steeper than the official data suggests, claiming that the "black" economy has been growing faster than the recorded one. For example, it is widely believed that smuggling of imports in order to avoid tax is even more rife than before.

Evidence of faster growth is found in power consumption, usually an accurate and easily measured guide. It grew 9 per cent last year and is now well above pre-crisis levels.

Manufacturing employment has picked up and even cement usage, devastated by the collapse of grandiose metropolitan projects, has responded to income gains.

There is even the prospect of a small pick-up in investment this year, albeit from very depressed levels. Some businesses see markets gaps to be filled in the oil/gas sector, despite problems in Aceh and Irian Jaya.

Of course, much of this progress will be to little avail if domestic conditions deteriorate further, consumers stop spending and buy dollars and manufacturers shy away from export commitments for fear of disruptions. That is a possibility if the rupiah, which has fallen another 10 per cent this year to again breach the 10,000 mark, continues to tumble.

But at the moment, Indonesia still has a functioning economy and a commercial class which sees good business opportunities and even likes President Abdurrahman Wahid for his inclusive attitude towards the country's minority ethnic Chinese entrepreneurs. The banks' capital adequacy may still be marginal and further falls in the rupiah will exaggerate bad-debt problems in a system with a big percentage of loans in dollars. But on a day-to-day basis, the banks work well enough.

The problems with the IMF have probably received more attention than they deserve. The fund may be forgiven for wanting strict accountability before making new disbursements. On the other hand, Indonesia has met almost all its macro-economic and budgetary targets.

Inevitably if there are to be debt restructurings and a return of some flight capital, forgiveness of some none-too-clean past activities is inevitable.

The balance now between justice and doing what is expedient is a difficult one.

There is no doubt, however, that the IMF matters, and the public spat with the institution has damaged the rupiah and thus exacerbated debt problems. It has also meant that interest rates have had to be increased to defend the currency.

With government debt, mostly the results of the banking sector collapse, now 100 per cent of gross domestic product and being financed largely with short-term rupiah borrowings, the level of short-term interest rates is vital if debt is to be stabilised and eventually reduced.

For now the economic situation for most people's daily life is not much worse than it was before the crisis, and a lot better than it was in 1998.

Massive transfers of wealth have taken place but the impact on the incomes of the vast majority, who own little capital and do not work in banks, construction or capital-intensive industries, has been limited.