| Consultative Group for Indonesia Tokyo, October 17-18,
2000
Statement by Mr. Anoop Singh, Deputy Director, IMF
1. Ladies and Gentlemen, it gives me great pleasure to be here. I am happy to report on
our recent contacts with Coordinating Minister Ramli and the new economic team in Jakarta.
As all of you here are aware, only last month, the IMF's Executive Board approved the
second review of the extended arrangement with Indonesia. This review was based on the
commitment of Minister Ramli and the new economic team to intensify implementation of the
program within the context of their new ten-point strategy for economic recovery and
poverty alleviation. Shortly, an LW team will begin discussions with the government on the
next quarterly review under the program.
2. The economic context for intensifying implementation of the program has improved
progressively during 2000. Indeed, recent indicators point to an economic recovery that is
developing more strongly than expected. Let me focus on three aspects of the ongoing
recovery that warrant attention:
- Real GDP growth accelerated to more than 4 percent in the second quarter, and we can
safely expect growth for the year to exceed the upper bound of the program's 3-4 percent
target range.
- The recovery has broadened beyond its initial dependence on consumption. There is
growing strength in a variety of key economic indicators, such as industrial electricity
usage and cement sales, testimony to the beginnings of a pick-up in investment.
- Export growth has been robust. Of course, Indonesia is benefiting greatly from higher
world oil prices. However, non-oil exports have also been growing strongly so far this
year---over 25 percent on a 12-month basis-with major contributions from both
resource-intensive and industrial products.
3. While the recovery has been stronger than expected, market sentiment continues to lag
behind the economic indicators. Although regional currency weakness has been a factor, the
decline in market sentiment has been particularly pronounced for Indonesia. The rupiah
continues to trade in an overly depreciated range near Rp9,000 to the US dollar; the stock
market has fallen almost 20 percent since early August, and the sovereign bond yield
spread has widened well beyond those of other Asian crisis countries.
4. The rupiah weakness is beginning to affect the macroeconomic framework. After a
prolonged period of virtual price stability, inflation has begun to creep up in Indonesia-
rising to about 7 percent on a 12-month basis, and even higher if the favorable effect of
falling rice prices is excluded. Therefore, inflation is likely to end the year somewhat
above the 5-6 percent range in the program. As a result, it has become more difficult to
make the macroeconomic policy mix as supportive of recovery as envisaged in the program.
There has been upward pressure on interest rates and the yield curve has steepened in
recent months. At the same time, the fiscal performance has been significantly stronger
than envisaged, although this is principally attributable to more buoyant oil revenues.
5. On balance, the program's macroeconomic framework for 2001 should still be considered
within reach. The framework aims at delivering 4-5 percent growth, a decline in inflation
from about 7 percent at end-2000 to 5 percent by end-2001, and further accumulation of
reserves. The current account surplus is expected to narrow somewhat, reflecting a
continued recovery in imports. We will discuss this framework with the authorities as part
of the discussions for the next review. A common goal will be to consider early measures
that will improve market confidence in the program and reduce the high downside risks to
which the macroeconomic framework remains vulnerable.
6. In this context it is commendable that the authorities have prepared a budget for 2001
that is well balanced between conflicting objectives. Most importantly, for the
medium-term framework (to which I will return shortly), the budget signals the start of
fiscal consolidation efforts. The target deficit of 3.7 percent of GDP is well below the
initial target for FY2000 and, in addition, has appropriate elements of caution built into
it; these include the use of a conservative oil price assumption and a contingency fund to
protect the budget from the risks of implementing decentralization (I will have more to
say on decentralization a little bit later). The authorities have also committed
themselves to make further progress in reducing untargeted subsidies during
2001---especially those that arise from petroleum products--while improving local
infrastructure and strengthening support for the poorest households. We have also urged
the government to review public sector wage policy so that it is more carefully tailored
to reforming the civil service and implementing decentralization. A succession of general
wage increases over the past two years has now restored average public sector wages to
their pre-crisis level, thereby giving the flexibility henceforth to focus on improvements
in structure and efficiency.
7. Overall, the budgetary framework and the associated financing need are, therefore,
deserving of support by the international community. The larger part--almost
two-thirds--of the budget deficit in 2001 is planned by the authorities to be met by asset
recovery--both from IBRA and from the privatization of state-owned enterprises. All things
considered, these targets for asset recovery can be considered to be achievable, although
intensified efforts will be necessary, especially giving privatization new momentum. This
leaves a net financing need of about 1 1/2percent of GDP or about $2.8 billion. In
addition, amortization payments of about $5 billion will fall due in 200 1.
8. As in previous years, we continue to counsel strongly against any use of domestic bank
financing to meet the budgetary needs. The bond market is also not sufficiently developed
to begin any significant bond sales for the purpose of financing the budget
deficit-indeed, the government's domestic debt (at about 50 percent of GDP) is already
overly burdened by the resolution of Indonesia's financial crisis. This means that the
international community should, as far as possible, contribute to meeting the remaining
financing need. Fortunately, rescheduling arrangements already in place by the Paris Club
and London Club will help meet scheduled amortization payments, and there is considerable
room to draw down the pipeline of project financing. This leaves about $2 1/2 billion that
will need program financing. Again, the larger part of this should be met through drawing
down on existing commitments, minimizing the need for new exceptional financing.
9. Implementation of the 2001 budgetary framework will go a long way toward setting the
stage for sustained recovery over the medium term. The IMF staff has looked at alternative
scenarios for the development of Indonesia's medium-term outlook. In our view, Indonesia
retains the clear potential for emerging fully from crisis in the coming years.
Indonesia's ability to reduce its government debt burden in an orderly way during this
period will be a key enabling condition for sustained recovery. Indeed, our projections
point to the feasibility of Indonesia being able to reduce its government debt burden from
its present level of 90 percent of GDP to about 65-70 percent of GDP by 2004. Such an
outlook is, of course, predicated on the ability of the authorities to entrench a virtuous
cycle of policy implementation and market response. Domestically, accelerated asset
recovery and intensified program implementation will be needed. If forthcoming, we can
expect them to be matched by rising market confidence that would stimulate new investment
and capital inflows, strengthening the exchange rate and allowing risk premia and real
interest rates to fall, thereby giving growth greater momentum.
10. Four sets of policy challenges are likely to define the course of Indonesia's medium-
term outlook.
First and foremost is asset recovery and restructuring
11. Three years into the crisis, markets still wait for Indonesia to demonstrate its
ability to deliver on the challenge of asset recovery and restructuring. Given that a
substantial portion of corporate debt remains unrestructured, this is clearly an
imperative for two reasons: first, to raise resources for the budget and help reduce the
government's debt burden; second, and fundamentally, to put the assets back to work in the
private sector. As such, the Fund-supported economic program contains quantitative targets
for the restructuring efforts of both IBRA and the JITF-the two principal institutions
charged with restructuring corporate debt. In IBRA, given the high proportion of debt that
is accounted for by the 21 largest obligors, the focus has been on this group. The
authorities have also began to take action against noncooperating debtors and former bank
owners, and IBRA's industrial assets sale program is being stepped up during the second
half of 2000.
12. At the same time, the experience in other Asian countries has cautioned that
considerable attention needs to be given to the governance of the process, especially the
quality of restructurings. These lessons also suggest that adherence to a set of
principles aimed at maximizing recovery for the state, transparency of process, and
procedures for oversight in all large cases, will be essential to maintaining quality,
uniformity of treatment, and market confidence. IBRA's new governing board should help
provide the institutional framework for such an approach.
13. An important burden also falls on the JITF-indeed, the difficulties are even greater
there because the JITF does not have the power to drive restructurings in the way that
IBRA is able to do. Nevertheless, in our view, the JITF has been reinvigorated under its
new leadership and policy framework. New restructuring incentives for JITF-led
restructurings have been developed, its case load greatly increased, and real progress is
finally being made in delivering completed restructurings. For sure, much more needs to be
done, and for this, the government should make fall use of the framework that allows
pressure to be placed on recalcitrant debtors.
The second major challenge is to take the banking system back to profitability
14. Given the past experience of failed public recapitalizations in Indonesia, as well as
the extent of the public support that has been provided in resolving the most recent
crisis, progress on bank reform is critical. Although the recapitalization process is now
virtually complete, the restructuring process-especially in the state banks-needs to be
carried much further, as the authorities have recognized. The IMF---along with the World
Bank, ADB, and others--is firmly engaged through policy advice and technical assistance in
helping with bank restructuring, raising supervision capacity, and helping improve
governance in the state banks. While progress is being made in these areas, profitability
in the banking system remains low, and there is need for considerable vigilance on the
part of the supervisory agencies to carry the process forward and maintain the highest
standards of governance.
15. Because of the financial crisis, state control of the banking system has risen
sharply. Presently, over 70 percent of banking system liabilities fall within the control
of the state (including IBRA). For this reason, the strategy in the program has
consistently emphasized the need to return the recapitalized banks to the private sector.
Ultimately, this is the best guarantor of governance, profitability, and competition in
Indonesia's banking system. However, the process has encountered setbacks. Recently, as is
now well known, the sale of IBRA's shares in two banks under its control was postponed to
2001. Markets leave viewed these sales as a bellwether of Indonesia's commitment to start
the process of returning assets to the private sector, To regain market confidence, the
government will need to schedule early timeframes for their sale in 2001.
The third major challenge is implementing decentralization with fiscal neutrality
16. The government is currently preparing to implement fiscal decentralization in 200 1.
There is much international experience that is guiding the government in its efforts,
including technical assistance from the World Bank and the IMF. Given the lessons of
international experience, the government is taking a number of actions to preserve fiscal
neutrality, prevent the general government deficit from rising during the decentralization
process and prevent failures of public service delivery. The immediate task is to ensure
that expenditure functions are transferred to local authorities in an orderly way, and in
step with the revenues that they will be receiving. Establishing the institutional
framework for this essential task is at the core of the authorities' current efforts. The
authorities are also considering mechanisms that would subject all borrowings by
subnational governments to strict limits. The international community needs to stand ready
to help the authorities in this historic endeavor.
The fourth major challenge is institution building and improved governance
17. The economic -program--and the successive letters of intent of the government--have
accorded high priority to institution building and improved governance, especially in the
economic institutions that are crucial for sustaining the macroeconomic framework and the
recovery. Improved fiscal transparency and measurement comprise one key set of
initiatives. With regard to restructuring policies, I have already spoken of the
initiatives that are crucial to the strength of the banking system. Equally important is a
robust and transparent institutional framework for asset restructuring and recovery,
focused on the institutions critical to overcoming debtor resistance. This includes reform
of the insolvency system and the improved functioning of the commercial court. Progress is
being made in all these areas. Slowly, the legal deterrent to recalcitrant debtors is
rising. Historic institutional change cannot come about overnight. In Indonesia, the
process is under way and we need to support it with technical assistance that also draws
on the lessons of international experience.
18. Allow me to conclude on an optimistic note. Indonesia today is, thankfully, in a very
different state from the crisis that characterized it just two years ago. Historic
economic as well as political change has been accomplished. The new economic team has
pledged policy continuity accompanied by an acceleration of structural reforms in key
areas. The financing needs that came to this meeting of the Consultative Group are now
relatively modest.
Progress is also being made in gradually reducing Indonesia's dependence on exceptional
financing. The international community should do all it can to further support Indonesia's
efforts.
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