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Overview
Prior to the Asian financial crisis of 1997, Indonesia, with its abundant natural resources and low labor costs, had one of the fastest growing economies in the world. Economic growth was very high, with an average growth rate of 7% between 1987 and 1997. At the same time, inflation remained low and the country's budget was balanced. These accomplishments, combined with the relative stability of the rupiah, turned Indonesia into one of the world's major emerging markets in the early 1990s.
However, these successes were deceptive, for massive capital inflows, averaging 12.7% of GDP in the years preceding the crisis, masked structural flaws and high levels of corruption. When the spillover effect of the 1997 financial crisis in Southeast Asia struck Indonesia, the country's economic structure was unable to cope. Foreign capital began to flow rapidly out of the country, triggering a collapse of the undercapitalized banking sector. Further, pressure on the rupiah led the government to abandon its informal peg with the US dollar and the value of the rupiah dropped by 75%. This currency crisis greatly damaged the ability of both the private and public sectors to service foreign debt. In 1998, GDP dropped by 13.7%. It only rose 0.2% the next year. This coupled with a spike in inflation during the crisis pushed almost 50% of the population below the poverty line.
Today the economy is beset by a variety of serious problems, although a slow and steady recovery seems to be underway. Since Megawati Sukarnoputri entered office in July 2001, the economic situation remains extremely tenuous. According to the Asian Development Bank (ADB), economic growth, previously driven by exports and domestic consumption, is set to slow slightly to 3.0 percent compared to 3.3 percent in 2001, and 4.8 percent in 2000. Natural disasters, such as flooding in Java, unemployment, and continuing security concerns will likely restrain domestic spending and foreign investment. Another concern is World Bank estimates of government debt that may remain at 99% of gross domestic product (GDP) in 2001. However, inflation is expected to accelerate only moderately, to an annual average of 8% in 2001 - a great improvement from 77% in 1998.
For a private sector view on the Indonesian economy, please see the following resources:
For more on oil and gas
For more on plywood
For more on textiles
For more on electronics
Natural Resources
Indonesia's main exports include oil, natural gas, plywood and manufactured goods. Indonesia is the 17th largest oil producer in the world and the only Asian member of the Organization of Petroleum Exporting Countries (OPEC). It accounts for about 1.9% of the world's oil production. Oil and gas remain critical to the Indonesian economy. The value of oil and gas exports reached 23% of all exports in 2000, compared with 20.1% in 1999. Indonesia has also been expanding its copper, nickel, gold and coal mining capacity for many years, although their contribution is still minor compared to oil and gas. The coal sector was opened to investment in 1993.
For more information on Indonesia's oil and gas sector, see:
Embassy of the United States of America. Petroleum Report Indonesia 2001, October 2001.
The state nationalized all natural resources under the Suharto regime and still owns all oil and mineral rights. This monopolization limits the participation of foreign firms to production sharing and work contracts. Major foreign oil and gas companies invested in the country are growing increasingly concerned about civil unrest in some of their areas of operation and increased levies by provincial governments with regional autonomy. Further, the government run oil company, Pertamina, retains a monopoly within Indonesia until 2004, which has dissuaded foreign oil companies from beginning new ventures.
Unsustainable logging operations have caused widespread pollution and environmental degradation and have sometimes destroyed the habitat and livelihood of local indigenous communities. The corrupt allocation of logging concessions and Government Reforestation Funds has been another source of disaffection and tension.
Macroeconomics
Indonesia's economy faces many challenges. Unemployment is extremely high, with an estimated 45 million Indonesians out of work. Further, public debt is also very high, at a level equal to gross domestic product. The government is attempting to curb the public budget deficit in an effort to attract investors back to the country.
For more information, please see Bank Indonesia's inflation report and the full IMF report
The government plans to undertake reforms, but success will require strict vigilance, which may be difficult to maintain at a time of political upheaval. The World Bank says it will increase lending to about $1 billion annually from 2002 if reforms accelerate. However, the bank will cease all lending if the government slips on corporate restructuring and in the case a breakdown in law and order.
The bank has lent billions of dollars to development projects and financial packages. A Consultative Group of Indonesia (CGI) meeting in November 2001 resulted in a decision to disburse over $3 billion, $1.3 billion of which would be tied to progress on policy performance, including a poverty reduction program.
For more information about World Bank programs in Indonesia, please see:
Project Highlights
The IMF completed its fifth review of the Indonesia program and voted to disburse $347 million, thus showing its support for Indonesia's restructuring policies.
For more information, please see Indonesia Update http://aric.adb.org/external/arr2001/indonesia.pdf" target="_blank">The World Bank and Indonesia.
World Bank. The Imperative for Reform. Brief for the Consultative Group on Indonesia, prepared for 11th. CGI Meeting, Jakarta, November 7-8, 2001.
Public Debt
The debt totaled $136 billion in 2002 - roughly equal in size to Indonesia's gross domestic product. In April 2002, the Paris Club of foreign investors under CGI agreed to reschedule $5.4 billion, which falls due between April and December, a development that should have a positive effect on investors. The rupiah was trading at 9,525 to the U.S. dollar on April 12, 2002 - nearly a 6 month high, indicating that this may be the case. Some however, believe that the debt rescheduling does not go far enough and that debts accumulated under the dictatorial regime of Suharto should be canceled.
The debt "exacts a major human cost by absorbing funds that could be used to foster growth and alleviate mass poverty," according to the International Crisis Group and as a result, the government may possibly "have to default on some debt or that the cost of repayment will inflict unbearable damage on other areas of public spending." Bringing public debt to a manageable level is a major focus of government policy, with the goal of reducing the debt to 60 percent of GDP by 2004. Towards this end, the government increased heavily subsidized fuel prices in January 2002, while simultaneously compensating the poor to decrease negative social consequences. However, the fuel subsidy remains substantial, at Rp 53.8 trillion or 3.7% of GDP. The government is also selling its stake in banks that were bailed out during the crisis. A majority share of Bank Central Asia (BCA) was sold in March 2002, and Bank Niaga is now for sale.
For more information, please see Bad Debt: The Politics of Financial Reform in Indonesia.
Poverty
According to World Bank estimates, over 30 million Indonesians live below the poverty line, and a substantial number more live just slightly above it. To help alleviate poverty, the government is pushing economic growth by focusing on strengthening rule of law and the judiciary, in part to reduce corruption, which will take time. Further, spending on education and health care are emphasized, although the responsibility for these services is passing to the provinces through decentralization. The Indonesian government has formed a committee to construct a nation-wide poverty alleviation strategy.
With much of the responsibility for social programs shifting to the provinces as a result of the regional autonomy legislation passed in early 2002, it remains to be seen whether local government will be able to implement effective programs to curb poverty. The 2002 state budget allocation for development, including education, agriculture, forestry and fishing projects, is Rp 47.1 trillion, or 2.8% of the budget.
Corruption
Indonesia is considered one of the most corrupt countries in the world, and corruption has been cited as one of the major factors holding back foreign investment. Many observers have reported that public and private funds, both domestic and foreign, are often not spent for their intended purpose and that a large proportion of development projects, including those financed by international donors, are affected by corruption. Corruption extracts a high cost from society and from the poor in particular, with an estimated 1 to 5 percent of income or revenue spent on unofficial payments. While anti-corruption laws do exist, they are largely ignored.
For more information, please see Transparency International's 2001 Global Corruption Report
During the 1990's, Indonesians began speaking out against nepotism and the concentration of power at the top. Suharto's children, cronies and military allies controlled many lucrative areas of business. For example, in 1996, Suharto granted a car making and clove trading monopoly to one of his sons. Indonesian government officials and opinion leaders believe that corruption, both public and private, is "widespread, systemic, and deeply embedded." (see Indonesia's 1999 Elections : A Second Chance for Democracy http://www.asiasociety.org/publications/indonesia/#The_Habibie_Administration) However, despite increased awareness of the problem, little real progress has been made.
Measures that are considered necessary to fight corruption effectively include improving the transparency of setting government budget priorities, improving audit arrangements, more careful structuring of the budget and improving the pay and quality of the civil service as well as strengthening the tax and legal systems.
For more information, see A Diagnostic Study of Corruption in Indonesia, Final Report, February 2002
Decentralization
Traditionally, nearly all of Indonesia's revenue from across the archipelago flowed to Jakarta, where most of it stayed. In 1999, the central government kept 94% of budget revenue.
However, beginning in 1999, the government began to decentralize its authority through autonomy laws passed by the Indonesian parliament, which have granted considerable power to the provinces. Laws on regional autonomy, applicable to the entire country, were passed in early 2001. Shortly thereafter, "special autonomy" was granted to the provinces of Aceh and Papua, where violent separatist conflicts have been ongoing. Mining projects in cooperation with foreign investors, such as Rio Tinto's gold mining company, were postponed in 2001 due to unstable security conditions and uncertainty over the autonomy laws. As the decentralization programs are still in the implementation stage, it remains to be seen what effect they will have on the economic well being of Indonesia and its provinces.
For more information on decentralization, see:
Syaikhu Usman. SMERU Report, "Indonesia's Decentralization Policy: Initial Experiences and Emerging Problems."
Toto Colongon, Hana Satriyo, and Adi Abidin. 1st Indonesian Rapid Decentralization Appraisal (IRDA).
Tapol Bulletin. "Can 'special autonomy' work?"
View more information on laws.
Challenges
Many of the weaknesses that exacerbated the financial crises in 1997 remain. These include a lack of government transparency and capacity, widespread corruption, a weak judiciary, vast economic inequalities and endemic poverty. The legal and banking sectors are in need of further reform, while the intensifying political turmoil in the provinces is likely to continue to deter foreign investment. Systemic reform will likely be slow and cautious. Through the Consultative Group of Indonesia (CGI) annual meeting of donor countries, the international economic community has been closely observing the implementation of Indonesia's economic and social policies.
In order for economic reforms to succeed, experts agree that progress will be required on a wider range of issues, including the reduction of corruption in politics and the legal system; greater governmental cohesion and a less adversarial relationship between the government and parliament. Analysts fear, that at this time of unstable domestic politics, it is not realistic to expect rapid progress on the financial reform agenda. Many analysts have stressed the need for law and order prior to effective international economic support.
For more information, please see Press Conference by IMF Managing Director April 27, 2001.
The IMF priority with the Indonesian government is to address the budget problem through bank reforms, corporate restructuring and legal reforms. The World Bank's main stated focus is to reduce poverty and vulnerability to poverty. The bank wishes to achieve this through efforts to attain macroeconomic stability, and accelerating bank and corporate restructuring.
For more information, please see Consultative Group for Indonesia, Jakarta, November 7-8, 2001
Resources
International Monetary Fund News Brief. "IMF Completes Fifth Review of Indonesia Program, Approves US$347 Million Disbursement."
Asia Times, "Invest or not? Indonesia Back in View."
Economist, "Trading on her father's image."
World Bank Brief. The Imperative for Reform.
World Bank. Prospects for Recovery and Reform in Indonesia: Talking Points for Visit to Tokyo, January 30 to February 1, 2002.
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