Indonesia wakes up to a burning issue

PUBLISHED : Thursday, 15 September, 2005, 12:00am
UPDATED : Thursday, 15 September, 2005, 12:00am

Until late last month, Indonesia's government did little to stem the rupiah's long slide, perplexing many. That reflects Indonesia's new political reality: ignoring the poor masses that put the president in power could cost him the next election. But if other problems are not resolved quickly, they could sap the economy and also cost votes.

Bank Indonesia spent US$6 billion, or 15 per cent, of its reserves between April and last month supporting the rupiah. Yet, by late August, it was down 17 per cent against the US dollar since January, forcing the government to raise interest rates, despite the political cost, by 0.75 per cent to 9.5 per cent.

'They're going to have to raise the rates again as the real interest rate is only around 1 per cent, but they need a 2 per cent to 3 per cent real interest rate to get people back into the rupiah,' says James Van Zorge, senior partner with investment consultancy Van Zorge Heffernan Associates in Jakarta.

Low real interest rates are behind the economy's boom, with a growth rate of 5.8 per cent from January to June and most analysts looking at 5.5 per cent to 6 per cent next year. Exports could hit US$40 billion this year, helping the current account to a projected US$2.7 billion surplus. Though with oil and gas dominating exports, rising world oil prices skew the picture somewhat.

Higher interest rates alone will not restore confidence, however. More unpopular steps are still necessary.

'The rupiah's woes basically are not a monetary problem. So the solution should be a fiscal one,' says David Sumual, an economist at fund manager Danareksa.

Eliminating fuel subsidies would create a budget surplus, whereas now a deficit is building towards 2 per cent of GDP. That means shovelling more debt on to an already large pile demanding interest. Left in place, subsidies will cost the government up to US$14 billion this year, equal to about 4 per cent of GDP.

'They don't have money for education, health and other important needs. They should just bite the bullet now, but politicians are overly concerned about the backlash,' says Mr Van Zorge.

They have reason to be, for a poor electorate now chooses Indonesia's leader. Last year, they made Susilo Bambang Yudhoyono, a development scholar and former general, their first directly elected president.

Hence Mr Yudhoyono's preference for spending foreign-currency reserves before raising interest rates and a preoccupation with arranging compensation for 15 million poor families before cutting fuel subsidies.

A little currency drama and budget bother now, while painful for businessmen and investors, will be worth the cost if it helps Mr Yudhoyono keep his job at the next election. It now looks as if the government will start handing out compensation, and possibly trimming subsidies, late next month, during Ramadan. A little extra money will go down particularly well for Muslims who often travel for family reunions. But it will likely be months more before the rusty bureaucracy gets the scheme working.

'If we keep waiting for such a programme to be in place, first it will never happen, on the other hand if he jumps the gun without any programme, it will be political suicide. Even with a half-baked system in place, cuts can at least begin,' says Fauzi Ichsan, Standard Chartered Bank's Indonesia economist.

Delays leave less money in the budget for compensation, causing many to worry about a spiralling deficit. Still, other measures to stabilise the currency and bolster confidence, including ordering banks to keep more money in their vaults, give some reassurance.

And if Mr Yudhoyono makes good on new promises to solve investment disputes with big foreign investors and enforce clearer investment rules, sentiment could warm next year.

'They're putting the right policies in the works to deal with this instability, but you will not see them take effect for the next three to six months. They're basically laying the groundwork for more sustainable growth in the future,' says Ong Sin Beng, an economist with JP Morgan.

Even though this confidence crisis will likely clear up in a few months, thanks to higher interest rates and fuel subsidy cuts, the government cannot rest; other pressing problems need attention.

State oil firm Pertamina often buys about US$60 million a day - to pay for imported oil products, such as petrol - from the US$200 million a day foreign exchange market - increasing pressure on the rupiah. Before last year, oil producers gave the government's share of their dollar revenues to Pertamina. Now they pay directly to Bank Indonesia.

'By redirecting [Pertamina's] purchases to Bank Indonesia they can solve the problem very simply,' says Cyrillus Harinowo, a former central banker and now an independent commissioner for Bank Central Asia.

A better investment climate could eliminate these imports by encouraging investment in the refineries Indonesia needs. Electricity also faces supply problems.

Despite the infrastructure constraints and low labour productivity, government-approved foreign investment rose 79 per cent to US$6.64 billion for January to July.

'It's only 10 months into this government, but there has been a lot of interest from Asia Pacific investors,' says Mr Van Zorge.

Mr Ong says: 'The potential in Indonesia is significant, very significant. It is a question of transparency and implementing rules uniformly across all provinces.'