Rebuilding Indonesia's economy

A stronger currency is needed to cut the cost of debt payments

By News Online's Mary Hennock

The government of new president Megawati Sukarnoputri takes charge of a shattered economy burdened with debt repayments bigger than Indonesia's gross domestic product (GDP).

How realistic is the prospect of economic recovery?

"The big issues remain how to finance the budget deficit...and partly how the strengthen the currency", said Laksono Widodo, head of research at ING Barings in Jakarta.

The problem of the budget deficit has its origins in Indonesia's gigantic foreign debts - which have become even more expensive to service as the currency has weakened.

The government must service $135bn of foreign debt.

Indonesia's external debt is 110% of GDP in 2001 and the budget is 5% in deficit, said Mr Widodo.

No quick fix

"This is not a problem that can be tackled overnight, not even in a year," said Ferry Hartoyo of Vickers Ballas Investment Reasearch in Jakarta.

The markets are waiting to see the new president's cabinet

The solutions hinge on planned cuts in subsidies, asset sales and a stronger currency.

To implement them the government will have to take "decisions that may not be politically popular" such as cutting in subsidies of fuel and electricity which will lead to price rises, said Mr Hartoyo.

Currency stabilisation

The central bank is pinning its hopes on currency stabilisation. The rupiah rose more than 10% in the two days after news that parliament had voted to replace President Abdurrahman Wahid.

On 26 July, it was trading steady at around 10,000 in the dollar, its strongest level in months.

Bank Indonesia deputy governor Achjar Iljas said a stronger currency could pave the way for interest rate cuts. Rates have been raised six times this year.

A stronger rupiah would also lead to it "less pressure on inflation", he said.

If the rupiah strengthens against the dollar, the cost of debt repayment will lessen, interest rates will come down and asset values will rise, making a planned sale of $50bn of assets more likely to succeed.

An improved exchange rate would have "a multitude of effects on a lot of micro and macro numbers", said Mr Widodo.

It would enable both government and companies to make credible budgets and allow companies to begin debt restructuring talks with banks, he said. If it led to interest rate cuts it would cheapen the cost of future borrowing.

The big issues remain how to finance the budget deficit...and partly how to strengthen the currency

Laksono Widodo, ING Barings

Political stability

Whether the rupiah can continue to strengthen depends on political stability, in particular on the stability of Megawati Sukarnoputri's cabinet, analysts say.

"If (the markets) sense a coalition of people with totally different interests then sentiment will become nervous", said Christopher Wood of ABN Amro.

Mr Hartoyo points out that divisions between the Muslim based PPI and Golkar persist.

If (the markets) sense a coalition of people with totally different interests then sentiment will become nervous

Christopher Wood, ABN Amro

The new government may be just as unable to exercise control over the country's major institutions as the last one, said Mr Hartoyo. "They'll fight over key positions", he said.

IMF tensions ease

Indonesia's relationship with the International Monetary Fund appears to be improving. Last week a senior IMF official in Jakarta said a $400m loan frozen since last December could be paid out as soon as August.

The loan was frozen because the Indonesian Bank Restructuring Agency had failed to sell a 30% stake in the country's biggest retail bank on schedule. IBRA is charged with disposing of banking assets worth about $50bn.

Now the IMF has given IBRA until September, said Mr Hartoyo. "They've become more lenient", he said.

"I think it's because they have no choice", said Roy Santoso of Kim Eng Securities in Jakarta. "Going back three or four months all the signs were on the wall that the new president was not going to last...they have to deal with the new cabinet."

Restructuring costs

The IBRA demonstrates the impact of political instability on economic renewal. The government ran up $65bn of foreign debt to recapitalise the banks but assets have yet to be sold to ease the burden.

In June, IBRA acquired its fourth head in one and a half years - I Putu Gde Ary Suta, who does not have the confidence of the markets because of his lack of experience in debt restructuring.

Asset sales have yet to take place because "Nobody is willing to sign on the dotted line because you may be accused of corruption at the end" due to political jockeying, says Mr Santoso.

Foreign investment

Indonesia badly needs foreign capital for its long-term development, but analysts say corruption and nepotism are rife and Indonesia must sort out its legal system before foreign investors will return.

"To grow the economy, you need investments, you need political stability. It's fairly simple, it just requires these people to get their act together and just do it", said Mr Hartoyo.

Another worry for investors is the weak currency, which lowers the value of their investments.

"The rupiah will trade on the politics more than the economy", said Mr Wood. "If there's any sign of the new government making decisions and it following it through then the rupiah could rally significantly."

But if fragile markets and political divisions persist, it could be a long time before the economy revives.