Indonesia - Economy

In colonial times Indonesia depended upon the export of a relatively small range of primary commodities. In the 17th and 18th centuries, the basis of the export-oriented economy was spices. In the 19th century, it shifted to sugar and coffee; in the 20th century, production of oil, tin, timber, and rubber has become fundamental. Despite export gains, however, subsistence agriculture, with rice as the chief crop, remains the principal occupation of a large proportion of Indonesians, and standards of living are low. Indonesia's record of economic growth and diversification is among the most successful in the developing world; but with the onset of the Asian financial crisis in mid-1997, with Indonesia at the epicenter, and the political upheavals and unrest that followed, economic growth has been arrested. The 1998 political unrest and drought that contributed to a recession hit the country hard, severely depressing the economy and halting economic growth.

Indonesia is exceptionally rich in coal, oil, and other industrial raw materials, but industrial development has lagged in relation to the size of the population and the national income. In part, this was a consequence of expropriation policies carried out by Sukarno and of chronic inefficiency and corruption among government officials. After the 1964–66 political crisis, the government of President Suharto took steps to stabilize the economy. Exporters were allowed to keep a larger proportion of their foreign exchange earnings. The government also imposed strict controls on imports, encouraged foreign investment, returned many nationalized assets, ended nonproductive projects, and reduced government control of the economy. The inflation rate, which had been 635% in 1966 and 120% in 1967, fell to 85% in 1968 and further declined to 10% in 1971. National economic planning was used to guide economic growth. Under the 1969–74 plan, the government successfully introduced fiscal and credit restraints, rescheduled internal debts, returned expropriated properties, liberalized foreign investment laws, and actively sought assistance from overseas. Economic growth was set back by the near-collapse of Pertamina, the giant governmentbacked oil conglomerate, in 1975 and the financing of its $10.5 billion debt, but accelerated as rising oil prices increased revenues in the late 1970s. The economy was again severely strained in the early 1980s as falling oil prices forced the government to cut back on its spending plans. Legislation requiring majority participation of ethnic Indonesians ( pribumi ) in all enterprises formed since 1974 has also slowed foreign investment. Indonesia's obligation to reduce production of oil, its chief export, in line with OPEC agreements, together with the decline in non-oil export earnings brought about by the worldwide recession, severely strained the government's resources. In an effort to meet the nation's developmental needs, Suharto was forced to make the unpopular move, long advocated by the IBRD and IMF, of ending subsidies on food and reducing subsidies on kerosene and other fuels. He also announced new trade policies to spur exports in an effort to reverse the nation's worsening economic condition.

In the 1980s policies were designed to reduce restrictions on imports and to encourage foreign investment. In areas of trade, debt, and currency management, Indonesia took a pro-active stance that was internationally acknowledged by increasing foreign investment and endorsement by multilateral organizations. Efforts focused on bureaucratic reform and efficiency, incentives to private investors, and diversification of sources of foreign exchange earnings resulted in steady growth in the manufacturing sector and in industrial exports. Specific structural reforms were deregulation of foreign investment allowing broader ownership rights in export oriented manufacturing sectors; and streamlining of the investment process, including the adjustment of procedural requirements; progressive reduction in tariffs and non-tariff barriers; major banking deregulation that opened the banking sector to foreign investment; privatization of the Jakarta Stock Exchange; the elimination of major subsidies and supports; and increasing participation of the private sector. The basis of recent Indonesian development still consists of smallholders (0.5 ha on average) in a rural-based economy with pockets of industry and large-scale mining and forestry, and a sizeable range of state-owned enterprises.

In 2000, however, the economy showed signs of being on the way to recovery with a stronger-than-expected real GDP growth rate of 4.8%, a budget deficit amounting to only 3.2% of GDP (below the government's target of 4.8%), and a surprisingly low inflation rate of 3.75%. On 4 February 2000, the government, now headed by Abdurrahman Wahid, signed for a second agreement under the Extended Fund Facility (EFF) of the IMF, in this case involving a $5 billion line of credit. In April 2000, a second agreement was reached with the Paris Club members for the rescheduling another $5.8 billion of principal owed on official debt. From 1989 to 1993 real GDP growth averaged 6.7%. Restrictive monetary policy and a conservative fiscal stance held inflation to below 10%. Amid efforts to keep the economy from overheating, real growth climbed to 7.3% and 7.5% in 1994 and 1995, respectively, before peaking in 1996 at 7.8%. Inflation was held to single digits, and the official unemployment rate was 3%, although underemployment was estimated at as high as 4%. In nominal terms, per capita income rose above $1000, and in purchasing parity power (PPP) terms, at least three time the nominal figure. Economic catastrophe struck in mid-1997, fueled by a loss of investor confidence in the region, particularly in the weaker economies, as Hong Kong came under Chinese control in July.

The collapse of currencies began in July in Thailand but spread swiftly to Indonesia. Within a year 75% to 80% of all businesses in Indonesia were technically bankrupt as the rupiah went from about 2,600 to one US dollar in June 1997 to a low of 17,000 to one US dollar in June 1998. GDP growth, which had been 8% in the first quarter of 1997, and 7% in the second quarter, fell to 3% in the third quarter and 2% in the fourth. In November 1997 an international bail-out package was arranged that included a stand-by agreement with the IMF with a $11.5 billion line of credit, an $8 billion loan from the World Bank and the Asian Development Bank (ADB), $5 billion loan from its own reserves, and $3 billion in US loan guarantees. The extended impact of the crisis can be seen in the figures for 1998, when real GDP fell by over 13%, industrial production was down by 18.24%, and the net outflow of invested capital reached of about $13.8 billion.

Economic distress erupted in bloody pogrom against resident Chinese in which over 1000 people were killed, dozens of women raped, over 2,500 shops, including about 40 shopping malls, were looted or destroyed, and the streets were left strewn with more than 1,000 vandalized vehicles. On 19 May, students took over the parliament building, and two days later President Suharto resigned, ending 32 years of autocratic rule. His designated successor was B. J. Habibie, the architect of Indonesia's ambitious shipping and aircraft manufacturing industry. Habibie promised elections, which were held in 1999. In the meantime, in August 1998, a second agreement was concluded with the IMF, in this case for a $7.4 billion line of credit offered under the terms of its Extended Fund Facility (EFF). The next month, the government reached an agreement with the Paris Club for rescheduling $4.6 billion of principal owed on official (foreign aid) debts.

The government's official debt situation was being radically altered. Pre-crisis, the government had incurred virtually no domestic debt, borrowing all capital expenditures abroad, primarily from the World Bank and the Asian Development Bank (ADB), and its external debt was at an unproblematic 25% to 27% of GDP. In 1998, total debt leapt to 78% of GDP, but with no domestic borrowing. In 1999, however, domestic borrowing went from $0 to $68.7 million, and combined with a record $75.8 million in foreign loans, government debt reached a peak of 102% of GDP. In 1999 real growth returned, but only at an anemic 0.2% level, as there was a net outflow of investment funds of almost $10 billion—a net loss of $2.7 billion in FDI and a net loss of $7.2 billion in portfolio investment, according to Bank Indonesia figures. The outflow continued, as did rising violence throughout the country around the parliamentary election, and, of particular international concern, before and after the referendum on the independence of East Timor. Economic frustrations doubtless aggravated the conflicts. In February 1999 the government estimated that 27% of the population was living in poverty. Inflation, though less that the 1998 average rate of 58.44%, was still high at 20.46%.

Unfortunately, both internal and external factors soon contrived to slow the momentum of the recovery. In December 2000, Indonesia's February agreement with the IMF-EFF for the $5 billion follow-on credit went into suspension as IMF staff found themselves unable to complete the program's third review. As both a cause and an effect of calls for his impeachment and removal, President Wahid, through a combination of neglect and defiance, was failing to implement the requirements of the IMF programs. Tensions were increased as thousands of Wahid's Islamic followers vowed to fight to the death his removal from office. It was not until August 2001, after Wahid's removal in July and the installation of Vice President Megawati Soekarnoputri as president, that discussions with the IMF could be reopened, and a new Letter of Intent negotiated under what were now changed circumstances. Megawati's pro-reform, pro-market economic team promised a favorable response in the international economy, but this was cut short, first by the global economic slowdown of 2001, and then the aftershocks of the 11 September 2001 terrorist attacks on the United States. In Indonesia, real growth rates of 5% and 4% in the first two quarters of 2001 fell to 3% and 2%, respectively in the last two quarters, producing an average 3.3% growth for the year. Inflation returned to double digits, at 11.5%, and in February 2002 the government reported that poverty had had an uptick, increasing to 14.5% of the population. The industrial production index after year-on-year increases every quarter in 2000 and for the first three quarters of 2001, fell 6% in the fourth quarter. The net outflow of capital continued, reaching $9 billion for 2001. Some $8.3 billion of the net outflow reflected divestment by private direct and portfolio investors, but $700 million was on the official capital account and reflected delays in the disbursement of adjustment loans due to the political turmoil of the first half of the year.

In the first two quarters of 2002, year-on-year declines in Indonesia's Industrial Production Index worsened, to about 12% and 14%, respectively. Net outflow of private capital continued, although at a reduced rate. More positive signs were an appreciation of the rupiah from 10,500 to one US dollar in December 2001 to 8,800 to one US dollar in May 2002; a spurt of private consumption spending of 10% ( yoy ) in the last quarter of 2001, which was still a positive 6.4% ( yoy ) in the second quarter of 2002; and a rise of the Jakarta Stock Exchange Index from 390 to 530. In the second quarter of 2002, the IMF made the decision that the Indonesian budget had been sufficiently reined in for it to extend its financial involvement in Indonesia until the end of 2003 (instead of ending it at the beginning of 2002), which was a necessary prerequisite for further dealings with Paris Club on rescheduling any of the $40 billion sovereign external owed to the Paris Club members, or for opening of negotiations with the London Club on rescheduling the $1.3 billion of commercial loans owed to members of that creditors' club. On 12 April 2002, Indonesia concluded its third post-crisis agreement with the Paris Club, rescheduling $5.4 billion of principal and interest owed. On 6 September 2002 Indonesia reached an agreement with the London Club for the rescheduling of its commercial debt to its members, which involved among its terms an extension of the repayment period to seventeen and a half years. The total debt-to-GDP ratio for the government fell from 90% for 2001 to a more manageable 70% in 2002, and the annual budget deficit was estimated to have fallen to below 2% of GDP, bettering the IMF-set target of 2.5%. Hopes that Indonesia might be safely on its way out of its post-crisis stagflation, even despite the continued global economic malaise, were shattered by the terrorist bombs in Bali on 12 October 2002 aimed at Western tourists vacationing on Kuta Beach. Beyond the death toll of nearly 200, which was not that unusual for the many trouble spots in the country, was the message that tourist enclaves and, perhaps, the industrial enclaves, were no longer safe for foreign visitors and foreign investors. After the Bali bombings, the rupiah depreciated to more than 9,000 to one US dollar and the Jakarta Stock Exchange Index fell back below 400, though by the beginning of 2003 both indicators of investor confidence had returned to near their pre-bombing levels. The World Bank, which had predicted a 3.5% real growth rate for Indonesia in 2002, reduced its prediction to 3.2%. Analysts agreed, however, that a real growth rate of at least 6% would have been necessary to finally bring the economy out of its post-crisis slump. Unfortunately, much depends not on the government's policies, and the real economic advantages that Indonesia continues to enjoy—ample natural resources, a relatively skilled work force, a strategic location, and a large and expanding internal market— but on what happens in the global economy in which it is embedded and over which it has little control.