Bank Indonesia’s 2007 economic-prognosis meeting last week concluded the country would grow at only 5.5 percent this year, lower than the government target of 5.9 percent and slightly below last year’s expansion of 5.6 percent. The central bank did chart out a brighter outlook for 2007, predicting growth at between 5.7 and 6 percent. But this projection is contingent upon tough preconditions and is vulnerable to high downside risks. The most probable outcome is likely to be the lower estimate, of 5.7 percent.
The reasons for this year’s lackadaisical economic performance are familiar. The dramatic fiscal measure of slashing fuel subsidies in October 2005 required an equally drastic tightening of monetary policy, while bureaucratic inertia foiled the government’s pump-priming program. The devastating earthquake in Yogyakarta, and another tsunami in the western part of Java all added to the economic slowdown. Bank lending grew only by 7.3 percent in the first nine months of this year
The macroeconomic conditions did, however, improve during the past three months, with year-on-year inflation down to 6.3 percent in October, the rupiah remaining stable and the central bank easing money policy by cutting its benchmark rate to 10.25 percent. Some revival in investment could also be noted from the significant increase in the imports of capital goods, to more than US$850 million in August.
The challenges, nevertheless, remain daunting if the country is to achieve 6 percent economic growth next year.
One of the conditions, set by the central bank, is that public spending should run according to schedule. Meanwhile, in the first eight months of this year, this bureaucratic “inertia” combined with high interest rates, prompted many local administrations to simply invest budget money in banks and bonds; money that should have been spent on local development.
The other conditions are no less challenging; the acceleration of infrastructure development, especially in energy and transportation, larger non-oil exports, better distribution systems for goods, an increase in production capacity and stability in administered prices — not another shock like the 126 percent fuel price hike last year.
These conditions require an increased pace of private investment and a significant improvement in public sector governance, neither of which are not likely to take place in the first half of next year because of the long delays in badly needed reforms. The problem is that the executive branch of the government does not have total control over these reforms; they are also in the hands of the House of Representatives.
Unfortunately, the House does not have any sense of urgency or crisis, although more than 11 million people are unemployed, 30 million others are underemployed and almost 40 million are living below the poverty line.
Bills on tax and investment have already been delayed for more than three years and are not likely to be completed this year. These laws could be enacted in the first semester of next year but there will likely be some time lag before they are fully enforced.
Likewise, the reform of labor regulations has been in limbo without a clear time table as the government has succumbed to pressures from trade union leaders, who are opposed to the amendments of the 2003 labor law. All these reforms are vital for businesses.
Easing inflation does provide room for Bank Indonesia to lower interest rates but persistently high business risks will not likely allow for the expansion in bank lending of at least 18 percent, which Bank Indonesia says is needed to support 6 percent growth.
Then there is the absence of any real progress in the reform of the public sector. Almost nothing has been done to fix state companies and the civil service, when it is this very bureaucratic machinery that must execute the reform measures already introduced early this year.
No wonder that the appointment of highly respected economist and policy-maker Boediono to the Yudhoyono Cabinet last December has not helped the government deliver on policy.
Concerted efforts are also needed to improve regional administrations’ fiscal management skills, as they are now in charge of managing more than 50 percent of the government’s budget.
The government should not be lulled into complacency by the brighter outlook foreseen by the central bank.
The preconditions for these rosy prospects will be tough to meet.
The Jakarta Post, November 29, 2006