Building U.S.-Indonesia Mutual Understanding Since 1994

USINDO – KADIN – DAI Conference “Reconstruction and the Economic Program of the Yudhoyono Government”

Introduction: This conference was organized by the U.S. Committee of the Indonesian Chamber of Commerce and Industry (KADIN/KIKAS). USINDO wishes to express gratitude to KIKAS, the cooperating organizations and P.T. Danareksa for making this event possible. The Jakarta conference was a follow up to a conference held in Washington, D.C. on October 21, 2004 to discuss the forthcoming economic agenda of the administration of President Susilo Bambang Yudhoyono, or SBY. The tragic earthquake and tsunami of December 26, 2004 changed the focus of the follow up conference to consider how the Yudhoyono government can balance the needs of disaster reconstruction, macro-economic stability, and investment-led growth. Development Alternatives, Inc. (DAI) was the co-sponsor of the original conference and we were pleased that DAI could join in Jakarta. The February 24 session was chaired by USINDO President Alphonse F. La Porta and Dino Vega of KADIN/KIKAS. USINDO Trustee Diono Nurjadin was responsible for conference arrangements on the Indonesian side.

H.E. Aburizal Bakrie, Coordinating Minister for Economic Affairs, opened the conference by asserting that the Indonesian government is in full control of disaster recovery. He reviewed the economic impact of the northern Sumatra disaster, noting that the Aceh economy was only 2.7% of total Indonesian GDP, thus regional and national economic growth are not hampered, for example, because Aceh LNG and natural resources industries are located in the interior, not along the devastated coast. The Minister recounted immediate relief needs and foreign participation, but the government’s reconstruction plan – being assembled by the national planning agency, BAPPENAS, will be ready by the end of March.

Undoubtedly there are challenges in reconstruction, he continued, including the relocation of populations away from the coast, as well as re-building roads and other infrastructure. For this purpose, the government is setting up a multi-donor trust fund for donor government and other contributions; these funds would not go into the regular Indonesian Government budget, however. Regarding specific projects, Minister Bakrie noted that the U.S. has offered to rebuild the road from Banda Aceh to Meulaboh but Japan has already committed to that project and has disbursed funds for it. Some other countries are specializing in sectors such as vocational education (Germany) and housing (Netherlands). Overall, the amounts pledged for reconstruction (US$1.7 billion) will be sufficient, provided the financial pledges are fulfilled.

Minister Bakrie asserted that most of the rebuilding should be done by Acehnese and that local people and officials have been consulted and involved in the planning at all levels. Rebuilding will begin in earnest in June and it is necessary to maintain macro-economic stability and revitalize the local economy. He referred to the Infrastructure Summit held in mid-January and the prospect of wide-scale infrastructure development stimulating growth. He also noted that Indonesia’s bond ratings have improved since the Yudhoyono administration took office and that Indonesia has been removed from the list of non-cooperating countries for money laundering. Moreover, the Indonesian stock market has reached the 1000 level, signifying the confidence of the marketplace in the Yudhoyono government.

On the political side, Minister Bakrie observed that “the government is happier” since Vice President Kalla won the Golkar chairmanship with 66% of the parliament members now in support. With this support, the government is on solid ground in facing the elections of local officials this year. He briefly mentioned the importance of reductions in the fuel subsidy and indicated that the government’s sectoral roadmap, which will emphasize SME and micro-enterprise development, will be issued in April. However, none of these measures benefiting the micro-economy will affect macro-economic stability, he claimed.

Noted economist Chatib Basri then presented an overview of the economy, including the impact of the disaster, the total economic impact of which was approximately US$4.4 billion. Despite the fact that 37% of Aceh’s productive sector was wiped out, the national impact would only be 0.4% in non-oil GDP. He explained that 2004 economic performance was better than expected; auto sales are up, consumer credit has grown, and consumer confidence rose sharply after the election of the SBY government. However, popular expectations are too high and one cannot expect the government to fix the economy in a few months.

Sources of growth in 2004 were consumption, a positive investment flow and exports. The debt-to-GDP ratio declined to 5.4% (the reason for improved bond ratings). However, problems include: overly high unemployment at 9.5%; fuel subsidies which have benefited the middle and upper class, whereas price increases will disproportionately affect the poor; deregulation; and corruption. Even taking these factors into account, Dr. Basri predicted “conservatively” that economic growth would reach 5.5% this year.

Panel I consisted of Sofyan Wanandi, Chairman of KIKAS and President of the Indonesian Manufacturers Association, Jim Boomgard, Vice President of DAI, and Joe Bartlett, President of the American Chamber of Commerce (AmCham) in Indonesia.

Sofyan Wanandi was the first speaker and he noted that since the fall of the Soeharto government in 1998, the succeeding governments of B.J. Habibie, Abdurrahman Wahid and Megawati Soekarnoputri had not devised any five year plans. This was the main reason why the KADIN “road map” was developed. The road map emphasized several priorities which included security, the judicial system, tax reform, the labor laws, infrastructure, decentralization, and industrial policy. The road map calls for three review periods in which KADIN will conduct a benchmark evaluation of government policies: 100 days, 1 year, and 5 years.

During the first 100 days of the new government’s tenure, the biggest change felt by the private sector is the willingness of the government to genuinely listen to the business community. Mr. Wanandi highlighted the revision in the investment policy which revised and shortened the negative list and investment procedure. In the area of tax reform, he reported that KADIN advocates several reforms in the tax laws, such as the abolishment of the tax court, reduction of tax rates, and the elimination of double taxation and dividend policies. The main thrust of KADIN’s lobbying effort will be the reduction of “gray areas” in the tax laws. The road map also calls for a review of current labor laws that hinder investment in order to reduce the high cost of the economy. KADIN is currently discussing with the government improvements to the legal system to improve predictability as well as to eliminate contradictions existing in several aspects of the decentralization and autonomy laws.

Joe Bartlett began by mentioning how KADIN’s road map is actually a product of a wide spectrum of the business community in Indonesia. The international chambers, including AmCham, contributed significantly in developing the priority areas and in other ways.

He observed that Indonesia is presently in a global competition for investment capital. On that score, there are 60 laws/by-laws that need to be reviewed since these policies create disincentives and reduce Indonesia’s ability to attract investment. It is therefore important that the government move beyond words into action. Mr. Bartlett added that current investors are the best “ambassadors” for Indonesia and there is a golden opportunity for the Yudhoyono government to improve the investment climate by resolving current high profile investment issues to move forward with the Paiton expansion, finalize the ExxonMobil project in Cepu, Central-East Java, as well as settling the CEMEX impasse. The business community needs to monitor and continually use the road map as its main benchmark. He suggests that quarterly meetings between government and the private sector should be arranged in order to create greater accountability for government policies and decisions. Lastly, Mr. Bartlett commented President Susilo Bambang Yudhoyono’s personal charisma is a valuable asset for the nation in its efforts to vie for more investment.

Jim Boomgard of DAI cited several key factors that are important in developing a national economy. Mr. Boomgard believes that, in spite of all attention given to SME’s (small-medium enterprises), size is not the best gauge in sustaining growth in the private sector. Industry and sectoral priority are more important to have a dynamic private sector. How responsive the business community is to profit-making incentives is an indicator as to whether institutional instruments are under-produced and need to be stimulated further. Free competition is the basic demand condition of the global investment picture. The global market, like it or not, is the master, and the ability to identify elements is needed to compete successfully in Indonesia.

Panel II featured the Honorable Saleh Afiff, former Coordinating Minister of Economic Affairs and well-known expert on the economics of poverty and growth, Honorable Arifin Siregar, former Ambassador to the United States, Minister of Trade, Central Bank Governor and Senior Advisor to Goldman Sachs, and Bill Foerderer, USAID Program Officer, representing USAID Director Bill Frej who was called away for an urgent meeting.

Professor Afiff led off by pointing out that the historical record offers a number of lessons in order to understand “what works and what doesn’t.” From 1970 to 1990, Indonesia was successful in increasing the literacy rate from 60% to 83%. Its growth rate averaged over 5.8% and poverty was reduced to only 1/6 of the total population. In the early years of the Soeharto presidency, there was a deep concern over the poverty level and low productivity in rural areas. The focus on the rural sector was important in order to assure real economic growth. The government was fortunate to have access to strong international support at a time when virtually no economist in the world would hold out any hope for Indonesia.

Professor Afiff stressed the need to separate the questions of what to do and how to do it. It is imperative to understand the impact on the poor and creating growth through sound macro-policies. This policy initiative was an important concept in obtaining the 5% economic growth per year — the equivalent to the growth in the rural sector. The three key factors for a sustained growth are:

(1) Macro-economic stability to control inflation and interest rates. The Soeharto government basically used exchange rate as a tool to “kick off” growth in the 1980’s. Economic reform through the reduction of the role of government is also vital for a vibrant economy. The 1985 decision to contract out import and export valuations to reduce tariffs was one measure used by the government. Deregulation would enable the private sector to play a more important role which is a prerequisite to create a more efficient economy.

(2) The importance of emphasizing investments in infrastructure with the prudent participation of the private sector.

(3) A multi-tier strategy linking agriculture supply and economic growth. The high growth of inelasticity of supply and its impact on poverty was proven in the 1997 economic crisis when food prices sky-rocketed and compounded the crisis.

In the short run, “politics is the master of economics.” The current challenge is to replicate the economic success of the past, insulated by politics,but connected to the poor. A strategic vision, linking growth to the poor must be applied.

Hon. Arifin Siregar focused on the nexus among reconstruction demands, the need to maintain macro-economic stability, and the necessity to promote growth. While giving the previous government credit for reversing the negative economic growth pattern, Arifin questioned whether giving priority now to reconstruction and growth might jeopardize monetary stability. He was concerned about inflationary increases greater than the present 7%. Inflation would also be affected by decreases in the value of the rupiah and other factors, but cuts in the fuel subsidy, he predicted, could lead to an increase in inflation to 10%. Therefore, he concluded, there is a need to stem inflationary expectations.

What is required is a balance among the three factors – growth, macro-economic stability and reconstruction – but a fourth factor should be added: equity. Countering inflationary increases in the first half of 2005, he recommends, would require a reduction in budget deficits by increasing tax and import revenues. He also favored financing the deficit through an offsetting increase in the inflow of investment capital, plus relying on external assistance to finance northern Sumatra reconstruction. He also urged that SME development be promoted in order to increase jobs/decrease unemployment.

Bill Foerderer, on behalf of USAID Director Bill Frej, recommended a bottom-up approach to private sector development and generally endorsed the SBY government’s approach. He averred that the future of economic reform lies in the regions which must maintain openness and transparency, provide quality public services, and replicate successful models of local economic development. Labor availability is also a necessity, citing efforts through the basic education initiative of President Bush to promote a literate and trainable work force; he endorsed the Yudhoyono’s policy of reducing fuel subsidies but boosting aid for education.

Mr. Foerderer cited several factors required to facilitate infrastructure and other investment: the passage of a new investment law; continuing legal reforms; and facilitating the business registration processes, thereby reducing time and opportunity costs. He commented that government decentralization is “not unambiguously good for some business activities” and said that “nuisance” taxes should be eliminated, “friction” for business ventures should be reduced, and the DPR should adopt legislation similar to the U.S. Interstate Commerce Act that specifies the role of the central government to regulate trade. An oversight body similar to the U.S. Interstate Commerce Commission might also be established, he concluded.