Indonesia: The Challenge of Sustaining the Economic Recovery -- Address by Anoop Singh
IMF News, October 4, 2000
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- Published: October 4, 2000
I. Recovery from crisis
- Crisis peak conditions (mid-1998):
- Exchange rate reached a low of more than Rp 15,000 to the US dollar (compared with about Rp 2,500 before the crisis).
- Output declined by about 13 percent by the end of 1998.
- Banking system had virtually ceased to function; corporate sector weighed down by recession, inflation, and corporate debt.
- Achievements since late 1999 / over the past two years:
- Output has been growing steadily for about a year; substantial consensus that Indonesia’s growth could reach 4 percent in 2000.
- Beginnings of recovery in both exports and domestic investment beyond initial domestic consumption dependence.
- Inflation kept low for much of the past year; rice prices had fallen by about 20 percent since their crisis peak.
- Rupiah stability: fluctuating in a range of Rp 8,000-9,000.
- Short term interest rates are in a much more supportive range, with room for further progress.
- Poverty rate—by most accounts—has fallen back sharply to well below its level at the peak of the crisis; falling rice prices contributed significantly.
- Policies and institutional reforms underpinning recovery:
- Radical reorientation of monetary policy focused on targeting of base money; Bank Indonesia (BI) used open market operations to sterilize past liquidity support and keep growth in net domestic assets and base money broadly in check.
- BI allowed to freely adjust interest rates; since early 1999 BI brought interest rates down close to pre-crisis levels.
- Fiscal policy allowed to become expansionary with broadened targeted social spending programs (e.g., targeted rice distribution (OPK) scheme).
- Successive banking system reforms backed by a comprehensive guarantee on banking system liabilities, closure of insolvent banks, and recapitalization of virtually all remaining banks.
II. Market confidence and fiscal sustainability
- Current market sentiment and its effects:
- Market confidence has been volatile in 2000; volatility beginning to affect macroeconomic achievements.
- 12 month inflation rate has now reached about 7 percent, largely due to a more depreciated rupiah.
- Investors remain in a wait and see attitude; flight capital has yet to return.
- Renewed pressure on nominal interest rates; delayed corporate restructuring hindered.
- Fiscal sustainability defined:
- Government must be in a position to repay debts now and in the future in an orderly way—without resorting to extraordinary measures.
- Simple measure: declining trend in the debt-to-GDP ratio, which generally requires economic growth to exceed the real interest rate.
- Key fiscal and debt statistics:
- External public debt amounts to almost $70 billion, equivalent to around 45 percent of GDP.
- Domestic debt amounts to around Rp 650 trillion, accounting for another 45 percent of GDP.
- In all, government debt amounts to around 90 percent of annual output.
- By comparison: Malaysia’s and Thailand’s government debt are below 65 percent of GDP; Korea’s below 40 percent of GDP.
- Interest payments on government debt are already absorbing about one third of government revenue; the bulk will be paid on bonds issued to recapitalize the banking system.
- Implications of high debt and market doubts:
- Investors’ doubts force higher interest rates (risk premia), which increase the budgetary burden and discourage new investment, detracting from growth.
- Historical international examples where concerns about fiscal sustainability kept interest rates well above inflation and contributed to low growth.
III. The strategy for fiscal sustainability and growth
- Overall objective and projection:
- Strategy: maintain favorable macroeconomic environment, pursue fiscal consolidation, and drive asset recovery to create a virtuous cycle of investment, lower real interest rates, and higher growth.
- Projections point to the government debt ratio falling to about 67 percent by 2004 if program fully achieved.
- Three challenges to implementing the strategy:
- Pace of withdrawing fiscal stimulus must be carefully managed to protect the poor.
- Strong political consensus required for maximizing asset recovery—especially IBRA’s; hold firm against vested interests and recalcitrant debtors.
- Institutional weaknesses to overcome (e.g., develop a bond market virtually from scratch to facilitate roll-overs and attract a wider investor base with a well-functioning secondary market).
- Principal avenues to reduce the debt ratio (with related recommendations and facts):
- Adjustment in the government budget:
- Crisis-related increases in subsidies, especially oil subsidies; untargeted subsidies presently amount to as much as 3 percent of GDP.
- Civil service reform: government wage bill has risen to above 5 percent of GDP because of successive and large wage increases over the past two years.
- Strengthen revenue base by rationalizing exemptions and tax holidays; eliminate diversion of significant revenues into off-budget accounts.
- Implement fiscal decentralization without adding to the budget deficit:
- Fiscal decentralization planned for 2001; international experience shows risk of rising general government deficit after decentralization.
- Preserve fiscal neutrality by ensuring expenditure functions are transferred to local authorities to match revenues (finance should follow function).
- Contain macroeconomic risks: strict limits on sub-national borrowing, particularly in early decentralization; bank lending to sub-national governments should be tightly controlled or even prohibited.
- Maintain overall budget framework flexibility by creating an expenditure margin as a contingency.
- Pursue recovery from publicly held bank and nonbank assets:
- IBRA controls assets with book value measured close to one-half of annual GDP and should return assets to private sector to raise factor productivity and attract foreign investment.
- Accelerating asset recovery is crucial; delay often leads to asset deterioration and lower sale prices.
- Bank asset recovery and nonbank privatization proceeds could be as important as budget deficit adjustment in reducing the debt ratio.
- Need coordination among institutions—especially IBRA and the JITF—and the government as owner of state-owned enterprises.
- Safeguard public resources from being used for additional bank recapitalization:
- Government debt rose primarily due to bank recapitalization costs during the crisis; previous episodes occurred in the 1990s.
- Ensure no further public-led recapitalization is required once present recapitalization is completed by:
- Enhanced supervision of the banking system and improved governance of state banks.
- Transforming banks into genuine intermediators of financial savings, ending directed lending practices and instituting proper appraisals and risk analysis.
- Privatization of the large state share in the banking system; government’s share of ownership in the banking system has risen to above 70 per cent.
IV. Concluding remarks
- Coordinated strategy to reduce government debt is essential to restore market confidence and sustain the recovery; international community committed to helping Indonesia meet these challenges.
- IMF role: provide technical assistance, policy advice, and financial support for implementation of the economic program; the program is that of the government and international support is to aid implementation.
International Monetary Fund — Address delivered at the University of Indonesia, 50th Anniversary Conference, October 4, 2000.