Indonesia: Return to Rapid Growth Cannot Be Taken For Granted


Dr Ross H. McLeod

Indonesia's draft 2003 budget announced in August this year is based on plausible estimates for inflation (8%), the exchange rate (Rp 8,700/$) and the interest rate (13%). Growth for 2002 is projected at about 4%, rising to 5% in 2003. Both projections are within the realms of possibility, but they seem too optimistic. The growth rate of GDP has been rising for the last two quarters, but it would be foolish to assume that this acceleration will continue.

A less promising picture emerges from investment spending, which is far more volatile than GDP. Its growth rate fell to -43% in the year to the December quarter 1998, rebounding to 26% in the September quarter of 2000. But it has been downhill since then, with growth of -7% registered in the December quarter last year. The deceleration was halted in the March 2002 quarter, but the absolute level of investment remained fully one-third below its pre-crisis peak.

These investment figures suggest that the economy is still far from being back to good health. Clearly, the private sector is still lacking in confidence. And without plenty of investment spending, it is difficult to be optimistic about growth prospects.

The government appears to see this as simply a business cycle problem that will go away as soon as there is some significant stimulus to aggregate demand. A better explanation is lack of certainty, which is largely attributable to the inadequacies of the legal system: its well-known inefficiency, incompetence and corruption. The legal system was no better during the Soeharto regime, but there was a certain consistency that derived from Soeharto’s domination of it. Although the rules of the game were heavily biased in favour of friends of the regime, at least they were reasonably well understood. But since Soeharto’s demise the legal sphere has turned into a free-for-all in which dishonesty goes unpunished, people of principle are threatened with bogus charges, and responsible firms are attacked by unscrupulous market predators.

Undertaking investments is very risky in such circumstances. Likewise, there is unlikely to be a resurgence of lending until banks can be confident that their rightful claims over borrowers will be properly enforced.

In short, there will be little reason for optimism about the medium to long term prospects for economic growth in Indonesia until the government commits itself to a thoroughgoing reform of the whole legal system.

WATCHPOINT: Rapid, sustainable growth is unlikely to return to Indonesia until firms and banks gain confidence in the legal system.


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