Global Policy Forum

By Ross Gittins

If poverty in Muslim countries provides a fertile ground for terrorists, we've suddenly discovered a reason for caring deeply about the economic progress being made by our next-door neighbours in Indonesia. Unfortunately, the news wasn't good even before the Bali bombers blew a hole in the prospects for tourism and foreign investment.

Superficially, however, it doesn't seem too bad. Take the figures released just this week by Professor Ross Garnaut, chairman of the Pacific Economic Outlook forecasting group. We were told that, after growing by 3.3 per cent in 2001, Indonesia's real GDP was expected to grow by 3.9 per cent this year and by 4.1 per cent next year (after subtracting 1 percentage point as an initial estimate of the lost income caused by the bombings).

What's wrong with that? Nothing if you've got a developed, mature economy such as ours. But if you've got a relatively undeveloped economy such as Indonesia's, it's simply not good enough. Because of its rapidly increasing population, because of its woefully inadequate infrastructure and because too much income finds its way into undeserving hands, Indonesia needs growth of about 6 per cent a year if ordinary workers are to be perceptibly better off and the ranks of the poor diminished.

And, in normal circumstances, 6 per cent a year isn't a big ask. For the three decades of President Soeharto's rule, annual growth averaged 7 per cent. But that, of course, was before the Asian crisis of 1997-98. Of the five countries most affected, Indonesia was by far the hardest hit - partly because of initial mismanagement by the International Monetary Fund. Five years later, its economy is still firing on only two cylinders.

So what actually happened? Indonesia had been enjoying the supposed benefits of the globalised financial markets. For several years, foreign banks had been eager to make short-term loans to local banks and corporations. Because the rupiah was informally pegged to the US dollar, people were happy to borrow in US dollars without bothering to hedge against adverse currency movements.

The same thing was happening throughout East Asia, but when a Thai bank fell over, the formerly gung-ho foreign investors got an attack of the collywobbles. A new and radical thought struck them: "Did you know there's a lot of corruption and cronyism in Asia? Really? Gosh, I want out."

The "contagion" spread from Thailand to Indonesia. All the foreign short-term lenders wanted their money back instantly. The authorities couldn't hold the fixed exchange rate and had to let it float - whereupon it sank like a stone. All the banks and corporations with unhedged US dollar loans found their value in local currency had suddenly doubled - as had interest payments. Virtually all the banks were under water and, eventually, 70 to 80 per cent of corporations became technically insolvent.

The IMF blundered in with its standard formula, designed for Latin America. It insisted the government jack up interest rates and slash spending, particularly on food and petrol subsidies. This made everything much worse, adding to the number of city workers thrown out of their jobs, particularly on Java. Prices jumped by 60 per cent. By May 1998 there was rioting and looting of shops owned by ethnic Chinese.

The government took over the banks it didn't already own, recapitalising them by replacing their bad debts with government bonds, on which it promised to pay interest. It borrowed heavily from the IMF, the World Bank, the Asian Development Bank and friendly governments such as ours. So now the Indonesian Government has debt equivalent to more than 100 per cent of GDP, roughly half foreign and half domestic (the bonds given to the banks). The interest bill on this debt absorbs about a quarter of total government spending.

Real GDP fell by 14 per cent, but real earnings per worker fell by 27 per cent. Officially, unemployment has increased only to 8 per cent, but this ignores all the city workers who, having lost their jobs, returned to their villages and thereby dropped out of the "formal" labour market. The World Bank's standard measure of extreme poverty is an income of less than $US1 ($1.80) a day. In 1996, half of all Indonesians had less than $US2 a day. By 1998, it was nearer two-thirds.

The one good thing Indonesians have to show for the crisis is the fall of the Soeharto regime and the advent of democracy. But they're paying a heavy price for their fledgling democracy. Government is more inefficient and corrupt. Decision-making is painfully slow. They haven't found a sensible balance between the legislature and the executive. They are decentralising government not to the regional level (regional governments might want to secede from the union) but the local level - which promises to make things even more inefficient and corrupt.

Five years after the crisis, not enough has been done to clean up the financial debris and the economy is merely limping along. Bank lending isn't growing and, in the absence of proper bankruptcy laws, many corporations remain insolvent. Foreign direct investment is continuing to leave, giving the country a capital account deficit - and, hence, a current account surplus. So exports greatly exceed imports, but not so much because they're booming (even though, with the rupiah still so weak, they're highly price-competitive) as because imports are flat.

(While I'm filling you in, agriculture accounts for 10 per cent of total exports, mining for 12 per cent and oil and gas for 23 per cent, leaving 55 per cent for labour-intensive manufactures such as textiles, clothing and footwear.)

Imports are weak partly because consumers have turned to (much cheaper) locally produced goods, but also because, with no inflow of foreign private capital, there's little business investment and so little importation of capital equipment. (Like all Asians, the Indonesians are perfectly capable of achieving rates of domestic saving that are amazing by Western standards. But for this they need that 6 or 7 per cent rate of growth in income, which they're not getting.) So what little growth the Indonesians are getting is coming mainly from consumption.

There's not nearly enough business investment and the government is in no position to be pumping money into social and economic infrastructure (or even to pay public servants decently as a first step towards reducing corruption). And exporters face too many other difficulties to adequately exploit their super-competitive exchange rate. Now add continuing population growth and our neighbours are left with living standards - real income per person - that, five years later, remain lower than in 1997 before the crisis. Not a plus point for the stability and security of our region.

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