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SURVEY OF RECENT DEVELOPMENTS

Paul R. Deuster

To cite this article: Paul R. Deuster (2002) SURVEY OF RECENT DEVELOPMENTS, Bulletin of Indonesian Economic Studies, 38:1, 5-37, DOI: 10.1080/000749102753620257

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ISSN0007-4918print/ISSN1472-7234online/02/010005-33 ©2002IndonesiaProjectANU

SURVEY

OF

RECENT

DEVELOPMENTS

PaulR.Deuster*

SUMMARY

Almost four years after the fall of Soehartoandfiveafterthefinancialcri

-sisbegan,Indonesiaisstillstrugglingto dealwitheconomicrestructuringandre

-covery,politicaltransition,decentralisa

-tion and redefining national identity. The nation has regained political and economicstability,butisinfragilecon

-ditionandislosingreformmomentum. Without substantial progress soon, avoiding renewed crises becomes un

-likely.Takingadvantageofpresentsta

-bilityisthereforecrucial.

Theeconomyisfarfromhavingbeen restructured, far from achieving rapid andsustainablegrowth,andfarfromre

-gaining theper capita output level of 1997.Thedemocratictransitionhasbe

-comeboggeddownwiththreechanges ofpresident,eliteinfightingandamore assertive parliament. The new presi

-dencyhasbroughtpoliticalstability,as Megawatiis likely to survive at least untilthenextelections. However,fun

-damental constitutional issues sur

-roundingthedirectelectionofexecutive figures,districtrepresentation,theinde

-pendenceofthejudiciary and therole ofthePeople’sConsultative Assembly (MPR)requireresolution.

Decentralisation has successfully reacheditsfirstbirthday.Whilemanyof thepredictedpitfallshavebeenavoided, thegovernmentmuststillwrestlewith allocationformulae,tradeandbusiness restrictions and taxes,minimum wage hikes,treatment offoreign investment andstateenterprises, delivery ofserv

-ices,andaccountability.Separatismand ethnicandreligiouschauvinismaretest

-ingIndonesia’ssenseofidentity.Sepa

-ratist movements in Aceh and Papua havegainedmomentum,despiteoffers of autonomy,and despite military ac

-tions.Ethnicandreligiousconflictsstill flare in Sulawesi, Maluku and Kali

-mantan. Debate is sharpening on the properroleofIslaminthestate,includ

-ing that of paramilitary and vigilante groupsformedtodefendIslamanden

-forcemoralvalues.

Indonesia’seconomicgrowthof3.3% in 2001 exceeded that of most of its neighbours, butrepresented aslowing from the4.8%growthrecordedin2000 andincludedamarkedslowdowninthe last quarter.The government has re

-stored relations with the International MonetaryFund(IMF),aswitnessedby therecentapprovalofanotherLetterof Intent(LOI)andextensionofthecurrent program until 2003.However,reforms are lagging,especially indebt restruc

-turing, banking, financial supervision, revenue generationand privatisation. Thegloomyinternational scenehasim

-pactedstrongly onIndonesia’s exports andcastsdoubtson2002growthpros

-pects. Given the slowdo wn in the economy inthefourthquarterof2001, lacklustre reform efforts and current poorglobalprospects,expectations are for somewhat less growth than last year—certainly lower in the first half,

butstrongerinthesecondastheworld economypicksup.

THEFOURHORSEMEN

OFINDONESIA1

Ratherthanreportingonlyondevelop

-mentsoverthelastfewmonths,itseems worthtakingalonger-termviewofwhat

has happened in Indonesia since the startofthecrisisinmid1997.Morethan fouryearsafterthecrisisbegan,thena

-tion is still wrestling with four major, closely intertwined issues, referredto hereasthe‘fourhorsemen’ofIndone

-sia: economic restructuring and recov

-ery, political transition to democracy, decentralisation of government func

-tions and redefining nationalidentity. Any one of these would be a serious challenge,letaloneallfouratonce.Suc

-cessfullydealingwiththesechallenges offersIndonesiatheopportunity tocre

-ateaprosperousanddemocraticcoun

-try.Butwhilethenationismovinginthe right direction and making significant gainsinmanyareas,itclearlymustde

-votemoreconcertedeffortandresolve tothesemajorissuesnow,toavoidcon

-tinued or renewed crises in coming years.

EconomicRestructuring

andRecovery

Indonesiaisstillrecoveringafterbeing thecountryhardesthitbytheAsianfi

-nancialandeconomiccrisisof1997–98.

ItsrealGDPdeclinedby13%in1998as its banking and modern corporate sectors collapsedinthewakeofshort

-termcapitaloutflows,revealingfunda

-mental structural deficiencies in the Indonesian‘miracle’.Restructuring and recovery hasbeenslow.Overall,Indo

-nesia islaggingbehindtheotherhard

-hit Asian countries, despite growing faster in 2001. Moreover,the recovery remainsfragileandrestructuring hasa longwaytogo.Corporatedebtsremain largelyunreconstructed,banklendingis limited, the governmentownsor con

-trols most of the bankingsystem and

substantial business assets, fiscal sus

-tainability is questionable, inflationary pressuresarestrongandtheinvestment clim ate is unattractive. As figure 1 shows,it will be anothersix years be

-foreIndonesiaregainsits1997level of percapitaoutput,assumingitmaintains 3% annualgrowth(Ali2002).With6% growththiscouldbecuttothreeyears, butattainingthiswouldbedifficultand requiresubstantial reforms.

PoliticalTransition

SincethedownfallofformerPresident SoehartoinMay1998,thecountryhas beenundergoingamajorpoliticaltran

-sitioninanefforttocreateamoredemo

-cratic polity. This began well with the smoothtransitiontoPresidentHabibie in 1998; the peaceful holding in June 1999ofthefreestparliamentaryelections since1955;and the MPR’sselection of Abdurrahman Wahid (Gus Dur) as president in October 1999. However, since then the process has become boggeddownbyeliteinfighting, bythe newassertiveness oftheMPRandPeo

-ple’sRepresentativeCouncil(DPR),and by conflict between the DPR and the president. The switch to a new presi

-dent, Megawati Sukarnoputri, in July 2001hasre-established political stabil

-ity,offeringIndonesiathechancetore

-gain momentum on political reforms. Box1reviewsthecurrentsituation.

Togetthepoliticaltransitionbackon track,keyconstitutionalandelectoralis

-suesmustbefacedsooninpreparation for elections in 2004. These issues in

-clude thefollowing. Should thepresi

-dentbeelected directlybythepeople? If so, in cases where nocandidate re

-ceivesaclearmajority,willtheresultbe determinedbywhohasthemostvotes, byanelectoralrun-off,orbyadecision

oftheMPR?Shouldgovernors,mayors andbupati(districtheads)alsobeelected directly? Should representatives be

elected by district,on aparty basis, or underamixedformula?Whatshouldbe therelativerolesandpowersoftheex

-ecutive, legis la ture and judicia ry? Should the MPR become the second body of a bicameral legislature? How will electioncampaignsandcampaign financingbehandled?

Decentralisation

AftermanyattemptsthroughoutIndo

-nesia’s history,oneofthemostradical decentralisationseverundertakenany

-whereintheworldis nowfullyunder way.UnderthelegalframeworkofLaws 22and25of1999,passedintherun-up

tothe1999parliamentary elections,and ofnumerousimplementing decreesand regulations, decentralisation officially beganon1January2001.Thefirstyear hasbeensuccessfulinimportantways, butdecentralisation isnowfacingaset ofcriticalchallenges. Themostserious

ofthesearethelackofequityinrevenue sharing;mushrooming localtaxes,fees andrestrictionsonbusinessesandtrade; uncertainty relatingtoinvestment; lack ofcleardirectionfromthecentreonde

-centralisation and monitoring; dispro

-portionateincreasesinminimumwages; and a lack of local electoral reform to improveaccountability.

NationalIdentity

Since the fall of Soeharto, separatist movements, ethnicand religious con

-flicts,andstrugglesoverthedegreeof socialandreligioustolerancehavecalled intoquestionIndonesia’sfundamental nationalidentity. Ethnicand religious tensions have led to widespread vio

-lence and killings in Maluku, Kali

-mantanandSulawesi.Whilethelevelof violenceiscurrentlydown,conflictscon

-tinuetoflareup,andthefearofbombs, especially in or near churches and

FIGURE1 GDPperCapitaa

(Rpmillion,1993prices)

a_{Projections to2007assume3%p.a.and6%p.a.GDPgrowthbeyond2001.}

Source:BPS. 1.0

1.5 2.0 2.5 3.0

1 99 3 19 95 1 99 7 19 99 2 00 1 20 03 2 00 5 20 07

BOX1 POLITICALOUTLOOK

FollowingthedismissaloftheerraticAbdurrahman WahidinJuly2001,newPresi

-dentMegawatiSukarnoputri inheritedaweakpresidencywithpowerhavingshifted

toanincreasingly assertiveparliament. Withherpartylackingaparliamentary ma

-jority,Megawatihashadtoaccommodateadiversecoalitioninhercabinet,including

representatives ofthe mainpoliticalparties,retiredmilitaryofficersand economic

technocrats. Notsurprisingly,maintaining astablegovernmentunderthesecircum

-stanceshasalreadyprovendifficult.Theglobalwaronterrorismprovokedvocalpro

-tests againstthe US bymilitantIslamicgroups,straining thegovernment’sshaky

coalitionofIslamicandnationalist parties.Megawatihasbeenabletosteeracourse

betweenofferingsupportforanti-terroristmeasureswhileassuagingdomesticoppo

-sitiontothewarinAfghanistan. International eventscouldcomplicatetheseefforts,

however,provokingafurtherroundofagitationbyIslamicgroupsduring2002.

Onecrucialtaskforthe governmentwillbe toensurethatthe DPRpasses key

legislation atatimewhenlegislators seemincreasingly willingtofrustratethegov

-ernment’spolicyagenda.TheMPR,consistingoflegislators andregionalandfunc

-tional representatives, willalsoconvene toconsidercontentious changes tothe

country’sconstitution. Thiscouldsparkadivisivedebateovertheformofpresiden

-tialelectionsandtheroleofIslaminthestate.

The governmentcontinuestoface mounting criticismover stalledeffortsto ad

-dresscorruptionandjudicialreform.Adhoccourtstotryhumanrightscasesareex

-pectedtogetunderwayearlythisyear,focusingonEastTimor,whichwillprovidea

keytestofthejudicialsystem.LegalexpertshavecriticisedMegawati’sappointment

ofanold-stylebureaucrattothekeypostofAttorneyGeneral.Amidcontinuedde

-mandsforactionagainstcorruption, thegovernmenthasprovokedhowlsofprotest

byflirtingwiththeideaofextendinganamnestytoSoeharto.Ontheotherhand,it

maypursuechargesagainstDPRSpeakerAkbarTanjungoverallegationshemisused

state fundsforelectoralpurposes.Whileweakeninga potentialrivalforthe presi

-dency,theprosecutionofAkbar,whoseGolkarPartysupportwascrucialtoMegawa

-ti’sappointment, couldsharpendivisionswithinthegovernment.

Ifallthiswerenotenough,separatiststrifeand communalviolencecontinueto

plaguethecountry.Thegovernmentseemsintentonpursuingarepressiveapproach

inthetroubledprovincesofAcehandPapua,whichislikelytoleadtomore,notless,

conflict.Intheabsenceofanywillingness onJakarta’sparttonegotiatewiththemain

stakeholders intheseprovincesandtoprosecutehumanrightsviolators,morevio

-lenceisexpected.

Thesemanifoldchallengesmayinfactproveinsurmountable,threateningthegov

-ernment’ssurvival.Butpresentinstitutional weaknessesmaybeMegawati’sgreatest

strength,astherearefewimmediatealternatives tothepresentgovernment. While

consolidating theirposition,the armed forceswouldriskmajor socialupheavalif

theyweretousurpcivilianauthority.SeniorofficersseemsatisfiedwithMegawati’s

presentaccommodation ofmilitaryinterests.Furthermore,internalsplitsareseverely

weakeningallthemajorpoliticalpartiesandtakingtheirleaders’attentionawayfrom

pressingnationalissues.Similarly,Islamicgroupsand othercivilsocietyorganisa

-tionsremaindividedandgovernmentcriticslackafocusedagendaaroundwhichto

galvaniseoppositiontoMegawati.Whilethismayboostherchancesofsurvival,such

institutional weaknesshardlyaugurswellforadvancingthecrucialpoliticalandeco

-nomicreformsrequiredforIndonesiatoovercomeitspresentcrisis.

RoddMcGibbon

USAIDDemocracyAdviserinJakarta

mosques,remainshigh.Tensionshave been heightenedby the creationand involvement in conflicts of paramili

-tary groupssuchas Laskar Jihad; by thepossibilityofmajorconstitutional amendments in relation tothe status ofIslam;andbyconcernsarisingfrom the September 11 attacks in the US and subsequent war on terrorism in Afghanistan.

The former province of East Timor willbecomeanindependent nationon 20May2002,aftermorethantwoyears of UN tutelage. The impact of East Timor ’ssecessionontherestofIndone

-siahasbeenminimal,withthesepara

-tiongenerallyaccepted,thoughnotwell understood,bythegeneralpublic.How

-ever,separatistmovementsinAcehand Irian Jaya—now officially known as

Papua—althoughmilitarilycontainedat

themoment,continue tosimmer.Spe

-cialautonomylawshavebeenpassedfor bothprovinces, butthesehave notyet beenembracedbytheintendedbenefi

-ciaries.Thekilling in Papuaofpro-in

-dependence leader Theys HiyoEluay, and the failure to arrest his killers, is jeopardisingeffortstowinacceptanceof thenewautonomypackagethere.

As a result of thevarious conflicts, military actions and natural disasters over thelastthree yearsorso, around 1.3millionpeoplespreadover20prov

-incesarenowclassifiedasinternallydis

-placedpersons(IDPs).Thetotalisquite fluid asmanypeoplefleeandthenre

-turnhomeorfindotherpermanentresi

-dences. The number includes both peoplebeingcaredforincamps,public buildings and community structures andthosewhohavefoundshelterwith family, friendsor comrades inprivate homes. Some of the larger concentra

-tions are in Maluku, with more than 460,000IDPs;CentralandEastJavawith nearly 200,000 (mostly from Central Kalimantan and located on Madura);

Sulawesi with around 240,000; Aceh with upto 18,000 and NorthSumatra withmorethan44,000Acehnese;Papua withover16,000;andWestTimorwith 50,000–80,000EastTimorese.Box2lists

someoftheeventsthathavehelped to producetheselargenumbersofIDPs.

Thecauses ofconflictare quitevar

-ied, and often location-specific. They

includeethnicandreligioustensions;re

-sentmentovertransmigration;struggles overeconomic,naturalandpoliticalre

-sources;realorperceivedsocialandeco

-nomicinequalities(oftenstemmingfrom past government actions); and inde

-pendenceorseparatistmovementsand the militaryresponses to them.Often, outsideagitatorsorsupporterssuchas LaskarJihadareinvolved.Theongoing natureofIndonesia’sinternalconflicts, theexistenceoflargenumbersofIDPs acting asconduits ofhostility to other partsofIndonesia—and,insomecases,

themselvesthesubjectofhostilityfrom nearbypopulations—andtheinabilityof

thegovernmenttorestrainorprosecute the perpetrators ofviolence and assist victims,raiseseriousconcernsaboutthe country’slong-termstability,andeven

itsviabilityasanintegratedstate.

DECENTRALISATION’SFIRST

YEARANDTHECHALLENGES

AHEAD

The first year of decentralisation de

-servestobedeclaredasuccess.Ina‘big bang’ approach, Indonesia wentfrom being a country inwhich 13% of gov

-ernmentexpenditures werehandledby localgovernments tooneinwhich35% wereso handled,a proportion on par with OECD countries. Major break

-downsinpublicserviceswereavoided; overtwomillionemployeesweretrans

-ferred from national to local govern

-ments;fundsweregenerallyreceivedon timeandinsufficientquantitytomain

-tain localgovernmentoperations; and

BOX2 PARTIALCHRONOLOGYOFINDONESIANDOMESTICCONFLICTS

Thefollowinglistisapartialchronologyofeventsthathaveresultedinlargepopula

-tiondisplacements inIndonesiaoverthelastthreeyearsorso.Manyothersmaller

communityconflicts,militaryactionsandnaturaldisastershaveaddedtothenum

-berofinternallydisplacedpersons(IDPs).

December1998.ViolenceeruptsbetweenChristiansandMuslimsinthetownofPoso

inCentralSulawesi.Whilethisisnotthefirsttimesuchviolencehasoccurred,itis

moreseriousandleadstoperiodicaloutbreaksoverthenextseveralyears,causing

extensivedamage,killingsandpopulationdisplacement.

January1999.ViolenceeruptsbetweenChristiansandMuslimsontheislandofAm

-boninMalukuprovince.Sincethenatleast4,000peoplehavedied,hundredsofthou

-sandshavebeendisplaced,andhundredsofbuildingshavebeendestroyed.

August–September1999.Buildingonviolenceandintimidationleadinguptotherefer

-endum,Indonesia-backedmilitiasgoontherampageintheaftermathofEastTimor ’s

overwhelming votefor independence on30August1999,killingciviliansandde

-stroying infrastructure on amassivescale.Some400,000persons aredisplaced,of

whom260,000becomerefugeesinWestTimor.

ViolencealsoeruptsontheislandofHalmahera,NorthMaluku,betweennatives

oftheislandandtransmigrants fromtheislandofMakian.Theviolencesoonspreads

tootherpartsofNorthMaluku.

December 1999.ContinuingriotsbetweenChristiansandMuslimsinMalukuleave

100dead.

January2000.Large-scaleriotsbetweenMuslimsandChristiansoccurinthetownof

MataramontheislandofLombok,apparentlyinresponsetothesectarianclashesin

Ambon.

April2000.Civilunrestresultsinthe destruction ofordamageto morethan5,000

homesandpublicbuildings,anestimated250deathsandapproximately 70,000peo

-pledisplacedinPosoandTentena,CentralSulawesi.

May 2000.Another sectarianclashinCentral Sulawesileaves98 deadandaround

4,000housesburnedordestroyed.

June–July2000.ViolenceinNorthMalukukillsmorethan114persons.Twentyare

killedinAmbon.Videosshowmeningovernment-issueduniformsfightingalong

-sidesectarianfighters.

September2000.Pro-IndonesiamilitiaskillthreeUNreliefworkersinAtambua,West

Timor.

March–April2001.EscalationofviolenceinCentralKalimantan,withattacksbyDayaks

onMadureseimmigrants, causesasuddeninfluxof58,000MadureseIDPsto West

Kalimantanand125,000toMaduraandotherpartsofJava.

June–July2001.TensionsincreaseinPontianak,WestKalimantan, asethnicDayaks

andMalayscallforremovaloftheMadurese,leadingtoforcedresettlement ofthe

latterfromPontianak.Some7,000areresettlednearby;othersaretoldtheymustbe

gonebyDecember.

AperiodofrelativecalminPosoisbrokenbyattacksonvillagesinthesurround

-ingarea.Inonevillagealone18peoplearekilled,includingwomenandchildren.

Houses,temporary barracksandmosquesareburned,resultinginanew roundof

displacement.

November–December2001.ExtensiveviolencebreaksoutagaininthePosoarea. Sources:Mason(2001),USAID(2001)andvariousothersources.

many localgovernments proved ener

-geticandcreative.Box3providesanas

-sessmentofthefirstyear,concentrating onfiscaldecentralisationissues.However, manyissuesneed attentiontokeepthe processontrack,asalreadynotedby,for example,Almetal.(2001),Lewis(2001), Dick(2001)andRamstetter(2000),andas highlightedbytheDonorWorkingGroup onDecentralization(2001).

SharingofFunds

Thegeneralresultofthesharingofgov

-ernmentfundsamong the three levels of government, including revenues sharedunderLaw25andtransfersdis

-tributedthroughtheGeneralAllocation Fund(DAU),has been for richer local governmentstoreceivemore.Thisraises manyconcerns about the equalisation principle of resource sharing. Whilea generallyacceptableallocationformula has been designed to furthergreater equality,theDPRhassofarintervened topreventitsfullapplication. Ithasdic

-tatedthatnounitofgovernmentshould receive less than in theprevious year, lockinginpastpatternsandmakingad

-justmentsbetweenunitsdifficult.

Taxes,FeesandRestrictions

Therehavebeenmanyreportsofexces

-sive taxes, fees and restrictions being appliedbylocalgovernmentsinpursuit ofrevenues, profits and rents(see, for example,Ray2001,2002).Inthetaxarea, Law34/2000—replacingtherestrictive

Law18/1997—authorisedlocalgovern

-mentstocreatenewtaxesandcharges, subjectonlytovague,hard-to-adminis

-terprinciplesanda30-dayreviewbythe

centralgovernment. Ifnoactionistaken bythecentrewithinthattimeperiod,the regulation in question stands.Despite identifying asproblematic at least 100 localregulations outofover3,000sub

-mitted,the centrehas notyet acted to rescindanyregulations, insteadasking

localgovernments toreconsider them. Many local governments are applying leviesand‘voluntary’contributionsthat distort tradeand thatfalloutsideLaw 34/2000. Levies and other chargeson agriculturalproducetransported across subnational borders, requirements for certificatesoforigin,loading/unloading andcargohaulagelevies,inspectionand quarantinerequirements, androadand transportchargesthatduplicatenational chargesareallcommon.

InvestmentUncertainty

Thepresentsituationcausesgreatcon

-cern,especiallyamongforeigninvestors. Itisnotclearwhodecideswhatinrela

-tion to present and potential invest

-ments.Thisuncertainty extendstowho controlsstateenterprises. Localgovern

-mentsaredemandinggreaterownership sharesandtaxesfromforeigncompanies operatingintheirarea,especiallymin

-ingcompanies.TheWestSumatraand SouthSulawesiprovincialgovernments successfully blockedthesaleoffurther sharesinPTGresikCementtoMexico

-basedminorityshareholder Cemex,by demandingthattheoperating unitsin their territories not be includedin the sale.TheprovincialgovernmentinRiau has managed toobtain a 50%share of anoilconcessionintheprovince,with anoptiontobuy uptoanother15%in the next two years. UntilAugust 2002 the concession is being operated by Caltexunderaone-yearextensionofits

productionsharingcontract,whichhad run out lastyear.Reportedly thestate oil company,Pertamina,and theRiau governmentareplanningtoformajoint venture to operate theconcession, re

-placingCaltex.Thisisunderstoodtobe thefirsttimethataforeignoperatorwill bereplacedintheoperationofagiven oilfield,ratherthananextensionorre

-newalbeingworkedout.Sincethisisan older field requiring sophisticated

techniquesandadditionalinvestmentto recovertheremainingoil,therearefears that thenew joint operating company willnotbeabletodothejobadequately.

LackofStrategicDirection

Despitethestrongstarttodecentralisa

-tion,theprocesslacksanoverallvision, direction and objectives, especially as shared by thecentral government, the DPR and regionalgovernments. With

-outsuchdirection,thereisariskthatde

-cisions will beadhoc,inconsistent and economically disruptive. Many ques

-tionsawaitresolution. Forexample,the centralgovernmentisstillstrugglingto

defineandcarryoutitsrole underde

-centralisation.It needs to improve its own managem ent procedures and reorienttheimplementation ofnational policiesandprioritiesthroughautono

-mouslocal governments. It mustalso redesignits procedures forsetting ob

-ligatory government functions and minimumservicestandardstoincorpo

-rateregionalconcerns,whilealsoensur

-ingthatallcitizensreceivecomparable minimumservices. Since decentralisa

-tionisanongoingprocess,thegovern

-mentmustmonitordevelopmentsand evaluatethemintermsofobjectives, so astoencourageusefuladjustments.

BOX3 DECENTRALISATION’SFIRSTYEAR

FirstYear.Inthefirstyearofitsimplementation,Indonesia’snewfiscaldecentralisa

-tionpolicyhasraisedIndonesia’ssubnational governmentexpenditure from13%to

roughly35%oftotalgovernmentexpenditure. ThisshifthasmovedIndonesiafrom

theaverageexpenditure levelofdevelopingcountriestothatofOECDcountriesina

veryshort,politically tumultuous, timeframe.Ithasdonesointhefaceofdirepredic

-tionsofbreakdownofpublicservicedeliveryanduntenableincreasedpressureonthe

fiscaldeficit.Sixpositiveachievements ofthefirstyearstandout.

1 Implementationwasquickandcomplete,withoutlengthydeliberations andwith

-outmajorincident.

2 Emphasiswasplacedongeneralpurposegrants,insupportoftheconceptofin

-creasedregionalindependence.

3 Aformulawasestablished fordistribution oftheGeneralAllocationFund(DAU),

addingacriticalleveloftransparency totheprocessandprovidingabaselineforfu

-tureallocationdebates.

4 Localitiesweregivenbroadertaxingpowers,whichalsosuggestsgenuinecommit

-menttoregionalautonomy.

5 Itwasreasonableandcommendable topassspecialautonomylawsforAcehand

Papua.

6 Theinvolvement of theDPRintheprocessisintrinsictoademocracyandgives

greaterlegitimacy.

EmergingIssues.Duringthepastyear,eightcriticalissueshaveemergedthatwill requirespecialattentionaspartoftheefforttobuildamoreconsistent,workablefiscal

decentralisationpolicy.

1 TheDAU’s‘holdharmless’provisiononrevenues(thatis,therequirement thatno

regionalgovernmentshouldsufferareductioninrevenues)makessenseintheearly

stagesofatransitioninordertoprotectexistingservicesaslocalgovernments adjust

tonewbudgetaryconditions. However,itremainsunclearforhowlongsuchmeas

-uresshouldhold,orhowtophasethemoutandoverwhattimeperiod.

2 Similarly,thecontingency fundthatwasestablished tosafeguardregionsagainst

possiblerevenueshortfallsshouldnotbeallowedtoexistindefinitely.

MinimumWages

Since1January 2001,thepower toset minimum wages has rested with the provinces.Therearefearsthatminimum wagesarebeingraisedfarbeyondwhat isreasonable, tothepointwherethein

-creases seriously weaken employment prospects, especially for youth, un

-skilledworkersandwomen.In2001sev

-eral provinces raised the minimum wagebyabout30%.Comingafterlarge risesin2000,the2001increasesbrought therealvalueoftheminimumwage(at justoverRp 300,000/monthinnominal terms)closetothepre-crisis levels.For

2002 pressurefrom unions and politi

-cians has led to announcements of furthersubstantialincreasesinthemini

-mumwage.Jakartaledtheway,propos

-ing an increase ofsome 38%;this was matched byincreases inthesurround

-ing regions of Tangerang, Bekasi and Bogor. Fortunately, several centres of labour-intensivemanufacturingexport

activity,suchasBandungandBali,have announcedsmallerincreases(oftheor

-derof10–25%),presumablymindfulof

thepotentialadverseimpactonemploy

-mentinkeygarment,footwearandtex

-tile industries. Box 4 discusses the controversy caused by the Jakarta in

-crease,whichwouldraisetheminimum

BOX3(continued) DECENTRALISATION’SFIRSTYEAR

3 Atpresentlocalgovernments maybeexercisingtoomuchtaxingauthority,tothe

detrimentoftradeandbusiness. Theareasforlocaltaxjurisdiction shouldperhapsbe

revisedsoastoinvolvesomecombination ofpayroll,motorvehicleandvalueadded

taxes.

4 Giventhewiderangeoflocalcapacitiestomanagetheirnew-foundrevenues,ques

-tionsariseastohowthesamepolicycanbeappliedtoallregions,andhowcapacities

canberaisedandequalisedquickly.

5 Hardbudgetconstraintsareneededtoavoidirresponsiblefiscalbehaviourbylocal

governingbodies.

6 Indonesia’sfiscaldecentralisationpolicyneedstobeformallyand closelymoni

-tored,with regularanalysisand evaluationto ensurethat the structuregrows and

changestomatchthecountry’sevolvingneeds.

7 Astrong,wellcoordinated centreiscrucialtoensurefairness,fullcomplianceand

continuedunityindeferencetolong-termgoalsforsuccessfuldecentralisation.

8 Anylong-termfiscaldecentralisationpolicyadjustments, especiallyfornaturalre

-sourcerevenues,musttakeintoaccountthespecialneedsandlegalstatusofAcehand

Papua.

Choices.Torespondtotheseemergingissues,Indonesia’spolicymakerswillneed

tomakesomedifficultchoicesinthenearfuturetosolidifyandimprovelong-term

fiscaldecentralisationpolicy.Somekeychoicesare:determination oftheDAUbyfor

-mulaorbynegotiation; grantswithorwithoutconditions; localtaxesbyprescribed

listorlocalchoice;alargerorsmallernaturalresourceshare;moreorlessprovincial

expenditure responsibility;andpaternalism ora hardbudget constraintasthe pri

-marymethodoffiscaldiscipline.

StrategyFramework.Decidingthesechoicesanddetermining thebestcourseofac

-tionwilldependlargelyonthenation’sobjectivesandaspirations forthefiscaldecen

-tralisation process.Hence thedevelopment ofa strategic frameworksetting forth

guidingprinciplesandultimategoalsisurgentlyneededtoleadthepolicy’sevolution

andstimulatepublicdialogue.

RoyBahl

AndrewYoungSchoolofPublicPolicy,GeorgiaStateUniversity

wagesignificantlyabove therealpre

-crisisrupiah level and bring it to just under $60/month, almost the pre

-crisisdollarlevel,despitearealdepre

-ciation of the rupiah of around 40%.

This causes major concern about the impactonemploymentinindustriesal

-readysqueezedbyhighpricesforim

-portedinputsandincreasesinfueland electricity prices.

BOX4 CONTROVERSYOVERTHEMINIMUMWAGEINCREASEINJAKARTA

Theannouncement ofa38%increaseintheminimumwageforJakarta,toRp591,000,

producedanoutcryfromemployers.Employergroups,mainlyrepresented through

Apindo(IndonesianBusinessmen’sAssociation), haveoftenarguedagainstthemini

-mumwage,eventhoughtheofficiallevelisostensiblybasedontripartiteagreement

amongApindo,unionsandgovernmentrepresentatives.Butlatein2001,Apindotook

theunprecedented stepofinstructingitsmembersnottopaythenewminimumwage

forJakarta,andrequestedthatthelocaladministrative courtdelaytheintroductionof

thenewlawpendingfurtherlegalaction.Thisrequestwasapprovedandthenlater

overturnedbytheadministrativecourtinearlyJanuary.

TheMinisterofManpowerandCooperatives,JacobNuwaWea,camedownstrongly

insupportoftheJakartagovernment’spolicy.Hebrandedfirmsunwillingtopaythe

newminimumashaving‘NewOrderattitudes’,andarguedthatApindorepresented

aminorityofemployers—whileneglectingtopointoutthatthesefirmsactedformany

largerestablishments withagreatershareofemployment, especiallyintheimportant

export-orientedindustriesandretailing.

Whatarethebroaderimplications ofthisconflict?Assomecommentators have

pointedout,amissingelementinpolicyformulation hasbeenthewiderlabourmar

-ketimplications ofsharplyrisingrealminimumwagerates(likelytobearound50%

intheperiod2000–02ifinflationis10%thisyear).Thepublicdebatehasbeendomi

-natedbyrepresentatives oflabourinterestsdefendingthosefortunateenoughtohold

jobsatorabovethecurrentminimumrate.Oneextraordinary twistoflogiccoming

fromalabour‘expert’advisingtheJakartagovernmenthasbeentheassertionthat

workersarejustcatchingupasaresultofproductivity gainsnotpassedontothem

sincethelate1980swhentheeconomywasbooming.Theimplication isthattheycan

bepassedonwhentheeconomyisdepressedwithoutanynegativesideeffects!

Bappenasisoneofthefewgovernmentagenciestohaveputthecaseforthe‘pub

-licinterest’.IthasdrawnonaSMERUreporttoarguethattheemploymentimplica

-tionsofthelargeminimumwageincreasescouldbedisastrousforbothexistingworkers

andnewjobseekers(SMERU2001).Ratherthanactingasasocialsafetynettopro

-videsometolerableminimumwageforworkers,minimumwagesarenowcloseto

theaveragewagefornewbluecollarentrantsintotheworkforce.Thusincreasesofa

magnitudeof30–40%,wellabovethe rateofproducer priceincreases,areputting

significant pressureonaveragewagesandwagecosts.

Thisepisodesuggeststhatmuchgreaterpublicdebateisneededontheimplica

-tionsofminimumwagepolicy,betweeneconomistsandlabouractivistsinparticular,

inthebroadercontextoflabourandincomespolicyingeneral.Onedangeristhat

Indonesiawillbecomeprematurely lockedinto a‘high-wage’policystraightjacket

earlyinthereformasiperiod.Promotionofelitelabourinterestsattheexpenseofbroader

employmentandequityconsiderations hasproveddisastrousinseveralotherThird

Worldcountries,especiallyinLatinAmerica,overthepasttwodecades.

ChrisManning

Partnership forEconomicGrowthadviserinJakarta

TheSMERUResearchInstituteunder

-took an econometric study of pooled data from the National Labour Force Survey(Sakernas)andalsosurveyed200 workersinover40firmsintheJabotabek (greater Jakarta) and Bandung areas (SMERU2001).Theinstitutefoundthat by 1999 and 2000 the minimum wage hadbecomebindingforthemajorityof workers; thatis, themajorityofwork

-erswereearningwagesatorbelowthe regulated minimum level. While in

-creasesintheminimumwagedefinitely benefitedwhitecollarworkersandthose whohadmanagedtokeeptheirfactory jobs, many otherworkers—mainly fe

-male, young and less educated—lost

their jobs or could notfind workas a resultoftheincreases.Forallworkers, SMERUestimatedtheelasticityofem

-ploymenttobe–0.112;thatis,forevery

10% increase in the minimum wage, therewasroughlya1% decreaseinto

-talemployment.Forfemalesandyouth, theelasticitywas–0.3;thatis,forevery

10%increaseintheminimumwage,em

-ploymentdecreasedby3%.Fortheless educated theelasticity was –0.2,a 2%

decreaseinemploymentforevery10% increaseintheminimumwage.

ElectoralReform

In order for decentralisation to work well,local governments needtobe re

-sponsive andaccountable tolocalcon

-cernsanddemands.Atthemomentlocal parliamentaryelectionsareparty-based;

peoplevoteforparties,notindividuals, and elections areheld only every five years. Hence parliamentary members tend tobe loyal totheir partiesrather thantotheirconstituents. Also,district headsandmayorsareselectedbylocal parliaments, not through direct elec

-tions,whichagainencouragesloyaltyto parliaments rather than to the local population.Reformofthelocalelectoral systemwillbecriticalifdecentralisation

istoimprovelocaldecision-makingand

accountability.

RECENTECONOMIC

DEVELOPMENTS

Weakprogressisbeingmadeonawide rangeofeconomicissues.Confidenceis stillabovethelowpointreachedinJune–

July2001,andtheeconomyoutperformed mostoftheregionin2001.However,the economyisweakeningandthemomen

-tumofreformhasslowed noticeablyas theconcernformaintainingstabilityhas takenpriority overaction.Criticisms of Megawatiandhergovernmentaregrow

-ing;exportsandinvestmenthaveslowed substantially;andseriousproblemscon

-tinuetofesterwithoutconcertedefforts toresolvethem.

Mood

Confidenceandhopeinthegovernment areclearlydownfromJuly,whenthere wasan immediate positivereaction to Megawatiassumingthepresidency,but arestillmuchhigher thantowardsthe end of theGus Dur regime (Pangestu andGoeltom2001;DanareksaResearch Institute 2001a, 2001b, 2001c,2001d). Nevertheless,a sense of stability and movementintherightdirection,albeit slow,seemstoprevail.Onthepositive sideareasuccessfulmeetingoftheCon

-sultative Group onIndonesia (CGI)in November;thesigninginDecemberand approvalinJanuaryofanewLOIwith the IMF; the budget deficittarget for 2001beingmet;theraisingoffuelprices andestablishmentofaschemeforauto

-maticadjustmentoftheseprices—with

-outincurringmajorprotest—inJanuary;

andtherelative stabilityoftherupiah. However,thesenseisalsogrowingthat whilethegovernmentmaybemuddling alongsuccessfully enough,itisnotbe

-ingsufficientlyvigorousinattackingthe issuesfacingthecountry.Hopesforsub

-stantialprogresshavebeendimmedby

sucheventsasthefailuretosellGresik Cement,thefailuretoprosecuteanysen

-ior person in relation tothe country’s various financialand corruption scan

-dals,andthesuggestiontoofferthelarge debtorsoftheIndonesianBankRestruc

-turing Agency (IBRA) a significantly extended period to repay their debts alongwithlowerinterestrates.Inaddi

-tion,theprospects fora near-term na

-tionalrenaissanceseemtobeworsening associal violence, widespread corrup

-tion,policyindecisiveness andpolitical infightingcontinue.

The11thmeetingoftheCGIinJakarta on7–8Novemberwasanoverallsuccess

forIndonesia,despitethe criticisms re

-ceived(WorldBank2001a,2001b).Twenty

BOX5 IMPORTANTFEATURESOFTHEIMFLOIOF13DECEMBER2001

Macroeconomic FrameworkandTargetsfor2002

Indicator Target

RealGDPgrowth 3–4%

Inflation

Endofperiod 9–10%

Average 10–11%

Currentaccountbalance $1.9billion(1.0%ofGDP)

Grossreserves $29.2billion

Centralgovernmentbalance –2.5%ofGDP

Basemoneygrowth 12–14%

StructuralBenchmarks

December2001

IBRAtocollectatleastRp27trillionincash(net)

ConcludetenderprocessforBankBCA

InitiatesaleprocessforBankNiaga

January2002

PublishIBRA’sscheduleofquarterlyassetrecoverytargetsfor2002

March2002

Beginprimaryauctionsoftreasurybills

Finaliseandimplementburden-sharingagreementbetween BIandthe government

relatingtoBIliquiditysupporttobanksin1997–98

Formulateplansfornationalauditandtaxarrearscollection, alongwithreporting

systems

June2002

CommenceoperationsofLargeTaxpayerDirectorateatDirectorateGeneralofTaxation

headquarters,andatonetotwoofficesinJakarta

Producereporton2001localgovernmentfinances

ConcludemajoritysaleofBankNiaga

Achieveatleasthalfof2002targetforprivatisationreceipts

EstablishAnti-corruptionCommission

July2002

ImplementnewtaxfilingandpaymentsystemsatLargeTaxpayerOffices

December2002

Completethirdroundofspecialauditsofstateenterprisesandadoptcorrectiveactions

countries, 11multilateral organisations andfivecivilsocietygroupsattended.The CGIdonorsindicatedstrongcontinuing supportfor Indonesia,whileemphasis

-ingtheimportanceandurgencyofreso

-lutepolicyaction.Theyparticularlyurged reformofthejusticesector,improvements inforestmanagement,apro-poorstance

duringthedecentralisationprocess,and theneedtomaintainfiscalsustainability and monetary prudence. Amounts of $3.14billioninon-budgetdisbursements

and$586millioninoff-budgetgrantsand

assistance were pledged.Although the totalissignificantlylessthanthe$5bil

-lionorsopledgedinthelastseveralmeet

-ings,lessassistancehadbeenrequested andthisamountwasagreedto.

InDecember,Indonesiapassedaper

-formancereviewbytheIMFandsigned anewLOIwhichwasapprovedinJanu

-ary. Box 5 shows the macroeconomic framework,performance criteria, struc

-tural adjustmentbenchmarks and tax administration reform milestones con

-tainedintheLOI.Whilesomeclaimthe IMF was lenienttowards Indonesiain view ofthe worseningglobaleconomy andtheattentionfocusedonfightingter

-rorismintheaftermathofSeptember11, theLOIdoescontainmanydetailedac

-tionsneeded forIndonesia toadvance

BOX5(continued) IMPORTANTFEATURESOFTHEIMFLOIOF13DECEMBER2001

Quantitative Performance Criteria(PC)andIndicativeTargets(IT)for2002,

byQuarter

Q1 Q2 Q3 Q4

(PC) (PC) (IT) (IT)

Monetaryandfiscaltargets(Rptrillion)

NetdomesticassetsofBI –11.5 –11.0 –8.5 3.9

Basemoney 117.8 123.7 128.2 138.2

Externaltargets($billion)

Netinternational reserves 18.7 19.5 19.8 19.8

MilestonesforTaxAdministrationInitiatives2001–02 January2002

MinisterofFinanceissuesaMinisterialDecreecreatingLargeTaxpayerOffices

MinisterofFinanceissuesinstructionsonnewsystemsandproceduresfortheseoffices

February2002

DirectorateGeneral(DG)ofTaxationformulatesagovernanceframeworkfortheseoffices

March2002

DGformulatesanationalauditplanandreportingsystemwithtargets

DGformulatesanationalarrearscollectionplanandreportingsystem

June2002

LargeTaxpayerRegionalOfficeatheadquartersandoneortwoLargeTaxpayerOffices

inJakartacommenceoperations

July2002

LargeTaxpayerOfficesimplementthenewtaxfilingandpaymentsystems

December2002

DGsubmitsstatusreporttoMinisterofFinance

Source:GovernmentofIndonesia(2001).

beyondjustmuddlingalong.Forexam

-ple,thegovernmentcommitteditselfto majortaxadministrationreform,includ

-ingtheestablishmentofspecialisedunits topursuelargetaxpayers.

AspointedoutinSiregar (2001)and Hamilton-Hart(2001), corruption isbe

-comingakeyissue.Increasingawareness ofanddissatisfactionwithcorruptionis undermining publicfaithinthegovern

-ment andthe president.Itispopularly believed thatcorruption is much more widespread today than underformer PresidentSoeharto.Whilefewjudgethe totalamountsbeingtakentobeasgreat, moreindividualsareperceivedasbeing involved.Moreover,morebribesarebe

-ingpaid,withlesscertaintythatwhatis promisedwillactuallybedelivered.One of the most serious consequences of spreading corruption isthat illegallog

-ging hasreachedepidemicproportions and isseriously threatening Indonesian forests(ICG2001).Itisgenerallybelieved thatlocaland nationalofficials,bothci

-vilianandmilitary,areheavilyinvolved, alongwithmajorprivatefirms.

Arecent study of2,300 respondents (comprising 650 publicofficials, 1,250 householdsand400businessenterprises) in14provincesfoundthat75% ofthem consideredcorruptioninthepublicsec

-tortobeverycommon,whilearound65% ofthehouseholdsreportedactualexperi

-enceofdealingswithcorruptpublicoffi

-cials(PartnershipforGovernanceReform inIndonesia2001).Themostcorruptor

-ganisationswereconsideredtobethetraf

-ficpolice,customsauthorityandjudiciary, whiletheleastcorruptwerereligiousin

-stitutions, the post officeandthe news media.Thepublicofficialssurveyedcon

-sideredthepublicinstitutionswherecor

-ruptionwasmostprevalenttobe,inorder, the National LandAgency,the Depart

-mentofIndustryandTrade,theDepart

-mentofForestryandtheDepartmentof the Interior. Onaverage they alsoesti

-matedthatalmosthalf(48%)ofpublicof

-ficialswerereceivingunofficialpayments. Thestudyreportedthat1–5%ofhouse

-holdincome,officialsalariesorcompany revenue was spenton unofficial pay

-ments.Thebusiness persons surveyed rankedcorruptionasthefourthmostsig

-nificantreasonfornotinvestinginIndo

-nesia, aftereconomic uncertainty, high inputcostsandthebusinessdownturn. Growth

ProvisionalfiguresissuedbytheCentral StatisticsAgency(BPS)suggestthatout

-putgrewby3.3%in2001,wellbelowthe 4.8%growthrateachievedin2000.More

-over,inthefourthquarteroutputdeclined by1.2%inrelationtothepreviousquar

-terandwasuponly1.6%comparedwith thelastquarterof2000—lessthanhalfthe

growthratefortheyearasawhole(table 1).Clearlyconsumption bybothhouse

-holdsandgovernmentdroveeconomic growththroughout2001,especiallyinthe third andfourth quarters.In thefourth quarter private and government con

-sumptionwereup4.4%and7.4%respec

-tivelyonaquarter-on-quarterbasis,and

9.2%and11%onayear-on-yearbasis.For

theyearasawholeprivateconsumption roseby5.9%andgovernmentconsump

-tion by 8.0%. On a quarter-on-quarter

basis export growth was negative for threeoutofthefourquarters;onlyinthe secondquarterwasitpositive.Similarly, growthininvestmentwasnegativeforthe firstthreequarters,beforeexperiencinga smallincreasein thefourthquarter.Im

-portgrowthwasnegative allyear ona quarter-on-quarterbasis,and onayear

-on-yearbasisfellbacksharplyfrom51%

inthefirstquarterto–30%inthefourth

quarter(table1).

Thesectorfigures(table2)showthat thesharpdeclineinagriculture(bearing inmindthatthedataarenotseasonally adjusted)pulledtotalquarterlygrowth into negative territory (–1.2%) on a

TABLE2 GDPGrowthbySector

(1993prices,%)

Sep–00 Dec–00 Mar–01 Jun–01 Sep–01 Dec-01

Year-on-yearGDP 4.1 6.9 4.8 3.8 3.2 1.6

Agriculture, livestock,

forestry&fisheries 0.3 13.2 3.7 1.7 –0.4 –2.8

Mining&quarrying 3.1 12.6 6.9 –0.3 –2.4 –5.9

Manufacturing 5.9 4.4 4.2 4.8 4.7 3.6

Electricity,gas&watersupply 8.0 7.7 7.3 9.9 8.9 7.6

Construction 4.1 4.7 6.2 5.7 3.5 0.7

Trade,hotels&restaurants 4.6 6.8 6.8 5.5 5.7 2.6

Transport&communication 8.7 7.8 6.4 7.0 7.6 8.9

Finance,rental&businessservices 4.4 3.6 3.9 3.4 2.7 2.0

Services 2.0 2.3 1.3 1.6 2.3 2.7

Quarter-on-quarterGDP 2.9 0.3 1.3 –0.7 2.3 –1.2

Agriculture, livestock,

forestry&fisheries 5.6 –11.5 15.4 –5.7 3.4 –13.7

Mining&quarrying 4.0 7.3 –4.4 –6.6 1.8 3.5

Manufacturing 3.0 2.2 –2.0 1.6 2.9 1.1

Electricity,gas&watersupply 3.3 2.5 –2.5 6.4 2.5 1.2

Construction 2.5 4.9 –2.0 0.3 0.4 2.1

Trade,hotels&restaurants 2.2 2.4 0.2 0.6 2.4 –0.6

Transport&communication 2.1 3.2 0.5 1.1 2.7 4.5

Finance,rental&businessservices 1.2 1.2 0.4 0.7 0.5 0.4

Services 0.2 –0.1 0.1 1.4 0.8 0.3

Source:CEICAsiaDatabase.

TABLE1 GDPGrowthbyExpenditure

(1993prices,%)

Sep–00 Dec–00 Mar–01 Jun–01 Sep–01 Dec-01

Year-on-yearGDP 4.1 6.9 4.8 3.8 3.2 1.6

Privateconsumption 4.0 4.7 4.0 4.7 5.8 9.2

Governmentconsumption 11.7 12.1 6.0 4.2 11.9 11.0

Investment 26.0 24.6 18.9 7.7 –0.8 –7.1

Exports 25.9 32.3 18.4 8.0 –2.6 –12.9

Imports 23.3 50.1 50.7 37.2 –3.7 –29.8

Quarter-on-quarterGDP 2.9 0.3 1.3 –0.7 2.3 –1.2

Privateconsumption 1.2 1.2 0.4 1.8 2.3 4.4

Governmentconsumption –5.5 8.2 –0.4 2.4 1.4 7.4

Investment 4.4 9.1 –3.4 –2.1 –3.9 2.2

Exports 3.2 4.7 –3.9 4.2 –7.0 –6.4

Imports 17.6 22.4 –3.6 –1.2 –17.4 –10.8

Source:CEICAsiaDatabase.

quarter-on-quarterbasis. Forthe full

yearagriculture andminingperformed poorly while electricity,gas and water supplyaswellastransportandcommu

-nicationdidbetter.Trade,hotelsandres

-taurantsperformedwellinthefirstthree quartersbutlesssointhefourthquarter intheaftermathofSeptember11.Manu

-facturinggrewslightlytoendthefourth quarterup3.6%overthelastquarterof

TABLE3 Budgetsfor2001and2002 (Rptrillion)

2001 2002

Revised %of Estimated %of Approved %of

GDP Outcome GDP GDP

TOTALREVENUE 286.0 19.6 299.9 20.3 301.8 17.9

Taxrevenues 185.3 12.7 184.7 12.5 219.6 13.0

Domestictaxes 174.3 11.9 174.2 11.8 207.0 12.3

Incometax 95.0 6.5 92.8 6.3 104.5 6.2

(ofwhichnon-oil&gas) (69.2) (4.7) (69.7) (4.7) (88.8) (5.3)

Valueaddedtax 53.5 3.7 55.8 3.8 70.1 4.2

Land&buildingtax 6.3 0.4 6.3 0.4 8.1 0.5

Excise&other 19.5 1.3 19.3 1.3 24.2 1.4

International tradetaxes 11.0 0.8 10.5 0.7 12.6 0.7

Non-taxrevenue 100.7 6.9 115.1 7.8 82.2 4.9

Naturalresources 79.5 5.4 86.7 5.9 63.2 3.7

ProfittransfersfromSOEs 9.0 0.6 10.4 0.7 10.4 0.6

Othernon-taxrevenues 12.3 0.8 18.0 1.2 8.7 0.5

TOTALEXPENDITURE 340.3 23.3 354.6 24.0 344.0 20.4

Centralgovernmentexpenditure 258.8 17.7 272.2 18.4 246.0 14.6

Routineexpenditure 213.4 14.6 232.8 15.8 193.7 11.5

Personnel 38.2 2.6 39.5 2.7 40.7 2.4

Goods&services 9.9 0.7 9.6 0.7 11.6 0.7

Interestpayments 89.6 6.1 95.5 6.5 88.5 5.3

Domesticdebt 61.2 4.2 66.3 4.5 59.5 3.5

Foreigndebt 28.4 1.9 29.3 2.0 29.0 1.7

Subsidies 66.3 4.5 81.6 5.5 41.6 2.5

Petroleum 53.8 3.7 68.4 4.6 30.4 1.8

Non-petroleum 12.5 0.9 13.2 0.9 11.2 0.7

Other 9.4 0.6 6.6 0.4 11.3 0.7

Development &netlending 45.5 3.1 39.4 2.7 52.3 3.1

Rupiahfinancing 21.7 1.5 19.7 1.3 26.5 1.6

Projectfinancing 23.7 1.6 19.7 1.3 25.8 1.5

Fundingofregionalgovernments 81.5 5.6 82.4 5.6 98.0 5.8

Revenuesharing 20.3 1.4 21.2 1.4 24.6 1.5

GeneralAllocationFund(DAU) 60.5 4.1 60.5 4.1 69.1 4.1

SpecialAllocationFund(DAK) 0.7 0.0 0.7 0.0 0.8 0.0

SpecialAutonomyFund 3.4 0.2

Overallbalance

(revenue–expenditure) –54.3 –3.7 –54.7 –3.7 –42.1 –2.5

2000.Growthinthefourthquarterover thethirdshowsamixedpattern:agricul

-tureandthetrade,hotelsandrestaurants sectorweredown,buttheothersectors wereup,althoughmostlyonlybyalittle.

FiscalSustainability

The most important immediate eco

-nomic issue is fiscal sustainability—a

necessary, butnotsufficient, condition forrecoveryandgrowth.Canprivatisa

-tion, asset recovery, program (policy

-based)loansandtaxrevenueincreases financethegrowingburdenofdebtin

-terestandprincipalpayments,revenue sharingwiththeregionsandheavysub

-sidies?Thediscussionhereextendsthat ofSiregar(2001).

2001Results.Theoutcomefor2001,as estimatedlateintheyear(table3),sug

-gests thatthe deficit targetof 3.7% of GDPwasmet.Meetingthistargethelps Indonesiatoregaincredibility andreas

-sure donors and investors that it can manageitsaffairs.Theestimatedresults indicate that overall revenues were Rp 14 trillion over target—natural re

-sourcerevenuesbyRp 7trillion,VATby

TABLE3(continued) Budgetsfor2001and2002

(Rptrillion)

2001 2002

Revised %of Estimated %of Approved %of

GDP Outcome GDP GDP

FINANCING 54.3 3.7 54.7 3.7 42.1 2.5

Domesticfinancing 34.4 2.4 44.2 3.0 23.5 1.4

Banks 0.0 0.0 7.6 0.5 0.0 0.0

Privatisation proceeds 6.5 0.4 5.0 0.3 4.0 0.2

Assetsales 27.0 1.9 31.0 2.1 19.5 1.2

Governmentbonds 0.9 0.1 0.7 0.0 0.0 0.0

Issued 0.9 0.1 0.7 0.0 3.9 0.2

Retired 0.0 0.0 0.0 0.0 3.9 0.2

Foreignfinancing(net) 19.9 1.4 10.5 0.7 18.6 1.1

Foreignfinancing(gross) 40.1 2.7 30.3 2.1 62.6 3.7

Projectloans 23.7 1.6 19.7 1.3 25.8 1.5

Programloans&

rescheduling offoreigndebt 16.3 1.1 10.6 0.7 36.8 2.2

Amortisation –20.1 –1.4 –19.7 –1.3 –44.0 –2.6

ASSUMPTIONS

Economicgrowth(%) 3.5 4.0

Inflationrate(%) 9.3 9.0

Oilprice($/barrel) 24.0 22.0

Oilproduction(mbcd)a _{1.46 1.3}

Exchangerate(Rp/$) 9,600 9,000

GDP(Rptrillion) 1,469 1,685

Interestrate(3-monthSBI,%) 15.0 14.0

a_{Millionbarrelsofcrudeperday.}

Source:MinistryofFinance;Wallace(2002).

Rp 2.3trillion,profitsfromstate-owned

enterprises(SOEs)byRp 1.4trillion,and othernon-taxrevenuesbyRp 5.7trillion.

Expenditure was also over budgetby Rp 14trillion,mainlyduetohigherthan expectedinterestrates(Rp 6trillion)and increased subsidies because of higher world energy prices (Rp 15 trillion). These overruns were partly offset by lower spending on development and otherroutineexpenditures (Rp 9trillion together).There wasa shortfallin for

-eign financing that was made up by domesticfinancing.Domestically,addi

-tionalfundsfromIBRAmorethancov

-ered the shortfall from privatisation. Foreign financing was Rp 9 trillio n lower thanexpected,mainly owing to lower than expected disbursements from foreign donor loans. Theoverall shortfallwasmadeupbyfinancingfrom banks—which presumably included

drawing on thegovernment’s account with Bank Indonesia (BI)—and/or

through arrearsor delaysofpayments to Pertamina and the state electricity company,PLN(Wallace2002).

2002Budget.TheDPRpassedthebud

-get for 2002 inNovember, well in ad

-vanceofthebeginningofthefiscalyear inJanuary.Ithasbeenwellreceivedby observers. While the DPR did tinker with thebudget,thefinalresult isstill achievable(table3).Thebudgetassump

-tionswereadjustedintheaftermathof September11toreflectagenerallymore pessimistic outlook. The growth rate wasadjusteddownfrom5%to4%;in

-flation up from 8% to 9%; and the exchange rate up from Rp 8,500 to Rp 9,000. Onthepositive side,oilpro

-ductionwasprojectedtoincreaseby7% whiletheassumptions forthe priceof oil ($22/barrel) and the interest rate (14%)remainedunchanged.

While adjusting total revenues and expenditures slightly,theDPRkeptthe deficit at thesame percentage of GDP

(implying a slightly lower absolute amountforthedeficitsincethegrowth assumptionhadbeenlowered).Itbudg

-etedforincreasedrevenuesbyproject

-ingmorenon-taxamountsfromnatural

resourcesandSOEs,andmoretaxrev

-enues,mainlyfromincometax.Thelarg

-estincreasesamongexpenditure items werefordevelopment andforregional governments(withmorefundsallocated torevenuesharing,theDAUandaspe

-cial autonomy fund). The largest de

-creaseamongexpenditureitemswasfor subsidies.Subsidiesaretofallfrom5.5% ofGDPin2001to2.5%in2002—avery

significant reduction. To finance the slightly lowerdeficit,domesticfinanc

-ingwasadjusteddownwards,especially the contribution from asset recovery, while foreign financing was increased slightly.

Howcrediblearetheunderlying2002 budgetassumptions, andwhatarethe implicationsoftheirnotbeingmet?The mostcriticalassumptionseemstobethe priceandproductionlevelofoil.Theas

-sumedpriceof$22/barrel is currently wellabovetheBrentoilpriceofaround $19/barrel; the futuredirection of oil pricesis uncertain;andIndonesia’soil pricemaywellremainbelow$22/bar

-relforalongtime.Theshortfallinrev

-enues from a lower price would be greaterthanthesavingsfromthedomes

-ticenergysubsidy(whichrisesandfalls withtheworldprice).Atanoilpriceof $19.50fortheyear,thelossinrevenue wouldbearoundRp 17trillion.Inview ofpresentstronginflationarypressures, interestratescouldalsobehigherthan the 14% assumption for much of the year. Each percentage point increase raisesthebudgetoutlaybyaboutRp 2.3 trillio n bec ause o f the substantial amountofvariableratebondsonwhich interestispaid—aroundRp 230trillion

inall.Whiletheexchangerateassump

-tion seems unrealistic, given that the

rate has settled at around Rp 10,000–

10,300/$inrecentmonths,depreciation beyond the assumed rate of Rp 9,000 wouldseemtohavelittlenegativeim

-pact,as dollar-based costs are slightly

lessthandollar-basedrevenues.

Howrealisticaretherevenuetargets? Non-oilincometaxrevenueandVATare

areasofconcern.Togethertheyareex

-pectedtoincreasefrom8.4%ofGDPin theplannedbudgetfor2001(or8.5%in theprojectedoutcome)to9.5%ofGDP intheapprovedbudgetfor2002,asub

-stantialrisethatwillinvolveraisingboth non-oilincometaxrevenueandVATby

over 25%. This will be difficult to achieve,despitethegovernment’splans tofocusonlargetaxpayers, undertake auditandarrearsreforms,andbroaden theVAT. Theexpectation of maintain

-ing revenues from SOEsat last year’s levelisalsoconsideredambitious.

Thegovernmentincreasedfuelprices byanaverageof22%on16January,only a coupleofweeks behindschedule. In addition,for all fuels except kerosene consumed by households, thegovern

-ment introduced automatic monthly priceadjustments.Thenewsystemsets thepricesofindustrialkerosene,auto

-motive diesel and industrial diesel at 75%oftherespectiveMidOilPlattsSin

-gapore (MOPS) prices plus relevant taxes.Thepriceofregulargasolinewill be setat100%ofthe MOPSpriceplus taxesanda5%‘administrativecharge’. Thisschemeshouldreducethefuelsub

-sidybutwillnoteliminateitcompletely, becausepriceshavenotbeensetat100% ofinternational prices,andbecauseno allowancehasbeen madefordistribu

-tion costs.Itis tobehoped thatitwill alsoremovefuelpricechangesfromthe political arena by making the adjust

-ments automatic. If carried through, theseactionsshouldsharplyreducesub

-sidiesfrom thoseoflastyearandkeep themwithinthisyear’sbudget.

Howbelievablearethegovernment’s financingplans?Onthedomesticfront, thereducedprivatisation targetofRp 4 trillionseemsfeasible—despitethepast

record of falling wellshort.Underthe new Minister for State Enterprises, Laksamana Sukardi, an 11.9% share

-holding inPT Telcomwas sold inDe

-cemberafteralmosttwoyearswithno privatisations of note. The target for IBRA assetrecovery for financing the budget is only Rp 19.5trillion, which seemsreasonable.Inadditiontheagency hasbeenchargedwithraisinganaddi

-tionalRp 28trilliontobeusedforretir

-ingdebt.Whilethisitemdoesnotappear in this year’s budget, success on this frontwillbeimportantforreducingthe burden ofthe interestpaymentsinfu

-ture budgets.On theforeign side, the ParisClubofofficialdonorswillprob

-ablyagreetorescheduleprincipal,and possiblyinterest,onofficialdebts.Since projectloans(whichfinancespecificac

-tivities)arecountedonboththeexpendi

-tureandfinancingside,theyarenotan issueforfinancingthedeficit—although

theyareimportant,ifnotessential,inim

-plementing many activities. Based on thepoorrecordofthelastfewyears,it maynotbeeasytomeettheconditions fordisbursementofthe$1.2billionavail

-ableunderpolicy-basedprogramsthat

providecashinsupportofpolicyadjust

-ments.

What is thelikelihood of Indonesia stayingwithintheprojectedbudgetdefi

-citandofobtainingfinancingforit?For thisyearitlooksdifficult,butachievable. Itwillrequirethatthegovernmentvig

-orously advance privatisation, asset recovery, improvements intaxadmin

-istration,andthemeetingofdonorpro

-gram requirements for disbursements. Thisisimportantnotonlyfor2002,but also for future years when growing amountsof domesticdebtmatureand international reschedulingbecomesless

likely.Policydriftrunstheriskthatthe government’s fiscal position will be

-comeunsustainable.

MonetaryIssues

Inflation.Inflationreached12.6%in2001, up from 9.4% in 2000. Taken together thesetwoyearsshowthelossofthecon

-trolachievedin1999,wheninflationwas brought downto2% after hitting77% in1998.Whilethe2002budgetassumes 9% inflation, knowledgeabledomestic andforeignobserversbelievethatitwill again exceed 10%—and the January

2002year-on-yearfigurewasashighas

14.4%.Inflationrunningatthislevelcan dorealharmtothepoorersegmentsof the community—especially those who

are dependentonslowly adjustingru

-ralandurbanwages—andcanthusfeed

social unrest. It may also encourage wage-pushinflationifincreasesinmini

-mum wages overcompensate. Hence, some tighteningof monetarypolicy is calledfortoachievelowerinflation.

Foravarietyofreasonsaquickreturn to2%inflationseemsunrealistic,butthis certainly doesnot justify settling for 10%.Thesereasonsincludetheneedto adjust energy and other administra

-tively mandatedpricesupwards tore

-duce subsidies, the expectation of continuing exchangeratedepreciation, and the build-up of expectations of

higherinflation.Thepass-throughcoef

-ficientfortheimpactondomesticprices ofchangesintheexchangeratehasbeen estimatedat0.13–0.23forthepost-crisis

period;thatis, a10%changeintheex

-changerateleadstoa1.3–2.3%change

intheconsumerpriceindex(CPI).While this relationship seemshigh,BISenior DeputyGovernorAnwarNasutionex

-plainsitby greaterimport penetration thaninyearspast;chroniclackofconfi

-denceintherupiahthatwilltaketime to overcome; extensive dollarisation; producers’abilitytopassonhighercosts

tocustomers;andIndonesia’shistoryof moderatelyhighandpersistentinflation (Nasution2002).

MoneyAggregates.The1999lawthat grantedBIits independencechargedit withthetaskofmaintaining thevalue oftherupiah.Thishasbeeninterpreted to meanprotecting the domestic pur

-chasingpoweroftherupiahratherthan maintaining asteadyexchangerate.BI hasbeenmovingtowardsinflationtar

-getingbyadjustingthemonetarybase toachievetheinflationtarget(Alamsyah et al.2001),butthereduction insubsi

-diesandtheincreasesinadministered prices,minimumwagesandsoonhave hampereditseffortsinthisarea.Gener

-ally,BI hasbeen unabletoachievethe targetsagreedtowiththeIMF,andac

-tual monetary base growth has been considerably higherthantargeted.Fig

-ure2, whichcompares theLOItargets withactualbasemoneygrowth,clearly showsthefailureof BItomeetits tar

-gets,despitethemhavingbeenrevised upwards repeatedly.The CPIhas also increasedsignificantly overtheperiod. (Allthreesetsoffiguresareindexedto November1997foreaseofcomparison.)

Interest Rates. The interest rate on 3-month Bank Indonesia Certificates

(SBIs)edgedupduring theyear from 14.7%p.a.inJanuaryto17.6%inDecem

-ber,reflecting the steadily increasing rate of inflation (figure 3);bank time depositratesfollowedsuit.Figure3also shows the real 3-month SBI rate (de

-finedhereasthenominalrateadjusted by thecontemporaneous year-on-year

CPIinflationrate).Thesteadyincreases intheSBIratethathaveoccurredsince May2000havebeenaccompaniedbya reduction in the real rate, which de

-clined from an initial level of around 10%toeventuallystabiliseatjust4–5%

during2001.Itisreal,ratherthannomi

-nal,interestratesthatindicatethetrue costofborrowingandtherealreturnto

FIGURE2 TargetedandActualBaseMoney(M0)andPricesa

(November1997=100)

a_{LOItargetsareindexedtoactualM0inNovember1997.}

Sources:IMFLOIs(various);CEICAsiaDatabase. 1 0 0

2 0 0 3 0 0 4 0 0

Nov-97 May-98 Nov-98 May-99 Nov-99 May-00 Nov-00 May-01 Nov-01

LOItargets

ActualM0

CPI

FIGURE3 InterestRatesandInflation (%pa)

Source:CEICAsiaDatabase.

-5

0 5 1 0 1 5 2 0

Dec-99 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01

3-monthSBI 3-monthtimedeposits

Inflation RealSBIrate

lending. Hence nominal rates could have been increased more in order to constrain base moneygrowthwithout having an unduly negativeimpact on theeconomy.

ExchangeRates.Themonetarycrisisof 1997 forced Indonesia to abandon its dollar exchangeratepeg,justasitdid ThailandandKorea.Figure4showsthe nominalandreal(nominaladjustedby theCPI)depreciationoftherupiahsince thebeginningofthecrisisinJuly1997. The real depreciation ofover 40% has helpedexportsoverthelastseveralyears. The accessionofMegawatitothe presi

-dencycausedasharpappreciationinthe currencyfromoverRp 11,000/$toaround Rp 8,500/$.However,theexchangerate hassubsequentlydeclined,tostabiliseat aroundRp 10,000–10,500/$,notverydif

-ferentfromthenominalrateatthebegin

-ningoftheyear.Inrealterms,allowing fordomesticinflation,thisrepresented aslightstrengthening oftherupiahfor theyear.Notetherelativestabilityofthe

realrateover mostoftheyearandthe still-substantial real depreciation re

-maining.

FinancialandCorporateSectors

Theweakconditionofthefinancialand corporatesectorscontinuestohinderfull recovery from the crisis. The govern

-ment now controls 60% of all bank branchesand77%oftotalassetsofthe commercial banksthrough acombina

-tionoftakingover,closingandrecapi

-talisingbanks.Corporatedebtsarestill largelyunrestructured,andthebanking systemhasbecomemainlyarepository forgovernmentbondsand SBIsrather thanactingasaproviderofloans.Tore

-create a functioning financial system that can support recovery and rapid growth,thebankingsystemmustreturn to productive lending, corporations needtobeplacedonasoundfinancial footing,andbothbankingandcorporate supervision mustbe strongenough to headoffareturnofpastabuses.

FIGURE4 NominalandRealDepreciation duringtheCrisis (June1997=100)

Source:CEICAsiaDatabase. 0

2 0 4 0 6 0 8 0 1 0 0

Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01

Nominal Real

Banking.Oneofthemost serious is

-suesfacing Indonesiaishowtoget its bankingsystembackupandrunning.If theeconomyistoexpand,therewillbe a needforcredittosupport continued growth. Following the government

-financedrecapitalisationofthebanks,all butafewwereabletoreachthecapital adequacyratio(CAR)of8%requiredfor 1January2002.However,atpresentthe assets of the banking system consist mainly of government recapitalisation bondsandSBIsratherthanloans,which provideessentialintermediation inthe financialsystem.Whileloanshavebeen pickingupslowly,inSeptember2001the averageloantodepositratioofallbanks wasstillaverylow 34.4%;theratiofor

the dominant government-controlled

group was 30.1%. The percentage of non-performing loans (NPLs) is also

high,at12%forstatebanks,10%forthe non-recapitalised (‘CategoryA’)private

sector and 30% for the foreign banks (table4).

Around 40% of the bonds held by banks are at fixed ratescurrently well belowSBIrates;hencethesebondstrade atalargediscount.Ifthebankswereto sell thesebondstoraisecashforlend

-ing, they would have to revalue their existingstockofbonds.Thiswouldhave seriousimplicationsfortheirCAR.Tech

-nically,sinceasecondarybondmarket does already exist, the valueof bonds heldshouldbemarkedtomarket,even

TABLE4 BankingIndicators (asatSeptember2001)

Banks Branches Assets Proportionof NPLs CAR

TotalAssets(%)

(no.) (no.) (Rp Bondsa SBIs Loans Capital (%of (%)

trillion) (gross) loans)

Governmentbanks

Statebanks 5 1,506 502 53 4 31 5 12 20

IBRAbanks

Jointlyrecapitalised 7 n.a.b 80 20 8 49 7 15 12

Takenover 4 n.a.b _{185 60 5 16 7 8 30}

Regionaldevelopment

banksc _{26 570 40 3 16 40 8 9 16}

Privatesectorbanks

CategoryAc _{70 n.a.}b _{101 0 17 40 7 10 13}

Foreignjointventures 25 n.a.b 43 0 12 69 15 30 25

Foreignbranches 10 n.a.b _{86 0 7 51 2 27 13}

Memoitemsb

Privatedomestic 3,321

Foreignbranchesand

jointventures 96

Total 147 5,493 1,037

a_{Excludesbondsheldbynon}

-recapitalised banksofRp39.9trillion.

b_{Detailedbreakdownnotavailable.}

c_{Didnotrequirerecapitalisation.}

Source: BI.

if they are not sold. (Information on pricesandyieldsinthesecondarymar

-ketisprovidedbelow.)Therehasbeen talkofexchangingtheexistingbondsfor ones paying higher rates of interest. These could be sold without reducing thevalueofbanks’assets—althoughthis

would addsignificantly totheinterest burdenonthenationalbudget.

Another key issue is bank supervi

-sion.TheIMFisworkingwithBItoim

-prove supervision, but much work remainstobedone.Confusingtheissue istherequirementinthe1999lawthata financialsupervisory body—independ

-entofBI—besetupbytheendof2002

totakeovernotonlybanksupervision, butallfinancialsupervision, including watching over the stock market, the commodity futures market, pension funds and insurancecompanies. Little work has beendone to date, and the governmentsofarlacksevenaplanon howtosetupsuchabody.

CorporateDebts.Theincompleteness ofcorporatedebtrestructuring remains a serious problem and a hindranceto therecoveryoftheeconomy.Totaldis

-tressed corporate debt (both offshore andonshore)isestimatedataround$60 billion. As ofJuly 2001,of thealmost $50 billion for which information is available, only 26%was subjectto le

-galagreementsonrestructuring.Com

-mercial termsfor restructuring (term sheets) had been negotiated and in

-cluded in memorandums of under

-standing(MOUs)foranother27%.For mostoftherestnegotiationshavebeen under way, without much progress. Unfortunately,the bankruptcysystem in Indonesia does not pose a credible threattorecalcitrant debtors.IBRAhas lostmostofthecasesithasbroughtto court,andithasnotbeenexercisingthe asset seizure powers contained in its owndecree.

TheJakartaInitiativeTaskForce(JITF) wasorganisedin1998 andbecameac

-tivein1999toassistindebtrestructur

-ing.While itdoeshave someleverage in beingable torefer non-cooperative

debtorsto the Financial Sector Policy Committee for onward referral to the AttorneyGeneral,andcanoffertaxand regulatoryincentivestopartiesconclud

-ingdebtrestructuring deals,JITFisba

-sicallyafacilitator ormediator.Todate ithas helpedbring atotalof$14.2 bil

-lionindealstotheMOUstage—$1.7bil

-lionin1999,$7.7billionin2000and$4.8 billionin2001.StartinginAugust2001, JITF began toassist in developingthe term sheets of the debtrestructuring MOUs into binding legal agreements. Around$6.0billionindebtsunderJITF hasreachedthelegalagreementstage. JITF’stargetsfor2002are foran addi

-tional$4–5billionintermsheetsandan

additional$2–3billionincompletedle

-galagreements.

A recent sample of IBRA and JITF cases, involving some $8billion, was analysed by the World Bank to deter

-mine how debts were restructured. About59% involved acombination of interestratereductions, termextensions and/orgraceperiodsonpayments,38% debttoequityconversions,andonly3% actual write-offsof principal. With so

fewwrite-offs,questionsarebeingasked

about the quality of therestructurings andtheadequacy ofthereductions in debt.Itremainstobeseenwhetherthe restructurings are achieving their goal ofreducingdebtstosustainable levels so that corporations can survive and prosper.

DebtManagement

Thegovernmentisfacingseriousprob

-lemsinmanagingitsforeignanddomes

-ticdebt.Furtherreschedulingofofficial foreigndebtswillbeneeded,asthecur

recapitalisation bondsatmarketvalue,

inexchangeoraspaymentforassets.

Based on trading in the secondary

market, it is possible to create a yield

curveandestablishcurrentmarketprices

forthevariousbonds.Theyieldsinearly

January ranged from 19.5% for bonds

maturing in six monthsto22.375%for

bonds maturing in seven years.Bond

pricesreflectedtheirinterestcouponrates

andmaturities.Forvariableratebonds,

pricesrangedfrom99.041%offacevalue

for a bondcurrentlypaying 17.61% in

-terest and maturing in six months,to

82.814%offacevalueforoneofferingthe

same interest rate but maturing in 7.5

years.Thepriceoffixed rateloansvar

-iedfrom82.836%offacevalueforaloan

paying 12% interest and maturing in

around2.75years,through75.395%for

onepaying10%andmaturinginalittle

overthreeyears,to70.27%foronepay

-ing14%interestandmaturinginalittle

oversevenyears.

Trade

AFTA. Early in January newspaper

headlinestrumpeted 2002 asmarking

the beginning of AFTA, the ASEAN

FreeTradeArea.Technicallytheimple

-mentationofAFTAstartedin January

1993whenASEANcountriesbeganre

-ducing tariffs. Atthat time a 15-year

phase-inperiodwasplannedandIndo

-nesia excluded some 20% of its tariff

lines. On several occasions since, the

ASEAN ministers have agreed to ex

-pandcoverageandquickenthepaceof

implementation, with final execution

scheduledforthis year.AtpresentIn

-donesia excludes only 1% of all tariff

lines,generallythoserelatedtoexplo

-sivesandotherdangerousitems,alco

-holic beverages and a few sensitive

itemssuchasrice.Bylastyear99%of

Indonesia’s ASEAN tariffs were be

-tween0 and5%.WhileIndonesia still

mustreducealargenumberof5%tar

-iffs to zero by the beginning of next

year,AFTAessentially hasalreadybeen

implemented. The final implementa

-tionwillbeaccompaniedbyanumber

ofsmall adjustments,but nothingtoo

startling thisyear or next, in contrast

towhatthemediahasbeenheralding.

Exports.Theglobalslowdowncaught

up withIndonesia late in 2001, when

exports plunged (Buehrer 2002). Total

exportsdecreasedbymorethan10%in

November over the previous month

and,despiteanincreaseof4.1%inDe

-cember,weredownby9.8%in2001over

2000.Non-oilexportsdecreasedinNo

-vembertothethirdlowestlevelforany

monthsincethebeginningofthecrisis

in1997,thenincreasedalittleinDecem

-ber.For the full year, non-oil exports

were down by 9.1% from 2000(figure

6).Exportsofbothelectronics andgar

-ments,whichhadpoweredIndonesia’s

strongexportgrowthin2000,contracted

in2001,by15%and5%respectively.In

-donesia’s experience throughthe first

threequarterswasinlinewiththeglo

-bal slowdown and the experience of

neighbouring countries (James2002).

However,thefurtherdeclineinexports

inthefourthquarterseemstohavegone

beyondthatexperienced bymostother

countriesintheregion.

Imports.Afterfallingsignificantly in

thefirstninemonthsoftheyear,imports

stabilised inthelast quarter(figure 6).

Overall, imports in 2001 were down

7.9%from 2000.However,thelevelfor

December2001waslittlemorethanhalf

that of December 2000. Thismonthly

level of imports was not much above

levelsrecordedattheheightofthecri

-sisinearly1998.

Privatisation andAssetRecovery

Forthisandthenextseveralyears,re

-ceipts from the privatisation of SOEs,

whetherbank or non-bank, and from

disposingoftheassetsunderIBRAcon

trol,willbethemostcrucialelementin

financing thebudget and maintaining

fiscal sustainability. Over the longer

termitwill beessentialtoachieveim

-provementsin tax revenues. This will

takesometime,however,asitwill in

-volvemakingsubstantialadministrative

improvements inone of themost cor

-ruptinstitutions inIndonesia.

PrivatisationofSOEs.Theprivatisation

programisatacrossroads. Afteressen

-tiallynosalesofSOEsin1999and2000,

the government did manage to sell a

minority 11.9% share in PT Telcom in

December2001, whilestill fallingwell

shortofits2001privatisationtarget.The

failureoftheproposedsaleofacontrol

-ling stakein GresikCementto Cemex

raisedseriousquestionsabouttherole

ofregional governments and thewill

-ingnessof thenational governmentto

sellmajoritystakesinSOEs—inparticu

-lartoforeigners. Theprivatisation pro

-grammustgoforwardthisyear,notonly

to helpovercome budgetdeficit prob

-lemsbutalsotoimprovetheefficiency

oftheeconomy.Thegovernmentneeds

toestablishconfidenceintheprogram,

reassertitscontroloverSOEsandcon

-firmitswillingness tosellmajoritypo

-sitions,includingtoforeigners.

IBRAAssetRecovery.IBRAwassetup

inJanuary1998attheheightofthecri

-sisasalimitedlifeagencywithasunset

dateofFebruary2004.Itwasintended

that it would manage the commercial

bankliabilities ofthegovernmentguar

-anteescheme;closefailedbanks,recapi

-talise surviving ones, and restructure,

mergeorsellbankstakenover;transfer,

restructure and liquidate theassets of

failedbanksandtheNPLsofrecapital

-ised banks; and sell corporate assets

transferred toitbyformerbankshare

-holdersinrepaymentofliquiditycred

-its and loans extended to affiliated

entitiesinexcessoflegallendinglimits.

Since it was established IBRA has

FIGURE6 Non-oilandGasTrade

($billion)

Source:BPS. 0

1 2 3 4 5

Dec-99 M ar-00 Jun-00 Sep-00 Dec-00 M ar-01 Jun-01 Sep-01 Dec-01 Exports

Imports Balanceoftrade

achieveditsvariouscashtargets:Rp 17

trillion for March 1999–March 2000;

Rp 18.9 trillion for March–December

2000; and Rp 27 trillion for January–

December2001.The2001cashflowwas

generatedbythesaleofassetsandcash

collectionsonloans(Rp 14.7trillion),the

saleofshares,mainlyfromtheHoldiko

Perkasaholdingcompany(Rp 11.7tril

-lion), and a number of other sources,

includingdividends,divestmentof10%

ofBankCentralAsia(BCA)andthedi

-vestmentofBankBukopin.Inaddition,

IBRAtransferred Rp 10.6trillion tothe

government in2001 by way of bond/

assetswaps,which involved returning

loans tobanks inexchange forrecapi

-talisationbonds.

ButIBRAhasdonelesswellwithits

maintaskofsellingassetsandnowfaces

tougher timesas it strugglesto doso.

Chiefamongthereasonsfortheagen

-cy’sdifficulties ispoliticalinterference.

The agencyhashadsixdifferentchair

-menandnumerousotherchangesintop

managementinjustfouryears.Inaddi

-tion, ithasbeensubjected toextensive

oversight andparliamentary question

-ingand directives. IBRAseemsunable

orunwilling toconfrontthelargestre

-calcitrant debtors and, where it has

taken action againstdebtors, has lost

mostofthecasesithasbroughttocourt.

Aswithprivatisation, thereseemstobe

areluctancetoselltoforeignbuyers,as

well asa beliefthat,by delayingasset

sales,betterpriceswillbeobtainedwhen

theeconomypicksup.Finally,questions

arebeingraisedaboutIBRA’stranspar

-ency,undermining supportforanddis

-couraginginvestors from dealingwith

theagency.

IBRAhasambitiousplanstoachieve

its 2002 cash target of Rp 48 trillion,

which includes Rp 19.5 trillion for fi

-nancing the national budget. ItsAsset

Management Credit (AMC)division,

whichistherepositoryofassetsoffailed

banksaswell astheworst NPLsofall

the recapitalised banks,is planningto

offerassetswithafacevalueofRp 126–

128trillion forsale.These willbe sold

through fourregularauctions (involv

-ingRp 55.7trillioninrestructured and

unrestructured loans);theformationof

ajointventurewithapartnerthatwill

payfortherighttomanageandsellas

-sets and share the receipts (involving

Rp 19.7trillioninassets);thesaleoftwo

collateralised debt obligations (‘asset

-backedsecuritisations’,worthRp 28tril

-lion); and the sale of two holding

companies,oneforpropertycompanies

and onefor non-property companies

(worthRp 13.4trillion).

TheAsset Management Investment

(AMI)divisionmanagesanddisposesof

theassetspledgedbyformerbankshare

-holders. Underthe Master Settlement

Acquisition Agreements, the manage

-mentofpledgedassetswastransferred

from stakeholders in various banks to

five mainholdingcompanies: PTHol

-dikoPerkasa(assetsfromtheownersof

BCA), PT Tunas Sepadan Investama

(BankBDNI),PTBentalaKartikaAbadi

(Bank Danamon), PT Kiani Wirudha

(Bank BUN) and PT Cakrawala Gita

Pratama(BankModern).Asithasdone

inthepast,AMIwillcontinuethisyear

to concentrate on sales from Holdiko

Perkasa,althoughthestockofvaluable

assetsremaining in this holding com

-panyisrunninglow.Of107Salimcom

-paniestransferred toHoldiko Perkasa,

allbut30havebeensoldataweighted

recovery rate of around 47% of book

value. The sales have gone well, al

-thoughthereareconcernsthattheSalim

grouphasbeen(orwillbe)abletoreac

-quiresomeoftheassetsindisregardof

thebasicprinciple ofnotselling assets

totheiroriginalownersbeforetheyhave

settled all theirdebts.The otherhold

-ing companies,including two smaller

onesnotnamedabove, hold117other

companies,butsofartheformerown

-ershavebeenuncooperative inapprov

-ingthesaleoftheseassets.Seriouslegal

issuesexistastotherightofIBRAtosell

assetsintheabsenceofsuchapprovals,

duetothenatureanddesignoftheun

-derlyinglegalagreements. Theagency

has proposed extending repayment

termsfortheseshareholderdebtorsfrom

fourto10years,whilealsoreducingin

-terestratessignificantly,fromabout17%

to9%.Thissuggestionhasgenerateda

stormofprotest,andhasraiseddoubts

about IBRA’s seriousness in pursuing

repayments.

ThemajortaskofIBRA’sothermain

division, the Bank Restructuring Unit

(BRU),is tosell banks now wholly or

largely in government hands. It cur

-rentlyoversees11banks.Thesecomprise

thetakenoverbanks(BCA,BankNiaga,

BankDanamon—intowhichanumber

ofotherbankshavebeenmerged—and

BankBali);thejointlyrecapitalised,pub

-licly listed banks (Bank Universal, BII

andBankLippo);andthesmall,jointly

recapitalised privatebanks(BankBuko

-pin,BankPrimex,BankPatriotandBank

ArtaMedia).Fiveofthese—BII,Univer

-sal,Primex,PatriotandArtaMedia—are

scheduledtobemergedbecauseofprob

-lemsinreachingthe8%CAR(although

itisnotclearhowmergingthemwould

solvetheproblem).

ThereareplanstosellIBRA’sshares

inBCA,BankNiaga,BankDanamon,BII

and Bank Lippo. The much-delayed

BCAtenderingprocesswasprogressing

wellasthispaperwasbeingwritten,but

awinnerhadyettobeannounced.Ifa

foreignbuyeracquiresBCAatareason

-ableprice,itwillbeamajoraccomplish

-ment.Thesellingofthebanksiscritical,

notonlytoraisecashforthebudgetbut

alsotoreturnthebankingsystemtopri

-vatehands,therebyhelpingtorevivethe

critical financialintermediation roleof

banking.

SPECIALITEMS

As this article was being written, two

much-discussed events were the up

-heaval inArgentinaandtheincreasing

priceofrice.ThedramaticeventsinAr

-gentina, involving several changes in

president and policies, have captured

the attention of Indonesia. Much has

been written,using thecase ofArgen

-tina,toharanguetheIMForraisefears

ofIndonesiasoonfollowingitintodis

-order.ThetruthofthematteristhatIn

-donesia isnotpresentlyinArgentina’s

circumstances,butcouldbecomesoover

an extended time if itdoes notfollow

sound policies. Argentina’s key prob

-lems werecausedby arigid exchange

ratepegtotheUSdollar,alackoffiscal

discipline(especially onthepartofpro

-vincial and local governments) and

structural and institutional rigidities.

TheUSdollarappreciated substantially

throughoutthe1990s,andArgentina’s

largesttradepartner,Brazil,devaluedits

currencyinthelate1990s.Thiscauseda

riseinArgentina’simportsfromBrazil,

and adecreaseinexportstoit.There

-sultingtradeimbalancewasfinancedby

borrowing abroad,creating a foreign

debtthatwasunsustainable inviewof

thetradeproblems.Indonesiadoesnot

havea fixedexchangerate policy;itis

keepingfiscaldeficitsandexternaldebt

reasonably undercontrol; and ithas a

much larger foreign trade base with

whichtoserviceitsforeigndebt.While

Indonesia couldpotentially becomeas

troubledasArgentinaifitdoesnotfol

-low sound macroeconomic and struc

-turaladjustmentpolicies,itis unlikely

todosointheshortormediumterm.

The rice priceis sparking fears ofa

repeat of thesevere inflation of 1998,

whenitwasoneofthemostvisibleand

sharply increasing prices.For the last

severalmonthsthepriceofricehasbeen

increasingsteadily.BytheendofDecem

-beritwasabout18%higherthanayear

earlier,andthiswasfollowedbyanad

-ditional 25% ormore increase inearly

January.However,thepresentsituation

isnotcomparableto1997,andthefears

aremisplaced.Backin1997–98thecoun

-trywasinthemidstofaseveredrought,

causingaslightdropinriceproduction

atthesametimeasinternational prices

wererisingdramatically.Thistimethe

causeoftheincreaseis lessclear.Indo

-nesian ricepricesarewellabove inter

-national prices, which have increased

onlymoderatelyinrecentmonths,and

privateimportersareallowedtobring

in rice. Although there is no obvious

explanation forthespirallingriceprice,

uncertaintyovertherecentlyannounced

fuelandenergypriceincreasesmaybe

a majorfactor. Now that theprice in

-creaseshavetakenplace,theexpectation

isforthericepricetostabiliseoreven

decreaseoverthenextfewweeksaspri

-vateimportsenterthemarket—asisal

-ready beginning to happen—and to

decreasefurtheronceharvestingbegins

inFebruary–March.

NOTES

* Theauthorissenioreconomistandeco -nomic growth team leader at the US Agency forInternational Development (USAID)in Indonesia. The views ex-pressedarethoseofthe authorand do notnecessarilyreflectthose ofthe US governmentingeneralorUSAIDin par-ticular.Theauthor gratefully acknowl-edgesthehelpofMohamad Rum Ali, whopreparedmostofthetablesandfig -ures;RoddMcGibbon, ChrisManning

and Roy Bahl forassistance with the boxes; and numerous othersfor their commentsandprovisionofmaterials. 1 This isa literaryreferenceto thefour

horsemen oftheApocalypse—Famine, War,PestilenceandDeath.Heretheterm is intended to focus attention on the existenceoffour very powerful,inter -twinedphenomenathathavethecapa -bilitytobringextensivebenefitormisery toIndonesians.

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