Indonesia's tottering economy, In the dream time The government is running on empty

(The Economist, Issue dated December 6, 2001.)

JAKARTA
WHEN Indonesia's new president, Megawati Sukarnoputri, named her cabinet in August, her economic line-up was hailed as a "dream team". The IMF, which had quarrelled with the previous government, quickly resumed lending. In a period of just three weeks, the rupiah rallied against the dollar by more than 25%. Having witnessed the demise of three presidents in as many years, Indonesians and foreigners alike were seized by the notion that a stable and capable government would at last get to grips with the country's struggling economy.

Just three months on, that idea seems dream-like indeed. The public debt has risen above 110% of GDP. A privatisation programme that would help stabilise the government's finances has not brought in a penny this year, despite the dream team's promises to the IMF. With the global slowdown pinching exports, and fears of terrorism hitting tourism, the outlook for growth is gloomy. The rupiah has lost almost all its recent gains. Indonesia's creditors are sounding increasingly grim. Could the country be heading for an Argentine-style nightmare?

In the short term, Indonesia should cope. Compared with Argentina, it has borrowed more of its debt from international financial institutions and friendly foreign governments, which tend to be less skittish than private lenders. But they, too, are rattled. In early November, at a meeting of an association of creditors called the Consultative Group on Indonesia, a World Bank official declared that the government had only six months to prove it was serious about sorting out the economy-and its own finances. The group did pledge loans of over $3 billion for 2002, but tied over a third of that to specific reforms.

On paper, there is nothing to worry about. At the IMF's urging, the government approved a sober budget for 2002 that would cut the deficit to 2.5% of GDP from the current 3.7%. That narrower shortfall will be financed through privatisation, asset sales from the government's bank restructuring agency, and more borrowing.

But things are unlikely to go according to plan. For starters, the budget is based on optimistic projections for the oil price and economic growth. Inflation is running above target, limiting the scope for interest-rate cuts and so keeping the cost of servicing the government's debt high. More important, Indonesia will struggle to meet its privatisation target of $650m.

The problem is not so much with the amount, which represents less than 3% of projected spending, as with the entire concept. Academics, MPs, trade unions, journalists and just about everyone else denounce privatisation as theft of the national patrimony. A regional governor recently managed to block the planned sale of a cement company by threatening to seize its biggest factory in protest.

Since much lending is tied to progress on privatisation, failure to make any headway would have a double impact on the budget. But instead of promising to meet their target, government officials wring their hands, mutter about the difficulties and muse about the sort of debt relief that Indonesia's increasingly impatient creditors are unwilling to offer.

Yet even if the big lenders stick to their guns, and withhold some loans, they will not want to push Indonesia into default. The IMF does not want the country to go bust and add to its string of failed reform programmes. Avoiding an economic crisis in the world's largest Muslim country seems all the more important just at present. The government, for its part, has muddled through financing shortfalls before, chiefly by cutting back on development spending. It could also resort to accounting tricks, such as withholding transfers to provincial governments, or delaying reimbursement to the state-owned petrol distributor for fuel subsidies. In other words, the likeliest outcome is a monumental fudge.

That might not sound so bad to Indonesian officials, but it will do the country's economy no good at all. With inflation already in double digits, and poised to increase because of a government pledge to raise fuel prices, the central bank is keeping interest rates high. Banks are in no mood to lend anyway, as they struggle to restore their balance sheets after the crisis of 1997. The government's financial straits put a fiscal stimulus out of the question. Foreign investment has evaporated-approvals in October were one-tenth the level of a year earlier. So privatisation, in addition to its budgetary virtues, is one of the few available means to inject new life into the economy. Time for foreign lenders to give the dream team a wake-up call?