USINDO-DAI Conference: Indonesia’s Future Economic Growth: Agenda for the New Government

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Ambassador Alphonse La Porta, USINDO President, began the opening remarks. He mentioned a follow-up conference on the overall bilateral relations on November 17 with the Centre for Strategic and International Studies and the Southeast Asia Program of the Paul H. Nitze School of Advanced International Studies, and also thanked DAI as co-sponsor and the panelists for participating in Thursday’s conference. He then introduced Tony Barclay, DAI President and CEO, who spoke of DAI’s long involvement with Indonesia. The company has been involved in the archipelago since the 1970s. Mr. Barclay then introduced Ambassador Soemadi D. M. Brotodiningrat, the Indonesian ambassador to the U.S. Ambassador Soemadi welcomed Indonesia’s new government and said there was a strong popular mandate backing this government. However, he cautioned against over-expectations.

Panel I: Macro-Economic and Financial Policy Overview

DAI’s Michael Morfit moderated the first panel, and introduced the process of how the panels were to proceed throughout the rest of the day. The two panelists, Iwan J. Azis, Cornell University, and Shari Villarosa, U.S. Department of State, identified the macroeconomic issues and challenges facing Indonesia’s new government. The primary issue Iwan Azis spoke of was Indonesia’s unemployment. He said the problem was not necessarily a lack of jobs, but a lack of jobs in the formal sector; the urban unemployed tend to be young professionals who do not wish to work in the informal sector. Though Mr. Azis commended the Megawati government for achieving macroeconomic stability, he wondered “at what cost?” The high price was the country’s unemployment.

Ms. Villarosa agreed that the Megawati government should be applauded for the stability it achieved, but cautioned on issues the new government is going to have to face. For one thing, Indonesia is lagging behind the other countries hit by the Asian financial crisis; only now has its GDP come up to pre-crisis levels. Ms. Villarosa saw the top challenge for Indonesia as attracting investors. The new government’s top financial priority should be the rolling back of fuel subsidies, as they only benefit the wealthy.  Both the rolling back of subsidies and attraction of more investment would mean more resources the government could apply to repaying its debt and spending in government programs.

Before commencing the question and answer session, Mr. Morfit first pointed out that both panelists agreed that the macroeconomic system was stable, yet Mr. Azis was slightly optimistic about the economy whereas Ms. Villarosa was a bit more skeptical. In response, both agreed SBY’s new cabinet was too new to judge. Mr. Azis again reiterated that unemployment must be addressed as soon as possible, while Ms. Villarosa again stressed that fuel subsidies need to be dealt with in order to free up government resources. The first question from the floor asked the speakers to suggest how a fiscal stimulus would be paid for.  Mr. Azis warned that the government cannot follow Latin America of the 1970s and 1980s and print more money as a solution; this would not work in Indonesia’s situation. One problem that arises is that the debts are being paid off by bond refinancing. Come 2008, this will cause a peak in the financial burden as they are called in. Ms. Villarosa’s solution again was to suggest the rolling back of subsidies and tax reform. Currently, she said, tax collection is too low and yet there are ostentatious displays of wealth.  In response, the question was posed as to the capacity for institutional reform.

A third questioner asked about the importance of Chinese and regional investment.  Ms. Villarosa answered that most of the capital that left Indonesia during the 1997 financial crisis has not yet returned. The Chinese, for instance, are mainly investing internally and for their own growth. The keys to attract more investment into Indonesia are greater stability and predictability. A country needs stability for investors to attempt to predict future outcomes and assess risk in order to feel comfortable to invest. Ms. Villarosa also underscored judicial reform and anti-corruption measures among the judiciary, public prosecutor’s office (at all levels) and police as absolutely necessary to restore the confidence of domestic and foreign investors alike.

To wrap up the first panel, Mr. Morfit asked each panelist to list the key elements that would indicate the new cabinet is succeeding. Mr. Azis cited a resolution of the debt issue and an improved investment climate. Ms. Villarosa again cited rolling back of fuel subsidies and a judicial system where people are being prosecuted for corruption.

Panel II: Business and Investment Climate

Jim Boomgard, DAI, moderated the second panel whose panelists included Diono Nurjadin of the Indonesian Chamber of Commerce (KADIN), Wayne Forrest from the American-Indonesian Chamber of Commerce (AICC) in New York, and John Phipps from the US-ASEAN Business Council. Mr. Nurjadin spoke of a “new” KADIN and suggested that one issue the SBY government will need to address is more coordination among the government’s ministries. KADIN has developed a 600 page report with recommendations outlined for the rule of law, taxation, employment, infrastructure, local autonomy, industrial strategy, and trade and investment policies. Particularly regarding taxation, KADIN proposes that an independent team be set up to work on specifically on tax reform. As it stands today, there is much that can be done to avoid paying taxes, thus a key component of tax reform must not cut taxes, but broaden the tax base and “promote tax compliance.” To improve the overall welfare of the state, the KADIN Road Map recommended that there are some goods that can remain tax free, or become tax free, such as necessary medicines. Tax reform is also imperative to create a more stable environment to promote competitive businesses and lower the transaction costs of doing business. There must also be efforts to prevent capital flight, to keep capital inside the country, in order to promote reinvestment.

Following Mr. Nurjadin, Mr. Forrest mentioned the China factor, citing that much, if not most, of the regional investment went there. Foreign direct investment in Indonesia dropped from 30 percent to 7 percent, again because much investment has shifted to China.  Mr. Phipps cited the success of democracy in Indonesia as a boost to investment. Necessary reforms that the Indonesian government must initiate to attract investment are:

• Rule of law reforms
• Anti-corruption measures
• Regulatory improvements
• Tax reform, transparency and predictability

The problems do not necessarily have to be solved all at once, but progress must be shown in these critical areas.

The panelists were asked what the first thing they would do as president. Mr. Nurjadin responded with reforming the taxation base and collection. Mr. Forrest would try to attract new investment in the mining sector, and Mr. Phipps concluded by suggesting he would broaden the commercial courts to enforce contracts. Following this, the audience wished to know if this new cabinet was pro-business. Again, it was said that currently it is still too early to tell, although reservations were expressed concerning the appointment of the Coordinating Minister for the economy and the ability of some other appointees to promote changes and reforms.

Panel III: Development Priorities for the New Indonesian Administration

With much of the discussion indicating that it was still too early to judge the new administration, moderator Alex Shakow asked if there was a problem of over-expectations, as Ambassador Soemadi suggested. Peter Timmer, from the Center for Global Development, began by saying that he was a “born pessimist,” but that he believed in the facts. He proceeded to go through a short history of the stages Indonesia has faced to show its growth and accomplishment, focusing on “pro-poor” periods of growth:

• 1880-1905: Period of Dutch colonialism where there was little domestic growth as a result of exploitive practices.
• 1905-1925: Income rose by 4-5 percent during the period of Dutch social consciousness.
• 1925-1950: War and revolutionary period which saw a decline in growth and an increase in poverty; the rate of decline was about 2.5 percent.
• 1950-1965: Sukarno period saw an overall recovery of the economy by about 2 percent, but this did not reach the poor.
• 1965-1990: Soeharto period of economic growth of about 3-3.5 percent per year; even more significant was a growth of about 6.5 percent among the poor, which continued for another 5 years, through the mid-1990’s.
• Late 1990s: period of deterioration; Indonesia witnessed a severe drought, the Asian financial crisis, and the collapse of government with no political institutions in place.

Why did Indonesia not fall apart? Mr. Timmer said that at this time in Indonesia’s history “stability was terribly important.”  Pro-poor growth policies would encourage investment in the capabilities of the poor, lower transaction costs and increase the demand for products that the poor produce, or increase the demand of their labor. He argued that the China aspect was much larger than people were initially making it, and the lack or deterioration of the national infrastructure was actually increasing transaction costs. Suggestions for SBY’s government are to invest in infrastructure, become serious about the poverty question (not the same as the unemployment question) and diversify agriculture away from rice production. In this context, he advocated that the new government move immediately to remove the ban on the commercial importation of rice as a benefit to low income earners and to encourage diversification.

Bill Foerderer of the USAID mission in Jakarta focused on a pro-growth strategy. He recommended a five year (to 2008) strategy involving regional stability, counter-terrorism, democracy and human rights promotion, prosperity, and humanitarian response. Agreeing with Ms. Villarosa, Mr. Foerderer recommended removing not just fuel subsidies, but also rice and sugar subsidies. He argued that the financial system should be secured by the promotion of rigorous banking reforms. Currently a few banks provide information regarding money laundering and major financial transactions. The time it takes to register a business in Indonesia needs to be reduced as well to promote growth. At the moment, it takes about 151 days to register a business in contrast to 52 days elsewhere in the region.

After hearing each strategy, the opening questioner inquired whether there were radical differences between the pro-poor and the pro-growth strategies. Mr. Timmer said the long term goals were similar, but in the short term to two strategies were different. Another question asked about what specifically needs to be done for agriculture? Mr. Timmer pointed out that agriculture is a key sector as it employs about 45-50 percent of the workforce. The current “rice mentality” can no longer drive growth and this was why diversification of the agricultural sector is a key issue. Mr. Foerderer agreed that investing in diversification was imperative, and the removal of subsidies, but there should also be a focus on reducing transaction costs.

Asked about poverty indicators, Mr. Timmer presented a not often used, but interesting, “starchy staple ratio” to measure poverty. The rural wage index has shown the deflator to be off by 25 percent in comparing incomes across historical periods with different economic measures. The starchy staple ratio on the other hand looks at high energy but cheap calories, i.e., where the poorest people expend income or labor for basic sustenance. The higher the ratio of these foods meant the poorer you are. There is no deflator necessary then for the starchy staple ratio.

The questions then shifted to education, as the moderator asked the panelists about the goals for Indonesian education and U.S. priorities for development assistance. Mr. Foerderer voiced the idea that education will lead to more growth which leads to an improved job market. Mr. Timmer observed that the main indicator keeping Indonesia from being eligible for the Millennium Challenge Account (MCA) is corruption. Mr. Shakow, the moderator, entered in the discussion by saying that according to the Transparency International studies, Indonesia ranks in the bottom 11 of countries on the corruption scale.

Returning to the issue of China, Mr. Timmer was asked to elaborate on why he thinks the China factor is much bigger than people initially suggested. Mr. Timmer responded that the FDI directed to China is primarily for the production of labor-intensive goods, and Indonesia is not going to be able to offer competitive prices to compete with China for labor-intensive jobs. Instead he suggests focusing on resource-intensive activities or added-value commodities to attract investment back into Indonesia.

Keynote Address: “Agenda for the New Indonesian Administration: a Rijsttafel of Policy Measures” speaker: David Loevinger, Deputy Assistant Secretary, U.S. Department of the Treasury.

After being introduced by Ambassador La Porta, Mr. Loevinger introduced the new Indonesia Analyst, Anna Jewell, before addressing his topic. He noted that it is a good sign that he is personally spending less time on Indonesia, and that there has been progress since the Asian financial crisis. Inflation is down to 5 percent, and the external debt is down to 60 percent. Foreign banks, he said, were essentially non-players in Indonesia’s banking system, but now about a third of the banking assets are held by foreign financial institutions. Referring to Mr. Nurjadin’s comments about ministry coordination, Mr. Loevinger said that it is difficult to retain investor confidence when there is little communication between the ministers.

Speaking from the Washington vantage point, he continued, it is necessary to maintain perspective. Though Indonesia was hit hard by the Asian financial crisis, it was a rather opportune time for this event to occur, if there was to be a financial downturn at all.  There was, at the time, investor appetite for risk, the high tech boom, and low global interest rates. Indonesia, however, still remains a heavily indebted country and is still vulnerable to risks. Mentioning Mr. Timmer’s forecast that Indonesia could qualify for the Millennium Challenge Account in five years, Mr. Loevinger disagreed. He said the board deciding who is eligible for the MCA retains authority to make exceptions. Therefore, it could be possible for Indonesia to become eligible in a shorter period of time if it shows progress in key areas: anti-corruption measures, transparency and legal reform.

Indonesia, moreover, needs a transparent monetary policy. There has been “incredible progress” in the banking sector reform, at least on the surface. It is still difficult to tell how well these reforms will work. There are still too many state-owned banks which are “fiscal time-bombs.”

The U.S. Treasury will continue to work with Indonesia, along with USAID, the Asian Development Bank, World Bank and IMF. Key issues will be the anti-money laundering and terrorist financing. However, Indonesia’s White Paper of President Megawati’s administration shared a vision of non-lending, financial management measures which is expected to be continued.

Asked about targeting anti-inflationary measures, Mr. Loevinger said the framework is in place, but the political will is needed to implement them.

E?=oPl ?Yw n favored closer coordination with APEC. Asanuma thought it should be managed more of, by and for the region and its role should focus on late bloomers like Indochina and Burma.

• Adding a closing point to this constructive exchange, moderator Erland Heginbotham called for greater participation in developments by business and scholarly groups which had done so much to pull governments forward in the 70s and 80s.

Ambassador Soemadi

Following lunch Indonesian Ambassador Soemadi who was Ambassador in Tokyo prior to coming to Washington spoke about Indonesian-Japanese relations characterizing them as good and anticipating they would remain so because of geostrategic mutual interests, economic complimentarity and mutually mature restraint. The relationship had been multi-layered involving not only government but business, NGOs, universities and social and cultural institutions.

Japan had greatly helped with the economic crisis, governmental reform and a dignified solution to East Timor. The two had cooperated on terrorism and piracy. Both were opposed to becoming nuclear states and had cooperated on WMD issues. If anything, the Ambassador thought, cooperation would increase in future.

Ambassador Soemadi also discussed the impact of 9/11 on the region; now “Indonesia is a direct victim” of terrorism, he said.  He went on to discuss the various anti-piracy and maritime security proposals, including those of Japan, including the “complication” of the U.S. backed Proliferation Security Initiative (PSI) with maritime security proposals.  He observed that Indonesia and Japan agree on strengthening the NPT non-proliferation regime and the “fulfillment” of the Comprehensive Test Ban Treaty (CTBT).  But he also worried about the consistency of the PSI with the NPT and other international agreements.

Another area in which Japan and Indonesia agree, he continued, is the denuclearization of North Korea.  Indonesia is ready to help advance the Six Party talks and see the ASEAN Regional Forum (ARF) as a possible supplement to what can be worked out in the Six Party context.  Finally, Ambassador discussed the impact on ASEAN of membership enlargement, raising problems of cohesion and a “developmental gap,” the rise of the ASEAN Plus Three format, and Japan’s limited security role in the region.