Economic Situation In East Asia: A World Bank Perspective from Jakarta

Remarks by Mark Baird
Country Director for Indonesia
East Asia and Pacific Region
The World Bank

Norwegian Ambassadors Regional Meeting
Jakarta, 10 April 2000

Unlike Dewi, I am not an Asian expert. But the World Bank does follow the Asian economies closely – and I will draw on our latest assessment of the situation in the region. I will then turn to what I know better – the situation in Indonesia. And try to explain why Indonesia has lagged other Asian countries in recovering from the crisis.

East Asia
From the World Bank's East Asia Regional Overview, March 20, 2000. The review focuses on the developing countries of East Asia and the Pacific. Japan is not included.

The East Asian economies grew by an estimated 6.5% in 1999. After a year of sharp contraction in 1998 (-7.5%), the five crisis-affected countries (Indonesia, Korea, Malaysia, Philippines and Thailand) bounced back – in classic V fashion – to grow by 4.7%. But performance within the group has been mixed, with Korea growing by 10% while Indonesia has had barely positive growth. China and Vietnam continue to outperform all but the best market economies, though their expansions (especially Vietnam's) have decelerated and structural problems haunt their outlook.

External developments supported this performance. Exports rose sharply on the strength of volume increases (e.g., for electronics) and a rebound in selected commodity prices, notably rubber and petroleum. These provided some relief from the import compression of the previous year, while maintaining a positive trade balance. The favorable current account balance, together with a threefold increase in portfolio and foreign direct investment inflow, were sufficient to offset continuing outflows of capital from bank and other private investors, especially in the crisis countries and China.

Inflation has also remained in check. After peaking in 1998 (8%), inflation fell to an average of 3% for the region as a whole in 1999. Despite lax monetary policy in some of the smaller economies (Laos, Mongolia, PNG) inflation has universally fallen to single digits. For Indonesia, inflation was negative in the year to February 2000.

All of this is good news for the region's poor. The crisis had increased the number of poor to an estimated 278 million in 1998, a sharp reversal of the three decade trend of falling poverty. Most of the poor – 213 million – live in China. However, most of the increment is in the five crisis-affected economies. Estimates vary, depending on the poverty line used. In Indonesia, there is now a broad consensus that poverty doubled to about 20% of the population. This means that about 20 million people – especially in urban areas, and on Java – fell below the poverty line. There is evidence that poverty has started to fall again, thanks in large part to lower rice prices. But it will take several years to get back to pre-crisis poverty levels.

The key to successful recovery is progress on financial and corporate restructuring. Looking across the region, three patterns emerge:

• All countries have nearly completed the carve out process of NPLs through asset management companies, set up London-style rules for voluntary resolution of past-due payments, and strengthened laws regulating banks and corporate insolvencies as well as government oversight powers for enforcement – with the collective effect of restoring some degree of confidence among depositors in the financial system.

• Progress in debt restructuring and NPL resolution is fitful, with Korea leading the way and Indonesia lagging behind, but no country has as yet approached the finish line in a marathon that may well take the better part of a decade to complete.

• In the process, many countries are opening their financial sectors to new owners and competitors, notably foreigners. Again, this process is differentiated, with Korea and Thailand having made the most dramatic changes, and Malaysia virtually none.

Overall, East Asia's recovery has gained momentum, broadened across the region, and is now creating jobs at a quickening pace. But this is not the time to relax the pace of reforms. Ominous clouds are on the distant Western horizon. In the US, interest rates are steadily rising – and equity markets have shown marked volatility in recent weeks. Despite some softening over the past month, oil prices remain well above past year's levels. Three points to note about these external developments:

• They have very different effects on different countries. Higher oil prices, for example, hurt Thailand, Korea and Japan, but benefit Indonesia. Interest rate increases are linked to floating rate debt – and these have the largest gross effects on China, Korea, Indonesia and Malaysia. Fortunately, earnings on now-substantial reserves cushion the net impacts substantially. And the negative effects of both shocks tend to be largest for the two countries best able to weather them, Korea and China. All countries are turning large current account surpluses, so the net combined effect is not sufficiently strong to derail the recovery in any one country.

• But only one shoe has dropped so far. These events have not yet been fully played out in the US and other OECD countries. These countries will sooner or later have to adjust. If this takes the form of sharply slower growth, east Asia could feel the shock in parallel. The good news is that a hard landing remains less likely than a smoother adjustment over a longer period.

• Even so, the region is unusually vulnerable to a common external demand shock. Because financial systems, especially banks, are still fragile, and corporations have not yet restructured fully their liabilities, the business sector is unusually dependent on buoyant demand to maintain cash flows and solvency. Because debt levels are high and cash balances low, creditworthiness is low and businesses have little cushion for new recession. And Governments are not in a position to maintain demand by borrowing their way through another major crisis.

Despite these external worries, the balance of risks probably remain higher on domestic policy. Were reform momentum to dissipate, the region's recovery might continue, but on a lower growth trajectory, and the Achilles' heel of high debt and low policy headroom would leave it exposed to external shocks for a longer time. Paradoxically, the success of the reforms to date may well become their greatest enemy – by generating complacency and reducing the political will to tackle vested interests holding up bank and corporate restructuring.


Indonesia

So where does Indonesia stand in this overall picture and why? Clearly compared to other countries in the region, Indonesia still lags well behind – on both policy reform and economic recovery. Yet, you have to balance this assessment against the political changes the country has been through over the past year. I believe these twin perspectives help explain the mood you currently find in Jakarta. I liken it to a drowning man who feels a sense of euphoria when he comes to the surface and starts to breathe fresh air, but then realizes the distance from shore, and questions whether he has the sense of direction, will and capacity to make it. This is very much the mood in Indonesia today. There is enormous relief that the political transition has passed so smoothly. One year ago, who would have predicted that Indonesia could hold genuinely fair and free elections, select a popular President and Vice President, cede independence (albeit in a painful process) to East Timor, start to tackle the tough issue of the role of the military, and initiate a dialogue with the independence movement in Aceh.

There has also been progress on the economic front. Inflation remains firmly under control. And economic growth has started to recover, buoyed by a revival in consumer confidence and spending. The new Government has prepared a sound and realistic budget, and successfully defended it before Parliament. This was a critical element of the Letter of Intent signed with the IMF in January. The international donor community has also shown their support through the assistance pledged at the CGI meeting in February, which is more than adequate to meet the financing requirements of the budget. And IBRA is finally moving on asset sales. The recent Astra deal is important -- not only to finance the budget, but also to signal IBRA's commitment to handle asset sales in an independent and transparent manner.

So, if things are going so well, why is everyone so worried about the future? What are the storm clouds gathering on the horizon -- which are making the swim to shore that much more difficult? Let me highlight a few:

• The economic recovery is still very fragile. The consumer boom has not yet been matched by rising investment or exports. There is certainly pent-up demand and excess capacity that can fuel growth for coming year. But this cannot be sustained without new investment. And this is still constrained by the overhang of corporate debt and the weak banking sector, as well as the uncertainty that hampers the return of flight capital and foreign investors.

• Implementation of the economic program, especially in the area of bank and corporate restructuring, has been slow and halting. As a result, disbursement of the next IMF tranche has been delayed until May at the earliest. This is not a problem from a financing point of view, since the IMF's money does not enter the budget but stays with the central bank. But it does undermine investor confidence. Progress has picked up over the past two weeks and the program is getting back on track. This will hopefully lay the groundwork for a successful Paris Club meeting later this week. But it has also forced the IMF into a high-profile policy role, which will be difficult to sustain over the longer haul.

• Bank and corporate restructuring, in turn, is hampered by the weak judicial system. The bankruptcy court is not providing a credible stick to bring debtors to the table. Nor has the Attorney General been very successful to date in prosecuting non-cooperative debtors or cases of corruption. Indeed, the gap between public expectations and progress on fighting corruption seems to be growing daily.

• The Government's ambitious program of fiscal and administrative decentralization adds one more uncertainty to the picture. This is clearly a political imperative – and one with potential economic pay-offs. But planning is running well behind schedule. Decisions are urgently needed on many issues, including the expenditure functions to be transferred, and to what level of government, the criteria for resource allocations from the center, and the groundrules for local-level regulations.

• Let me end with one issue which is not widely discussed: the lack of attention to the Government's development program. Spending on development has been slashed to meet the Government's targets for the fiscal deficit and debt reduction. But the reality is that essential services, for primary education, health, roads and irrigation, are being run into the ground. More needs to be done to target the limited resources available on priority programs – and ensure that they are well used.

There is an important link between recent political and economic developments. The Government has understandably been pre-occupied in its first months of office with larger political issues: national unity, regional tensions, and the role of the military. And no one can expect all of these economic issues to be tackled over night. It will take many years, for example, to reform the judiciary and rebuild the country's basic infrastructure. But there is an impatience to see a clear vision of how the Government plans to tackle the country's economic problems – and concrete steps to show serious commitment to implementing reforms. It is important to strike while the external economic environment is favorable and international goodwill toward Indonesia is strong.

Of course, implementation has never been Indonesia's strong suit. And the task is made more difficult by recent political changes, including broader participation in decision making and a rising tide of nationalism. We will have to accept that economic policy may no longer have the same clarity and consistency as in the past. I sometimes hear investors lamenting the good old days – when policy was predictable, and you knew who to talk with to fix a problem. But we should not forget that we all praised Indonesia when it chose the path of democracy. We should also accept the uncertainty that it inevitably brings – and be patient as the Government tries to tackle very deep-seated problems inherited from the past.