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Interview with Daniel Citrin: Investment climate holds Indonesia’s future

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
June 2003
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IMF Survey: Indonesia has a large and youthful population. Is its economy now in a position to create more jobs and do more to reduce poverty?

Citrin: Since the crisis, Indonesia has not yet had growth that’s been rapid enough to begin to reduce unemployment and poverty in a meaningful way. But it has registered a reasonable 3-4 percent growth pace over the past few years, and this has taken place in the face of severe external shocks, such as the aftermath of 9/11, the Bali bombing last October, the regional SARS outbreak, and the Iraq war. The economy really has been quite resilient.

With Indonesia’s significant achievement of stabilizing the macroeconomic situation and the progress made in restoring the health of the banking sector, the stage is now set for growth to accelerate to the 6 percent pace needed for unemployment to decline and poverty to be reduced substantially. But to achieve this, Indonesia will need to do a lot more to strengthen the investment climate. A stronger investment climate will require, among other things, legal reforms, anticorruption efforts, and appropriately balanced labor regulations—regulations that protect workers but allow for enough flexibility in the labor markets.

Fiscal and economic decentralization is another area that will need attention in this regard. It is an important part of the democratization process—something that the IMF has supported—but it has also led to a number of tax, trade, and other regulatory concerns. To work effectively, decentralization needs to be coordinated; otherwise, it will make it difficult for businesses to plan and operate in a stable environment. It will also be important to improve tax and customs administration. These are the sorts of areas that affect the investment climate—for foreign and for domestic investors—and it is where Indonesia now needs to shift its efforts.

IMF Survey: Is the will there?

Citrin: For many people in government, the will is there, but the big challenge is learning how to implement these reforms in a new democracy. The government certainly recognizes the problems and has the desire to change. But there are many areas, such as the legal system, where there is a need to fundamentally reform the way business is done and introduce efficient practices on the basis of good governance and accountability. While the country is well on its way to establishing the appropriate institutions, laws, and regulations, implementing these changes and having them really take hold is going to take time.

IMF Survey: Is the size and power of China’s economy also casting a long shadow?

Citrin: China’s economic strength obviously poses new challenges, but it’s not something that should necessarily be perceived as a negative for Indonesia or the region. First of all, China’s growth produces a vast export market for Indonesia. Also, it appears that there is now significant direct investment in Indonesia coming from China. A growing and emerging Chinese economy that is integrated with the rest of the world, including with southeast Asia, is a good thing for Indonesia—not something to be feared. But this does, of course, mean that Indonesia’s economy must be flexible to adjust to this challenge.

IMF Survey: During the Asian financial crisis, Indonesia’s banking sector was obviously a big issue. How effective has the restructuring effort been? And what role are foreign banks playing in this process?

Citrin: The first requirement of the restructuring process was to stabilize and recapitalize the banking system. That’s been done. The second phase involved returning ownership to private hands, because that’s the best way to ensure that financial intermediation takes place on a commercial basis and with good governance.

This second phase got off to a very slow start, but over the past year and a half there’s been a lot of progress. Since early 2002, Indonesia has sold majority stakes in three banks that it took over during the crisis. There are several still to be returned to private hands, which IBRA [Indonesian Bank Restructuring Agency] aims to do by early 2004. Indonesia has also started selling stakes in banks that had been under state ownership prior to the crisis.

The process has succeeded in injecting private ownership and expertise. IBRA’s three bank sales have all entailed foreign investor participation, which has provided not only capital but also much-needed technical knowledge and expertise. The banks are now in a much better position to support the recovery by revitalizing their lending activities.

A key issue here is the need to improve risk management. You don’t want banks to start lending without adequate supervision and without adequate internal risk management systems in place. At the same time, there needs to be a pool of creditworthy borrowers out there that the banks can lend to. Some of these things will take time, but we already see a resumption of lending to consumers and to the small and medium-sized enterprise sector. From our perspective, the restructuring process is now at a point where the banks should increasingly be able to resume normal functions.

IMF Survey: During and after the crisis, there were criticisms that the IMF was overly strenuous in the demands made in connection with its support for Indonesia’s adjustment program. True?

Citrin: I don’t think so. The IMF always tries to balance the need for adequate country ownership with the function we provide, which is conditional lending to encourage countries to make the right decisions and implement them, which is not always easy politically.

Indonesia’s crisis was deeper than other crises in the region and complicated by political factors. Implementation of the program came in fits and starts for perhaps two to three years. You can always go back and think about how certain policies could have been designed differently, but even if a better policy had been possible in theory, the question is whether it could have been implemented in a chaotic political environment and with so little information available to the staff in so many critical respects.

But once political stability was restored and policy implementation became more even, we saw the program start to work. Over the past couple of years, implementation has been much improved, and we’ve seen the fruits of the government’s hard work and the validity of the program’s basic approach. As a result, the country is now at a point where, upon the expiration of the current IMF-supported program at end-2003, it may be possible to forgo another arrangement with the IMF and end its reliance on exceptional financing from the Paris Club. Those are reasonable objectives to shoot for, and would be an indication of the success of the program.

IMF Survey: Whether or not Indonesia enters into another adjustment program with IMF support, it will be entering an election cycle next year, and these cycles are notoriously dangerous. Politicians are tempted to make short-term and dubious economic decisions, and markets are typically skittish. What can Indonesia do to stay on track and calm nervous markets?

Citrin: The authorities have to maneuver carefully through this period and work very hard in two ways—first of all, by making it clear to the public, including markets, that whether or not there’s an IMF-supported program, they will continue to pursue stable macroeconomic policies and steady structural reforms. The Indonesians should make it clear that this commitment to sound policy is their own, not something they are doing because it is imposed by the IMF. Then they have to convince the public and the markets that they can pursue their stated policy course by, of course, backing up their words with actions. These are the big challenges the government faces.

IMF Survey: Assuming the country is doing its part, how can the IMF help, particularly if there is no IMF-supported program in place?

Citrin: There are many ways we can support Indonesia. At the same time it’s important that Indonesia signal to the world that it will continue to cooperate with the IMF, and the international community, in a constructive way. Ending the IMF program, if that’s the course the country takes, is a sign that the recovery has reached a mature phase. We would expect thereafter the normal constructive dialogue between Indonesia and the international community to continue.

On the IMF’s part, we will continue to exchange views and assess policies in the context of our annual Article IV review of members’ economic policies, and ongoing surveillance through informal visits of headquarters-based staff as well as our resident representative office. We can continue to furnish technical assistance upon request. We currently provide Indonesia with technical assistance in tax and customs administration, public expenditure management, banking system supervision, and legal reform. With regard to the latter, we are helping Indonesia set up a commercial court system.

At the same time, and back to the issue of the program, as a member of the IMF, Indonesia should take advantage of our resources if the situation warrants, and the government should keep its options open. Of course, Indonesia is very aware that other Asian crisis countries have already graduated from IMF programs. So in that sense, it is understandable that it wants to stand on its own two feet. And it’s something the IMF supports—it is, after all, a sign of the program’s success.

But markets do get nervous. Thailand and Korea turned their financing arrangements into precautionary arrangements in 1999-2000. Other countries have asked for precautionary arrangements in similar circumstances. One concern had been the financing gap, but the other is what the Minister of Finance has coined as the “credibility gap.” Indonesians have to judge for themselves the best way to bridge that credibility gap. The important thing is that Indonesia’s policy course needs to be what it is with or without an IMF-supported program. Ultimately, it’s all about their policies and their performance. Whatever our formal relationship is, the IMF will do whatever it can to support Indonesia.

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