Indonesia - the economic perspectives / Anne Booth. - [Electronic ed.]. - Bonn, 1999. - 20 S. = 65 Kb, Text . - (FES-Analyse)
Electronic ed.: Bonn : FES Library, 2000

© Friedrich-Ebert-Stiftung



  • In mid-1999 many observers were expressing cautious optimism that the Indonesian economy might be on the path to a sustainable recovery from the economic crisis which had caused a contraction in GDP of nearly 14 per cent in 1998. But events in August and September 1999 demonstrated how vulnerable the economic recovery still was. The revelations concerning payments made by Bank Bali to third parties has brought into disrepute not just officials in the Indonesian Bank Restructuring Agency (IBRA) but also in Bank Indonesia and the Ministry of Finance as well as key advisers to President Habibie. In addition, the post-ballot turmoil in East Timor has inevitably affected both national and international confidence in the economic recovery.

  • There is growing evidence that the recovery is demand constrained; fiscal policy in 1998/99 was much tighter than originally forecast and it is far from clear that the predicted deficit in the 1999/2000 fiscal year (5.8 per cent of GDP) will eventuate. Real interest rates remain high and in mid-1999, there was little sign that investment expenditures were recovering from the massive decline which occurred in 1998.

  • Although there is now a consensus that the effect of the crisis on poverty and unemployment has not been as severe as predicted in the latter part of 1998, the incidence of poverty has increased, and there has been a marked increase in the numbers of workers in agriculture and in the informal sector of the non-agricultural economy. Real wages have fallen sharply since mid-1997.

  • The presidential elections in October went reasonably smoothly, and produced a result which pleased many Indonesians. President Habibie lost office to Abdurrahman Wahid, a well-known Islamic leader and pro-democracy activist, with Megawati Soekarnoputeri (the daughter of the first president of the Republic of Indonesia) becoming vice-president. The new cabinet contains several well-known reformers, but the economic ministers, led by Kwik Kian Gie, lack experience in government and come from different political backgrounds; thus it is not clear how well they will perform as a team.

  • Continuing political uncertainty combined with the far-reaching decentralisation measures led to declining morale among the civil service and a virtual freeze on new policy initiatives in the final phase of the Habibie administration. President Wahid appears committed to further political and economic decentralisation. At least two central government departments will be abolished and several other departments and agencies will undergo major changes. But in the wake of the decision to allow East Timor to become independent, it is far from clear that such measures will be sufficient to stem the swelling tide of demands for greater autonomy, or indeed for outright independence, in several provinces outside Java.

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The Bank Bali affair and the costs of bank recapitalisation

A statement issued by the IMF at the time of the Consultative Group in Indonesia (CGI) meeting in Paris in the last week of July, 1999 suggested that economic recovery was underway. The IMF predicted a real GDP growth rate of 1.5 to 2.5 per cent per annum in the 1999/2000 financial year, single digit inflation and some reduction in the ratio of external debt stock to GDP (Table 1). CGI donors pledged $5.9 billion in budget support. The then Economics Coordinating Minister (Ginanjar Kartasasmita) predicted that at the next CGI meeting, to be held in January 2000, a smaller amount of assistance would be required (Jakarta Post, 29 July 1999).

Unfortunately events in August and the first part of September severely affected the business and financial climate in Indonesia, leading to a weakening of the rupiah against the dollar and other major currencies, a fall in the Jakarta stock market and a general decline in investor confidence. In early August reports began circulating in the local and international press about serious irregularities in the accounts of Bank Bali, the private Indonesian bank in which the UK-based Standard Chartered Bank was intending to acquire a minority stake. An audit of Bank Bali's books carried out on behalf of Standard Chartered revealed that a large payment had been made to a third party. Subsequently an expert on banking law (who had apparently received information from dissident factions within GOLKAR) revealed that a sum amounting to rupiah 56 billion (around $80 million at the exchange rate prevailing in July 1999) had been paid by Bank Bali to a company controlled by, among others, the deputy treasurer of GOLKAR, Setya Novanto. The payment had been made for the company's "assistance" in recovering Bank Bali claims on other banks (including the liquidated BDNI), but as all such loans were in effect guaranteed by the government it was far from clear why the payment was necessary. To many observers, it seemed obvious that the payment was in effect a contribution to the election war chest of the pro-Habibie faction within GOLKAR, and would be used to pay off those members of the MPR who voted for President Habibie in the upcoming election.

Throughout August, the press came up with more revelations in what, inevitably, became known as "Baligate", and politicians from various parties demanded that officials at both Bank Indonesia and the Ministry of Finance as well as IBRA (the Indonesian Bank Restructuring Agency) be investigated for their involvement in the scandal. Calls were made for the resignations of the Minister of Finance, the Governor of the Central Bank and senior officials in IBRA. As the controversy rumbled on, it became clear that the credibility of all three institutions, and the integrity of their top officials, were seriously compromised. In addition, allegations were made that President Habibie's younger brother and other members of his inner circle, including the President of the Supreme Advisory Council, A. A. Baramuli, were implicated. During the last week in August, the World Bank country director for Indonesia was quoted in the Jakarta press as stating that if the case was not satisfactorily resolved, the World Bank would have difficulty in continuing to provide budgetary support to Indonesia (Jakarta Post August 25 1999). The World Bank Vice President for East Asia, Jean-Michel Severino, told the Singapore press that the World Bank had been joined by both the Asian Development Bank and the International Monetary Fund in pressing the Indonesian government to resolve the problem, and that all three institutions demanded that the culprits be "subject to the full extent of the law". He added that in his view the Indonesian government's response to the affair had been too slow and stated that the three institutions may be forced to withhold support if the government did not act quickly (Straits Times, 30 August 1999).

Such threats inevitably depressed business confidence; in the last week of August the rupiah weakened and the stock market fell. The announcement that an international firm (Price Waterhouse Coopers) was to carry out an independent audit of all transactions relating to the affair did not inspire confidence that there would be a speedy resolution, especially as the Governor of Bank Indonesia, Dr Sabirin, made it known that the auditors would not have access to the personal bank accounts of senior officials implicated in the transactions. The Price Waterhouse Coopers report was completed in early September, and submitted to the Chairman of the State Audit Board, Dr S.B. Joedono. The full report was not made public (it was not made available even to the IMF or other foreign donors) but an abbreviated version was circulated quite widely in Jakarta and abroad. While the auditors complained that they had not been afforded adequate time and access to information to meet all the conditions of their terms of reference, they did set out in some detail flaws in IBRA operations, and argued that the organisation was, and continued to be, highly vulnerable to fraud and misconduct (Far Eastern Economic Review, 23/9/99). Towards the end of September the parliament approved recommendations that seven top officials, including three top officials at IBRA, the Minister of Finance, the Chairman of the Supreme Advisory Council and the Governor of Bank Indonesia be suspended pending further investigations into their conduct.

There can be little doubt that the Bank Bali affair was a major reason for the loss of confidence in the leadership of President Habibie, and his defeat at the hands of the opposition candidate in the October presidential elections. The other main factor was the savage retribution carried out against the population of East Timor after their overwhelming vote in favour of independence in the ballot of August 30. After his election, President Wahid moved quickly to release the full text of the Price Waterhouse Coopers report, and at the end of November it was announced that the Indonesian Bank Restructuring Agency (IBRA) would be placed directly under his control, to ensure its independence. A new vice-president was appointed to the agency. While these changes will go some way to restoring the agency's national and international credibility, the job it faces is enormous. Perhaps paradoxically, Bank Bali was one of the best-managed private banks in the country and one of the few in whose acquisition foreign banks had shown much interest. The news of irregularities in its books immediately gave rise to speculation about the state of most of the other banks under IBRA's care. While the Indonesian government hopes that many of the country's troubled private banks will eventually receive new injections of capital from foreign shareholders, in the meantime it has no option but to use public funds to recapitalise those banks not yet shut down.

But the recapitalisation costs of private banks is estimated by most observers to be much less than those of the state-owned banks, even though at the time the crisis began, the private banks accounted for a much larger share of the total loan market. Several of the state-owned banks have been amalgamated into a new institution (Bank Mandiri) with substantial job losses, but this move is unlikely to make much difference to the total cost of recapitalisation. In May 1999, the Minister of Finance announced that the total cost of recapitalising the 35 banks that had been placed under the control of the Bank Restructuring Agency (IBRA) was $44 billion; two thirds of this amount would be used by the state-owned banks. Most analysts expect the eventual cost to be higher; the eventual cost of a comprehensive rescue could well amount to some Rupiah500 trillion or around 60 per cent of GDP in 1999. Much of this massive sum will come from new government treasury bonds, which began to be issued in 1999. The interest costs on these bonds will be wholly borne by the government and there are widespread concerns about the implication of this for the public finances in coming years.

Table 1: Macroeconomic Projections for 1999/2000 and 2000/2001




Macroeconomic variables (% Change):

Real GDP growth








Fiscal variables (% of GDP)

Overall balance




Domestic financing




External financing




External variables (US$ billions):

Current account




a) Exports




b) Imports




c) Services




Capital account




a) Public sector




b) Private sector




Overall balance




Gross reserves




Other variables (% of GDP):

Current account




External debt




Debt service ratio a




a As per cent of exports of goods and non-factor services

Sources: IMF (1999), Table 1

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Budgetary policy and rising public debt

By August 1999, final out-turn data were available for the 1998/99 budget; in several respects they were rather surprising. Domestic non-oil revenues rose much more rapidly than the revised budget had forecast; in fact they had increased by 62 per cent, which was far above the rate of inflation for the fiscal year 1998/99. Given that real GDP had contracted by more than 15 per cent, domestic revenues were predicted by most observers to fall over 1998/99. The much higher than expected growth was mainly due to the growth in revenues from the withholding tax on time deposit interest rates, reflecting the fact that interest rates were very high for most of the financial year. The other surprising development on the revenue side of the budget was the much higher than forecast revenues from export taxes; this was largely due to the export tax on palm oil which was imposed to depress domestic prices but which had the added effect of increasing budgetary receipts. Development revenues were double those of the previous fiscal year but well below budget targets.

On the expenditure side, routine expenditures fell well short of budget targets, mainly because of lower than forecast expenditures for both interest payments. This was in large part due to the faster than expected appreciation of the rupiah in the final part of the fiscal year. Total routine expenditures increased by 66 per cent which was considerably more rapid than inflation. Development expenditures also fell short of the budget forecast and in fact contracted slightly in real terms. Project aid disbursements were well under the budget forecast as were "other expenditures" mainly related to the social safety net programmes. Project aid disbursements were obviously affected by the change in cabinet after President Habibie assumed office and doubts over donor commitments. The upshot of increased domestic revenues and lower than forecast expenditures was that the FY 1998/99 budget deficit, originally forecast to be around 8.5 per cent of GDP was actually only two per cent of GDP. As the World Bank pointed out in its report to the CGI Paris meeting in July 1999, the 1998/99 budget outturn could in fact be considered contractionary, if the fiscal stimulus is defined as the change in fiscal stance, where the fiscal stance is the difference between the actual and the cyclically adjusted deficit. Given the severity of the GDP contraction over the fiscal year, it would have been necessary to have run a much larger deficit relative to GDP to bring about a fiscal stimulus. The argument that fiscal policy was too contractionary was supported by evidence (published by the Central Board of Statistics in September 1999) that the rate of inflation would be much lower in calendar year 1999 than most experts had predicted, and could even be negative over the 1999/2000 fiscal year.

If in fact during 1998/99 both monetary and fiscal policy in Indonesia were pro-cyclical, then it could be argued that government policy actually aggravated the decline in real economic activity. Why did the government allow this to happen? A failure to predict the effect of policies such as high interest rates on government revenues was possibly one reason; slowness in disbursing aid was another. But at bottom, there can be little doubt that most officials in the Ministry of Finance were reluctant to step too hard on the fiscal accelerator. Three decades of rhetoric regarding balanced budgets made it very difficult for them to sanction a far higher deficit before borrowing than had ever been incurred during the years of Soeharto's rule. In addition there may have been fears about both the economic and the political implications of a growing burden of foreign debt. For most of the decade from 1987/88 to 1997/98, government policy had been to reduce the government and government-guaranteed foreign debt by accelerating both interest and principal payments. It was probably very difficult for many officials to accept that this policy would have to be thrown into reverse, at least until economic recovery was well underway.

The IMF and the World Bank in their CGI reports both predicted that the budget deficit in 1999/2000 would be 5.8 per cent of GDP. The World Bank report pointed out that a deficit of this magnitude "was designed primarily to impart a fiscal stimulus to an economy that continues to operate at significantly below capacity". But both the World Bank and other observers also argued that the deficit for the 1999/2000 fiscal year may be lower than this target figure. Domestic revenues may be rather higher than the budget forecasts, partly because oil revenues in rupiah terms will be higher (world prices have strengthened more rapidly than was forecast in the budget, and the rupiah could remain relatively weak until well into 2000), and partly because other domestic revenues may be higher as the economy picks up. On the expenditure side, lower domestic interest rates could lessen the budgetary cost of bank restructuring.

Even if the size of the fiscal deficit was much smaller than predicted in 1998/99, and could be quite modest in 1999/2000, there are still widespread concerns about the size of the fiscal deficit in the medium term, and its implications for the total stock of public debt. Budgetary planning in Indonesia has always been difficult because of uncertainties over both the world oil price and the exchange rate. In addition as the stock of government external debt mounted in the 1980s, movements in world interest rates also became a crucial variable in forecasting budget expenditures. Now that domestic debt is increasing as a result of the bank restructuring process, trends in domestic interest rates are also going to have an immediate impact on the expenditure side of the budget. Public debt now comprises three elements:

  1. existing stock of government external debt plus new debt commitments; servicing charges on new debt will increase as grace periods expire,

  2. the stock of debt incurred by state owned enterprises and state banks,

  3. the outstanding stock of bank restructuring bonds.

The World Bank has forecast that total government debt at the end of 1999, including bank restructuring bonds, will be about 102 per cent of GDP, which represents a fourfold increase from the pre-crisis period. This increase is alarming to many observers, although it should not be forgotten that in the latter part of the 1980s the government external debt (there was no domestic debt at that time) was around 80 per cent of GDP. In the decade from 1987 to 1997, the Indonesian government was able to reduce the foreign debt stock relative to GDP mainly because of rapid economic growth and prudent fiscal management. Lower world interest rates also helped. Certainly a return to economic growth rates of five to six per cent per annum would be of great help in reducing the burden of the debt over the next five years and beyond. But there are real fears that if growth remains sluggish, the fiscal deficit may be difficult to close and thus new borrowings may be needed, possibly at higher rates of interest. This could lead to an ever greater debt burden which may eventually be unsustainable.

In forecasting future trends in both budgetary revenues and expenditures over the next five years there are thus several factors which are of crucial importance. Some such as trends in world interest rates the government can do little about. But there are some important determinants of budget outcomes which the government can influence. On the revenue side three are particularly important:

  1. increases in non-oil domestic revenues relative to GDP through more efficient tax administration, and through other measures such as extending the coverage of the VAT to more goods and services.

  2. growth of revenues from privatization of state assets.

  3. accelerated pace of asset recovery by IBRA.

As far as (a) is concerned, most tax experts agree that while non-oil domestic revenues have risen in Indonesia since the tax reforms of the mid-1980s, the ratio of such revenues to GDP is still too low, in comparison with other countries in the region. But as most officials now acknowledge, increasing tax compliance is extremely difficult when most businesses and private citizens have so little confidence in the probity and competence of the central government. Greater decentralisation of the tax system may aid compliance, but to be realistic a dramatic improvement in the ratio of non-oil taxes to GDP over the next few years seems unlikely. It is more likely that government revenues will be increased through at least partial privatisation of some state enterprises, although again with the stock market depressed, and investor confidence still very fragile, it may be difficult to sell large numbers of shares at reasonable prices, either to domestic or foreign buyers. If IBRA can sell a substantial part of the assets transferred to it, this could offset at least part of the cost of bank restructuring, but few observers expect asset sales to cover the total cost, or even half of it.

On the expenditure side, there is certainly scope for substantial savings through the elimination of subsidies, and it seems clear that a reduction in the fuel subsidy will be essential if the budget is to be brought into balance over the next five years. But that will mean a sharp increase in the price of gasoline and other fuel products which will hurt broad sections of the population. It is far from certain that a new government eager to assert its populist credentials will be prepared to take such a step. It is more likely that a new administration would wish to increase expenditures on those government programmes which directly affect the great majority of the population such as health and education. This may be desirable on developmental grounds; it is well-known that Indonesian government expenditures on both health and education are quite low relative to GDP compared with most other Asian economies. But substantial increases will make the goal of deficit reduction harder to achieve. In addition there will be many other demands for increased expenditures. A thorough reform of the entire civil service structure is clearly needed, and that could lead to demands for higher salaries. In addition the new decentralisation measures will almost certainly lead to increased demands on the central budget.

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The new decentralisation laws

Whatever the final judgement of historians on the short presidency of Dr Habibie, there can be little doubt that the climate of political reformasi which he ushered in has produced some remarkable developments in relationships between the centre and the regions in Indonesia, which are likely to have extremely important consequences for the public finances, and indeed for economic policy more broadly in coming years. In May 1999 the parliament passed, and the president signed, laws 22 and 25, about regional government and financial relations between the central government and the regions respectively. The first law was drafted by a small working group within the Department of Home Affairs, while the second reflected a long process of discussion and debate between the Department of Finance and other government agencies, both at the centre and in the regions, which had been continuing since the early 1980s. In the event both laws contained dramatic new policy initiatives which even the most ardent proponents of reform would not have believed possible a year earlier.

The main provisions of Law 22 on regional government are:

a) Abolition of the hierarchical relationship between the centre, provinces (daerah tingkat satu) and districts (daerah tingkat dua, kabupaten/kotamadya).

b) Regional heads (kepala daerah) at both province and district level will be elected by regional parliaments and will be accountable to parliaments rather than to what in the past have been regarded as higher levels of government. While governors will continue to represent the centre in the regions, district heads (bupati/walikota) will no longer act as representatives of the centre, and will be accountable only to the local parliament and the local electorate.

c) The central government will retain responsibility for international relations, defence, justice, monetary and fiscal affairs and religious affairs; in addition it will retain overall control of national economic planning, national administration, high technology policy, human resource development policy and natural resource conservation.

d) Districts (daerah tingkat dua, kabupaten/kotamadya) will assume responsibility for implementation of programmes in the following sectors: public works, health, education and culture, agriculture, communications, industry and trade, investment, environmental and landuse affairs, cooperatives and labour.

e) Regions which cannot carry out the functions devolved to them could be amalgamated with other regions; in addition provinces might carry out functions which districts (daerah tingkat dua, kabupaten/kotamadya) are unable to perform.

The main provisions of Law 25 are:

a) The existing central government grants to the regions (province, kabupaten and village) from both the routine and the development budgets will be abolished.

b) They will be replaced by "equalization grants" (dana perimbangan), which will comprise a general allocation (dana alokasi umum), a special allocation (dana alokasi khusus), receipts from the Land and Building Tax (Pajak Bumi dan Bangunan) and the Land and Building Titles Administration Fee (Bea Perolehan Hak atas Tanah dan Bangunan), and a share of revenues from natural resource exploitation.

c) The general allocation (dana alokasi umum) will amount to at least 25 per cent of central government domestic revenues as determined in the annual state budget (APBN). The provinces will retain ten per cent of this allocation and the remaining ninety per cent will go to the regions. There is however provision for a change in this division if provinces are forced to take over some expenditure responsibilities from the districts.

d) The special allocations will allocated from the central budget to elected regions based on their special developmental needs.

e) Regions will receive 15 per cent of revenues from oil exploitation carried out within their borders, and 30 per cent from natural gas exploitation. They will receive 80 per cent of the government revenues accruing from mining other than oil and gas, from forestry, and from fisheries. The act does not clarify whether "region" in this context is the province or the district, but states only that this remains to be determined in future regulations.

f) Regions may, with the permission of the regional parliament, borrow domestically to finance a part of the budget (how much is not specified) but may borrow abroad only through the central government.

g) Regional heads will be responsible in all financial matters to regional parliaments which must approve budgets and receive full reports on budget implementation from the relevant officials.

According to sources close to the drafting teams, the main purpose of both these laws is to bring government closer to the people, and to empower regional parliaments. The old hierarchical system, whereby governors and district heads (bupati/walikota) were largely if not wholly accountable to the centre or the province and could be removed by the Minister of Home Affairs, will go. Clearly this represents a dramatic break with not just the New Order system of government but also with a much longer tradition going back to the Dutch colonial era. Such a break is very much in the spirit of reformasi, which blames much of the corruption and nepotism of the Soeharto era on the very tightly centralised system where most key decisions affecting the entire country were taken by the President and a few ministers, and where regional officials were totally subordinate to the centre. Just as the presidency should be weakened and parliament's power strengthened at the national level, so should regional parliaments have a much greater role in policy-making and implementation at the regional level.

But even those who are broadly sympathetic to the goals of reformasi and who have in the past argued for greater decentralisation in Indonesia must have some concerns about the proposed changes enshrined in these two laws. Together their basic aim is dramatically to enhance the functions and the budgets of the districts, at the expense of the provinces and, possibly, sub-district levels of government. Does this mean the demise of provinces, except in so far as they still have some functions delegated from the central government? Will the districts be able to cope with their augmented responsibilities? What role is to be given to the sub-district levels of government (kecamatan and desa)? Will the reforms reduce the very high dependency on central government grants which has characterised regional and local government finance for decades? Will the resource-rich provinces be able to cope with their greatly increased revenues? And what will be the net effect of the reforms on the central government budget, where there is already concern about the growing deficit and fiscal sustainability?

These are all complex questions and comprehensive answers will have to await the implementation of both laws, and the promulgation of regulations which specify the criteria for the allocation of both the general and the special grant allocations. But some speculative comments are possible. To begin with the issue of the future role of the province, it seems clear that neither law envisages the complete abolition of the province, but at the same time it is the district (kabupaten and kotamadya) which will have the main responsibility for carrying out the expenditure functions assigned to the regions. To do this they will need more personnel, and it is likely that many civil servants currently working in the province will be reassigned to the districts. So may a number of officials currently working in government departments in Jakarta. If these moves carry with them the opportunity for promotion, they may not be widely resisted. The 1999/2000 budget envisages a very substantial increase, of 37 per cent, in the routine grants to the regions which are used mainly for salaries and wages. One assumes that this will give the districts the capacity to recruit and promote more staff, either from the provincial governments or from the centre, or indeed from the private sector.

However it appears that there will not be a significant increase in the INPRES (development) grants in 1999/2000; as a proportion of total domestic revenues they have increased only slightly over the previous fiscal year, while as a proportion of total development expenditures they have fallen compared with the previous fiscal year. Even if more of the INPRES funds previously allocated to the provinces are given to the districts it seems unlikely that there will be a dramatic increase in capacity for implementing development projects at the district level in the near term. In 1999/2000 the routine and the INPRES grants together amount to just over 25 per cent of total domestic revenues (the minimum amount laid down in Law 25). If the districts (and sub-district levels) are to be given enhanced expenditure responsibilities it is clear that both the general and specific allocations will have to be increased in future. Neither law has much to say about the responsibilities of the sub-districts (kecamatan) and villages (desa), and in fact it appears that the villages will lose the INPRES grants which they have been allocated ever since Repelita 1 (1969-74). They will become completely dependent on the districts for both routine and development funds. Greater autonomy at the district could thus mean sharply reduced capacity at the village level.

Several studies have already stressed that the new rules regarding the division of government revenues from the exploitation of natural resources will give a small number of provinces (Aceh, Riau, East Kalimantan, Irian Jaya) greatly increased funds compared with the regional grants received under the old INPRES system. This, one assumes is quite deliberate; both laws were drafted against a background of ongoing disturbances in Aceh, and the very real possibility of growing secessionist movements both there and elsewhere in the archipelago. But it is clear that their implementation will lead to greater disparities in development spending in different parts of the country. Such disparities could be ameliorated if Law 25 had explicitly allowed for the sharing of proceeds from central taxes such as the income or the value added tax. This would have benefited Java and some of the more urbanised parts of the Outer Islands such as North Sumatra. But revenue-sharing was not raised in the law, although it could be introduced in subsequent regulations.

Most observers agree that the immediate impact of the provisions regarding resource revenue sharing on the central government budget will not be very great, especially as total oil and gas revenues will rise this year because of higher world prices. Whether the four provinces which stand to gain most from the new rules will be able to use the money productively is of course another issue. Some have argued that the new law will simply lead to a "decentralisation of KKN". But even if this is true it can also be argued that at last regions in Indonesia now have a real chance to compete among themselves to attract both domestic and foreign investment by providing competent and effective government. The extent to which they will do so remains to be seen.

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Trends in investment, exports and real GDP

The very sharp contraction in GDP (of 13.7 per cent) in calendar year 1998 was not uniform across all types of expenditure. Recent figures from the Central Board of Statistics (CBS) shows clearly that investment expenditures contracted far more sharply than either government or private consumption expenditures. Thus in 1998, expenditures on gross fixed capital formation were only 22 per cent of GDP, compared with 32 per cent in 1997. Data for the first two quarters of 1999 indicate that the contraction in investment expenditure was continuing, in spite of the fact that total GDP was growing again, although the rate of decline is likely to be slower in 1999 than in 1998. The continuing decline in investment expenditures was mirrored in the import data for the first half of 1999 released by the CBS in September. Total imports in US$ were down 13.3 per cent compared with the first six months of 1998; imports of capital goods were down by 50 per cent, and imports of raw materials and other intermediate inputs by 5.5 per cent. On the other had imports of consumption goods showed a considerable increase (36 per cent).

These figures confirm that the economic recovery, to the extent that it was occurring at all in mid-1999, was based almost entirely on household and government consumption expenditure. Of course an improvement in consumer confidence is an important part of the recovery process but so far it does not seem to have had much effect on investor confidence, either domestic or foreign. It is probable that the combination of high interest rates, a tighter than predicted fiscal stance, and the ongoing problems in the banking system have together led to a further fall in investment expenditures. It is difficult to know if firms which want to invest are simply unable to get access to loans from the banking system, or if there is a lack of demand because of a perception that profitable investment opportunities are still very limited. Certainly high real interest rates deter many potential investors; firms with spare cash probably prefer to place it in a time deposit with a guaranteed rate of return, rather than invest in working capital, or in new plant and equipment to expand output for a still uncertain market.

Both lower real interest rates and a more expansionary fiscal stance are probably essential if investor confidence is to improve and the demand for loanable funds on the part of the private sector increase. In addition there is still much that the government can do to improve the investment climate by way of removing unnecessary impediments to investment, especially by small and medium scale entrepreneurs, and to ensure that investment funds are channelled into the most productive sectors. Many distortions have been present in the Indonesian economy which have led to disproportionate amounts of investment going into activities where returns were likely to be low. Accelerating the rate of growth over the next five years and beyond is thus not only a matter of increasing investment expenditures as a proportion of GDP but also of achieving an improvement in the quality of investment expenditure. Reducing the share of investment accounted for by government seems one promising route to take. This is not the same thing as cutting all government investment expenditures acros the board, but rather ensuring that government investment is channelled into sectors which are in turn likely to lead to improved productivity in the private sector, rather than government buildings and other perquisites for the bureaucracy.

One of the most disappointing aspects of Indonesian economic performance since late 1997 has been the apparent failure of the export sector to take advantage of the very substantial real depreciation of the rupiah which occurred, especially in 1997/98. Data published by the CBS in early September showed some increase in both oil and gas and other exports in July 1999 compared with June 1999, although the July figure is still well below that of July 1998 ($3.97 billion in July 1999 compared with $3.56 billion in June 1999 and $4.59 billion in July 1998). Total export revenues in dollars for the seven months January to July 1999 were down 12 per cent compared with the same period for 1998. However, the available data suggest that the volume response to the rupiah depreciation was quite impressive in 1998, and continued to be robust, especially for manufactured exports, in the first five months of 1999. For most categories of primary commodities, excluding fuels, export volumes increased in January-May 1998, compared with the same months in 1997, when the rupiah was still trading at around 2,500 to the dollar. Most categories of non-primary exports also saw quite healthy volume increases between 1997 and 1998, although earnings either stagnated or dropped. This trend continued for the first five months of 1999; for all non-primary exports, volume increased by almost 50 per cent while dollar earnings increased by only six per cent. Unit values of most of Indonesia's manufactured exports slumped in the latter part of 1998 and early 1999, although the textile and garment sector appears to have been especially badly hit. This reflects falling prices on world markets for many textile products and also some tendency for Indonesian exporters to increase production of lower quality textiles and garments.

In some export industries the slump in revenues has been due to falling volume rather than prices; this is true of footwear for example where European and American importers of branded shoes apparently switched their orders to other countries because of fears that their Indonesian suppliers would not be able to deliver on time. Certainly the problems in the banking sector have hurt the export sector and the government has been under considerable pressure to address them. The main initiative so far has been the establishment of the Bank Ekspor Indonesia, which started operations on September 1, 1999 with a paid-up capital of rupiah 3 trillion. The new bank will not raise funds from the public but will obtain all its capital from foreign financial institutions including the World Bank, the Asian Development Bank and the Japan Export Import Bank. Its President told the media at the end of August 1999 that the new bank's products would include guarantees on letters of credit issued to finance imports of local exporters and working capital loans. He expected that it would lend $100 million per month (Jakarta Post 24/8/99). But the new institution will not be able to lend directly to exporters, but only through other banks. Spokespersons for trade organisations expressed disappointment that the bank was not implementing a direct loan system, and feared that lending through third parties would only increase costs and cause delays.

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The debate over poverty and unemployment

In August and September 1998 several alarming estimates of the effect of the crisis on poverty were prepared and circulated by both the Central Board of Statistics, and international agencies. These estimates received considerable attention, although it was clear that they were based on some rather extreme assumptions. By early 1999, a "revisionist" view of the impact of the Indonesian crisis on poverty was gaining ground. Evidence from several sources, including a survey of key informants at the kecamatan level across the country, and a special round of the Indonesian Family Life Survey carried out by the Rand Corporation both indicated larger falls in mean household expenditures in urban than in rural areas, and a sharp fall in expenditure inequalities. The Rand study cautioned that their estimates of poverty were very sensitive to the inflation rate used. The crux of the problem lay in the fact that the incidence of inflation was not uniform across expenditure groups. As would be expected given the magnitude of the devaluation over 1998, the price of traded goods in the CPI, especially food, had risen more rapidly than the prices of non-traded items such as housing. Thus any adjustment to the poverty line between 1996 and late 1998 or early 1999 had to take into account not just the overall high rate of inflation but also the sharp change in relative prices of traded and non-traded goods. Because the poverty line basket of goods and services is more heavily weighted towards traded items such as food, compared with the CPI basket, it was to be expected that the poverty line would increase at a faster rate than the CPI.

On July 10, 1999 the Director of the UNSFIR (United Nations Support Facility for Indonesian Recovery) and the Head of the Central Board of Statistics (CBS) announced that an analysis of a special "SUSENAS type" survey carried out by the CBS in December 1998 indicated that 49.5 million people (24.2 per cent of the population) were below the poverty line. Of these, 17.6 million were in urban areas and 31.9 million were in rural areas. These results immediately gave rise to demands that the CBS clarify the methodology used to estimate the poverty line. The key problem was that the poverty line in both urban and rural areas used by the CBS is divided into a food and non-food component. While the food poverty line had risen rapidly in step with inflation, several commentators pointed out that the non-food component had been increased by far more than the rate of change in non-food prices.

To clarify matters, the CBS published some revised estimates of poverty in both 1996 and 1998 which used a comparable poverty line. The conclusion was that between 1996 and 1998 the number of poor in Indonesia had increased by around 11.7 million people. The headcount measure of poverty is the proportion of the population below the official poverty line indicated that in late 1998 16.7 per cent of the population were classified as poor, compared with 11.3 per cent in 1996 and 115.1 per cent in 1990. Thus it seems that at the end of the 1990s the headcount measure of poverty in Indonesia will be higher than it was at the beginning of the decade.

In addition to the rather extreme predictions about increasing poverty which were current in the latter part of 1998, there were also widespread predictions that there would be a rapid increase in unemployment. Prior to the crisis, the 1996 Labour Force Survey showed that slightly less than five per cent of the labour force was unemployed and looking for work; many of these were young, relatively well-educated, first time job seekers. As the crisis deepened in late 1997 and early 1998, there were fears that many workers in sectors such as construction, manufacturing, wholesale and retail trade and financial services would become unemployed. In fact the Labour Force Survey for August 1998 indicated that, compared with the same survey from the previous year, the overall rate of unemployment increased only slightly, from 4.7 to 5.5 per cent. Urban unemployment increased from 8.0 to 9.3 per cent, and rural from 2.8 to 3.3 per cent. There was little change in the labour force participation rate (in fact it increased slightly for women), so it seems unlikely that those who have lost jobs as wage or salary workers have withdrawn in large numbers from the labour force.

A further comparison has been made by the CBS between the August 1997 SAKERNAS and the special "SUSENAS type" survey carried out in December 1998. (The August 1997 data had to be modified to ensure comparability with the December 1998 data). This comparison also shows little change in overall unemployment. It indicates that youth unemployment, already high in 1997 did not worsen as a result of the crisis; in fact it fell slightly. But rates of unemployment among the highly educated (those with more than senior secondary qualifications) increased from the already high level prevailing before the crisis. The most striking trend revealed by this comparison was towards greater "informal sector" employment, where the informal sector is defined as employees in agriculture, all family workers and the non-professional self-employed. Their numbers increased by almost five per cent between 1997 and 1998, whereas the formal sector contracted by the same amount. In fact it appears that much of the increase in informal sector employment was in agriculture; in rural areas all other sectors experienced a contraction in employment while in urban areas only trade, transport and other services experienced an increase, and that was quite modest. A comparison of the labour force data for August 1997 and 1998 show an increase in the agricultural labour force of 4.76 million.

Inevitably given the numbers of workers surging back into the agricultural sector as a result of the contraction in employment opportunities in other parts of the rural economy, combined with the rapid inflation in 1998, real wages in agriculture fell sharply in the latter part of 1997 and 1998. One recent study has plotted trends in real wages for unskilled farm workers in the three large provinces of Java from 1996 to 1999; the downturn began in mid-1997, and continued until September 1998. The early months of 1999 saw some recovery but in all three provinces real wages in early 1999 were little more than half their 1997 peak. Real wages also fell sharply for construction workers employed by the Public Works Department, and for production workers. The decline in real wages over 1997-8 was not due to cuts in nominal wages but rather to the very high inflation over calendar 1998. The implication of these falls is clear; those wage workers who kept their jobs, or found new wage employment in agriculture, had to accept real wages which were substantially lower than before the crisis.

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Economic policy-making in a climate of political uncertainty

By the end of September, it was clear that the Habibie administration was virtually paralysed. Six cabinet ministers had already resigned in order to take up seats in the MPR (Peoples' Consultative Assembly which elects the President). In several cases it appeared that they were positioning themselves for roles in a new cabinet led by another president. A well-known political commentator, Wimar Witoelar, was quoted as telling a Reuters correspondent that "for all practical purposes the government is no longer there. It is a measure of this government's irresponsibility that knowing their time is up, its members just jump ship and leave the whole thing unattended" (Straits Times, 28/9/99). One cabinet minister who resigned, A.M. Saefudin announced that he would be a presidential candidate, challenging President Habibie. Abdurrahman Wahid also announced that he would be a presidential candidate. These developments, while deepening popular cynicism about the ambitions of several senior politicians in the Habibie cabinet, also indicated that the presidential race could become both bitter and divisive.

In the event the election went more smoothly than many had feared. President Habibie made a speech accounting for his period in office; this was expected to be accepted by the MPR, albeit with a small majority. When it was rejected, a clear signal was given that Dr Habibie's hopes of re-election were virtually zero. He then announced that he would not be a candidate, leaving the way open for a race between Abdurrahman Wahid and Megawati Soekarnoputeri. Wahid won by a surprisingly large majority (373 votes to 313), which was in part due to the perceived lack of effort on the part of Megawati to solicit support for her candidature. The disappointment felt by many of Megawati's supporters led to violent demonstrations in Jakarta, and in several other locations. But what could have been a very tense stand-off between the two candidates was defused when Megawati was voted into the vice-presidency by a large majority. The new "Cabinet of National Unity" announced by President Wahid contained some well-known reformers but also a number of relative unknowns. The key job of Coordinating Minister for Economics and Commerce was given to Kwik Kian Gie, a Megawati supporter of long-serving member of parliament for Megawati's party. Kwik has long been a high profile figure among opposition politicians in Indonesia and an outspoken critic of corruption and cronyism in the Soeharto era.

The new Minister of Finance by contrast, Bambang Sudibyo, is a little known academic from Gadjah Mada University who is a close associate of Amien Rais. The Industry and Trade portfolio went to Jusuf Kalla, a businessman from South Sulawesi and Laksamana Sukardi, a former banker and Megawati supporter became Minister for Investment and State Enterprises. He will oversee the privatisation process. It is still too early to predict how this rather disparate group will perform as a team; by early December 1999 there were already rumours of Mr Kalla's involvement in corrupt practices under the Soeharto and Habibie administrations. Accusations of corruption also led to the dismissal of Mr Hamzah Haz, the Coordinating Minister for People's Welfare and Poverty Eradication. President Wahid admitted that many members of the cabinet got their jobs as a result of political horse-trading and some were scarcely known to him. This hardly boded well for effective decision-making in the coming months and years.

It is clear that the economic and social reform agenda which faces the new administration is daunting. One of the few respected technocrats in the Habibie administration, who did stay at his post in the run-up to the MPR, Minister of National Economic Planning Dr Boediono, set out what he saw as the main medium term challenges in a speech delivered in mid-August. He stressed that the crisis had left a "costly economic legacy" not just in the form of a devastated banking sector and a deeply indebted non-bank corporate sector, but also in the form of severe constraints on the public finances which would in turn limit the capacity of government to spend more on infrastructure rehabilitation and expansion, and on education and health care. In order to overcome the fiscal constraint, the government will have to work hard at increasing government revenues (by several percentage points of GDP), while at the same time prioritising expenditures on infrastructure maintenance, on basic health care and education, so that the neediest receive the services they require while those able to pay are encouraged to do so. He also stressed the need to improve the business environment by removing burdensome licensing requirements which often affect small and medium scale businesses most severely. In addition he emphasised the need for fundamental reform in the legal and judicial systems.

Very few informed commentators would disagree with this list; many would probably want to add further items. Some of the reforms which Dr Boediono emphasised will not involve large budgetary expenditures but they will challenge powerful vested interests in both the bureaucracy and the private sector. The new parliament will certainly be more supportive of the broad goals of reformasi than the outgoing one, but it would be naive to imagine that many of its members will not succumb to monetary and other inducements offered by powerful individuals and groupings, whether political, economic or religious. The challenge not just for the administration of President Wahid, but also for those which will succeed it, will be to improve the accountability of public officials and public institutions at all levels. Only by strengthening existing audit procedures and putting new ones in place can corruption be brought under control. A free and responsible press is also essential in controlling abuse of office. These institutions have taken many decades, indeed centuries, to develop in the western democracies and they can hardly be expected to emerge overnight in Indonesia. But a start has been made, and the task now is to persevere, whatever the composition of the new administration may be.

© Friedrich Ebert Stiftung | technical support | net edition fes-library | September 2000