Promoting higher economic growth amid crisis
Anwar Nasution, PROFESSOR OF ECONOMICS AT THE UNIVERSITY OF INDONESIA
Sumber : JAKARTA POST, 1Februari 2012
Blessed with a fast-growing labor force, a declining dependency ratio, natural resources and a strategic geographic location, Indonesia has the potential to book double-digit growth in the future, catching up with China and India.
To tap this potential, the country needs three policy changes. First, it must relax its over-emphasized austerity macroeconomic policy that has begun to neglect economic growth, and must particularly relax its tight fiscal policy and appreciating exchange rate.
Second, Indonesia must introduce radical supply-side reforms to reverse a decade of lost competitiveness and boost long-term growth. Structural reforms are particularly needed in input markets, from electricity, harbors, airports, labor and land as well as the streamlining regulatory system to relieve the bottlenecks that were adding to production costs even before the Asian financial crisis in 1997.
Third, the country needs to rebuild its public institutions after undergoing major and wide-ranging reform in the social, economic and political spheres since the fall of Soeharto in 1998. New institutions are needed to take advantage of political democracy, broad regional autonomy, greater use of the market mechanism and greater integration of the national economy into global markets.
To make the market work effectively and efficiently, Indonesia needs to upgrade its legal and accounting systems; improve property rights; enforce contracts; provide relevant, accurate and timely market information as well as eradicate corruption. Good public institutions are key for providing social protections.
New institutions are also the key to mobilizing revenue through the tax system and implementing new fiscal rules and market-based and forward-looking monetary policies for stabilizing the markets, promoting economic growth, maintaining a low inflation rate and reaping the benefits of the globalized economy.
The three policy changes are part of policies to raise the international competitiveness of the Indonesian economy. This, in turn, will promote new investment in the agriculture sector and manufacturing industry, including resources-based industries, and integrate them into global and regional supply chains. At the same time, new investment and growing exports will create more jobs for the uneducated and unskilled labor force.
Three elements of the short-run stabilization program of the IMF of 1997-2003 are still being implemented until today. First, replacement of monetary policy operating strategy targeting exchange rates with inflation targeting. As a result, the fixed exchange rate was replaced in 1997 with a flexible exchange rate system and inflation targeting was introduced in 2000.
To implement the single objective of a monetary policy to attain inflation targets, a new Bank Indonesia law that was modeled after the Bundesbank of Germany was enacted in 1999. Since then, the central bank has no longer been responsible for attacking unemployment or targeting the growth of nominal GDP.
To achieve its single objective to control the inflation rate, monetary policy is supported by conservative fiscal policy and a sustainable public debt strategy.
For this, the second component of the IMF program was to replace the balanced-budget rule that had been used for 32 years during the Soeharto administration, with fiscal rules similar to the Growth and Stability Pact of the EU.
The Soeharto administration financed its budget deficit only with official development aid (ODA) from a consortium of foreign donors. The new fiscal rules under the IMF program set the ceilings of annual budget deficit to 3 percent of GDP and the ratio of public debt to GDP to 60 percent.
Applicable to all layers of government, the fiscal rule is enshrined in the Public Treasury Law of 2004. A sustainable budget deficit and low inflation rate help reduce risk premiums, facilitate the maturity of domestic currency debts and help resolve the “original sin” and upgrade rating of government bonds in international financial markets.
The governments during the Reform era overemphasized austerity and neglected growth. Since the recovery of Indonesian economy in 2000, the budget deficit has consistently ranged from 2.2 percent (2000) to 0.1 percent (2008) of annual GDP and debt to GDP ratio reduced from 89 percent in 2000 to 25.2 percent in 2011. This and the high expenditure for energy subsidies reduced the availability of development expenditures to build needed infrastructures.
The IMF program rebuilt the financial market by allowing market-based monetary policy. For this, sovereign bonds were injected to recapitalize the banking system, which is the core of the financial system, and upgrade the prudential rules and regulations of the financial system.
The IMF program totally ended the financial repression, which was a quasi-fiscal operation operating via credit programs and an instrument for KKN (corruption, collusion and nepotism).
Dissatisfied with the poor quality of bank supervision that led to the crisis in 1997, the IMF program required the merger of Bank Indonesia’s supervisory department and Bappepam (the Capital Market Supervisory Agency) into the Financial Services Agency (OJK). Modeled on the Financial Supervisory Agency in the UK, the OJK will provide the same level playing field to all types of financial institutions.
Supported by a surge of short-term capital inflows and surplus in balance of payments due to rising commodity exports, Bank Indonesia has allowed appreciation of the rupiah, both in nominal and real terms. A stronger rupiah lowers the prices of imports to make it easier to achieve inflation targets.
The appreciation of the rupiah, however, has caused four problems in the economy. First, its external competitiveness has been eroded in the manufacturing industry and other sectors. Competitiveness is further eroded by an undervaluation of Chinese renminbi, low labor productivity, inadequate infrastructure and a poor investment and business climate.
Second, a reduction of efficiency and the stronger rupiah provides incentive for a reallocation of resources from more productive tradable sectors to less-productive non-tradable sectors. This shift triggers asset bubbles in the land and property markets. Traditional policy instruments such as increasing interest rates may reduce the bubble but exacerbate the imbalance of capital inflows.
Third, increasing regional disparities as natural resources are mainly produced outside Java while the outcompeted labor-intensive agriculture and manufacturing sectors are primarily produced on Java.
Fourth, decreasing efficiency of the financial system and the behavior of taking excessive risks as the business community is encouraged to increasing borrowing from seemingly low-cost foreign sources. ●
To tap this potential, the country needs three policy changes. First, it must relax its over-emphasized austerity macroeconomic policy that has begun to neglect economic growth, and must particularly relax its tight fiscal policy and appreciating exchange rate.
Second, Indonesia must introduce radical supply-side reforms to reverse a decade of lost competitiveness and boost long-term growth. Structural reforms are particularly needed in input markets, from electricity, harbors, airports, labor and land as well as the streamlining regulatory system to relieve the bottlenecks that were adding to production costs even before the Asian financial crisis in 1997.
Third, the country needs to rebuild its public institutions after undergoing major and wide-ranging reform in the social, economic and political spheres since the fall of Soeharto in 1998. New institutions are needed to take advantage of political democracy, broad regional autonomy, greater use of the market mechanism and greater integration of the national economy into global markets.
To make the market work effectively and efficiently, Indonesia needs to upgrade its legal and accounting systems; improve property rights; enforce contracts; provide relevant, accurate and timely market information as well as eradicate corruption. Good public institutions are key for providing social protections.
New institutions are also the key to mobilizing revenue through the tax system and implementing new fiscal rules and market-based and forward-looking monetary policies for stabilizing the markets, promoting economic growth, maintaining a low inflation rate and reaping the benefits of the globalized economy.
The three policy changes are part of policies to raise the international competitiveness of the Indonesian economy. This, in turn, will promote new investment in the agriculture sector and manufacturing industry, including resources-based industries, and integrate them into global and regional supply chains. At the same time, new investment and growing exports will create more jobs for the uneducated and unskilled labor force.
Three elements of the short-run stabilization program of the IMF of 1997-2003 are still being implemented until today. First, replacement of monetary policy operating strategy targeting exchange rates with inflation targeting. As a result, the fixed exchange rate was replaced in 1997 with a flexible exchange rate system and inflation targeting was introduced in 2000.
To implement the single objective of a monetary policy to attain inflation targets, a new Bank Indonesia law that was modeled after the Bundesbank of Germany was enacted in 1999. Since then, the central bank has no longer been responsible for attacking unemployment or targeting the growth of nominal GDP.
To achieve its single objective to control the inflation rate, monetary policy is supported by conservative fiscal policy and a sustainable public debt strategy.
For this, the second component of the IMF program was to replace the balanced-budget rule that had been used for 32 years during the Soeharto administration, with fiscal rules similar to the Growth and Stability Pact of the EU.
The Soeharto administration financed its budget deficit only with official development aid (ODA) from a consortium of foreign donors. The new fiscal rules under the IMF program set the ceilings of annual budget deficit to 3 percent of GDP and the ratio of public debt to GDP to 60 percent.
Applicable to all layers of government, the fiscal rule is enshrined in the Public Treasury Law of 2004. A sustainable budget deficit and low inflation rate help reduce risk premiums, facilitate the maturity of domestic currency debts and help resolve the “original sin” and upgrade rating of government bonds in international financial markets.
The governments during the Reform era overemphasized austerity and neglected growth. Since the recovery of Indonesian economy in 2000, the budget deficit has consistently ranged from 2.2 percent (2000) to 0.1 percent (2008) of annual GDP and debt to GDP ratio reduced from 89 percent in 2000 to 25.2 percent in 2011. This and the high expenditure for energy subsidies reduced the availability of development expenditures to build needed infrastructures.
The IMF program rebuilt the financial market by allowing market-based monetary policy. For this, sovereign bonds were injected to recapitalize the banking system, which is the core of the financial system, and upgrade the prudential rules and regulations of the financial system.
The IMF program totally ended the financial repression, which was a quasi-fiscal operation operating via credit programs and an instrument for KKN (corruption, collusion and nepotism).
Dissatisfied with the poor quality of bank supervision that led to the crisis in 1997, the IMF program required the merger of Bank Indonesia’s supervisory department and Bappepam (the Capital Market Supervisory Agency) into the Financial Services Agency (OJK). Modeled on the Financial Supervisory Agency in the UK, the OJK will provide the same level playing field to all types of financial institutions.
Supported by a surge of short-term capital inflows and surplus in balance of payments due to rising commodity exports, Bank Indonesia has allowed appreciation of the rupiah, both in nominal and real terms. A stronger rupiah lowers the prices of imports to make it easier to achieve inflation targets.
The appreciation of the rupiah, however, has caused four problems in the economy. First, its external competitiveness has been eroded in the manufacturing industry and other sectors. Competitiveness is further eroded by an undervaluation of Chinese renminbi, low labor productivity, inadequate infrastructure and a poor investment and business climate.
Second, a reduction of efficiency and the stronger rupiah provides incentive for a reallocation of resources from more productive tradable sectors to less-productive non-tradable sectors. This shift triggers asset bubbles in the land and property markets. Traditional policy instruments such as increasing interest rates may reduce the bubble but exacerbate the imbalance of capital inflows.
Third, increasing regional disparities as natural resources are mainly produced outside Java while the outcompeted labor-intensive agriculture and manufacturing sectors are primarily produced on Java.
Fourth, decreasing efficiency of the financial system and the behavior of taking excessive risks as the business community is encouraged to increasing borrowing from seemingly low-cost foreign sources. ●
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