From Asia Times Online,

<FONT color=#000000 size=3>Indonesia hypes the economy</FONT>
By Bill Guerin

JAKARTA - Despite current unfavorable economic indicators, optimistic 2006 budget parameters set by the Indonesian government assume the country's US$280 billion economy will grow by 6.2% to $304 billion, and that inflation will be pegged at about 8%, as will interest rates be pegged.

The central bank, meanwhile, predicts the economy will grow 5-5.7%, similar to last year. Inflation slowed to 17.1% last month from a six-year high of 18.4% a month earlier, and analysts expect it to drop further. The bank's benchmark interest rate is 12.75%, and observers expect it to remain at that level or go up marginally, possibly a quarter point.

High unemployment and poverty levels carry a social-political economic risk and could even threaten stability. At least 17% of the country's 220 million people are unemployed or underemployed, and 40 million live on $2 a day or less.

"The year 2005 was not an easy year ... We must examine what we did in 2005 and admit the shortcomings and weaknesses," President Susilo Bambang Yudhoyono said in his New Year's address. "Only by doing so can we move forward."

His administration had been stretched to the limit in handling a series of unforeseeable calamities, such as natural disasters and contagious diseases, he said.

In a December cabinet reshuffle, Yudhoyono made significant changes in his economic team, which had been criticized for bureaucratic inertia and failing to sufficiently improve the investment climate, as well declining growth and soaring inflation.

His appointment of former International Monetary Fund regional director Sri Mulyani as minister of finance and respected technocrat Boediono as coordinating minister for economic affairs won praise from investors and the markets.

The team's focus in 2006 will be on containing the inflation rate, maintaining macroeconomic stability and taking steps to address the remaining impediments in the investment climate. Continued efforts to strengthen the financial sector can be expected, including sound banking supervision and improvements in the asset quality of state-owned banks. This would enhance the ability of the banking sector to support private economic activity.

"Since economic stability and inflation is one of our focuses in 2006, we will do anything to ensure inflation will not go up so that by the end of 2006 we can reach our target of single-digit inflation," Boediono, who like many Indonesians uses only one name, said last week.

The government plans to focus on curbing price pressures to improve consumers' purchasing power and restore economic stability.

The central bank will need to cut interest rates to boost investment and consumer spending, but conversely any further pressure on inflation and the exchange rate could see it increasing rates.

"We will accelerate spending and improve the investment climate, and will cooperate with Bank Indonesia [the central bank] to help reduce interest rates and boost investment," Boediono said.

Approved domestic and foreign investment plans last year reached Rp110.86 trillion ($11.66 billion), an increase of 88.02 % - more than Rp58.96 trillion ($6.2 billion) in 2004.

Although Rp18 trillion will be spent this year on building roads, bridges, irrigation facilities and other infrastructure to boost investment and reduce unemployment, servicing sovereign debt will account for a massive 21% of government expenditure.

The payments of Rp73.47 trillion in interest and Rp60.38 trillion in principal due this year are much higher than the mere 2.7% of the budget allocated for capital spending - badly needed to help stimulate the economy.

Inflation hit 17.1% year-on-year in December following massive fuel price rises forced on the government by soaring global oil costs and a slump in the rupiah. Expensive fuel has driven up transport costs by more than 40% and food prices have increased by 18%, says Badan Pusat Statistik (BPS-Statistics Indonesia), a government institution directly responsible to the president.

October fuel increases had pleased investors and the market but the ensuing hike in the cost of living has been a major blow to the poor. The price of kerosene, the main cooking fuel of the masses, soared by 185.71 %, while petrol increased by 87.5 % and diesel by 104.76%. Inflation also hit hardest at the lower end of the consumer sector as wealthier consumers are better placed to protect themselves against inflation.

Though inflation fell in December for the first time in seven months, the rise in inflation, along with rising interest rates, has slowed economic growth overall and put the brakes on consumer spending, with both consumer loans and credits for business expansion becoming more expensive.

This limits working capital options, economic expansion, job creation and puts the brakes on public consumption, which for several years has been the main driver of growth in the economy. Labor-intensive industries have slashed more than 1 million jobs in the past three months.

Though consumer prices fell by 0.04% in December, the first time in seven months, the fuel price increases have led to a decline in real disposable income for consumers and raised input costs for the business sector.

Unfinished business

On the business side, several other pending issues have to be addressed, such as the excessive regulatory burden, investment and labor law amendments and tax reforms. The government will push through a number of policies this year to promote robust economic activity for the private sector and help spur growth, geared to providing certainty and stability for the business community.

A draft revision of the labor law is due to be delivered to legislators for deliberation in February or March. Several articles in the law, which forces companies to pay compensation for workers who opt to resign, are reported to be under amendment to encourage companies to hire more workers.

Business leaders warn that the tax system is already causing domestic and foreign investors to withdraw or minimize their investment. Crucial tax reforms in the pipeline may not be implemented until early 2007 after an expected drawn-out debate in the legislature, and a planned corporate tax cut would not take effect until 2010.

"Businesses are already going to China and Vietnam, and one of the main problems is our tax policy," said Sofyan Wanandi, chairman of the National Economic Recovery Committee. "Even Indonesian businesses are investing elsewhere.

The 35% company tax rate made it uncompetitive for businesses, Wanandi added.

The Indonesian Chamber of Commerce and Industry said the proposed amendments "place too much power in the hands of tax officials and excessively heavy sanctions on taxpayers".

Peter Fanning, chairman of the International Business Chamber, warned, "If the bills are not revised, we believe that it will scare away potential investors and make existing investors consider leaving."

Tax receipts account for more than 75% of government revenue, and the budget sets tax revenue at Rp416.3 trillion, or 13.7% of gross domestic product this year.

Boediono has warned the business community not to expect to enjoy tax cuts or write-offs. "The government needs the income from taxes to fund development of the educational and health sectors," he told a news conference.

The economy has grown in the face of a formidable series of challenges over the past year, including the tsunami, high world oil prices, avian influenza and polio outbreaks.

The president's election promises and goals of economic growth of 7% by 2009, job creation and poverty reduction remain in place. This year is likely to be much the the same as last year, in terms of intent and commitment, darkened by anxieties about external factors and sustainability of growth.

Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has been in Indonesia for 20 years, mostly in journalism and editorial positions. He has been published by the BBC on East Timor and specializes in business/economic and political analysis related to Indonesia. He can be reached at

(Copyright 2006 Asia Times Online Ltd. All rights reserved.)
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