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Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Survey of recent developments
Stephen V. Marks
To cite this article: Stephen V. Marks (2004) Survey of recent developments, Bulletin of
Indonesian Economic Studies, 40:2, 151-175, DOI: 10.1080/0007491042000205268
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Date: 19 January 2016, At: 19:57
Carfax Publishing
Bulletin of Indonesian Economic Studies, Vol. 40, No. 2, 2004: 151–75
Taylor & Francis Group
SURVEY OF RECENT DEVELOPMENTS
Stephen V. Marks
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Pomona College, Claremont CA
SUMMARY
Two major factors, one internal and one external, shaped developments through
the middle of 2004. The internal factor was the national election process, which
led to a realignment of political power among the parties in the legislative elections in April, and offered the prospect of even greater changes in the presidential election to follow. The external factor was foreign capital, which readily
flowed into Indonesia in the early months of 2004, reflected in a series of record
highs in the Jakarta Stock Exchange index, but then seemed to waver in May, perhaps because of the growing threat of higher US interest rates, uncertainty about
the election, or concern about inflation. Sharp declines in the value of the rupiah
and local stocks mirrored similar though less severe developments throughout
Southeast Asia and around the globe.
The imminent first-ever election of an Indonesian president through a direct
vote by the public raised hopes of change for the better, particularly with respect
to governance and the performance of the economy. However, the structural factors that have held back economic growth in Indonesia since the crisis of 1997–98
will not change overnight. The new president could have a popular mandate, but
will have to assemble a coalition in a parliament in which power will be more
fragmented than ever.
As the presidential election approached, polls showed the electorate’s top priorities to be an improved economy and reduced corruption. However, recent
months have witnessed several steps backward, as interventions in domestic
trade and the escalation of fuel subsidies have created costly inefficiencies and
new opportunities for corruption. A recent proposal to establish a vast new social
security system monopolised by the government is also problematic in an environment in which governance remains weak. Personal income tax changes being
considered by the Ministry of Finance could significantly reduce government revenues, an outcome the government can ill afford.
Despite enactment of a host of new laws in the last six years in such areas as
anti-monopoly, bankruptcy and anti-corruption, as well as the initiation of a longterm judicial reform process, recent events have shown that the legal system
remains a major source of uncertainty in the business environment.
ISSN 0007-4918 print/ISSN 1472-7234 online/04/020151-25
DOI: 10.1080/0007491042000205268
© 2004 Indonesia Project ANU
152
Stephen V. Marks
TABLE 1 Votes and Seats Obtained by Parties in the DPR Election
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Party
Partai Golongan Karya (Golkar)
Partai Demokrasi Indonesia Perjuangan (PDIP)
Partai Kebangkitan Bangsa (PKB)
Partai Persatuan Pembangunan (PPP)
Partai Demokrat
Partai Keadilan Sejahtera (PKS)
Partai Amanat Nasional (PAN)
Partai Bulan Bintang (PBB)
Partai Bintang Reformasi (PBR)
Partai Damai Sejahtera (PDS)
Partai Karya Peduli Bangsa (PKPB)
Partai Keadilan dan Persatuan Indonesia (PKPI)
Partai Persatuan Demokrasi Kebangsaan (PDK)
Partai Nasional Banteng Kemerdekaan (PNBK)
Partai Nasional Indonesia (PNI) Marhaenisme
Partai Pelopor
Partai Penegak Demokrasi Indonesia (PPDI)
Seven others
Totals
Votes
No.
%
DPR Seats
No.
%
24,480,757
21,026,629
11,989,564
9,248,764
8,455,225
8,325,020
7,303,324
2,970,487
2,764,998
2,414,254
2,399,290
1,424,240
1,313,654
1,230,455
923,159
878,932
855,811
5,457,851
21.6
18.5
10.6
8.2
7.5
7.3
6.4
2.6
2.4
2.1
2.1
1.3
1.2
1.1
0.8
0.8
0.8
4.8
128
109
52
58
57
45
52
11
13
12
2
1
5
1
1
2
1
0
23.3
19.8
9.5
10.5
10.4
8.2
9.5
2.0
2.4
2.2
0.4
0.2
0.9
0.2
0.2
0.4
0.2
0.0
113,462,414
100.0
550
100.0
Source: General Election Commission, www.kpu.go.id/suara/dprkursi.php.
POLITICAL DEVELOPMENTS
The outcome of the general election of 5 April reflected widespread discontent
with the leadership of President Megawati Soekarnoputri and her Indonesian
Democratic Party of Struggle (PDIP). The party’s share of the national vote fell
from 33.7% in 1999 to just 18.5%. The share of the Golkar party, which finished
second overall in 1999, fell by less, from 22.4% to 21.6%, and so it was the overall
winner. Five other parties each had at least 6% of the vote, with the remainder
split among a host of others. Two new parties drew considerable support: Partai
Demokrat (Democrat Party), the vehicle for the presidential candidacy of Susilo
Bambang Yudhoyono, and the Islam-based Partai Keadilan Sejahtera (Prosperous
Justice Party). Table 1 shows the votes cast for the various parties in the elections
for the national legislature (DPR), and the DPR seats these parties will have.1
The Presidential Election
The first direct presidential election in Indonesia’s history was to be held on
5 July. As the election approached, five pairs of presidential and vice-presidential
contenders emerged, only three with a realistic prospect of victory. Table 2 shows
the pairs of candidates—in most cases very odd couples—along with their major
institutional affiliations and levels of opinion poll support as of early May. The
Survey of Recent Developments
153
TABLE 2 Presidential and Vice-Presidential Candidates,
Their Affiliations and Opinion Poll Support
Candidates
Primary
Organisational
Affiliations
National Poll,
1–8 May 2004
(%) a
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Susilo Bambang Yudhoyono Democrat Party; retired military officer;
former cabinet minister
M. Jusuf Kalla
Golkar Party; former cabinet minister
Megawati Soekarnoputri
Hasyim Muzadi
Wiranto
Salahuddin Wahid
Amien Rais
Siswono Yudo Husodo
Hamzah Haz
Agum Gumelar
Indonesian Democratic Party of Struggle
(PDIP); incumbent president
General Chair, Nahdlatul Ulama
Golkar Party; retired armed forces chief
under Presidents Soeharto and Habibie
Chair, Nahdlatul Ulama; National Human
Rights Commission
National Mandate Party (PAN); Chair,
People’s Consultative Assembly (MPR)
General Chair, Indonesian Association of
Farm Groups (HKTI)
United Development Party (PPP); incumbent
vice president
Retired military officer; former cabinet minister
41.0
11.2
10.0
4.4
3.0
a Respondents
were asked which of 10 possible candidates would make the best president
for Indonesia; 4.2% indicated a preference for Abdurrahman Wahid, who was disqualified
for health reasons from running for president, and 11.3% for other candidates. The remainder (14.0%) did not know or did not respond.
Source: International Foundation for Electoral Systems (IFES) poll released 31 May 2004,
based on face-to-face interviews with 1,000 eligible voters around the country.
polls suggested that in all likelihood there would be a run-off election between
the top two pairs of candidates,2 unless Susilo Bambang Yudhoyono and M. Jusuf
Kalla could muster an outright victory in the initial round despite the weakness
of the nascent party apparatus behind the former. If necessary, the run-off would
be held on 20 September, with the inauguration of the new leadership to occur in
any case on 20 October.
As the presidential campaign got under way, there were few discernible differences in the economic policy stances of the candidates. Megawati as incumbent
had the clearest track record, which seemed to be her primary disadvantage.
However, she also had certain advantages of incumbency. Just before the start of
the presidential campaign, for example, it was announced that the government
would provide an extra month’s salary to civil servants, the military and the
police, and an extra month of pension benefits to retirees (JP, 27/5/04).
154
Stephen V. Marks
TABLE 3 Recent Macroeconomic Data and Government Projections, May 2004
Realised Values
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Major economic indicators
Rate of inflation, CPI (% p.a.)
Exchange rate (Rp/$)
Real economic growth (% p.a.)
Gross domestic product
Expenditure side
Private consumption
Government consumption
Investment
Exports
Imports
Production side
Agriculture
Manufacturing
Non-oil & gas
Other
Government finance
Deficit (% of GDP)
Tax revenues (% of GDP) a
Debt (end of year, % of GDP)
Total
Foreign
Domestic
a Includes
bData
Projections
2001
2002
2003
2004
2005
2006
12.5
10,241
10.0
9,375
5.1
8,578
5.5
8,500
5.5
8,500
5.0
8,600
3.4
3.7
4.1
4.8
5.2
5.6
4.4
9.0
7.7
1.9
8.1
4.7
12.8
–0.2
–1.2
–8.3
4.0
9.8
1.4
4.0
2.0
5.2
1.3
3.0
5.5
4.6
4.4
0.4
5.3
7.1
8.2
4.0
8.0
9.3
8.8
9.7
1.0
4.1
5.0
3.8
1.7
4.0
4.2
4.0
2.5
3.5
3.8
4.8
2.3
4.9
5.2
5.5
2.4
6.4
6.9
5.4
2.6
7.1
7.5
5.7
2.8
12.8
1.7
13.1
2.0
13.8
1.1
13.5
87.7
42.6
45.1
77.6
38.0
39.6
66.4
31.4
35.0
60.7
27.3
33.4
0.7–0.9
0.3–0.5
13.5–13.6 13.6–13.7
54.4b
24.3
30.4
49.3
22.0
27.2
oil and gas revenues.
as shown in source.
Source: Rancangan Rencana Kerja Pemerintah (RKP) Tahun 2005 [Draft Government Working
Plan for 2005], presented at the Parliamentary Budget Committee Working Meeting, 4 May
2004.
MACROECONOMIC PERFORMANCE
Despite concern about the slow recovery of investment, and real GDP growth
well below the rates recorded before the economic crisis, the economy appeared
stable in macroeconomic terms through the first months of 2004. Table 3 shows
realisations of some main economic indicators for Indonesia over 2001–03, and
projections made by the government in early May. The government stuck by its
earlier real growth forecast of 4.8% for 2004, and predicted 5.2% real growth in
2005. However, within days of the release of these forecasts, serious signs of insta-
Survey of Recent Developments
155
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TABLE 4 Components of GDP Growth
(2000 prices;a % p.a. year on year)
GDP
By expenditure
Private consumption
Government consumption
Investment
Exports
Imports
By industry sector
Agriculture, livestock, forestry
& fisheries
Mining & quarrying
Manufacturing
Electricity, gas & water supply
Construction
Trade, hotels & restaurants
Transport & communication
Financial, rental & business
services
Services
Non-oil & gas GDP
a Expenditure
Dec-02
Mar-03
Jun-03
Sep-03
Dec-03
Mar-04
4.9
5.5
4.8
3.7
4.1
4.5
3.5
17.9
6.9
4.5
10.6
3.2
6.1
3.7
5.8
5.1
4.3
10.6
1.3
6.3
–0.2
4.4
9.7
2.3
0.6
1.6
4.2
12.4
–1.8
3.3
1.5
5.7
12.8
4.2
0.8
6.5
3.6
1.9
4.6
8.0
6.4
6.5
8.8
4.3
–1.0
6.2
6.3
5.4
7.6
12.4
1.9
1.4
5.3
5.9
6.1
6.5
8.5
1.6
–3.7
4.6
7.5
7.0
3.5
11.7
5.0
–2.9
4.0
3.8
6.8
3.8
13.6
1.5
–2.7
5.5
2.2
7.3
6.1
13.8
7.4
2.9
8.1
3.9
7.8
3.9
7.1
4.1
4.7
4.4
4.9
4.4
5.9
7.0
5.6
4.2
4.8
5.0
data calculated by splicing 2000 price data onto 1993 price data.
Source: CEIC Asia Database.
bility appeared in the form of sharp declines in the value of the rupiah and local
stock prices. Both projections may thus turn out to be rather optimistic.
Economic Growth
Table 4 shows that real economic growth accelerated slightly to 4.5% year on year
in the first quarter of 2004. Private consumption continued to grow robustly,
though it may slow as the depreciation of the rupiah causes prices of tradable
goods to rise. Government consumption had the highest growth rate of any
expenditure category, at 12.8% year on year. Investment grew at a moderate rate,
though it remains at only about two-thirds of its pre-crisis share of GDP. Exports
were nearly flat, while imports surged. On the production side, transport and
communication services continued to grow robustly, along with construction and
trade, hotels and restaurants. Growth of the manufacturing sector accelerated.
Output in the mining sectors, including oil and gas, contracted, while agricultural
output was almost flat year on year.
156
Stephen V. Marks
FIGURE 1 Inflation, the Exchange Rate and Base Money Growth
% p.a.
30
25
Rp/$
10,000
8,000
Base money growth (lhs)
20
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15
CPI inflation (lhs)
6,000
Exchange rate (rhs)
4,000
10
5
0
Dec-2002
2,000
Mar-2003
Jun-2003
Sep-2003
Dec-2003
Mar-2004
0
Source: CEIC Asia Database.
Inflation and the Exchange Rate
Consumer price index (CPI) inflation reached a low of 4.6% year on year in
February 2004, but then rebounded in March, April and May (figure 1). The
increase in inflation was initially only minimally related to the exchange rate: the
rupiah depreciated against the dollar by 1.7% in March, and by only 0.9% in
April. However, in May it depreciated by 6.3%, and year-on-year inflation accelerated to 6.5%. For the purpose of comparison, table 5 shows changes in the value
of various currencies in terms of the dollar over the first five months of 2004.
Indonesia experienced by far the greatest depreciation among all the Asian countries listed, with only Brazil coming close to it among the other countries.
To put this depreciation in context, particularly given recent shifts in the relative values of currencies of other nations, figure 2 shows two alternative measures of the real exchange rate. One of these is the real effective exchange rate
(REER), which compares wholesale prices in Indonesia with those in other countries, expressed in common currency units, and thus provides an indication of the
competitiveness of tradable goods produced in Indonesia.3 The massive nominal
depreciation of the rupiah in 1997–98 made Indonesia’s tradable goods highly
competitive, but since then the nominal appreciation of the rupiah has exceeded
the difference between inflation in Indonesia and in other countries. By the end
of 2003, despite the negative long-term consequences of the 1997–98 crisis for the
country, this index was within 4.5% of its value in 1995. The alternative measure
of the real value of the rupiah shown in figure 2 is the real exchange rate (RER).
It is the ratio of non-tradable to tradable goods prices within Indonesia, and thus
shows the prices faced by domestic producers and consumers. On this basis, the
real depreciation of the rupiah during the crisis was much less severe, and the
Survey of Recent Developments
157
TABLE 5 Change in Value of Various Currencies against the Dollar, Jan–May 2004
(%)
Asia
Non-Asia
Korea
+2.7
+2.6
+0.9
+0.1
+0.0
+0.0
–0.4
–0.4
–0.8
–1.1
–1.5
–2.2
–2.3
–3.2
–3.7
–5.1
–5.2
–8.6
–8.9
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United Kingdom
Russia
India
Singapore
Malaysia
Hong Kong
Philippines
Pakistan
Argentina
Mexico
Japan
Thailand
Euro Area
New Zealand
Australia
Canada
Brazil
Indonesia
Source: Pacific Exchange Rate Service, University of British Columbia, fx.sauder.ubc.ca.
FIGURE 2 Real Exchange Rate: Alternative Measures a
(1995 = 100)
120
100
80
60
40
REER
20
0
Jun-1995
a See
Jun-1997
Jun-1999
RER
Jun-2001
Jun-2003
text for an explanation of both measures.
Sources: REER: International Monetary Fund (IMF), International Financial Statistics, calculations by the author; RER: Bank Indonesia (unpublished).
158
Stephen V. Marks
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BOX 1 40 MILLION UNEMPLOYED?
It has become the ‘conventional wisdom’ that Indonesia faces a major
problem of labour absorption, with some 40 million people registered as
unemployed. This figure is cited frequently by presidential candidates and
social commentators alike, yet it has no scientific basis, and bears little
relationship to labour market realities. Worse, focusing on unemployment
as Indonesia’s major labour issue distorts the relevant policy choices.
Unemployment is defined precisely in international and Indonesian
national surveys as the number of people both not working and seeking
work during a specified reference period. According to the latest (2003)
National Labour Force Survey data, the unemployment rate amounts to
9.5% of the total labour force, or some 9.5 million persons out of a workforce of 100 million—a far cry from the often quoted 40 million.
As found in previous annual surveys, the urban, young and educated
comprise a much higher proportion of the unemployed than might have
been expected on the basis of their shares in the total workforce. Many
studies have shown that a significant proportion of these individuals are
unemployed by choice—in the sense that they are, in effect, queuing for
better modern sector jobs after completion of school and university rather
than taking on readily available but less attractive jobs. In short, not only
is the true level of unemployment less than one-quarter of the popularly
quoted figure, but also a large part of the true total represents voluntary
unemployment. Programs often suggested for dealing with the unemployment problem, such as job creation activities in villages or assistance to
small-scale enterprises, are unlikely to affect the behaviour of urban youth
looking for better jobs in the cities. It is precisely jobs of this kind that they
are seeking to avoid.
The figure of 40 million is in fact an approximation to the sum of the 9.5
million actually unemployed and about 28 million people reported as
currency has subsequently recovered nearly all its lost ground, so that the incentives given by these prices are not much different from those prior to the crisis.
Minimum wage growth has moderated, after several years of dramatic
increases in many parts of the country (Alisjahbana and Manning 2002). For
example, the increase in Jakarta was just 6.8% for 2003 and 6.3% for 2004—in both
cases close to or below the rate of inflation. However, a measure now under discussion would change the basis for calculation of minimum wages. The present
standard is a market basket of 43 commodities said to constitute ‘minimum life
needs’ (kebutuhan hidup minimum). The new standard would be an expanded market basket that would constitute ‘suitable life needs’ (kebutuhan hidup layak). There
is some concern that this more ambitious basis could cause minimum wages to
jump in the future, putting further pressure on employment in the modern sector
(box 1). In any case, for the present, moderate depreciation of the rupiah may be
Survey of Recent Developments
159
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BOX 1 (continued) 40 MILLION UNEMPLOYED?
working less than 35 hours a week (this total was actually 38 million in 2003).
The latter group is often referred to as the ‘under-employed’, but this is also
misleading because the category includes a high proportion of people, many
of them married females and children, who work less than 35 hours a week
by choice (estimated at 16 million in the 2003 survey). They are not underemployed in the conventional sense of working less than the arbitrary standard of 35 hours and seeking more work, but are voluntarily underemployed in the sense of choosing to work ‘part time’—that is, less than this
standard.
Neither the unemployment nor the under-employment figure captures
the essence of the main labour market problem—low productivity resulting
in low wages—which affects a much higher proportion of the workforce.
The big policy issue is not creation of jobs per se: the informal sector offers a
ready outlet for work if individuals and families are desperate and, indeed,
those most in need cannot afford to be out of work. Rather, it can be argued
that the key problem is creation of ‘better’ jobs through policies that induce
more investment and greater efficiency in the use of labour and other factors
of production, thus raising productivity and wages, with flow-on effects for
improved living standards and reduced poverty. To portray the key issue as
finding jobs for a fictitious ‘40 million unemployed’ is to divert attention
from this much more important agenda. Recent attempts to regulate the
labour market for the benefit of workers, including implementation of an
aggressive minimum wages policy that is likely to deprive many workers of
the opportunity to graduate from informal sector activities into more productive formal sector employment (Manning 2004), would not seem to have
helped in this regard.
Chris Manning
ANU
beneficial from the viewpoint of expanding job opportunities (by virtue of reducing wage costs expressed in foreign currencies), given the substantial real wage
increases of recent years and given that productivity growth has been slow in
Indonesia compared with competitor countries, China in particular.
Capital Flows and Stock Prices
With the expiry of the concessional agreement between Indonesia and the Paris
Club of creditor countries in December 2003, the government is now obliged to
rely more on commercial creditors. On 3 March, a government issue of $1 billion
worth of 10-year dollar-denominated debt with an effective yield of 6.85% p.a. (a
spread of 277 basis points over yields on 10-year US Treasury bonds) was warmly
received by foreign creditors. On the other hand, the Ministry of Finance reports
that foreign investors sold off 22.5%, or about Rp 1.9 trillion (roughly $200 mil-
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160
Stephen V. Marks
lion), of their holdings of rupiah-denominated government debt at the end of
March, thus providing a clear indication of concern about the risk of renewed
rupiah depreciation. Indeed, the rupiah lost 11.2% of its value against the dollar
between 27 April and 2 June.
The rupiah value of the Jakarta Stock Exchange (JSE) composite index hit
record highs during January, February and April 2004, though its foreign currency value remained well below the peak levels attained before the 1997–98 crisis. However, after reaching a record high of 818 on 27 April, the index retreated
sharply over the next several weeks. By the end of May it was down 10.5% from
its record level the previous month, compared with a decline of 9.8% in stock
prices in emerging markets overall during the same period.
In the midst of this turbulence, Bank Indonesia (BI) governor Burhanuddin
Abdullah wrote to four unnamed foreign banks warning them to refrain from
speculating against the rupiah (JP, 14/5/04). While central bankers sometimes
use moral suasion against speculators at such times, some observers argued that
the warning would be counterproductive because it implied that BI saw itself as
powerless to influence the strength of the currency through its own policies.
Speculation is usually viewed negatively in Indonesia, and in many other
countries. However, it is useful to revisit the ancient truth that profitable speculation stabilises prices, since it is the profitable speculator who buys when prices
are low and sells when they are high. Thus, speculators who do profit help to stabilise the market, while speculators who do not help to stabilise the market are
punished by the market itself. This may be cold comfort to policy makers, since
herd behaviour can emerge in which the individually but not collectively
rational decisions of market participants can greatly increase the volatility of
asset prices. In that case it is important for the central bank to adjust fundamental monetary conditions sensibly to help calm these markets. A contraction of liquidity and a consequential increase in interest rates could help stem capital
flight, for example.
The net value of foreign purchases of shares at the JSE has been positive during every calendar year since 1995, though without question foreign activity has
at times exacerbated market volatility. Figure 3 shows the JSE index on a monthly
basis since 2000, as well as net purchases by foreigners. For almost all months
during this period, net buying by foreigners has been positive. Foreign investors
missed the start of the rally in the JSE in early 2003, but were soon on board and
appear to have contributed significantly to it. However, the net foreign purchase
value for May 2004 showed a sharp swing to net sales by foreigners, which coincided with the sudden weakening of the rupiah. Clearly it was not just a handful
of banks that were concerned about the currency, and it will take more than moral
suasion by BI to stabilise it. Of paramount importance is whether the central
bank’s commitment to sound monetary policy is credible.
Global Financial Instability to Return?
Observers as diverse as Kenneth Rogoff, former chief economist of the IMF, and
Joseph Stiglitz, one of the IMF’s most prominent critics in recent years, have
worried that a financial bubble may have emerged in developing countries, propelled by loose monetary policy in the US (Wall Street Journal, 23/1/04). Rogoff
suggests that an international financial crisis could recur within two to three
Survey of Recent Developments
161
FIGURE 3 Net Purchases by Foreigners, and the Jakarta Stock Exchange Index
(Rp trillion)
5
4
3
Net purchases (lhs)
1,000
800
JSE composite
price index (rhs)
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600
2
400
1
0
-1
Dec-2000
Dec-2001
Dec-2002
200
Dec-2003
0
Sources: Datastream; Jakarta Stock Exchange; Bapepam.
years (Financial Times, 1/4/04). Such a crisis would presumably be triggered by
the inevitable tightening of credit in the US as its economy rebounds in a context of persistent fiscal deficits, given the relatively high levels of public debt to
GDP in emerging market economies. With total public debt at 66.6% of GDP at
the end of 2003, Indonesia was close to the global average, which the IMF puts
at about 70%.
One indicator of a possible bubble has been the narrowing of spreads between
interest rates on public debt in emerging markets and those on US Treasury securities. The concern is that these spreads will increase significantly as credit tightens in global capital markets. An increase in interest rate spreads is already evident for Indonesia: for the March issue of international bonds mentioned earlier,
the spread rose from the initial 277 basis points to more than 400 basis points by
early May. The prospect of higher interest rates on domestic debt has become
more immediate as well: an auction of Rp 3.5 trillion ($379 million) of government debt was cancelled in late May because potential buyers demanded higher
yields than the Ministry of Finance wished to pay (Bisnis Indonesia, 26/5/04).
It is difficult to say how well prepared Indonesia is to weather a new financial
crisis, particularly when so much depends on intangible factors like the quality
of political leadership, but one simple macroeconomic indicator appears to offer
comfort. Figure 4 shows that foreign exchange reserves net of IMF credits have
trended upward since early 1998, and particularly since the middle of 2002. From
late April through late May, however, BI sold nearly a billion dollars worth of foreign exchange (mostly not shown in figure 4) to support the rupiah. To put these
reserve levels in some context, BI reported that public offshore debt stood at $82
billion and private offshore debt at $52 billion in March. Total foreign debt
162
Stephen V. Marks
FIGURE 4 International Reserves and Use of IMF Credit a
($ billion)
40
Reserves
35
30
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25
20
15
10
5
Reserves net of IMF credit
IMF credit
0
Dec-1995
aReserves
Dec-1997
Dec-1999
Dec-2001
Dec-2003
include both foreign exchange and Special Drawing Rights (SDRs).
Source: IMF, International Financial Statistics.
service rose 39% in March to $1.96 billion during that month (JP, 8/6/04). Other
factors relevant to the resilience of the economy will be discussed later, in the
context of fiscal policy and bank regulation.
MONEY AND BANKING
The accelerating rate of monetary expansion noted by Kenward (2004) may have
set up the rupiah for its recent weakness (figure 1). Over the long run, a rate of
money growth equal to the sum of inflation and real economic growth is to be
expected; on this basis, the growth rate of money consistent with the government’s growth and inflation projections (table 3) is around 10% p.a. Toward the
end of 2003, monetary expansion was excessive by this standard. The growth rate
of base money peaked at 25.2% year on year in November 2003, though it had
eased to 17.1% by April 2004 (figure 1).4 One of the reasons for the expansion of
base money towards the end of 2003 was the mutual fund crisis described by
Kenward (2004), in response to which BI injected extra liquidity into the economy.
Nevertheless, base money growth has clearly trended upward since the second
half of 2002, despite moderate real growth and, until the last few months, declining inflation.
Interest Rates
The evidence of excessive monetary expansion in recent months is mirrored by
evidence on interest rates. Figure 5 compares the nominal rate of interest on
three-month BI Certificates (SBIs) with that on three-month US Treasury bills.
Survey of Recent Developments
163
FIGURE 5 Indicator Interest Rates: Three-Month SBIs and US Treasury Bills
(% p.a.)
20
SBIs
16
Treasury bills
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12
8
4
0
Dec-2000
Dec-2001
Dec-2002
Dec-2003
Sources: Bank Indonesia; US Council of Economic Advisors, Economic Indicators, www.
gpoaccess.gov/indicators/index.html.
With investors able to move their funds internationally, interest rates in Indonesia
will have to exceed foreign interest rates by enough to compensate investors for
perceived risks plus the expected rate of depreciation of the rupiah. The dramatic
narrowing of the spread between US Treasury bills and SBIs to roughly 6% in
recent months would have made financial investment in Indonesia less attractive,
leading eventually to a sell-off of rupiah assets. The actual rupiah depreciation
that has occurred may have reduced the expected future depreciation of the currency, thus inducing investors to hold rupiah assets once more, although this
view must be qualified with reference to investor expectations about the future
conduct of monetary policy.
Under the 1999 law on BI, the mission of the central bank is to maintain a stable value of the rupiah. Why, then, has BI been so obsessed with lower interest
rates? One reason is that it wishes to avoid issuing more SBIs through open market operations as a means of removing excess liquidity, since this would increase
its own interest expenses. Another is that higher interest rates would increase the
interest burden on the government. The policy independence of the central bank
in the midst of the presidential election is also rather suspect, since lower interest
rates tend to benefit incumbent politicians.
A final motivation is to coax additional lending to the corporate sector from the
banking system. Although investment lending from banks increased 16% year on
year in April, this was from a low base as a result of large-scale loan write-offs following the banking collapse of 1998–99, making this number difficult to interpret.
In real terms the April amount outstanding was only 45% of that in April 1997.
However, the real sector has benefited considerably since the crisis from being
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164
Stephen V. Marks
able to repurchase much of its original bank borrowings at a fraction of their original value (either from the banks themselves or from the government via the
banks and non-performing loans that the government took over). Moreover, it is
debatable whether the low real level of lending is a cause or an effect of the sluggish recovery of investment. In any case, many companies have turned to the
bond market as an alternative to bank loans. The value of corporate bonds outstanding more than doubled between 2001 and 2003, and at the end of 2003
equalled 67.3% of investment loans from banks.
By the end of May, BI publicly recognised that excess liquidity in the financial
system had to some extent fuelled the speculation against the rupiah. Senior
deputy governor Anwar Nasution blamed the excess of liquidity on the slow
recovery of bank lending to the corporate sector (JP, 29/5/04), though clearly BI
had itself generated this excess liquidity through expansion of base money in its
pursuit of lower interest rates.
In early June, as the rupiah depreciated to Rp 9,590/$, BI announced that
measures would be taken to absorb some liquidity, and that SBI interest rates
would not be allowed to go lower. The principal measure was to be an increase
in the minimum reserve ratio (that is, the ratio of each bank’s deposits at BI to its
customers’ deposits), from 5% to 6, 7 or 8%, depending on the size of the bank’s
total deposits. This policy, to be implemented in July, would increase the demand
for base money relative to supply, and thus have the same impact as the sale of
SBIs. For BI, however, it had the advantage of being cheaper, as the central bank
intended to pay a much lower interest rate (3% p.a.) on compulsorily increased
reserves than it would have to pay on voluntarily purchased SBIs. For market
interest rates, however, the impact would be much the same, since there would
be a corresponding decrease in the supply of base money relative to the demand
for it.
The Banking System
Regulatory and institutional weaknesses in the banking system persist. On the
heels of the scandals at the state-owned Bank Negara Indonesia and Bank Rakyat
Indonesia in late 2003 (Kenward 2004), BI closed two small banks, PT Bank
Dagang Bali and PT Bank Asiatic, on 8 April. These closures did not pose a threat
to the stability of the banking sector, given the small size of the banks (JP,
13/4/04). Nevertheless, with its blanket guarantee of bank liabilities, the government could be liable for up to Rp 3.4 trillion in combined liabilities of the two
banks, with Rp 2.2 trillion in combined deposits. The episode was a reminder that
future potential liabilities for the central government lurk beneath the surface of
the banking system.5
The practices that led to the closure of the two banks can best be described as
fraud. The banks were both captive to family business groups. Each appears to
have been plundered by its owners (who were related to each other by marriage)
through the extension of loans to related entities that were covered up by falsified accounts. BI has been criticised for its handling of this episode, since it had
known about serious problems at the banks since mid 2001 (Kompas, 25/4/04).
For their part, BI officials argue that initially it was hoped that the situation
could be turned around through close supervision and technical assistance. The
suspect legal system once more played a central role: no owners of troubled
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Survey of Recent Developments
165
banks, even those who engaged in fraud, have been sent to prison following the
banking collapse of 1998–99; a few have been convicted, but have fled the country to avoid prison terms. When the consequences of illegal behaviour are few
and the potential gains great, it should come as no surprise that such behaviour
persists.
Finally, there is continuing concern both inside and outside BI about the poor
management of the state banks. The fundamental problem is the absence of a
residual claimant—an owner with a controlling interest in the banks—who will
have a strong incentive to enforce strict internal controls and clean up lending
practices. As one government official put it to me, nobody gets fired in state
banks. The sale of minority stakes will not solve the problem.
FISCAL ISSUES
The fiscal situation has improved, as reflected in simple measures such as the
debt to GDP ratio and in more sophisticated measures of fiscal sustainability
(Marks 2004, in this issue). However, concern about the government’s potential
burdens under the blanket guarantee of bank liabilities, or even under more limited deposit insurance, has been heightened by the closures of Bank Dagang Bali
and Bank Asiatic. In addition, new concerns about increased expenditure and
possibly reduced tax revenues have emerged, in each case partly related to the
presidential election.
Increased Burden of Fuel Subsidies
The public sector as a whole gains on net (through tax and non-tax revenues)
from higher oil prices, but the central government itself loses from the fuel subsidy as well as from the sharing of natural resource revenues with the regions.6
The subsidy was originally budgeted at Rp 11.4 trillion in 2003 (0.6% of GDP), but
eventually cost Rp 26.0 trillion (1.5% of GDP), primarily as a result of higher
petroleum prices. The cost of the subsidy for 2004 was originally put at Rp 14.5
trillion, based on a crude oil price of $22 per barrel and an exchange rate of
Rp 8,300. But by May, with average crude oil prices at $35 or higher and the
rupiah weaker, the national oil and gas company Pertamina estimated that the
cost of the subsidy could rise to Rp 40 trillion in 2004 (JP, 27/5/04)—more than
10% of the state budget and at least 2.0% of the revised GDP estimate.
The high cost of the subsidy was exacerbated by the election-year decision to
hold fuel prices constant throughout 2004. Previously, fuel prices had been linked
to a Singapore benchmark gasoline price. To get a sense of the magnitude of the
subsidy per unit, at the start of 2004 the spot wholesale gasoline price in Singapore
was 26.6% higher than the retail gasoline price in Indonesia. Gasoline prices in
Singapore then rose by 14.4% in dollar terms, and by 22.4% in rupiah terms, by
mid May.7,8 The costs of the subsidy increase with higher oil prices and a weaker
rupiah not only because of a higher subsidy per unit of fuel consumed, but also
because measured consumption tends to rise owing to increased illegal diversion
of fuel products to other countries.
In March and April, Indonesia became a net importer of crude oil for the first
time (Asian Wall Street Journal, 18/5/04). With crude oil prices at 13-year highs,
this development was especially painful. It was related not only to the fuel sub-
166
Stephen V. Marks
TABLE 6 Proposed Changes in Personal Income Tax Exemptions, 2004
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Personal income tax exemptions (Rp)
Taxpayer
Working spouse
Non-working spouse
Other dependants
Maximum number of other dependants
Current Income Tax Law
Proposed Level
2,880,000
2,880,000
1,440,000
1,440,000
12,000,000
12,000,000
1,200,000
1,200,000
3
2
sidies, which kept demand high, but also to moribund production due to low
investment in oil exploration and oilfield development.9
Further, the differential between the official price of kerosene for households
(Rp 700 per litre) and industry (Rp 1,800) causes shortages for households, since
kerosene intended for domestic use gets diverted illegally to industry. In early
May, the Minister of Energy and Mineral Resources vowed that Pertamina would
revoke the licence of any retailer caught engaged in such diversions (JP, 6/5/04).
Discussions earlier in the year about adding colour to kerosene intended for
households broke down over the question of who would bear the cost. The best
approach would be simply to sell kerosene at a single price to all buyers, since
households are paying almost as much as industrial users anyway, and have
faced shortages (JP, 19/4/04). In the process, corruption would be reduced.
Tax Policy
Fiscal policy makers emphasise the importance of expanding tax revenue. In
practical terms, this would provide some protection against additional government liabilities from bank failures, compensate for diminished net natural
resource revenues and the burdens of fiscal decentralisation and bureaucratic
reform, and allow for additional economic development expenditure. Yet the
government’s own projections indicate that tax revenues will remain flat as a percentage of GDP over the next several years (table 3). It is thus of concern that
changes in personal income taxation that would significantly reduce revenues
have been under consideration within the government. In May the Ministry of
Finance projected revenues from these personal income taxes to be Rp 47.9 trillion in 2004, which would be 13.5% of total central government revenues or 2.4%
of GDP.10
Under the new proposal, personal tax exemptions (penghasilan tidak kena pajak,
or PTKP) would be increased this year, and the top marginal income tax rate
would be lowered from 35% to 30% within five years.11 The current and proposed
exemptions are shown in table 6. The Ministry of Finance (2004) has estimated
that enlargement of the exemptions would lower revenues by Rp 5.6 trillion, or
about 0.3% of projected 2004 GDP, but did not estimate the revenue impact of the
cut in the top rate.
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Survey of Recent Developments
167
An argument could be made for reduction of the top rate on the grounds that
it would lessen incentives for tax avoidance and evasion, and would provide
incentives for additional work effort and saving. There may also be merit in
adjustment of the tax system in a way that would excuse more lower-income
households from paying taxes, on the grounds of both equity and administrative
efficiency. In fact, a 2003 decree of the Minister of Finance does just that: the government now bears the income taxes on the first Rp 1 million of monthly labour
income for workers whose monthly wage is Rp 2 million or less.12 The ministry
estimated the budgetary cost of this measure at Rp 2.2 trillion in 2003.
The problem with the large proposed increase in exemptions is that not only
are many lower-income taxpayers relieved of personal income tax obligations,
but also the taxes of all higher-income earners are cut, since the entire tax schedule is lowered. My own rough estimate of the net budgetary cost of the increased
exemptions is Rp 16.0 trillion or 0.8% of GDP. This estimate comes from a detailed
analysis of the personal income tax system based on data from the 2002 National
Socio-Economic Survey (Susenas). The methodology for an earlier version of this
analysis is described in detail in Marks (2003). The basic approach is to calculate
income tax payments, household by household, based on application of the
income tax code, and then use Susenas household weights to estimate tax payments on a national level.
One concern with this approach is that there is no way to identify the income
on which taxes are actually paid. I assume that it is not feasible to tax farm
income, but that other business and rental income is taxed. I also assume that
only the wages of regular workers are taxed (the self-employed and those without a fixed employment relationship are excluded), and I exclude occupations for
which income is hard to tax (such as street vendors, household servants, public
transportation drivers, and workers in agriculture, forestry and fisheries). Given
these and other assumptions necessitated by data limitations and imperfections,
the estimated level of income tax revenues predicted from this analysis is not very
reliable; I estimate it at Rp 25.1 trillion based on application of the current income
tax law and at Rp 16.0 trillion if the proposed measures are implemented.13
However, the difference in the level of personal income tax revenues generated by
these two policies is more reliable, since the errors that affect both of these levels
similarly tend to cancel out; I estimate the revenue loss caused by the new policy
at 39.9% of personal income tax revenues. Application of this figure to the Rp 47.9
trillion in personal income tax revenues projected for 2004 yields my net cost estimate of Rp 16.0 trillion.14
It is not clear whether this estimate is more or less accurate than the figure of
Rp 5.6 trillion derived by the Ministry of Finance. The conclusion I draw from this
analysis is simply that there is some risk that the policy change could be very
costly, and that further examination of the proposal is merited. Also, in fairness
to the ministry, the increase in personal income tax exemptions was part of a
larger package. It proposes to compensate for the lost personal income tax revenues through changes in the value added tax system, taxation of bond mutual
fund interest, application of higher penalty income tax rates to individuals without tax identification numbers, and use of deemed income for business owners
with turnover of less than Rp 1.8 billion. The last of these measures could be controversial, however, and certainly could hurt small business.
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168
Stephen V. Marks
Proposed Social Security System
The government submitted legislation to the DPR in December 2003 that would
establish a comprehensive social insurance system for Indonesia. Although the
details of the plan have not been made public, a basic outline has emerged. The
system would be administered by the central government, and participation
would be compulsory. It would consist of a pension system, national health insurance, worker disability and death benefits, and an old-age saving scheme.
The pension system would consolidate the existing pension programs for the
military, civil servants and private sector employees, but would also extend coverage to those currently without a pension. It would use a defined benefit
approach—promising a pre-specified level of pension benefits—which recent
reports have put at 70% of the minimum wage. Since there are now well over 100
different minimum wages throughout Indonesia, this would not only tend to be
unworkable but would also mean that the basis for the increase in pension disbursements would be a highly uncertain policy variable that regional governments could manipulate at the expense of the central government.
The old-age saving plan would use a defined contribution approach, in
which a lump sum payment would be made upon the retirement, death or disability of the worker, equal to the contributions made on the worker’s behalf
plus investment income. Contributions for health insurance, the pension and
old-age savings would be split equally between employers and employees,
while the death and disability benefits would be funded by employers only.
Current discussions put the sum of employer and employee contributions at 6%
of the gross wage for national health insurance and perhaps as much as 13% for
the other components. These rates would be well above contribution rates in
comparable developing countries. More importantly, they appear to have been
determined quite arbitrarily, rather than on the basis of the extensive and
detailed actuarial calculations that usually underpin properly designed social
insurance plans.
The contributions burden for the pension system would fall principally on
workers in the modern sector—less than 30% of the total workforce—and their
employers. Proponents of the legislation claim that contributions would also be
obtained from some informal sector workers, but Bird (2003) notes that experience in countries at comparable levels of development shows that it is virtually
impossible to collect medical or pension premiums from such workers.
Collections can be difficult even in the formal sector. Currently only nine million
of an estimated 25 million regular wage workers in the private sector contribute
to the supposedly compulsory Jamsostek (Jaminan Sosial Tenaga Kerja, Worker
Social Security) pension program.15 The avoidance problem might not be so bad
if workers had confidence in the program, but Arifianto (2004) notes that both
rates of return on Jamsostek investments and benefit payments have been low. A
system in which workers in the modern sector effectively cross-subsidised informal sector workers would be even less attractive. Either the payroll tax would be
evaded or it would reduce employment in the modern sector.
The draft law specifies that the government will pay some portion of the costs
of coverage of indivi
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Survey of recent developments
Stephen V. Marks
To cite this article: Stephen V. Marks (2004) Survey of recent developments, Bulletin of
Indonesian Economic Studies, 40:2, 151-175, DOI: 10.1080/0007491042000205268
To link to this article: http://dx.doi.org/10.1080/0007491042000205268
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Bulletin of Indonesian Economic Studies, Vol. 40, No. 2, 2004: 151–75
Taylor & Francis Group
SURVEY OF RECENT DEVELOPMENTS
Stephen V. Marks
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Pomona College, Claremont CA
SUMMARY
Two major factors, one internal and one external, shaped developments through
the middle of 2004. The internal factor was the national election process, which
led to a realignment of political power among the parties in the legislative elections in April, and offered the prospect of even greater changes in the presidential election to follow. The external factor was foreign capital, which readily
flowed into Indonesia in the early months of 2004, reflected in a series of record
highs in the Jakarta Stock Exchange index, but then seemed to waver in May, perhaps because of the growing threat of higher US interest rates, uncertainty about
the election, or concern about inflation. Sharp declines in the value of the rupiah
and local stocks mirrored similar though less severe developments throughout
Southeast Asia and around the globe.
The imminent first-ever election of an Indonesian president through a direct
vote by the public raised hopes of change for the better, particularly with respect
to governance and the performance of the economy. However, the structural factors that have held back economic growth in Indonesia since the crisis of 1997–98
will not change overnight. The new president could have a popular mandate, but
will have to assemble a coalition in a parliament in which power will be more
fragmented than ever.
As the presidential election approached, polls showed the electorate’s top priorities to be an improved economy and reduced corruption. However, recent
months have witnessed several steps backward, as interventions in domestic
trade and the escalation of fuel subsidies have created costly inefficiencies and
new opportunities for corruption. A recent proposal to establish a vast new social
security system monopolised by the government is also problematic in an environment in which governance remains weak. Personal income tax changes being
considered by the Ministry of Finance could significantly reduce government revenues, an outcome the government can ill afford.
Despite enactment of a host of new laws in the last six years in such areas as
anti-monopoly, bankruptcy and anti-corruption, as well as the initiation of a longterm judicial reform process, recent events have shown that the legal system
remains a major source of uncertainty in the business environment.
ISSN 0007-4918 print/ISSN 1472-7234 online/04/020151-25
DOI: 10.1080/0007491042000205268
© 2004 Indonesia Project ANU
152
Stephen V. Marks
TABLE 1 Votes and Seats Obtained by Parties in the DPR Election
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Party
Partai Golongan Karya (Golkar)
Partai Demokrasi Indonesia Perjuangan (PDIP)
Partai Kebangkitan Bangsa (PKB)
Partai Persatuan Pembangunan (PPP)
Partai Demokrat
Partai Keadilan Sejahtera (PKS)
Partai Amanat Nasional (PAN)
Partai Bulan Bintang (PBB)
Partai Bintang Reformasi (PBR)
Partai Damai Sejahtera (PDS)
Partai Karya Peduli Bangsa (PKPB)
Partai Keadilan dan Persatuan Indonesia (PKPI)
Partai Persatuan Demokrasi Kebangsaan (PDK)
Partai Nasional Banteng Kemerdekaan (PNBK)
Partai Nasional Indonesia (PNI) Marhaenisme
Partai Pelopor
Partai Penegak Demokrasi Indonesia (PPDI)
Seven others
Totals
Votes
No.
%
DPR Seats
No.
%
24,480,757
21,026,629
11,989,564
9,248,764
8,455,225
8,325,020
7,303,324
2,970,487
2,764,998
2,414,254
2,399,290
1,424,240
1,313,654
1,230,455
923,159
878,932
855,811
5,457,851
21.6
18.5
10.6
8.2
7.5
7.3
6.4
2.6
2.4
2.1
2.1
1.3
1.2
1.1
0.8
0.8
0.8
4.8
128
109
52
58
57
45
52
11
13
12
2
1
5
1
1
2
1
0
23.3
19.8
9.5
10.5
10.4
8.2
9.5
2.0
2.4
2.2
0.4
0.2
0.9
0.2
0.2
0.4
0.2
0.0
113,462,414
100.0
550
100.0
Source: General Election Commission, www.kpu.go.id/suara/dprkursi.php.
POLITICAL DEVELOPMENTS
The outcome of the general election of 5 April reflected widespread discontent
with the leadership of President Megawati Soekarnoputri and her Indonesian
Democratic Party of Struggle (PDIP). The party’s share of the national vote fell
from 33.7% in 1999 to just 18.5%. The share of the Golkar party, which finished
second overall in 1999, fell by less, from 22.4% to 21.6%, and so it was the overall
winner. Five other parties each had at least 6% of the vote, with the remainder
split among a host of others. Two new parties drew considerable support: Partai
Demokrat (Democrat Party), the vehicle for the presidential candidacy of Susilo
Bambang Yudhoyono, and the Islam-based Partai Keadilan Sejahtera (Prosperous
Justice Party). Table 1 shows the votes cast for the various parties in the elections
for the national legislature (DPR), and the DPR seats these parties will have.1
The Presidential Election
The first direct presidential election in Indonesia’s history was to be held on
5 July. As the election approached, five pairs of presidential and vice-presidential
contenders emerged, only three with a realistic prospect of victory. Table 2 shows
the pairs of candidates—in most cases very odd couples—along with their major
institutional affiliations and levels of opinion poll support as of early May. The
Survey of Recent Developments
153
TABLE 2 Presidential and Vice-Presidential Candidates,
Their Affiliations and Opinion Poll Support
Candidates
Primary
Organisational
Affiliations
National Poll,
1–8 May 2004
(%) a
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Susilo Bambang Yudhoyono Democrat Party; retired military officer;
former cabinet minister
M. Jusuf Kalla
Golkar Party; former cabinet minister
Megawati Soekarnoputri
Hasyim Muzadi
Wiranto
Salahuddin Wahid
Amien Rais
Siswono Yudo Husodo
Hamzah Haz
Agum Gumelar
Indonesian Democratic Party of Struggle
(PDIP); incumbent president
General Chair, Nahdlatul Ulama
Golkar Party; retired armed forces chief
under Presidents Soeharto and Habibie
Chair, Nahdlatul Ulama; National Human
Rights Commission
National Mandate Party (PAN); Chair,
People’s Consultative Assembly (MPR)
General Chair, Indonesian Association of
Farm Groups (HKTI)
United Development Party (PPP); incumbent
vice president
Retired military officer; former cabinet minister
41.0
11.2
10.0
4.4
3.0
a Respondents
were asked which of 10 possible candidates would make the best president
for Indonesia; 4.2% indicated a preference for Abdurrahman Wahid, who was disqualified
for health reasons from running for president, and 11.3% for other candidates. The remainder (14.0%) did not know or did not respond.
Source: International Foundation for Electoral Systems (IFES) poll released 31 May 2004,
based on face-to-face interviews with 1,000 eligible voters around the country.
polls suggested that in all likelihood there would be a run-off election between
the top two pairs of candidates,2 unless Susilo Bambang Yudhoyono and M. Jusuf
Kalla could muster an outright victory in the initial round despite the weakness
of the nascent party apparatus behind the former. If necessary, the run-off would
be held on 20 September, with the inauguration of the new leadership to occur in
any case on 20 October.
As the presidential campaign got under way, there were few discernible differences in the economic policy stances of the candidates. Megawati as incumbent
had the clearest track record, which seemed to be her primary disadvantage.
However, she also had certain advantages of incumbency. Just before the start of
the presidential campaign, for example, it was announced that the government
would provide an extra month’s salary to civil servants, the military and the
police, and an extra month of pension benefits to retirees (JP, 27/5/04).
154
Stephen V. Marks
TABLE 3 Recent Macroeconomic Data and Government Projections, May 2004
Realised Values
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Major economic indicators
Rate of inflation, CPI (% p.a.)
Exchange rate (Rp/$)
Real economic growth (% p.a.)
Gross domestic product
Expenditure side
Private consumption
Government consumption
Investment
Exports
Imports
Production side
Agriculture
Manufacturing
Non-oil & gas
Other
Government finance
Deficit (% of GDP)
Tax revenues (% of GDP) a
Debt (end of year, % of GDP)
Total
Foreign
Domestic
a Includes
bData
Projections
2001
2002
2003
2004
2005
2006
12.5
10,241
10.0
9,375
5.1
8,578
5.5
8,500
5.5
8,500
5.0
8,600
3.4
3.7
4.1
4.8
5.2
5.6
4.4
9.0
7.7
1.9
8.1
4.7
12.8
–0.2
–1.2
–8.3
4.0
9.8
1.4
4.0
2.0
5.2
1.3
3.0
5.5
4.6
4.4
0.4
5.3
7.1
8.2
4.0
8.0
9.3
8.8
9.7
1.0
4.1
5.0
3.8
1.7
4.0
4.2
4.0
2.5
3.5
3.8
4.8
2.3
4.9
5.2
5.5
2.4
6.4
6.9
5.4
2.6
7.1
7.5
5.7
2.8
12.8
1.7
13.1
2.0
13.8
1.1
13.5
87.7
42.6
45.1
77.6
38.0
39.6
66.4
31.4
35.0
60.7
27.3
33.4
0.7–0.9
0.3–0.5
13.5–13.6 13.6–13.7
54.4b
24.3
30.4
49.3
22.0
27.2
oil and gas revenues.
as shown in source.
Source: Rancangan Rencana Kerja Pemerintah (RKP) Tahun 2005 [Draft Government Working
Plan for 2005], presented at the Parliamentary Budget Committee Working Meeting, 4 May
2004.
MACROECONOMIC PERFORMANCE
Despite concern about the slow recovery of investment, and real GDP growth
well below the rates recorded before the economic crisis, the economy appeared
stable in macroeconomic terms through the first months of 2004. Table 3 shows
realisations of some main economic indicators for Indonesia over 2001–03, and
projections made by the government in early May. The government stuck by its
earlier real growth forecast of 4.8% for 2004, and predicted 5.2% real growth in
2005. However, within days of the release of these forecasts, serious signs of insta-
Survey of Recent Developments
155
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TABLE 4 Components of GDP Growth
(2000 prices;a % p.a. year on year)
GDP
By expenditure
Private consumption
Government consumption
Investment
Exports
Imports
By industry sector
Agriculture, livestock, forestry
& fisheries
Mining & quarrying
Manufacturing
Electricity, gas & water supply
Construction
Trade, hotels & restaurants
Transport & communication
Financial, rental & business
services
Services
Non-oil & gas GDP
a Expenditure
Dec-02
Mar-03
Jun-03
Sep-03
Dec-03
Mar-04
4.9
5.5
4.8
3.7
4.1
4.5
3.5
17.9
6.9
4.5
10.6
3.2
6.1
3.7
5.8
5.1
4.3
10.6
1.3
6.3
–0.2
4.4
9.7
2.3
0.6
1.6
4.2
12.4
–1.8
3.3
1.5
5.7
12.8
4.2
0.8
6.5
3.6
1.9
4.6
8.0
6.4
6.5
8.8
4.3
–1.0
6.2
6.3
5.4
7.6
12.4
1.9
1.4
5.3
5.9
6.1
6.5
8.5
1.6
–3.7
4.6
7.5
7.0
3.5
11.7
5.0
–2.9
4.0
3.8
6.8
3.8
13.6
1.5
–2.7
5.5
2.2
7.3
6.1
13.8
7.4
2.9
8.1
3.9
7.8
3.9
7.1
4.1
4.7
4.4
4.9
4.4
5.9
7.0
5.6
4.2
4.8
5.0
data calculated by splicing 2000 price data onto 1993 price data.
Source: CEIC Asia Database.
bility appeared in the form of sharp declines in the value of the rupiah and local
stock prices. Both projections may thus turn out to be rather optimistic.
Economic Growth
Table 4 shows that real economic growth accelerated slightly to 4.5% year on year
in the first quarter of 2004. Private consumption continued to grow robustly,
though it may slow as the depreciation of the rupiah causes prices of tradable
goods to rise. Government consumption had the highest growth rate of any
expenditure category, at 12.8% year on year. Investment grew at a moderate rate,
though it remains at only about two-thirds of its pre-crisis share of GDP. Exports
were nearly flat, while imports surged. On the production side, transport and
communication services continued to grow robustly, along with construction and
trade, hotels and restaurants. Growth of the manufacturing sector accelerated.
Output in the mining sectors, including oil and gas, contracted, while agricultural
output was almost flat year on year.
156
Stephen V. Marks
FIGURE 1 Inflation, the Exchange Rate and Base Money Growth
% p.a.
30
25
Rp/$
10,000
8,000
Base money growth (lhs)
20
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15
CPI inflation (lhs)
6,000
Exchange rate (rhs)
4,000
10
5
0
Dec-2002
2,000
Mar-2003
Jun-2003
Sep-2003
Dec-2003
Mar-2004
0
Source: CEIC Asia Database.
Inflation and the Exchange Rate
Consumer price index (CPI) inflation reached a low of 4.6% year on year in
February 2004, but then rebounded in March, April and May (figure 1). The
increase in inflation was initially only minimally related to the exchange rate: the
rupiah depreciated against the dollar by 1.7% in March, and by only 0.9% in
April. However, in May it depreciated by 6.3%, and year-on-year inflation accelerated to 6.5%. For the purpose of comparison, table 5 shows changes in the value
of various currencies in terms of the dollar over the first five months of 2004.
Indonesia experienced by far the greatest depreciation among all the Asian countries listed, with only Brazil coming close to it among the other countries.
To put this depreciation in context, particularly given recent shifts in the relative values of currencies of other nations, figure 2 shows two alternative measures of the real exchange rate. One of these is the real effective exchange rate
(REER), which compares wholesale prices in Indonesia with those in other countries, expressed in common currency units, and thus provides an indication of the
competitiveness of tradable goods produced in Indonesia.3 The massive nominal
depreciation of the rupiah in 1997–98 made Indonesia’s tradable goods highly
competitive, but since then the nominal appreciation of the rupiah has exceeded
the difference between inflation in Indonesia and in other countries. By the end
of 2003, despite the negative long-term consequences of the 1997–98 crisis for the
country, this index was within 4.5% of its value in 1995. The alternative measure
of the real value of the rupiah shown in figure 2 is the real exchange rate (RER).
It is the ratio of non-tradable to tradable goods prices within Indonesia, and thus
shows the prices faced by domestic producers and consumers. On this basis, the
real depreciation of the rupiah during the crisis was much less severe, and the
Survey of Recent Developments
157
TABLE 5 Change in Value of Various Currencies against the Dollar, Jan–May 2004
(%)
Asia
Non-Asia
Korea
+2.7
+2.6
+0.9
+0.1
+0.0
+0.0
–0.4
–0.4
–0.8
–1.1
–1.5
–2.2
–2.3
–3.2
–3.7
–5.1
–5.2
–8.6
–8.9
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United Kingdom
Russia
India
Singapore
Malaysia
Hong Kong
Philippines
Pakistan
Argentina
Mexico
Japan
Thailand
Euro Area
New Zealand
Australia
Canada
Brazil
Indonesia
Source: Pacific Exchange Rate Service, University of British Columbia, fx.sauder.ubc.ca.
FIGURE 2 Real Exchange Rate: Alternative Measures a
(1995 = 100)
120
100
80
60
40
REER
20
0
Jun-1995
a See
Jun-1997
Jun-1999
RER
Jun-2001
Jun-2003
text for an explanation of both measures.
Sources: REER: International Monetary Fund (IMF), International Financial Statistics, calculations by the author; RER: Bank Indonesia (unpublished).
158
Stephen V. Marks
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BOX 1 40 MILLION UNEMPLOYED?
It has become the ‘conventional wisdom’ that Indonesia faces a major
problem of labour absorption, with some 40 million people registered as
unemployed. This figure is cited frequently by presidential candidates and
social commentators alike, yet it has no scientific basis, and bears little
relationship to labour market realities. Worse, focusing on unemployment
as Indonesia’s major labour issue distorts the relevant policy choices.
Unemployment is defined precisely in international and Indonesian
national surveys as the number of people both not working and seeking
work during a specified reference period. According to the latest (2003)
National Labour Force Survey data, the unemployment rate amounts to
9.5% of the total labour force, or some 9.5 million persons out of a workforce of 100 million—a far cry from the often quoted 40 million.
As found in previous annual surveys, the urban, young and educated
comprise a much higher proportion of the unemployed than might have
been expected on the basis of their shares in the total workforce. Many
studies have shown that a significant proportion of these individuals are
unemployed by choice—in the sense that they are, in effect, queuing for
better modern sector jobs after completion of school and university rather
than taking on readily available but less attractive jobs. In short, not only
is the true level of unemployment less than one-quarter of the popularly
quoted figure, but also a large part of the true total represents voluntary
unemployment. Programs often suggested for dealing with the unemployment problem, such as job creation activities in villages or assistance to
small-scale enterprises, are unlikely to affect the behaviour of urban youth
looking for better jobs in the cities. It is precisely jobs of this kind that they
are seeking to avoid.
The figure of 40 million is in fact an approximation to the sum of the 9.5
million actually unemployed and about 28 million people reported as
currency has subsequently recovered nearly all its lost ground, so that the incentives given by these prices are not much different from those prior to the crisis.
Minimum wage growth has moderated, after several years of dramatic
increases in many parts of the country (Alisjahbana and Manning 2002). For
example, the increase in Jakarta was just 6.8% for 2003 and 6.3% for 2004—in both
cases close to or below the rate of inflation. However, a measure now under discussion would change the basis for calculation of minimum wages. The present
standard is a market basket of 43 commodities said to constitute ‘minimum life
needs’ (kebutuhan hidup minimum). The new standard would be an expanded market basket that would constitute ‘suitable life needs’ (kebutuhan hidup layak). There
is some concern that this more ambitious basis could cause minimum wages to
jump in the future, putting further pressure on employment in the modern sector
(box 1). In any case, for the present, moderate depreciation of the rupiah may be
Survey of Recent Developments
159
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BOX 1 (continued) 40 MILLION UNEMPLOYED?
working less than 35 hours a week (this total was actually 38 million in 2003).
The latter group is often referred to as the ‘under-employed’, but this is also
misleading because the category includes a high proportion of people, many
of them married females and children, who work less than 35 hours a week
by choice (estimated at 16 million in the 2003 survey). They are not underemployed in the conventional sense of working less than the arbitrary standard of 35 hours and seeking more work, but are voluntarily underemployed in the sense of choosing to work ‘part time’—that is, less than this
standard.
Neither the unemployment nor the under-employment figure captures
the essence of the main labour market problem—low productivity resulting
in low wages—which affects a much higher proportion of the workforce.
The big policy issue is not creation of jobs per se: the informal sector offers a
ready outlet for work if individuals and families are desperate and, indeed,
those most in need cannot afford to be out of work. Rather, it can be argued
that the key problem is creation of ‘better’ jobs through policies that induce
more investment and greater efficiency in the use of labour and other factors
of production, thus raising productivity and wages, with flow-on effects for
improved living standards and reduced poverty. To portray the key issue as
finding jobs for a fictitious ‘40 million unemployed’ is to divert attention
from this much more important agenda. Recent attempts to regulate the
labour market for the benefit of workers, including implementation of an
aggressive minimum wages policy that is likely to deprive many workers of
the opportunity to graduate from informal sector activities into more productive formal sector employment (Manning 2004), would not seem to have
helped in this regard.
Chris Manning
ANU
beneficial from the viewpoint of expanding job opportunities (by virtue of reducing wage costs expressed in foreign currencies), given the substantial real wage
increases of recent years and given that productivity growth has been slow in
Indonesia compared with competitor countries, China in particular.
Capital Flows and Stock Prices
With the expiry of the concessional agreement between Indonesia and the Paris
Club of creditor countries in December 2003, the government is now obliged to
rely more on commercial creditors. On 3 March, a government issue of $1 billion
worth of 10-year dollar-denominated debt with an effective yield of 6.85% p.a. (a
spread of 277 basis points over yields on 10-year US Treasury bonds) was warmly
received by foreign creditors. On the other hand, the Ministry of Finance reports
that foreign investors sold off 22.5%, or about Rp 1.9 trillion (roughly $200 mil-
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160
Stephen V. Marks
lion), of their holdings of rupiah-denominated government debt at the end of
March, thus providing a clear indication of concern about the risk of renewed
rupiah depreciation. Indeed, the rupiah lost 11.2% of its value against the dollar
between 27 April and 2 June.
The rupiah value of the Jakarta Stock Exchange (JSE) composite index hit
record highs during January, February and April 2004, though its foreign currency value remained well below the peak levels attained before the 1997–98 crisis. However, after reaching a record high of 818 on 27 April, the index retreated
sharply over the next several weeks. By the end of May it was down 10.5% from
its record level the previous month, compared with a decline of 9.8% in stock
prices in emerging markets overall during the same period.
In the midst of this turbulence, Bank Indonesia (BI) governor Burhanuddin
Abdullah wrote to four unnamed foreign banks warning them to refrain from
speculating against the rupiah (JP, 14/5/04). While central bankers sometimes
use moral suasion against speculators at such times, some observers argued that
the warning would be counterproductive because it implied that BI saw itself as
powerless to influence the strength of the currency through its own policies.
Speculation is usually viewed negatively in Indonesia, and in many other
countries. However, it is useful to revisit the ancient truth that profitable speculation stabilises prices, since it is the profitable speculator who buys when prices
are low and sells when they are high. Thus, speculators who do profit help to stabilise the market, while speculators who do not help to stabilise the market are
punished by the market itself. This may be cold comfort to policy makers, since
herd behaviour can emerge in which the individually but not collectively
rational decisions of market participants can greatly increase the volatility of
asset prices. In that case it is important for the central bank to adjust fundamental monetary conditions sensibly to help calm these markets. A contraction of liquidity and a consequential increase in interest rates could help stem capital
flight, for example.
The net value of foreign purchases of shares at the JSE has been positive during every calendar year since 1995, though without question foreign activity has
at times exacerbated market volatility. Figure 3 shows the JSE index on a monthly
basis since 2000, as well as net purchases by foreigners. For almost all months
during this period, net buying by foreigners has been positive. Foreign investors
missed the start of the rally in the JSE in early 2003, but were soon on board and
appear to have contributed significantly to it. However, the net foreign purchase
value for May 2004 showed a sharp swing to net sales by foreigners, which coincided with the sudden weakening of the rupiah. Clearly it was not just a handful
of banks that were concerned about the currency, and it will take more than moral
suasion by BI to stabilise it. Of paramount importance is whether the central
bank’s commitment to sound monetary policy is credible.
Global Financial Instability to Return?
Observers as diverse as Kenneth Rogoff, former chief economist of the IMF, and
Joseph Stiglitz, one of the IMF’s most prominent critics in recent years, have
worried that a financial bubble may have emerged in developing countries, propelled by loose monetary policy in the US (Wall Street Journal, 23/1/04). Rogoff
suggests that an international financial crisis could recur within two to three
Survey of Recent Developments
161
FIGURE 3 Net Purchases by Foreigners, and the Jakarta Stock Exchange Index
(Rp trillion)
5
4
3
Net purchases (lhs)
1,000
800
JSE composite
price index (rhs)
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600
2
400
1
0
-1
Dec-2000
Dec-2001
Dec-2002
200
Dec-2003
0
Sources: Datastream; Jakarta Stock Exchange; Bapepam.
years (Financial Times, 1/4/04). Such a crisis would presumably be triggered by
the inevitable tightening of credit in the US as its economy rebounds in a context of persistent fiscal deficits, given the relatively high levels of public debt to
GDP in emerging market economies. With total public debt at 66.6% of GDP at
the end of 2003, Indonesia was close to the global average, which the IMF puts
at about 70%.
One indicator of a possible bubble has been the narrowing of spreads between
interest rates on public debt in emerging markets and those on US Treasury securities. The concern is that these spreads will increase significantly as credit tightens in global capital markets. An increase in interest rate spreads is already evident for Indonesia: for the March issue of international bonds mentioned earlier,
the spread rose from the initial 277 basis points to more than 400 basis points by
early May. The prospect of higher interest rates on domestic debt has become
more immediate as well: an auction of Rp 3.5 trillion ($379 million) of government debt was cancelled in late May because potential buyers demanded higher
yields than the Ministry of Finance wished to pay (Bisnis Indonesia, 26/5/04).
It is difficult to say how well prepared Indonesia is to weather a new financial
crisis, particularly when so much depends on intangible factors like the quality
of political leadership, but one simple macroeconomic indicator appears to offer
comfort. Figure 4 shows that foreign exchange reserves net of IMF credits have
trended upward since early 1998, and particularly since the middle of 2002. From
late April through late May, however, BI sold nearly a billion dollars worth of foreign exchange (mostly not shown in figure 4) to support the rupiah. To put these
reserve levels in some context, BI reported that public offshore debt stood at $82
billion and private offshore debt at $52 billion in March. Total foreign debt
162
Stephen V. Marks
FIGURE 4 International Reserves and Use of IMF Credit a
($ billion)
40
Reserves
35
30
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25
20
15
10
5
Reserves net of IMF credit
IMF credit
0
Dec-1995
aReserves
Dec-1997
Dec-1999
Dec-2001
Dec-2003
include both foreign exchange and Special Drawing Rights (SDRs).
Source: IMF, International Financial Statistics.
service rose 39% in March to $1.96 billion during that month (JP, 8/6/04). Other
factors relevant to the resilience of the economy will be discussed later, in the
context of fiscal policy and bank regulation.
MONEY AND BANKING
The accelerating rate of monetary expansion noted by Kenward (2004) may have
set up the rupiah for its recent weakness (figure 1). Over the long run, a rate of
money growth equal to the sum of inflation and real economic growth is to be
expected; on this basis, the growth rate of money consistent with the government’s growth and inflation projections (table 3) is around 10% p.a. Toward the
end of 2003, monetary expansion was excessive by this standard. The growth rate
of base money peaked at 25.2% year on year in November 2003, though it had
eased to 17.1% by April 2004 (figure 1).4 One of the reasons for the expansion of
base money towards the end of 2003 was the mutual fund crisis described by
Kenward (2004), in response to which BI injected extra liquidity into the economy.
Nevertheless, base money growth has clearly trended upward since the second
half of 2002, despite moderate real growth and, until the last few months, declining inflation.
Interest Rates
The evidence of excessive monetary expansion in recent months is mirrored by
evidence on interest rates. Figure 5 compares the nominal rate of interest on
three-month BI Certificates (SBIs) with that on three-month US Treasury bills.
Survey of Recent Developments
163
FIGURE 5 Indicator Interest Rates: Three-Month SBIs and US Treasury Bills
(% p.a.)
20
SBIs
16
Treasury bills
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12
8
4
0
Dec-2000
Dec-2001
Dec-2002
Dec-2003
Sources: Bank Indonesia; US Council of Economic Advisors, Economic Indicators, www.
gpoaccess.gov/indicators/index.html.
With investors able to move their funds internationally, interest rates in Indonesia
will have to exceed foreign interest rates by enough to compensate investors for
perceived risks plus the expected rate of depreciation of the rupiah. The dramatic
narrowing of the spread between US Treasury bills and SBIs to roughly 6% in
recent months would have made financial investment in Indonesia less attractive,
leading eventually to a sell-off of rupiah assets. The actual rupiah depreciation
that has occurred may have reduced the expected future depreciation of the currency, thus inducing investors to hold rupiah assets once more, although this
view must be qualified with reference to investor expectations about the future
conduct of monetary policy.
Under the 1999 law on BI, the mission of the central bank is to maintain a stable value of the rupiah. Why, then, has BI been so obsessed with lower interest
rates? One reason is that it wishes to avoid issuing more SBIs through open market operations as a means of removing excess liquidity, since this would increase
its own interest expenses. Another is that higher interest rates would increase the
interest burden on the government. The policy independence of the central bank
in the midst of the presidential election is also rather suspect, since lower interest
rates tend to benefit incumbent politicians.
A final motivation is to coax additional lending to the corporate sector from the
banking system. Although investment lending from banks increased 16% year on
year in April, this was from a low base as a result of large-scale loan write-offs following the banking collapse of 1998–99, making this number difficult to interpret.
In real terms the April amount outstanding was only 45% of that in April 1997.
However, the real sector has benefited considerably since the crisis from being
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164
Stephen V. Marks
able to repurchase much of its original bank borrowings at a fraction of their original value (either from the banks themselves or from the government via the
banks and non-performing loans that the government took over). Moreover, it is
debatable whether the low real level of lending is a cause or an effect of the sluggish recovery of investment. In any case, many companies have turned to the
bond market as an alternative to bank loans. The value of corporate bonds outstanding more than doubled between 2001 and 2003, and at the end of 2003
equalled 67.3% of investment loans from banks.
By the end of May, BI publicly recognised that excess liquidity in the financial
system had to some extent fuelled the speculation against the rupiah. Senior
deputy governor Anwar Nasution blamed the excess of liquidity on the slow
recovery of bank lending to the corporate sector (JP, 29/5/04), though clearly BI
had itself generated this excess liquidity through expansion of base money in its
pursuit of lower interest rates.
In early June, as the rupiah depreciated to Rp 9,590/$, BI announced that
measures would be taken to absorb some liquidity, and that SBI interest rates
would not be allowed to go lower. The principal measure was to be an increase
in the minimum reserve ratio (that is, the ratio of each bank’s deposits at BI to its
customers’ deposits), from 5% to 6, 7 or 8%, depending on the size of the bank’s
total deposits. This policy, to be implemented in July, would increase the demand
for base money relative to supply, and thus have the same impact as the sale of
SBIs. For BI, however, it had the advantage of being cheaper, as the central bank
intended to pay a much lower interest rate (3% p.a.) on compulsorily increased
reserves than it would have to pay on voluntarily purchased SBIs. For market
interest rates, however, the impact would be much the same, since there would
be a corresponding decrease in the supply of base money relative to the demand
for it.
The Banking System
Regulatory and institutional weaknesses in the banking system persist. On the
heels of the scandals at the state-owned Bank Negara Indonesia and Bank Rakyat
Indonesia in late 2003 (Kenward 2004), BI closed two small banks, PT Bank
Dagang Bali and PT Bank Asiatic, on 8 April. These closures did not pose a threat
to the stability of the banking sector, given the small size of the banks (JP,
13/4/04). Nevertheless, with its blanket guarantee of bank liabilities, the government could be liable for up to Rp 3.4 trillion in combined liabilities of the two
banks, with Rp 2.2 trillion in combined deposits. The episode was a reminder that
future potential liabilities for the central government lurk beneath the surface of
the banking system.5
The practices that led to the closure of the two banks can best be described as
fraud. The banks were both captive to family business groups. Each appears to
have been plundered by its owners (who were related to each other by marriage)
through the extension of loans to related entities that were covered up by falsified accounts. BI has been criticised for its handling of this episode, since it had
known about serious problems at the banks since mid 2001 (Kompas, 25/4/04).
For their part, BI officials argue that initially it was hoped that the situation
could be turned around through close supervision and technical assistance. The
suspect legal system once more played a central role: no owners of troubled
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Survey of Recent Developments
165
banks, even those who engaged in fraud, have been sent to prison following the
banking collapse of 1998–99; a few have been convicted, but have fled the country to avoid prison terms. When the consequences of illegal behaviour are few
and the potential gains great, it should come as no surprise that such behaviour
persists.
Finally, there is continuing concern both inside and outside BI about the poor
management of the state banks. The fundamental problem is the absence of a
residual claimant—an owner with a controlling interest in the banks—who will
have a strong incentive to enforce strict internal controls and clean up lending
practices. As one government official put it to me, nobody gets fired in state
banks. The sale of minority stakes will not solve the problem.
FISCAL ISSUES
The fiscal situation has improved, as reflected in simple measures such as the
debt to GDP ratio and in more sophisticated measures of fiscal sustainability
(Marks 2004, in this issue). However, concern about the government’s potential
burdens under the blanket guarantee of bank liabilities, or even under more limited deposit insurance, has been heightened by the closures of Bank Dagang Bali
and Bank Asiatic. In addition, new concerns about increased expenditure and
possibly reduced tax revenues have emerged, in each case partly related to the
presidential election.
Increased Burden of Fuel Subsidies
The public sector as a whole gains on net (through tax and non-tax revenues)
from higher oil prices, but the central government itself loses from the fuel subsidy as well as from the sharing of natural resource revenues with the regions.6
The subsidy was originally budgeted at Rp 11.4 trillion in 2003 (0.6% of GDP), but
eventually cost Rp 26.0 trillion (1.5% of GDP), primarily as a result of higher
petroleum prices. The cost of the subsidy for 2004 was originally put at Rp 14.5
trillion, based on a crude oil price of $22 per barrel and an exchange rate of
Rp 8,300. But by May, with average crude oil prices at $35 or higher and the
rupiah weaker, the national oil and gas company Pertamina estimated that the
cost of the subsidy could rise to Rp 40 trillion in 2004 (JP, 27/5/04)—more than
10% of the state budget and at least 2.0% of the revised GDP estimate.
The high cost of the subsidy was exacerbated by the election-year decision to
hold fuel prices constant throughout 2004. Previously, fuel prices had been linked
to a Singapore benchmark gasoline price. To get a sense of the magnitude of the
subsidy per unit, at the start of 2004 the spot wholesale gasoline price in Singapore
was 26.6% higher than the retail gasoline price in Indonesia. Gasoline prices in
Singapore then rose by 14.4% in dollar terms, and by 22.4% in rupiah terms, by
mid May.7,8 The costs of the subsidy increase with higher oil prices and a weaker
rupiah not only because of a higher subsidy per unit of fuel consumed, but also
because measured consumption tends to rise owing to increased illegal diversion
of fuel products to other countries.
In March and April, Indonesia became a net importer of crude oil for the first
time (Asian Wall Street Journal, 18/5/04). With crude oil prices at 13-year highs,
this development was especially painful. It was related not only to the fuel sub-
166
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TABLE 6 Proposed Changes in Personal Income Tax Exemptions, 2004
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Personal income tax exemptions (Rp)
Taxpayer
Working spouse
Non-working spouse
Other dependants
Maximum number of other dependants
Current Income Tax Law
Proposed Level
2,880,000
2,880,000
1,440,000
1,440,000
12,000,000
12,000,000
1,200,000
1,200,000
3
2
sidies, which kept demand high, but also to moribund production due to low
investment in oil exploration and oilfield development.9
Further, the differential between the official price of kerosene for households
(Rp 700 per litre) and industry (Rp 1,800) causes shortages for households, since
kerosene intended for domestic use gets diverted illegally to industry. In early
May, the Minister of Energy and Mineral Resources vowed that Pertamina would
revoke the licence of any retailer caught engaged in such diversions (JP, 6/5/04).
Discussions earlier in the year about adding colour to kerosene intended for
households broke down over the question of who would bear the cost. The best
approach would be simply to sell kerosene at a single price to all buyers, since
households are paying almost as much as industrial users anyway, and have
faced shortages (JP, 19/4/04). In the process, corruption would be reduced.
Tax Policy
Fiscal policy makers emphasise the importance of expanding tax revenue. In
practical terms, this would provide some protection against additional government liabilities from bank failures, compensate for diminished net natural
resource revenues and the burdens of fiscal decentralisation and bureaucratic
reform, and allow for additional economic development expenditure. Yet the
government’s own projections indicate that tax revenues will remain flat as a percentage of GDP over the next several years (table 3). It is thus of concern that
changes in personal income taxation that would significantly reduce revenues
have been under consideration within the government. In May the Ministry of
Finance projected revenues from these personal income taxes to be Rp 47.9 trillion in 2004, which would be 13.5% of total central government revenues or 2.4%
of GDP.10
Under the new proposal, personal tax exemptions (penghasilan tidak kena pajak,
or PTKP) would be increased this year, and the top marginal income tax rate
would be lowered from 35% to 30% within five years.11 The current and proposed
exemptions are shown in table 6. The Ministry of Finance (2004) has estimated
that enlargement of the exemptions would lower revenues by Rp 5.6 trillion, or
about 0.3% of projected 2004 GDP, but did not estimate the revenue impact of the
cut in the top rate.
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Survey of Recent Developments
167
An argument could be made for reduction of the top rate on the grounds that
it would lessen incentives for tax avoidance and evasion, and would provide
incentives for additional work effort and saving. There may also be merit in
adjustment of the tax system in a way that would excuse more lower-income
households from paying taxes, on the grounds of both equity and administrative
efficiency. In fact, a 2003 decree of the Minister of Finance does just that: the government now bears the income taxes on the first Rp 1 million of monthly labour
income for workers whose monthly wage is Rp 2 million or less.12 The ministry
estimated the budgetary cost of this measure at Rp 2.2 trillion in 2003.
The problem with the large proposed increase in exemptions is that not only
are many lower-income taxpayers relieved of personal income tax obligations,
but also the taxes of all higher-income earners are cut, since the entire tax schedule is lowered. My own rough estimate of the net budgetary cost of the increased
exemptions is Rp 16.0 trillion or 0.8% of GDP. This estimate comes from a detailed
analysis of the personal income tax system based on data from the 2002 National
Socio-Economic Survey (Susenas). The methodology for an earlier version of this
analysis is described in detail in Marks (2003). The basic approach is to calculate
income tax payments, household by household, based on application of the
income tax code, and then use Susenas household weights to estimate tax payments on a national level.
One concern with this approach is that there is no way to identify the income
on which taxes are actually paid. I assume that it is not feasible to tax farm
income, but that other business and rental income is taxed. I also assume that
only the wages of regular workers are taxed (the self-employed and those without a fixed employment relationship are excluded), and I exclude occupations for
which income is hard to tax (such as street vendors, household servants, public
transportation drivers, and workers in agriculture, forestry and fisheries). Given
these and other assumptions necessitated by data limitations and imperfections,
the estimated level of income tax revenues predicted from this analysis is not very
reliable; I estimate it at Rp 25.1 trillion based on application of the current income
tax law and at Rp 16.0 trillion if the proposed measures are implemented.13
However, the difference in the level of personal income tax revenues generated by
these two policies is more reliable, since the errors that affect both of these levels
similarly tend to cancel out; I estimate the revenue loss caused by the new policy
at 39.9% of personal income tax revenues. Application of this figure to the Rp 47.9
trillion in personal income tax revenues projected for 2004 yields my net cost estimate of Rp 16.0 trillion.14
It is not clear whether this estimate is more or less accurate than the figure of
Rp 5.6 trillion derived by the Ministry of Finance. The conclusion I draw from this
analysis is simply that there is some risk that the policy change could be very
costly, and that further examination of the proposal is merited. Also, in fairness
to the ministry, the increase in personal income tax exemptions was part of a
larger package. It proposes to compensate for the lost personal income tax revenues through changes in the value added tax system, taxation of bond mutual
fund interest, application of higher penalty income tax rates to individuals without tax identification numbers, and use of deemed income for business owners
with turnover of less than Rp 1.8 billion. The last of these measures could be controversial, however, and certainly could hurt small business.
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Stephen V. Marks
Proposed Social Security System
The government submitted legislation to the DPR in December 2003 that would
establish a comprehensive social insurance system for Indonesia. Although the
details of the plan have not been made public, a basic outline has emerged. The
system would be administered by the central government, and participation
would be compulsory. It would consist of a pension system, national health insurance, worker disability and death benefits, and an old-age saving scheme.
The pension system would consolidate the existing pension programs for the
military, civil servants and private sector employees, but would also extend coverage to those currently without a pension. It would use a defined benefit
approach—promising a pre-specified level of pension benefits—which recent
reports have put at 70% of the minimum wage. Since there are now well over 100
different minimum wages throughout Indonesia, this would not only tend to be
unworkable but would also mean that the basis for the increase in pension disbursements would be a highly uncertain policy variable that regional governments could manipulate at the expense of the central government.
The old-age saving plan would use a defined contribution approach, in
which a lump sum payment would be made upon the retirement, death or disability of the worker, equal to the contributions made on the worker’s behalf
plus investment income. Contributions for health insurance, the pension and
old-age savings would be split equally between employers and employees,
while the death and disability benefits would be funded by employers only.
Current discussions put the sum of employer and employee contributions at 6%
of the gross wage for national health insurance and perhaps as much as 13% for
the other components. These rates would be well above contribution rates in
comparable developing countries. More importantly, they appear to have been
determined quite arbitrarily, rather than on the basis of the extensive and
detailed actuarial calculations that usually underpin properly designed social
insurance plans.
The contributions burden for the pension system would fall principally on
workers in the modern sector—less than 30% of the total workforce—and their
employers. Proponents of the legislation claim that contributions would also be
obtained from some informal sector workers, but Bird (2003) notes that experience in countries at comparable levels of development shows that it is virtually
impossible to collect medical or pension premiums from such workers.
Collections can be difficult even in the formal sector. Currently only nine million
of an estimated 25 million regular wage workers in the private sector contribute
to the supposedly compulsory Jamsostek (Jaminan Sosial Tenaga Kerja, Worker
Social Security) pension program.15 The avoidance problem might not be so bad
if workers had confidence in the program, but Arifianto (2004) notes that both
rates of return on Jamsostek investments and benefit payments have been low. A
system in which workers in the modern sector effectively cross-subsidised informal sector workers would be even less attractive. Either the payroll tax would be
evaded or it would reduce employment in the modern sector.
The draft law specifies that the government will pay some portion of the costs
of coverage of indivi