INDONESIA ECONOMIC TRENDS 1999
-- SIGNS OF LIFE

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Economic Issues during the Political Transition

24. The above figures formed part of the backdrop for the public debate that surrounded the parliamentary election and its aftermath. As of July 1999, it was unclear what sort of government would emerge by the end of 1999, and leading political parties (PDI-P, Golkar, PKB, PPP, and PAN) had not yet articulated clearly what changes in Indonesia's economic policies they would seek.

25. Though the politics remained uncertain, it was clear that the a new government would have to face at least the following financial, real sector, and institutional issues:

Financial Sector
--Banks:

26. The banking sector took a direct hit in the financial crisis, and recovery efforts were still in the early stage. The IMF, World Bank, and Asian Development Bank were assisting Bank Indonesia, the Ministry of Finance, and the Indonesian Bank Restructuring Agency (IBRA) in this effort. The government had begun issuing recapitalization bonds to a few eligible private banks under a formula whereby the bank owners were obligated to provide 20 percent of the required capital, and the GOI would provide the rest, becoming the majority owner. An equivalent process involving the state-owned banks, where problems were larger, was to begin in July or August. The interest-bearing bonds replaced non-performing loans, which were in turn transferred to IBRA for collection/restructuring. Estimates were that the GOI would issue about Rp 550 trillion (US$ 80 billion) in recapitalization bonds, equivalent to 55 percent of 1998 GDP.

27. Paying the coupon (mostly linked to market interest rates) on those bonds would seriously crimp a new government's budget for several years, but declining interest rates made the payments appear more feasible. IBRA's program to restructure and recover non-performing loans from the rescued banks was'an essential element in financing the program. For FY 1999/2000, the GOI estimated that Rp 34 trillion (about US$ 5 billion) would be needed to pay the interest costs. Half of that (Rp 17 trillion) was on the GOI's budget, and IBRA was expected to provide the other half. IBRA's Rp 17 trillion was to come partly from sales of assets that firms pledged to pay for their earlier bank liquidity credits, and from loan recoveries. However, as of July, IBRA had hardly begun either asset sales or loan recoveries, having auctioned only some, vehicles and paintings.

28. The loan recovery effort was also a political issue because the debtors, whose company names and amounts were published in newspapers in June, included many Soeharto family members and close associates. IBRA faced a dilemma: on the one hand there was pressure to foreclose on debtors and sell their assets quickly to raise funds and to underline the seriousness of the program, but such quick sales would depress market prices and could lead to allegations of preferential treatment if some debtors managed to buy back their assets cheaply.

--Debt:

29. Indonesia's private external debt stood at US$81.5 billion as of March 1999, according to the Bank Indonesia Governor's July 1999 testimony to parliament. (For a breakdown of the debt according to publicly available information as of late 1998, see table 10). In addition, there was approximately US$ 50 billion in domestic corporate debt. The debt had increased since the onset of the economic crisis in mid-1997, when borrowers were caught unable to service their debts as the rupiah depreciated and economy slowed, and lenders refused to roll over short-term loans or extend new credits.

Table 10. Indonesian Foreign Debt Overhang

Note: Available data for November 1998.
Sources: Bank Indonesia and World Bank.

30. Restructuring efforts were underway in many cases but were inherently complicated. Neither the Indonesian Debt Restructuring Agency (INDRA, essentially a swap facility allowing debtors to lock in a Rp/US$ exchange rate, with the requirement that they begin making rupiah payments immediately), the revised bankruptcy law that took effect in August 1998, nor the Jakarta Initiative (facilitation service, with assistance from internationally experienced debt workout specialists) launched in November 1998 had made significant headway in resolving the issue.

31. Foreign creditors said inconsistent bankruptcy procedures were a serious problem, since the result was that debtors did not feel compelled to come to the table. In some cases it was creditors (those who had already provisioned for the non-performing loans), rather than the debtors, who were seen as dragging their feet in hopes of improved economic conditions that would lead to more favorable settlements. The issue was becoming more complicated in light of IBRA's high-profile efforts to recover domestic debts, because many of the same firms had substantial foreign debts.

32. There were some signs of progress as of mid-1999, as the Jakarta Initiative started to get up and running and anecdotal evidence suggested the debtors were becoming more willing to negotiate. one high-profile group, Astra International (automobile assembly and sales and palm oil export, among other businesses), reached agreement in June 1999, after over a year of negotiations, to restructure US$ 1.1 billion in foreign debt and additional domestic debt.

Real Economy
--Real sector recovery/restructuring:

33. It was essential to revitalize the real sector, but there was no way to address the real sector fully without resolving financial issues first. Banks had to be more stable and corporations had to become more creditworthy (by resolving existing debts, for example) before normal lending for working capital and business expansion could resume.

34. Furthermore, in the context of the overhaul of the political system that was underway, many Indonesians wanted to overhaul the economic system too, rather than try to simply restore the pre-crisis structure. This added complexity to the recovery process. The deep recession that resulted from the financial crisis was not viewed as a purely economic issue that called for technical solutions, but instead as the result of years of crony capitalism in need of a top-to-bottom overhaul.

35. One line of argument -- stemming in part from the November 1998 People's Consultative Assembly (MPR) session that mandated development of a "people's economy" -- held that the government should foster growth of small and medium enterprises, so that control of the economy would not simply revert to conglomerates when the economy recovered. The issue was sensitive because many existing conglomerates were owned by ethnic-Chinese Indonesians. It was also difficult to imagine an impartial way to change the ownership of existing firms or parcel out shares in state-owned corporations. The "people's economy" debate was muted as of mid-1999, but remained a potential political issue.

Social Safety Net:

36. Indonesia has historically not had much of a social safety net system, so introducing one in mid-1998 to address poverty and unemployment on an emergency basis was difficult. The government initially created programs in three areas to help the poor: ensuring food availability (almost 10 million households were said to be purchasing rice at subsidized prices as of February 1999); supplementing purchasing power through job creation and loans to small enterprises (labor-intensive public works projects, for example); and preserving access to education and other critical social services (in part through block grants to poor schools).

37. In FY 1999/2000 (which began April 1), the GOI allocated 12 percent of its budget (about US$ 3.8 billion out of a US$ 33 billion budget) to social safety net programs, in part to be financed through a US$ 600 million World Bank loan. The program was widely viewed as necessary not only to help the targeted groups, but also to provide a general fiscal stimulus to the economy. Even so, the program remained controversial because there were allegations of leakage and because some non-government organizations argued that the assistance was not reaching the neediest families. A new government would have to contend with such criticisms, as well as decide at what level to continue such programs.

Institutional and Legal Issues
Corruption:

38. Eliminating "collusion, corruption, and nepotism" (KKN) remained the slogan of the day. The issue remained more political than economic, and more sound than substance, but a new government was likely to have to account for its efforts to overturn the culture of corruption that permeated business and government. That would be no easy feat. As of mid-1999, there were distinctions being made between the alleged corruption of former President Soeharto and his family and close associates, business tycoons who abused bank regulations, and "ordinary" corruption in the government. There were calls for the perpetrators in the first two categories to be brought to justice, but broad-based civil service reform was seen as needed for the latter. Public interest in anti-corruption efforts remained high. Non-government organizations were reporting allegations of government officials, corruption to the media, and had published detailed studies of the cost of corruption in certain areas of everyday life, such as obtaining identity cards.

Legal reform:

39. As a subset of the corruption issue, the dysfunctional legal system was increasingly being viewed as a root problem that had to be addressed before lasting economic recovery could occur. Both improved law enforcement and improved laws were needed. The magnitude of the crisis meant that a range of new legal issues had arisen, placing increasing stress on a system that malfunctioned to start with. Issues such as bad loans were nearly impossible to resolve in a system where property rights were only vaguely defined, there was no central registry for collateral, and court decisions were often controversial or unenforceable. Foreign and domestic creditors attempting to use the commercial courts got a taste of this. Political figures appeared to appreciate the seriousness of the issue and were already calling for replacement of supreme court justices, but no one had come forward with a comprehensive action plan for legal reform.

--Regional autonomy and fiscal equalization:

40. A new issue on the horizon--not directly resulting from the economic crisis, but part of the ambitious slate of laws passed in 1998-99--was a rearrangement of central and regional government authority and revenue. President Habibie signed two companion laws in May 1999.

41. The "Regional Government Administration" law said that governmental authority should devolve to the level of "autonomous regions," in most cases meaning the sub-provincial regency level (roughly equivalent to a U.S. county). Exceptions were foreign affairs, defense, justice, monetary, and religious affairs, and would also include "national strategy" and "regional strategy" issues, not yet defined. The "Fiscal Equalization" law said that the central government would share revenues with regions. It included specific revenue sharing formulas for natural resources such as oil and gas.

42. The laws were to be implemented over two years, but officials at both the central and regional levels were uncertain about that timing and concerned that the laws were mutually inconsistent. Regulations remained to be written. Even so, one Finance Ministry official said, the laws amounted to a "revolution" in that they transferred a great deal of power to regional governments. Activists in restive provinces such as Aceh and Riau had already proclaimed the fiscal sharing law insufficient, and a new government was sure to have to cope with both the logistical and political complications of the issue.

next: Policy Outlook -- Continuity Expected
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