IMF Statements at Donor Meetings
Indonesia and the IMF
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Consultative Group Meeting for Indonesia
January 21, 2003
1. Ladies and Gentlemen, thank you very much for the opportunity to address you once again on the occasion of the annual CGI meeting. Since the last occasion more than a year ago, there have been a number of domestic and external events that have had significant impacts on Indonesia's economic and financial circumstances. The following stand out of course: the weakening in global growth in the aftermath of September 11th, and more recently, the tragic events here in Bali in October. Such events would have profound effects on any country, let alone one in the midst of recovery from crisis. It is at such a time that strong support from the international community for Indonesia is all the more important.
2. In my remarks today, I will address the following topics. First, I will take stock of developments over the last year, assessing them in relation to the key policy priorities that were identified in the Government's economic program for 2002 supported by the IMF. Second, I will provide you with our assessment of Indonesia's short-term economic prospects in light of the current global environment and in the wake of the Bali attacks. Finally, I will address what we see as the main priorities for 2003.
3. Before doing so, however, let me briefly report on the status of Indonesia's EFF program, which is now on its fourth and final year. The seventh review of the program was completed last December, following satisfactory progress in policy implementation scheduled for that review, and we have now initiated discussions for the eighth review, which will set out the government's economic program for 2003 in detail. We will continue these discussions following the conclusion of this meeting, with a view to completing the review by the end of the first quarter of this year.
Achievements During 2002
4. In reviewing Indonesia's performance during 2002, it would be useful to remind ourselves of the challenges facing the government when it formulated its 2002 economic program in late 2001. Market sentiment had deteriorated as a result of the September 11th attacks, global growth was weakening, and there was a perception that the pace of structural reform implementation in Indonesia would slow.
5. In light of the challenging economic environment, the following main policy priorities were identified for achieving macroeconomic stability and promoting growth:
6. How has performance in the past year measured up? On the macroeconomic front, performance has been positive. Major progress was made towards restoring a healthy and sustainable budget position. The budget deficit is estimated to have fallen to under 2 percent of GDP, below the program target of 2.5 percent of GDP, and down from 3.6 percent of GDP in 2001. As a result of this success, and helped by the appreciation of the rupiah, 2002 also witnessed a large reduction in Indonesia's public debt burden. The public debt-to-GDP ratio fell from nearly 90 percent at the end of 2001 to almost 70 percent by the end of last year. Further in this area, the Government in November restructured a significant portion of its debt held by state banks, lengthening and smoothing the maturity of its debt repayment profile in coming years.
7. On the monetary policy front, Bank Indonesia was successful in containing the price pressures that emerged in 2001, and although the government's goal of reducing inflation to single digits by year-end was not quite reached, single-digit inflation is likely to be achieved early this year. Lower inflation and a stronger rupiah have enabled BI to lower interest rates —from nearly 18 percent in December 2001 to under 13 percent at present—thus providing support for the economi recovery.
8. Let me now turn to the implementation of reforms in the three other priority areas, where performance was more mixed. Even there, however, there was good progress on a number of fronts. Let me highlight a few:
9. Notwithstanding all of this progress, the investment climate remains weak. Although financial market conditions improved considerably, several high-profile legal cases focused observers' attention on the slow pace of reform in the legal and judicial sphere. The recent establishment of the Anti-Corruption Commission is welcome, but much will depend on its implementation and operation. Decentralization, which on the whole has proceeded relatively well, has also raised problems for both existing businesses and prospective investors, in the form of new and conflicting regulations and taxes. Investors have also expressed increasing concern about the framework for labor regulations and the trend of increasing minimum wages. And recently, the terrorist attack in Bali has heightened concerns related to internal security. All this means that the Government must do all it can to improve the investment climate and build growth prospects in the period ahead.
Indonesia's Current Economic Prospects
10. Indonesia's economic prospects for 2003 in particular will depend on a number of factors. Late last year, particular attention was focused on the impact of the Bali attacks. Together with the Indonesian authorities, we have reviewed the latest indicators and updated the outlook. I should highlight that there is still much uncertainty regarding the likely response of tourism. The main features of our current assessment is as follows:
Priorities for 2003
11. Let me now turn to the key policy priorities for this coming year. While much has been achieved, the reform agenda remains unfinished. Growth, while positive, remains disappointing relative to the 6 percent pace needed to make significant inroads to reducing poverty and unemployment. The overriding objectives for the 2003 program therefore are to: (i) consolidate recent gains in macroeconomic stability; (ii) strengthen public debt sustainability over the medium term; (iii) continue to make progress in restoring a sound banking sector capable of performing its critical financial intermediation function; and (iv) enhance the investment climate through a range of reforms.
12. The government has already made a good start toward meeting these challenges:
13. In addition to these efforts, we are confident that a prudent monetary policy aimed at reducing inflation further will be maintained, and that additional steps to enhance bank stability through continued improvements in supervisory capacity and the regulatory framework will be taken.
14. In order to lay a firm foundation for Indonesia's economic recovery, however, it will also be essential to begin to tackle more decisively the problems related to the investment climate. Historically, Indonesia's considerable economic strengths have made it an attractive destination for foreign investment: a large domestic market and labor force, abundant natural resources, a solid infrastructure, and a strategic location among some of the world's major trade routes. However, foreign direct investment flows into Indonesia remain at less than half their pre-crisis peak. Investment by Indonesians also remains weak, with the result that through September of 2002, gross fixed capital formation was still running about 35 percent below its pace in 1997.
15. What then is most needed to restore market confidence and support investment in Indonesia? Legal and judicial sector reform must be a critical element of any strategy to produce sustained improvement in the investment climate. Ensuring the effective operation of the newly-created Anti-Corruption Commission, passage of amendments to the bankruptcy law, and continued efforts to strengthen the commercial court are specific priorities. A sensible labor market policy that strikes a balance between protecting workers' rights and preserving a flexible labor market is also important in light of recent concerns that have been expressed. Continued care will need to be taken to ensure that decentralization does not lead to an unduly complex and unstable regulatory framework that discourages investors. Customs and tax administration, which are often reported to have deteriorated in terms of transparency, predictability, and fairness, are also frequently cited as disincentives for investment. These are some key areas where the Government will need to make a serious commitment to addressing problems if it is to have a significant impact on the overall investment climate.
16. To conclude, thanks to the significant achievements that have been made this past year, the Government has begun to lay a solid foundation for Indonesia's economic recovery from the crisis. While the Bali attacks pose a significant concern for the outlook, Indonesia stands a good chance of weathering the incident with only a modest impact. However, without further progress on critical reforms as outlined above, there is a risk that growth over the medium term will not reach the pace needed to generate enough jobs and reduce poverty in a meaningful way.
17. We have provided our assessment of what is needed over the next year for Indonesia to cross the bridge towards a sustainable recovery. Implementation of such an agenda will require broad-based commitment from the Government and its partners in Parliament and elsewhere. As we have seen in the last few weeks, the pre-election environment in 2003 poses greater challenges for the Government as it seeks to implement its reform program. The economic team will need to work even harder to convince the public of the merits of its program. With such a show of commitment, we believe that the Government's economic program for 2003 would deserve the continued strong support of the international community.
18. Finally, the Government is now considering its strategy for 2004 and beyond, following the expiration of the current Fund arrangement. We certainly share in the wish that Indonesia can complete its recovery from the 1997-98 crisis as soon as possible, thereby no longer needing to seek recourse to exceptional financial support from the international community. But this will require that Indonesia redouble its effort in the implementation of the reform agenda. In the meantime, together with the Indonesian authorities, we will assess the outlook as it evolves, and in due course consider all options.
IMF EXTERNAL RELATIONS DEPARTMENT