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Jakarta Post

Remarkable Indonesia rising? Only God knows

  • Anwar Nasution

    The Jakarta Post

Jakarta   /   Fri, December 27, 2013   /  11:04 am

A series of books published by foreign writers are praising successful domestic reforms in Indonesia since the fall of president Soeharto in May 1998, when Indonesia made a great leap from the authoritarian political system to democracy, from a centralized government system to a decentralized one and from a relatively closed economy to a more globalized open system.

Many of them predict a bright future for the Indonesian economy, soon to join BRICS (Brazil, Russia, India, China and South Africa) or OECD (Organization for Economic Cooperation and Development), having already made great contributions to the international community both through ASEAN and the G-20.

But most of them neither show what kind of progress has been made, nor pinpoints the remaining problems or offers suggestions on how to fix them.

Only Allah, God Almighty, knows whether the rosy predictions can be realized.

The quality of the Cabinet ministers has been quickly eroding with the messy political system and the President'€™s lack of leadership during the reform era.

The dictatorship of president Soeharto has not been replaced by a visionary and charismatic leader who leads us to prosperity.

Soeharto, who had minimal formal education, entrusted key economic and diplomatic posts to well-educated technocrats who obtained their PhDs in economics from the University of California at Berkeley (consequently, a writer of the pseudo-leftist Rampart magazine dubbed Dr. Widjojo Nitisastro cs. the Berkeley Mafia).

In contrast, the current President, Susilo Bambang Yudhoyono, is an alumnus of the US Army Staff and Command School at Fort Leavenworth and obtained his Master'€™s degree from a neighboring state university and a doctorate in agriculture economics from the Bogor Agriculture University (IPB) with distinction.

The technocrats under Soeharto exploited the international environment for the benefit of Indonesia, among others things, to finance the entire government budget deficit for 32 years of his administration by ODA from the Western creditors. The Soeharto administration also invited foreign direct investment (FDI) to create jobs for the surplus unskilled and uneducated labor mainly in Java.

During the oil boom in the 1970s and 1980s, Indonesia successfully prevented the appreciation of its currency to avoid the Dutch disease. Indonesia also used the oil money to strengthen the fundamentals of its economy by improving its education and health care system, population control, building rural infrastructure, modernizing the agriculture sector and promoting its labor intensive manufacturing industry. The oil money was also used to modernize the tax system and customs procedure to facilitate external trade.

Expanded job opportunities, as well as increases in production and prices of the agriculture sector, helped eradicate poverty. In contrast, the present administration eradicates poverty mainly though provision of rice for the poor (raskin) and cash transfer.

The current weaknesses in public institutions are particularly evident in three areas, namely: Poor legal and accounting systems, market failures and government failures. The first weakness raises transaction costs in the economy as it cannot adequately protect private property rights and enforce contracts.

During his campaign in 2009, the political platform of President Yudhoyono was to eradicate corruption. In reality, corruption has been rampant during his term of office, involving his inner circle and key officials of his political party.

Weaknesses in the legal and accounting systems are also reflected in poor tax administration that resulted in a low tax-to-GDP ratio of 12-13 percent at present.

The second weakness is evinced particularly in the successive bank failures after the crisis in 1997, including the Bank Bali scandal in 2000 and the Bank Century case in 2008. The decision to bailout the tiny Bank Century was made when Yudhoyono attended the G-20 Pittsburg meeting in 2008 to discuss, among other things, governance of the financial sector.

These successive bank scandals also indicate the failure of independency in Bank Indonesia (BI), the central bank.

The two bank scandals happened because of the strong political interventions of the government on the bank supervisors for not enforcing the bank'€™s prudential rules and regulations strictly.

The third weakness is reflected by the inefficiency of state-owned enterprises owned by the three layers of government: central, provinces and regencies/municipalities. Many of them, such as Hotel Indonesia, are now rented out to private investors.

Rapid economic growth since the year 2000 was actually mainly due to positive external shocks and hardly influenced by the government'€™s economic policy. Poor government policies are reflected in the low trade and FDI to GDP ratios in Indonesia, the lowest among the ASEAN-5 countries, while the index of economic freedom, regulatory quality rank and ease of doing business are relatively poor.

The positive external shocks were mainly because of the rise of prices of primary commodities exported from Indonesia, such as coal, palm oil, rubber, fish and other mining products. Their destinations are mainly China and India, growing 9 to 10 percent per annum continuously for over the past 30 years for China and since the early 1990s in the case of India. Rapid economic growth, mechanization, motorization and urbanization in these two countries require all kinds of energy and raw materials while their more prosperous population requires better quality of foods, among other things, from Indonesia.

There are three weaknesses in the current short-term stabilization policy in Indonesia. First, too rigid application of fiscal and debt rules that have replaced the balance budget rule of Soeharto'€™s New Order since the financial crisis in 1997.

In reality, the budget deficit has been kept around 2 percent of the annual GDP and debt ratio around 27 percent. The present budget deficit is entirely financed by issuing sovereign bonds (SUN) in both domestic and international financial markets, including the Samurai bonds partly guaranteed by the Japanese government.

The policies to limit budget deficit and government debt are good for image building by improving Indonesia'€™s rating in the international financial market. The restrictive policy is, however, bad for economic development as there are no financial resources to build infrastructure and address the other development bottlenecks.

Second, until recently, BI allowed appreciation of the real effective rates of the rupiah supported by the boom of primary commodities and surge in short-term volatile capital inflows to buy SBI (Bank Indonesia'€™s Certificates of Deposit) and government bonds. The sovereign bonds mainly issued to recapitalize the financially collapsed domestic banks during the crisis in 1997 and to finance budget deficit.

The appreciation of the rupiah reduced prices of imports and made it easier for BI to achieve its inflation target. Rupiah appreciation, however, has caused an outbreak of the harmful Dutch disease in the economy.

Third, there has been no effort to deepen the existence of the narrow and shallow money and capital markets in Indonesia by, for example, building the Post Office Bank as a narrow bank by using the already wide branch network of post office. The function of a narrow bank is only to mobilize savings and sell insurance policies, and uses the proceeds to buy securities.

The narrow financial market makes it more difficult to use interest rates as the operating target of monetary policy, particularly when the role of short-term capital flow as a provider of liquidity is quite significant, currently about 33 percent, in the SBI and SUN markets.

At the same time, the heavy reliance on short term capital flows affects stability of the exchange rate and bond prices that subsequently affect government funding, banks'€™ capital and portfolio of the mutual fund industry that heavily invested in both instruments.

The writer is a professor of economics at the University of Indonesia. He was previously the senior deputy governor of Bank Indonesia and chairman of the State Auditing Agency (BPK). He obtained his
PhD degree in economics from Harvard University, Cambridge, Massachusetts.