Indonesia Assessment 1994: Finance as a Key Sector in Indonesia's Development 9789814379458

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INDONESIA ASSESSMENT 1994 Finance as a Key Sector in Indonesia's Development

The Institute of Southeast Asian Studies (ISEAS ) was estab lished as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists conce~ned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Tr ustees comprising nominees from the Singapore Government, the National University of Singapore, the various Cha mbers of Commerce, a nd professional and civic organizations. A ten-ma n Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic a nd administrative officer. The Research School of Pacific and Asian Studies at the Australian National University is horne to the Indonesia Project and the D epartment of Political and Social Change, which a re the joint organizers of the Indo nesia Update Conference. The Upda te offers an overview of recent eco nomic a nd political developments in Indonesia. Each conference devotes much of its at tention to a theme of particular impo rtance in Indonesia's development. Financial support for the conference series is provided by the Australian Internatio nal Development Assistance Burea u. The Indonesia Assessm ent series contains papers presented at these conferences, toge ther with o th ers specially commissioned for inclusion. The Indonesia Project is a major international centre of research and graduate training on the econ omy of Indonesia. Established in 1965, it is well known and respected in Indonesia and in other places where Indonesia attracts serious scholarly and official interest. The Project obtains its core fu nding from the Australian National University; in addition, the Australian Department of Foreign Affairs and Trade h as provided an annual gra nt since 1980. A major activity is producing and distributing a n internationally recognized journal on the Indonesian economy, the Bulletin of Indonesian Economic Studies, three times a year, each issue of which contains a Survey of Recent Economic Developments. The Department of Political and Social Change focuses on research in domestic politics, social processes and state-society relations in Asia and the Pacific. It has a long established interest in Indonesia n affairs .

INDONESIA ASSESSMENT 1994 Finance as a Key Sector in Indonesia's Development Edited by Ross H. McLeod

Resea rch School of Pacific a nd Asia n Studi es AUST RALI AN NATIO NAL UN IVE RS IT Y Ca nberra. Austra lia INST ITUTE OF SOUTHEAST AS IAN STUDIES Singa pore

Published jointly by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Panjang Singapore 0511

Research School of Pacific a nd Asia n Studies Australian National University Canberra ACT 0200 Australia

All rights reserved. No part of this publication may be reprodu ced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prio r permission of the Institute of Southeast Asia n Stu dies.

© 1994 Institu te of Southeast Asian Studies Th e responsibility for facts and opinions expressed in this publication rests exclusively with the authors and th eir interpretations do not necessarily reflect the views or th e policy of the Institute or its supporters.

Cataloguing in Publication Data

Indonesia Assessment 1994: Finance as a Key Sector in Indonesia's development / edi ted by Ross H . McLeod . 1. Finance-Indonesia. 2. Indonesia-Econ omic conditions-1945 3. Indonesia-Po litics and government-1966I. McLeod, Ross H. II . Seri es 1995 DS644.4 I411994 ISBN 981-3016-98-1 Printed and bound in Singapo re by Prime Packaging Industries Pte Ltd .

sls95-1380

Contents Tables, figures, appendices Foreword by Phillip Flood AO Glossary Contributors Acknowledgem ents 1

Introduction Ross H. McLeod

vii ix XV

xvii xxi 1

PART A: ECONOMIC AND POLITICAL DEVELOPMENTS 2

Recent economic developments Mari Pangestu

21

3

Organising the transition: Indonesian politics in 1993/94 Richard Robison ·

49

PART B: FINANCE AS A KEY SECTOR IN INDONESIA'S DEVELOPMENT

I

The Reform Process

4

Financial reform: achievements, problems and prospects Ali Wardhana

79

5

Comments on Professor Wardhana's paper Stephen Grenville

94

6

The sequencing of economic deregulation in Indonesia George Fane

101

vi

Contents

II

Monetary and Exchange Rate Policy

7

Problems of implementing monetary policy in Indonesia Boediono

III

Banking Sector Refonns

8

Banking sector reforms in Indonesia, 1983-93 Anwar Nasution

130

9

Bank soundness requirements: a central bank perspective Hendrobudiyanto

158

10

Bank soundness requirements: a commercial bank perspective Manggi Habir

119

171

11

The case against deposit insurance in Indonesia Kathryn G. Marshall

IV

Domestic and International Capital Markets

12

The role of the Indonesian capital market D . Cyril Noerhadi

13

Indonesian capital market development and privatisation David K. Linnan

223

Problems and prospects for the life insurance and pensions sector in Indonesia Catherine Prime and David M. Knox

248

14

186

202

268

15

Indonesia's foreign debt Ross H . McLeod

V

Small-scale Finance

16

Small-scale finance: lessons from Indonesia Soeksmono B. Martokoesoemo

292

17

The cooperative rural finance program in Indonesia Henk A.J. M oll and Karel Palallo

314

References Ind ex

334

347

Tables 2.1 2.2 2.3 2.4 2.5 8.1 8.2 8 .3 9.1 9.2 10.1 10.2 10.3 10.4 10.5 11.1 11.2 12.1 12.2 12.3

Budget forecasts Major targets from sixth five-year plan and long-term development plan Factors affecting base money, 1992-94 Growth of major non-oil exports Summary of foreign investment deregulation package Monetary indicators, 1982-93 Development of SBis and SBPUs, 1986-93 Average expense and profit rates of banks, 1981-92 Average capital adequacy ratios at March, 1994 Assets of BPRs and commercial banks Size and structure of the banking industry Government and private banks' loans, deposits and capital Composition of state and private banks' rupiah deposit base Average one-month rupiah deposit rates by bank group Bank soundness scoring system Interest rate differences between bank groups Selected characteristics of high- and lowinterest rate private domestic banks (1992) Jakarta Stock Exchange market activity, 1977-94 Trading of equities by type of investor, 1993-94 Funds raised by capital market and banking system, 1989-93

23 25 28 35 40 133 142 150 160 162 172 173 174 175 178 194 197 204 212 215

List of tables, figures and appendices

Vlll

13.1 15.1 16.1 16.2 16.3 16.4 16.5 16.6 16.7 17.1 17.2 17.3 17.4 17.5

Jakarta Stock Exchange rights offerings, 1993 Alternative debt composition strategies for Indonesia, 1984-88 Bimas disbursement and repayment performance Terms of KIK /.KMKP lending (1980) BRI village units' lending cost components Kupedes lending Kupedes borrowers and portfolio quality BRI village units' deposit mobilisation International comparisons of rural financial institutions Financial development in a hypothetical group during the first six years Development of the Cooperative Rural Credit Program, 1979-93 Main financial data for all groups, 1989-93 Lending in the groups, 1989-93 Rural Credit Department main financial data, 1989-93

235 282 294 296 298 299 300 302 305 322 326 326 327 329

Figures 6.1 12.1 15.1 15.2 15.3 15.4 17.1

Competitiveness and capital inflow JSX Composite Share Price Index, 1988-94 Government spending, borrowing and debt service Long-term debt disbursements and payments Actual and hypothetical long-term debt Yen exchange rate indices Cooperative rural finance program organisational structure (1993)

114 207 275 277 279 280 316

Appendices 8.1 9.1 10.1

Chronology of financial sector reforms Bank Indonesia early warning indicators and ratios Elaboration of the soundness scoring system

155 170 185

Foreword Philip Flood AO*

The Indonesia Update Conference is a major opportunity for Australians to be informed about and to assess economic and political developments in our largest and most important neighbour. The Australian National University, and especially those concerned within the Research School of Asian and Pacific Studies, deserve congratulations for the way this conference has attracted distinguished Indonesian representation, and for their contribution, and those of other Australian scholars, to knowledge about Indonesia in government, business, academia, the media and the wider community. This is reflected especially in the presence of Professor Dr Ali Wardhana who, as a senior Minister for twenty years and now as Special Adviser to the President, has played a distinguished role in overseeing the sound macroeconomic management of the Indonesian economy. Impressive attendance at this conference is also a tribute by the wider community to the strength of scholarship about Indonesia within this University. More and more Australians are aware that Indonesia's economy has been growing strongly, and that Indonesia has played an important role in enhancing security and stability in Southeast Asia. But I wonder how many appreciate the scale of change which has taken place in Indonesia over the past thirty years, the dramatic nature of change which is continuing now, and the fact that Indonesia is becoming a very influential nation in world affair s. By the_middle of the next century Indonesia will be, in terms of population, the third largest country in the world, after China and India. Ind on esia's popula tion w ill have overtaken that of the *Tex t of the O pening Address to the Ind onesia Update Conference, August 1994.

X

Flood

United States, and may be between 300 and 350 million. If Indonesia should sustain average GOP growth rates of recent years, by the year 2050 Indonesia's economy will be larger than that of Japan today and will be close to that of the United States. Per capita gross domestic product by then is likely to be greater than that of contemporary Spain. If Indonesia's GOP should grow at an average of 7 per cent annually, per capita GOP would be higher than that enjoyed today by Australia and approaching that of Canada. During the decade 2000-2010 the affluent middle class in Indonesia, living mainly in the larger cities, will probably grow to something like two or three times the entire population of Australia. Australians now at school will therefore be dealing, during their working lives, with a neighbour which is a major power wielding great influence in world affairs. An important component of Javanese culture is the dukun-a person who has a special role in healing and in divining the future . The dukun is likely to be consulted by a farmer seeking to know the most appropriate time to start planting rice seedlings, by the merchant wanting to know the most favourable day to set off on a business trip, or by parents who want to know the most auspicious day for their daughter's wedding. A wise dukun would certainly say it is intrinsically hazardous to make projections and growth rate assumptions for many years ahead. But he would concede that they provide a broad indication of where Indonesia is heading and what this means for our region. A dukun would have less difficulty in reflecting on the changes in Indonesia over the past thirty years. President Soeharto's New Order Government has succeeded in transforming Indonesia from an impoverished and divided country into a dynamic and rapidly developing one. The New Order has managed the country's growth with an impressive degree of success. Just as in Australia, there are disagreements in Indonesia about national goals. In Indonesia these focus on many issues-the pace and direction of keterbukaan or openness, the place of Islam in national life, the widening gap between the affluent and the poorer sections of the society, the behaviour of large conglomerates and those controlling them, the evolution of dwifungsi, the role of legal institutions as a source of protection for the rights of ordinary people, and the Javanisation of many political and cultural arrangements. There are, too, unresolv ed issues concerning the province of East Timor.

Foreword

xi

The question is raised: Has the process of establishing political institutions gone far enough such that the eventual transition to a new President will be a successful one? My own view is that there are good grounds for thinking that the political, economic and social structures of the New Order, though still changing significantly, are robust enough to survive the passing of power to a new President. There are no major power brokers in Indonesia today who would seek to upset the momentum of economic development which has benefited the vast majority of Indonesians. We err if we underestimate the pride and self confidence which Indonesians feel in their achievements. Though there are strong and divided voices about the path ahead, there is a conviction among the elites that the gains of the past thirty years in relative stability and sustained economic growth must be preserved and built upon. Indonesians know they are the leading country in Southeast Asia; they know they have the resources and the skills to build in the coming decades on the kind of progress which has been made in the last three. While the transition, when it takes place, may not be smooth, it seems unlikely to be associated with the kind of trauma which shook the archipelago in the mid sixties. There is no doubt that President Soeharto has presided over a remarkable transformation in Indonesia. I would like to hope that he will visit Australia during his current and latest five-year term of office. Indeed it would be appropriate if he visited during 1995, the fiftieth anniversary of Indonesia's declaration of Independence. This would acknowledge the unique role Australia played in subsequent years in taking the initiative to have the UN Security Council begin the process of ending hostilities with the Netherlands, and then for our action to sponsor Indonesia's admission to the United Nations. It was on 10 August 1947 in a message broadcast from Radio Djogjakarta that the then Republican Premier Amir Sjarifuddin declared to the Australian Prime Minister J. B. Chifley that: ... [t]he Government and people of Indonesia have, with relief and deep gratitude, followed every move of your Excellency's Government in defending the Indonesian cause before the forum of the United Nations. We have noted with great satisfaction that the Australian people have upheld an old tradition in assisting the Indonesian people, who are linked with the Australian people in

Flood

xii their common struggle in the cause of freedom and democracy (Darling 1994:248).

These events of nearly 50 years ago are not as well remembered in Australia as they should be. As well as reminding us of links from the past, a visit by the President in 1995 would consolidate the remarkable developments of recent years to strengthen a wideranging bilateral relationship, and it would help set the framework for strong cooperation in the future . President Soeharto, more than any other leader, has made a major contribution to ensuring a benign strategic environment for Australia, and has fostered stability and cooperation throughout the region. In suggesting this I am not urging that we should agree with every policy Indonesia has adopted during his period as President. My point is more that the Australian community should offer a warm welcome to a neighbouring leader. We should create the conditions in which he should feel welcome here, in the same way that we have created such conditions for an American President and for a Japanese or a Chinese Prime Minister. Since returning to Australia, one part of my present role has brought me into contact with State Ministers and Departments of Education, and of course with a large number of universities and colleges. This has made clear to me what a tiny proportion of Australia's school age population is being exposed to any effective teaching about Indonesia. While there is an unparalleled level of academic expertise about Indonesia in our universities, and while the Indonesian language is taught more widely here than anywhere outside Indonesia and Malaysia, very few primary and high school children across the nation are learning anything about Indonesia and its place in our political and commercial future. With the exception of the Northern Territory and Queensland, our children still go through primary and secondary school with only the most rudimentary exposure to knowledge about Indonesia and other countries in Asia. The appreciation by national political leaders of all parties of the importance of Indonesia is not matched by effective action at the state level to train teachers, change curricula, and provide effective teaching materials. The knowledge available in our universities and reflected in the Update Conferences is not reaching Australia's children. Now let me turn to today's special topic, which bears on economic reform in Indonesia and Australia. In the last 26 years since the establishment of the New Order, and especially since th e early 1980s, th ere has been substantial

Foreword

Xlll

reform of economic policies in both Indonesia and Australia. There are important parallels in the way both Australia and Indonesia have approached economic policy in recent years. At the risk, perhaps, of oversimplifying the process, it can be said that one important theme of the reform process here in Australia has been the trend towards a greater reliance on market forces. Associated with this, of course, has been the widespread recognition that we need to become more export-oriented, especially in our dealings with Asia . Vigorous though the reform process has been in Australia, I think it is fair to say that we have been outdone by the vigour of that process in Indonesia. The deregulation process began in Indonesia in the early 1980s, when the so-called 'economic technocrats', with the strong support of President Soeharto, moved to introduce the first of a series of deregulation 'packages' . In the eleven years since that process began, a continual stream of packages has been announced, each one removing or streamlining regulations and controls on economic activity in a wide range of sectors. Of course, some of these were more adventurous than others but, taken together, they constitute a remarkable set of reforms to the Indonesian economy. Firmly and steadily, the previously Byzantine set of controls on economic activity that existed in Indonesia at the end of the Sukamo era has been whittled away. Needless to say, the deregulation process has been only one of the factors which has contributed to Indonesia's economic success in recent years, but it has clearly been an important factor . And the role of the senior policy-makers such as Professor Ali Wardhanaand colleagues such as Professor Widjojo Nitisastro, Dr Radius Prawiro, Professor Mohammad Sadli, and so on-has been quite central to the process. Rarely has such a small group of policymakers played such an influential role in changing the direction of economic policy in any country. Indirectly, we in Australia have benefited from Indonesia's economic success. If events had been otherwise in Indonesia during the past quarter-century, we might have had a large neighbour beset with enduring economic problems, with all of the political and social consequences which would have flowed from that. Instead, today we find ourselves next to a nation that has done extremely well, and with which, I hop e, we will develop even closer links during the years ahead .

xiv

Flood

Very important challenges remain. Indonesia's income per capita is still low. The process of development needs to continue. This is true especially in Eastern Indonesia, and in some areas of Java. Looking to the next decade, there are important political challenges which Indonesia will need to address. And environmental problems will certainly become more pressing, especially on Java, as the population soars well beyond the 100 million mark (in an area just over half the size of the state of Victoria). Australia, and the whole of Southeast Asia, has a vital stake in Indonesia's continued success. Here in Australia we will continue to be ready to do what we can to contribute to the process of development in Indonesia. In opening this important conference, I look forward to a stimulating and informative discussion on the financial issues to be discussed today. They will provide a window into the future economic and political directions of Indonesia.

Glossary $ ABRI BAKORSTANAS Bimas BPPC BPPT BRI dwifungsi

FKPPI Golkar ICMI Jamsostek kabupaten Kadin Kassospol keterbukaan KIK/KMKP KNPI Kopassus KORPRI Kosgoro KUK

means US dollar throughout armed forces military security body mass guidance agricultural extension program Clove Marketing Board Agency for the Evaluation and Application of Technology Bank Rakyat Indonesia dual (military-civil) function association of children of former military officers state political party Association of Muslim Intellectuals Workers' Social Security district (level of government below province) Chamber of Commerce and Industry Social and Political Affairs Command openness subsidised loan program for small business State Youth Association Special Forces civil servants' corps Veterans Association small business lending

xvi

Kupedes LBH

Glossary

general purpose village lending Legal Aid Institute

MO

base money

Ml

narrow money

M2

broad money

Pakdes

December policy package

Pakfeb

February policy package

Pakjan Pakjul

January policy package

Pakjun Pakmar

June policy package March policy package

Pakmei

May policy package

Pakto PAL

Pancasila

July policy package

October policy package state ship building company five principles of state

PDI

Indonesian Democratic Party

Petisi 50 PKI

Petition of 50 Indonesian Communist Party

pribumi SBI SBPU SBSI Simpedes SPSI

yayasan

indigenous Indonesian Bank Indonesia certificate money market securities industrial organisation (not officially sanctioned) village savings deposit workers' union (officially sanctioned) foundation

Contributors Keynote Speaker at Indonesia Update 1994 Professor Dr Ali Wardhana is one of the key members of the group of past and present government officials known collectively as the 'Berkeley Mafia' (after the University of California at Berkeley, where many of them studied) or the 'technocrats'. This group is widely credited with quickly restoring stability to the economy following the chaos of the last few years of former President Sukarno's reign, and with overseeing the sound macroeconomic management which has permitted such rapid growth and structural transformation of the economy over the last quarter of a century. He was Minister of Finance in the first cabinet of President Soeharto's New Order Government, serving three five-year terms before becoming the Coordinating Minister for Economics, Finance and Industry for a further five year term. After relinquishing this position in 1988, he became an Adviser to the Government, and in 1993, a Special Adviser to the President. It was during Pak Ali's term as Coordinating Minister that the first, far-reaching banking d eregulation policy package was introduced, in June, 1983, and he was also instrumental in introducing the even more startling second deregulation package in 1988, following which Indonesia's banking system could be said to have become one of the most liberal in the world. Pak Ali's attention has not been restricted merely to macroeconomic management and microeconomic reform in the banking sector. He has also had a strong involvement in policies responsible for the extraordinary growth of the stock market, and in the arduous process of preparing new laws for the banking, insurance and pension funds sectors and for the capital market.

xviii

Contributors

Other Contributors Dr Boediono is a Director of Indonesia's central bank, Bank Indonesia. He also teaches Economics at Gadjah Mada University in Yogyakarta, and was previously Assistant Deputy for Fiscal Affairs at the National Planning Agency (Bappenas). He is a member of the Editorial Board of the Bulletin of Indonesian Economic Studies. Dr George Fane is a Senior Fellow in the Department of Economics, Research School of Pacific and Asian Studies, at ANU. His areas of specialisation are development economics and tax and trade policy, with reference to Indonesia and Australia. Phillip Flood AO is Director General of the Australian International Development Assistance Bureau (AIDAB), and a former Ambassador to Jakarta. Dr Stephen Grenville is Assistant Governor (Economic) of the Reserve Bank of Australia. He was formerly attached to the International Monetary Fund representative office in Jakarta. Manggi Habir is a faculty member of the Indonesian Institute of Management Development. He also provides consultancy services in the finance area. He was a staff correspondent for the Far Eastern Economic Review in the early 1980s. Mr Hendrobudiyanto has been an executive director of Bank Indonesia since 1983. His main responsibilities now are in the field of bank supervision, and he is one of two Bank Indonesia representatives on a government committee charged with working with the state banks to deal with their well publicised problems with bad loans. David Knox is the Foundation Professor of Actuarial Studies and Director of the Centre for Actuarial Studies at the University of Melbourne. David Linnan is an Associate Professor at the University of South Carolina School of Law. He is currently conducting research as a Fulbright Scholar at the Jakarta Stock Exchange and with the Capital Market Supervisory Agency (Bapepam), in cooperation with the Faculty of Law at the University of Indonesia.

Contributors

xix

Dr Ross H. McLeod is a member of the Indonesia Project in the Department of Economics, Research School of Pacific and Asian Studies, at the Australian National University. He has worked in Indonesia in the past as a consultant with Bank Indonesia and with the Department of Finance. Dr Kathryn G. Marshall is based at the Department of Economics at Ohio University, where she works on Southeast Asian economies. She is currently a visitor to the Department of Economics, Research School of Pacific and Asian Studies, at ANU. Dr Henk A.J. Moll is a Lecturer at the Department of Economics, Wageningen Agricultural University, and has worked as an adviser to the cooperative bank in Indonesia, Bank Bukopin. Dr Anwar Nasution teaches at the Faculty of Economics at the University of Indonesia, and is a well known commentator on Indonesian economic affairs. He is a member of the International Advisory Board of the Bulletin of Indonesian Economic Studies. D. Cyril Noerhadi is President Director of PT KDEI, the Indonesian Securities Clearing and Depository Corporation, and also teaches in the Magister Management (MBA) program at the University of Indonesia. Karel Palallo is Head of the Small Enterprise Group of Bank Bukopin. Dr Mari Pangestu is Head of the Department of Economics at the Centre for Strategic and International Studies in Jakarta. She also teaches at the Faculty of Economics at the University of Indonesia and at the Prasetya Mulya Institute of Management. She is a member of the Editorial Board of the Bulletin of Indonesian

Economic Studies. Ms Catherine Prime is an actuary, lawyer, and businesswoman, with extensive experience in the financial services industry. She is a past President of the Institute of Actuaries of Australia, and is currently principal of P & K Actuaries, which she founded in 1987. Richard Robison is Professor of Asian Studies at Murdoch University. He is Director of its Asia Research Centre, which undertakes research on social, political and economic change in

XX

Contributors

contemporary Asia. H e is the author of several books on the political economy of Indonesia. Dr Soeksmono B. Martokoesoemo was a Director of Bank Indonesia from 1966 to 1981, during which time he was heavily involved in guidance and supervision of the lending operations of Indonesian banks. Since then he has served as Director of the Agriculture and Rural Development Department of the Asian Development Bank, and as Senior Adviser to Bank Rakyat Indonesia and the Jakarta Stock Exchange.

Acknowledgments

Several organisations and many individuals have contributed in various ways to the success of this year's Indonesia Update conference and this Indon esia Assessment volume. Financial support was provided by the Australian International Development Assistance Bureau (AIDAB), which has made a special grant to support the Update conference series, the Department of Foreign Affairs and Trade (through its annual grant to the Indonesia Project), and the Research School of Pacific and Asian Studies at the ANU. I thank each of these institutions for their assistance. Phillip Flood, AO, Director General of AIDAB, gave the opening address at the conference, and his speech is presented here as a Foreword. I thank him, along with the Indonesian Ambassador to Australia, Mr Sabam Siagian, the Director of the Research School of Pacific and Asian Studies, Professor Merle Ricklefs, and Professor Ross Garnaut, Convenor of the Economics Division, for their personal support for the conference. I am especially grateful to all those speakers and session chairpersons who made the long journey from Jakarta-and others who travelled less far from warmer parts of Australia and braved the cold of Canberra in winter in order to share their thou ghts with us. In addition to the papers presented at the conference, several more (apart from my own) were written specifically for this volume. These were contributed by George Fane, Boediono, Anwar Nasution, Kathryn Marshall, David Linnan, Henk Moll and Karel Palallo. I greatly appreciate the effor t all these contributors have put into drafting and revising their papers in order to meet a very demanding publishing deadline, as well as that of those who presented papers at the conference.

xxii

Acknowledgements

Organisation of the conference and preparation of the manuscript for this volume were ably assisted by many colleagues. Bev Fraser and Allison Ley from the Department of Political and Social Change played major roles in ensuring both that the conference ran smoothly and that the editing and formatting work was completed in a very short time. Peta Kennedy added considerably to the quality of the manuscript at the proof-reading stage with her keen editorial eye, also working to extremely tight time constraints. Beth Thomson stepped in at the last minute with invaluable formatting assistance. Winnie Pradela's background support as Indonesia Project Administrator was greatly appreciated. Other Project members Liz Drysdale and Lynn Moir lent a hand from time to time, and several graduate and undergraduate students gave up some of their precious time to help with running the conference. I am grateful for the contributions of the Head of the Indonesia Project, Dr Hal Hill, and of Professor Ben Kerkvleit and Dr Harold Crouch, of the Department of Political and Social Change, who were always ready to give me the benefit of their advice, but who also gave me a great deal of freedom to organise the conference and prepare this volume. My colleague Dr Chris Manning, organiser of last year's highly successful Update, gave me many helpful hints based on his own experience. As last year's editors noted, the Indonesia Assessment series is now well established as a major annual publication on Indonesia. With the move to publication by the Institute of Southeast Asian Studies in Singapore, it is hoped that the series will reach a much wider audience-especially in that region-than was possible when the volume was published in-house. My final word of thanks, therefore, goes to our new publishers, for their cooperation in bringing this volume so quickly to what I hope will be a large and appreciative readership.

R.H.M.

1 Introduction Ross H. McLeod Background A little over a decade ago, I wrote a survey of Indonesia's financial sector, in which I emphasised the extent to which its development had been repressed, and drew attention to its domination by stateowned institutions. I asserted that '[t]here have been no major changes ... in the kinds of policies adopted concerning money and finance', and predicted that the future only promised 'more of the same'-even going so far as to say that government interventions could 'be expected to be extended' (McLeod 1984:106-107). These words were actually written in 1982 and, to my embarrassment, the predictions had been proven totally wrong several months before the paper even was published. For .m e, this experience has reinforced the idea that economists should be content to restrict themselves to the safer tasks of analysing and explaining what has already happened, and avoiding the temptation to foretell the future! Indonesia's financial sector in fact has been totally transformed in the decade or so since a wide-ranging package of deregulatory measures for the banking sector was introduced on June 1, 1983. The obvious success of that package-'Pakjun' as it was known-together with the awareness that many significantly counterproductive regulatory interventions were still in existence, emboldened the government to introduce an even more radically deregulatory package a little over five years later, on 27 October, 1988. It seemed natural to dub this 'Pakto', but the Indonesian penchant for coining new words using selected syllables from small groups of words such as 'Paket Oktober' would soon be tested by the increasing frequency with which new policy packages were beginning to appear, and the fact that there are only twelve months in the year. The collection now includes Pakjan, Pakfeb, Pakmar, Pakmei, Pakjun, Pakjul and Pakto, as well as Pakdes I and II.

2

McLeod

In the early 1980s, the contribution of Indonesia's financial sector to the development process remained exceedingly modest. The sector was almost totally dominated by the banking system which, in turn, was dominated by a small number of very large state-owned institutions. These state banks were little more than administrative arms of the government which (together with the large state enterprise sector) supplied them with most of their funds and, to a large extent, told them where to lend and on what terms. Competition was minimal; indeed, according to the laws of that era, each state bank was supposed to focus on only one or two sectors of the economy. Very little attention was paid to the idea of banks as intermediaries, so efforts to mobilise funds from the public were very modest. Nor was there much of an attempt by these banks to provide an efficient payments mechanism to facilitate larger money transactions and payments or transfers across large distances (or, for that matter, payments across town). Few individuals had bank accounts, and it was common to see people going in and out of banks with large envelopes or briefcases full of banknotes-sure indications of the unpopularity of cheques as a means of payment. Credit cards were entirely unknown. By the early 1990s, things could hardly have been more different. The market share of the state banks had shrunken dramatically as private banks (both domestic and foreign) proliferated, and their branch networks expanded at a frenzied pace . In the Indonesia of 1994, millions of individuals have established new banking relationships, and now operate cheque and savings accounts and place their funds as time deposits. Bank loans have become far more widely available, both for small businesses and for individuals. Hundreds of thousands of credit cards have been issued, and automatic teller machines are sprouting in shopping malls and hotels all over the country; even telebanking has made its appearance. Bank offices in the cities gleam with marble and chrome, and well trained tellers give friendly and efficient service. Meanwhile, at the village level, the poorer members of the population are also finding basic bank services increasingly available to them. Progress has not been restricted to the banking system. The Jakarta Stock Exchange, virtually moribund even after more than a decade of government prodding, sprang to life at the end of the 1980s. There is now a steady flow of new company listings, trading activity has achieved volum es undreamed of only five years ago,

Introduction

3

and bank loans are now having to compete with equity capital raisings direct from investors in the financing of large corporations. The legal foundation has been laid for the expansion of the life insurance and pension funds industry, both still in their infancy, which should help to generate an increasingly large flow of savings through the capital market in the future. There is far from unanimous acceptance of the view that these changes are all for the better, however. There are genuine (if not necessarily well founded) concerns that they have helped the rich rather than, or at the expense of, the poor; that they have been responsible for increased concentration of economic power; that they have allowed foreign interests too great a role in determining Indonesia's economic destiny; and that, after all, government planners and visionaries are still better able to determine the appropriate directions for economic development than market forces. The strength of these views within the community-and even within the ranks of those policy-makers who have been broadly in favour of the general direction of the new policies-has been such that the reforms remain incomplete. Notwithstanding the dramatic deregulatory progress that has been achieved in such a short time, important policy interventions still exist, the underlying philosophy of which appears to contradict that of those reforms: the determination of most financial prices has been left to the markets, but the exchange rate is still controlled, and there has been a reluctance to allow interest rates on the central bank's instruments of monetary policy to be genuinely market-determined; the rupiah is freely convertible to other currencies, yet the government attempts by various means to limit both capital inflow and outflow; not all banks are permitted to deal in foreign exchange, despite the strong demand for foreign currency loans and for foreign currency deposit accounts; informal controls on the pricing of new share issues have been in place in the last two years, and the government has tried to control the scheduling of these issues; rules exist which force the allocation of a minimum proportion of new issues to small investors; a compulsory system of social security insurance operated by a state-owned monopoly was introduced at the same time new laws intended to stimulate the emergence of voluntary insurance and pensions arrangementsprovided under competitive conditions (mainly by private sector firms)-were being enacted; and there are indications that, no sooner have moves been made to deal with problems at the state banks,

4

McLeod

more funds are being directed to-and will quite likely be frittered away just as quickly by-other state-owned financial institutions 1 outside the banking sector. Nor has the process of policy reform been uni-directional. The former emphasis on controlling both the allocation and the cost of finance has been succeeded by a new concern to protect investors who entrust their savings to financial institutions and (through the capital market) to the corporate sector. It is facile to characterise this simply as a shift from deregulation to re-regulation as some have done . The underlying philosophy is entirely different, and reflects the view that by this means, markets can be made to work better-whereas the previous approach sought to override them. This is not to say, however, that the approaches followed have been well thought out, or even that they are necessarily worthwhile. The first major attempt to focus on the protection of peoples' savings was contained in a weighty document of some 600 pages introduced in February 1991 ('Pakfeb'). This bore the hallmarks of has ty over-reaction to the embarrassment caused by the virtual failure of one of Indonesia's top private banks (Bank Duta) some months earlier (and not long after it had been given a clean bill of health to list its shares on the stock exchange), as a 2 consequence of its heavy involvement in currency speculation. But Bank Duta had been operating in breach of already existing prudential regulations which sought to limit the extent of such speculation. The problem, then, was not the lack of prudential regulations, but the failure to enforce them. This was highlighted 1 PT Askrindo, a company which has lost large amounts of taxpayers' funds insuring mainly sta te bank loans, recently has been recapitalised UP, 7 December 1993); PT Bahana, a venture capital company intended to stimulate the emergence and expansion of sma ll businesses, but whkh has made virtually no discernible progress in this endeavour, recently has been revived and given an expanded role (Pangestu, this volume); and the government leasing company, PT Pann Multifinance, is to be required to provide lease finance to domestic airlines to ease the burde n of having to purchase aircraft from the state aircraft manufacturer, PT lPTN (FEER, 24 November 1994). Even the nation's reafforestation fund has been turned into a financial intermediary-drafted to the cause of helping to ensure that IPTN's new N250 aircraft will fly, by requiring it to provide a zero-interest loan for an ind efinite period to help cover production costs UP, 7 July 1994). 2

The bank was able to be resurrected by the injection of new equity.

Introduction

5

again less than two years later by the failure of another prominent private bank, Bank Summa, owned by one of Indonesia's largest conglomerates. Bank Summa's demise was also brought about by activities which breached existing prudential regulations (specifically, those which sought to limit the concentration of loans on particular groups of borrowers) so, again, the existence of written rules proved insufficient to ensure adherence to prudent banking practice. Finally, the state-owned Bank Pembangunan Indonesia (Bapindo) was revealed in 1994 also to have breached the prudential regulations by lending an amount far in excess of its own capital to a single borrower, without security, and even without contracts having been signed. The new emphasis on depositor protection, therefore, should not be accepted uncritically as a movement in the right direction, despite its seemingly laudable objectives. Depositor losses have been very limited, to be sure, having been restricted to larger depositors at Bank Summa (and even these depositors may recover most of their funds once the liquidation process is complete). On the other hand, there were no major cases of depositor loss through bank failures in the two decades prior to the introduction of Pakfeb either. Moreover, there is little doubt that there have been very large losses to taxpayers (rather than depositors) by virtue of the large scale of so-called 'problem loans' at Bapindo and the other state banks. Overview This book concerns itself mainly with describing and analysing the changes that have occurred in the financial sector over the last decade or so, and the policy reforms that have brought about these changes. Although there are brief references to the dramatic financial reforms of an earlier era-namely, those which were implemented as part of Indonesia's remarkably successful macroeconomic stabilisation efforts at the beginning of President Soeharto's 'New Order' government-the primary focus is largely on the process of microeconomic reform in finance, commencing with the 1983 banking deregulation package. Macroeconomic policy reforms are also tackled, but it is probably fair to say that the major initiatives in this area were carried out long ago; Indonesia has had an enviable record amongst developing countries for many years for its fine record of successful macroeconomic management.

6

McLeod

Indonesia by now has gone further down the road of financial deregulation than most other developing countries; indeed, in some respects at least, it has gone further than many more developed countries such as Australia (where entry to new foreign banks remains closed, for example). By and large, the allocation of financial resources is now determined by markets rather than by direct government intervention; competition rather than monopoly or oligopoly is the order of the day; and belief in the ability of state-owned banks, insurance companies and other financial institutions to hasten the development process has given way to far greater reliance on the private sector. The rest of the volume is presented as two parts. The first contains surveys of recent economic and political developments, in keeping with the pattern established in previous issues in the Indonesia Assessment series. The second, containing the bulk of the chapters, is concerned with the theme of the 1994 Indonesia Update conference: Finance as a Key Sector in Indonesia's Development. In turn, this part is sub-divided into five sections. The first section takes a broad view of the process of economic reform as a whole, with particular emphasis on reform of the financial sector. Indeed, it is in this sector that reform has been most radical, creating expectations for real sector reforms that have been difficult to fulfil, and yet building a record of success that is hard to ignore. The second section looks at two of the most important aspects of macroeconomic management-namely, monetary and exchange rate policy-while the remaining chapters are concerned mainly with the microeconomics of the finance sector. The third section focuses on banking, which remains by far the largest component of Indonesia's formal financial system (space and time constraints prevented informal finance from being covered), and the fourth turns attention to the growing importance of capital markets-both domestic and foreign-as outlets for saving and sources of investment funds. The final section then discusses Indonesia's experience at the small-scale end of the finance spectrum. Recent developments Mari Pangestu's report on recent economic developments shows that Indonesia's macroeconomic management continues its past record of success. Growth is brisk, inflation is reasonably well under control, investment approvals are running at record levels, and the balance of payments is very healthy. The only real causes for concern are the

Introduction

7

marked slow-down in n on-oil exports, and the apparent loss of momentum in trade policy reform. An emerging issue is the difficulty of managing the money supply, given the government's commitments to the open capital account and the policy of steady depreciation of the rupiah against the dollar, to w hich further reference is made below. Richard Robison's discussion of the current state of play in Indonesian politics focuses on what now is widely regarded as the biggest challenge the nation has had to face for many years: the transition to a new president. President Soeharto himself has expressed his intention to step down when his current term expires in 1998, and many observers believe it would be difficult for him to hold on to power if h e tried to stay in office beyond that time. Finding the right person to fill the shoes of a president sufficiently strong and astute to be able to stay in power for three decades will be no easy task, however. Finance as a key sector in Indonesia's development As Grenville points out, Professor Ali Wardhana not only was 'present at the creation of the Indonesian financial sector as we now know it, but he was mid-wife at its birth and its guardian as it grew up'. 'Pak Ali' (as he is widely known) looks back in his paper over 'only' the last decade of that growing-up process, in which mainly microeconomic reforms have been in the spotlight. While quick to point out the difficulty of m easuring the impact of the set of financial reforms introduced over an extended period-and when real sector p olicies and Indonesia's external circumstances were also changing in significant ways-he is in no doubt that Indonesia is better off now than it would have been in the absence of these reforms: I believe that the size and diversity of the present financial system is much g reater than it would have been; that the array of instruments offered is much broader and much better suited to meet the more varied needs of the economy; that the fin ancial system m eets the needs of the economy more efficientl y; that the system is, and will continue to be, able to meet a much grea ter sha re of the country's d e mands for financial services than it wo uld have been without the reforms; and, finally, that th e leve ls of human s kills and knowledge and organisational infrastructure now found in the financial sector, are much higher than they would have been.

8

McLeod

Some of the aspects h e chooses to highlight include: the shift in emphasis to market allocation of financial resources and to private rather than state-owned banks; the new concern for depositor protection by means of prud ential regulation and supervision of banks; the seriousness with which the government recently has been approaching the task of improving the performance of the state banks; and Indonesia's considerable success in bringing banking services to the rural population. Perhaps in response to criticisms that the 1988 reforms were responsible for rapid money growth and overheating of the economy in 1989-90, he draws attention to the lack of monetary restraint throughout 1989 and the early part of 1990. This had more to do with the conduct of open market operations than with the opening of the banking sector to competition, and had to be corrected by a strong 'tight money policy' beginning in early 1991. In another reference to macroeconomic reform, he discusses the introduction of central bank certificates and money market securities as instruments for the conduct of open market operations, and acknowledges the ineffectiveness of the credit ceiling policy prior to 1983. Stephen Grenville is another long-time observer of Indonesian finance, first as a post-graduate research student, then as a member of the International Monetary Fund's Jakarta representative office, and more recently as an occasional adviser on aspects of monetary policy. He rightly draws attention to Pak Ali's central role in the earlier phase of finan cia l reform in the first years of the Soeharto regime , which succeeded remarkably quickly in restoring macroeconomic s tability to an economy that, in 1965, had experienced hyperinflation, and that had been labelled by Higgins (1968)-so Nasution reminds us-as 'the number one failure among the major underdeveloped countries'. Grenville also draw s attention to the acceptance of a dramatically larger role for private banks, non-bank finance, and markets. He seems even less willing than Pak Ali to claim that this has led to significant impro vem e nts in allocative efficiency (and argues that one of the greatest benefits of the reform process may be found in the discipline it h as imposed on macroeconomic policymaking). He notes th a t other countries hav e experienced rapid economic d evelopment without deregulating their finance sectors, and wonders 'wh e the r the economy is getting a good re turn for [the] highly paid resources go ing into th e [financial) sec tor'. An answer is s uggested by the fact th a t the contr ibution of thi s sec tor to GOP

Introduction

9

increased from 3.5 per cent in 1985 to 4.2 per cent in 1992 (as Nasution points out)-presumably because resources were able to be employed there (by mainly private sector institutions) in such a way as to earn a satisfactory rate of return . While noting that the monetary authorities are experiencing increasing difficulty in trying to fix both the exchange rate and interest rates, Grenville seems unprepared to recommend either the adoption of a floating exchange rate or of a 'hands-off approach in relation to the current account deficit. This is certainly a policy issue of increasing importance, and is considered in several other papers. No discussion of finance policy in developing countries would be complete without touching on the question of the appropriate sequencing of financial reforms, the topic of George Fane's paper. Fane points out what many other discussions of Indonesia's reform sequencing forget: namely, that the process began in the late 1960s, not in 1983. The first step involved getting inflation under control (by adopting fiscal restraint). Opening up of the capital account did not occur until the inflation battle had been won, and Fane suggests that there are good reasons why this was a sensible approach. He notes also that the capital account has never been fully open; there has always been some policy ambivalence, reflected in controls on offshore borrowing, direct foreign investment, and foreign portfolio investment. Nevertheless, on the spectrum ranging from open to closed, Indonesia's policy certainly has been nearer the former extreme, and Fane finds that the economy does not appear to have suffered from this and other financial reforms which have been undertaken in the 'wrong' sequence-i.e. in advance of far-reaching real sector reforms. Grenville's commonsense assertion on sequencing also bears repeating here: 'In practice, of course, policy-makers do what they can, and take whatever reforms they can, in whatever order they come.' The capital account is also of central importance in Boediono's paper. He agrees with the notion that the open capital account has imposed an important form of discipline on macroeconomic policy, but is inclined to stress this also in a negative sense-i.e. as an obstacle to the smooth conduct of monetary management. As noted above, Pangestu also draw s attention to this problem in her paper, and my own paper on Indonesia's foreign debt also touches upon it. Briefly stated, th e problem would appear to be as follows. Interes t rates, and rates of return generally, are relatively high in Indonesia, given th e strength of the rupiah in recent years. This

10

McLeod

generates private capital inflow to borrowers in search of cheaper funds and from investors in search of higher returns . This capital inflow has tended to exceed the current account d eficit, so that the balance of payments h as often been in surplus. The surplus has an expansionary impact on the money supply which, if not countered, would cause excessive infl ation. The central bank has been reasonably successful in s terilising the mon e tary impact of the build-up of its foreign exchange reserves, by issuing large quantities of its own certificates (known as SBis). By focusing on the central bank balance sh eet, the process can be seen to result in an expansion of assets (in the form of reserves) and liabilities (in the form of SBis). But international reserves are loans to the rest of the world, while SBis are borrowings from the public. What has been happening, then, is that the private sector has been borrowing funds offshore and converting them to rupiah; the central bank has then been b orrowing rupiah from the private sector and making loans to foreigners. The net amount of foreign capital inflow thus has been greatly reduced, and d omes tic inte rest rates have remained relativ ely high . The central bank's own profitability has suffered greatly because of the negative spread be tween the yields on its foreign assets (even afte r allowing for depreciation of the rupiah) and the cos t of borrowing domes tically. Like Grenville, Boediono is well aware of the difficulty of trying to control both exchange rates and interest rates, and con cedes th a t some policy adjustment eventually will be n ecessary. But he argues that floating the rupiah would be 'a leap in to th e unknown ', so tha t there is great reluctance to m ove in this direction. Elsewhere in his paper, Boediono exp resses a strong preference for policy changes to be made in small ste ps rather than large ones, and thus for adjustme nts to be made earlier ra ther th an later in response to perceived changes in the economic 'fund am entals'. This provides an interesting contras t with Grenville, w h o app lauds Indonesia's three 'bold devaluations' (in 1978, 1983 and 1986). While Indon esia undoubted ly has been wise to set its exchange rate so as to maintain its competitiveness in world m a rke ts, it is certainly worth asking whether this purpose might have been better served by a series of smaller, more frequent exchange rate adjustments. It is n ow eight years since the last ' bold devaluation', and Indonesia's money market is still plagued by rumours from time to time that another is about to occur.

Introduction

11

Another most interes ting aspect of Boediono's paper is the author's defence of policies which involve the simultaneous attempt to control both prices and quantities in certain key markets. This position is justified in terms of the unavailability of good quality information on a timely basis, and in terms of the thinness of domestic markets (in which small shifts in demand or supply can cause large price changes). This is an issue worth debating at length; unfortunately, that is not possible here, but it is to be hoped that this paper will stimulate further discussion. The next three papers, by Anwar Nasution, H endrobudiyanto, and Manggi Habir, are concerned mainly with the microeconomic reform process in the banking sector. Nasution's paper provides the most complete review of the process, touching also on macroeconomic issues along the way. Many of the points he discusses have been mentioned already; on e additional aspect of Indonesia's macroeconomic policy success to which he draws attention is its rapid movement away from h eavy dependence on the oil sector, following the reductions of oil prices in the mid 1980s. A further point of interest (noted but not explained) is the growing importance of foreign currency de?ominated deposits and loans in Indonesian banking. Perhaps this will be adopted as a research topic by a PhD student in the near future! Hendrobudiyanto and Habir both concern themselves with the more recent developments in the regulation of banks-specifically, with the consequences of unleashing the forces of competition in 1988, and the impact of the new emphasis on prudential standards since 1991. One of the interesting issues raised by Hendrobudiyanto's paper is the apparent, but hitherto largely undocumented, shift in the central bank's approach to bank supervision. This seems to be taking it away from the rather mechanical system for evaluating banks' soundness set out in Pakfeb (and summarised in Habir's paper) to an approach which puts far greater emphasis on detective work and professional judgemen t on the part of the regulators. These include the implementation of an ea rly warning system to help detect deterioration in banks' financial condition, and the establishment of special teams to help banks (especially the state banks) to come to grips with their bad loan problems. The experience gained by these teams should be invaluable in designing more effective methods of supervision for the future. Another point of interes t is the discussion of attempts to extend central bank supervision to Indonesia's thousands of 'secondary'

12

McLeod

banks (a point also raised by Soeksmono, and of the introduction of a credit information system capable of reporting on all bank loans down to those of only about the equivalent of $15,000. The secondary banks are small individually and in aggregate, and they are excluded from participation in the payments clearing system. Failure of such banks would therefore appear to have no significance for the stability of the banking and monetary system (concern for which provides the traditional rationale for close supervision and control of banks). Likewise, it is hard to see the need for the central bank to inform itself about individual loans as small as $15,000 when the real need seems to be to detect and monitor loans of the order of many millions of dollars (as in the case of Bapindo) and foreign exchange speculation involving hundreds of millions of dollars (as in the case of Bank Duta). Again, Hendrobudiyanto's paper should serve as a useful starting point for debate of these kinds of issues. Habir's paper discusses the impact of the various policy reforms from the viewpoint of the institutions directly affected by them. He notes the challenges facing banks in adjusting to the now much tougher competition (not only amongst themselves, but also from the increasingly important capital market) and to the new prudential standards. He describes clearly the virtual explosion of banking activity since 1988, and the rapid decline of the state banks (in terms of their market share) over the last decade. In particular, it is of interest to note the relative success of the state and domestic private banks in mobilising deposits from the public and private sectors. The state banks continue almost to monopolise the public sector market, whereas the private banks have already captured the lion's share of private sector deposits. What is it, then, that keeps public sector deposits with the state banks? Again, this might be an interesting area for further research. In his discussions of the system by which the central bank rates the soundness of the commercial banks, Habir notes that the results are distorted by the inclusion of certain aspects which have nothing to do with prudential standards-namely, the requirement that domestic banks should allocate at least 20 per cent (by value) of their loans to small businesses, and the requirement that foreign and joint venture banks should allocate at least half their loans to the support of export activity. He also draws attention to the curious scoring system, which fails to penalise increasingly blatant non-

Introduction

13

compliance with the rules relating to capital adequacy, foreign exchange exposure, and concentration of lending. The last paper in this section, by Kathryn Marshall, discusses the proposal to establish a sys tem of d eposit insurance in Indonesia (which is also supported by Soeksmono). Marshall argues against such a move-support for which was greatly boosted by the failure of Bank Summa in 1992-on various grounds. Central to the argument is the problem that such arrangements, designed to protect depositors from loss in the event of failure of their bank, seem almost inevitably to increase greatly the probability of such failure. She discusses the less-than-confidence-inspiring experience with deposit insurance in the US, and notes that depositors seem well aware of the risks they face. Evidence for this is the relatively small proportion of total deposits held at the more risky private banks, and the differentiated structure of interest rates across institutions-lowest at the state and foreign banks, higher at the large private banks, and higher still at the smaller private banks. Interestingly, she notes that even with the heightened competition brought about by the 1988 reforms, these interest rate differentials appear to have in creased rather than decreased, indicating both that depositors are making their own judgements about risk, and that those who use the riskier banks are being compensated for higher risk by the higher rates offered. Cyril Noerhadi's paper switches our attention to the capital market, the most important part of which is the Jakarta Stock Exchange. He contrasts the almost negligible progress achieved in more than a decad e prior to th e implementation of a series of reforms with the truly remarkable and sustained burst of activity since 1989. The competitive threat this development poses for the banks is evidenced by data comparing long-term lending by the banks with the amount of (long-term) finance raised by the issue of shares and bonds. In contrast with the government's original intention of involving the 'little people' in ownership of Indonesian corporations, the paper notes that foreigners dominate the demand for issued shares. Noerhadi also documents problems that emerged as average daily tradin g in th e secondary market grew suddenly from 10,000 shares in 1987 to n early three million by 1990, one result of which has been to s timulate a move to scripless trading. Development of th e capital market is also the focus of David Linnan's paper. Perhaps the major contribution here is his observation that, jus t as it is important for Indonesia's real sector to

14

McLeod

remain competitive in global commodities and product markets, so it must be conscious of the need for its capital market to be competitive. In tum, the structure of regulation of the capital market bears significantly on its competitiveness. Already there are signs of domestic companies growing impatient with what they see as regulatory inefficiency and unnecessary intervention, and choosing to issue their securities in overseas markets. The problem here, as Linnan sees it, is the propensity to allow non market-based considerations such as concerns about the distribution of income and wealth, the power of private sector conglomerates, and the extent of foreign involvement in ownership of companies in Indonesia, to influence the design of the regulatory environment. While not denying the legitimacy of such concerns, he implicitly questions the appropriateness of trying to act on them through the medium of capital market regulations, rather than by more direct means, if the main impact is simply to cause large corporate financing transactions to move offshore. Perhaps the major source of investment funds for capital markets in more developed economies is the life insurance and pension funds industry. As Prime and Knox point out, the industry is still in an embryonic state in Indonesia. New laws have been enacted in order to provide a firmer legal basis for these activities, but the missing element now would appear to be a strong demand from individuals for these forms of insurance (the one against dying too young, the other against dying too old). Just as informal financial arrangements can substitute for poor or absent banking services, so too there are informal insurance arrangements in countries such as Indonesia where formal insurance is not widespread. In particular, the extended family can usually be relied upon to care for dependants if a breadwinner dies, and to care for older members when they are no longer able to support themselves. An important part of the government's policy in relation to pensions is favourable tax treatment of savings in this form. This is common practice around the world, although the rationale seems somewhat dubious. It seems to rest largely on the view that people will not save enough in the absence of this additional incentive, but it would be difficult to substantiate this assertion. More important, perhaps, as the authors point out, encouraging people to save more in this form does not guarantee that aggregate savings will increase. Instead, the paternalistic policy which encourages people to save in the form of pensions is likely to be confounded to a large extent by

Introduction

15

individuals' stubborn insistence that they themselves are the best judge of their own self-interest. This is likely to lead them to cut down on other forms of saving or, having been induced to cut down on consumption earlier in life, to react by cutting back on the length of their working careers (i.e. by retiring earlier), thus reducing their lifetime earnings and, quite possibly, their total savings prior to retirement. Prime and Knox draw attention to restrictions on the investment of life and pension funds overseas. The rationale, presumably, is that Indonesian saving should be kept in Indonesia, in order to finance the development process. But this ignores the fact that there is a great degree of freedom on the part of Indonesian firms (and the government) to borrow abroad in order to fund their investment plans. There would therefore seem to be no strong justification for prohibiting capital outflow- the main benefit of which in this case would be from greater diversification of life insurance companies' and pension funds' asset portfolios. It may be noted also that other aspects of finance policy are premised on the notion that there is now too much capital inflow. A major problem with the new pension law and regulations is that existing defined benefit pension plans (i.e. those that guarantee a retirement pension of a certain monetary amount) will have to be brought up to 'fully-funded' status. Most of the existing plans are those of state en terprise 'foundations' (yayasans), which have operated hither to largely on a ' pay-as-you-go' basis (i.e . paying pension benefits from current revenues). The state enterprises concerned now have very large unfunded liabilities, and Prime and Knox express their concern about the immense implications of sudden compliance with the 'full funding' requirement: Initially there is the co ns id eration of where such large amounts of capital would be found ... within the time limit, since it seems unlikely that the government would want to appropriate budget funds for this purpose. Then, assuming the funds are found, these large additional amounts would need to be invested.

One way of dealing wi th the problem, which would require neither new capital nor additional investment, would be for the government to issue bonds to these yayasans equal in value to the amount of the unfunded pension liabilities. The funds notionally raised in this manner would be injected into the parent state enterprises as new equity, and these firms in turn would inject them

16

McLeod

into the yayasans. No funds would actually change hands, but the net effect would be that the yayasans would now have a portfolio of government bonds which would enable them to meet their future pension liabilities. The government, of course, would need to amortise these bonds and pay interest to the yayasans, but this would merely take the place of the reduced future flow of profits from the state enterprises which would otherwise occur if they needed to pay pension benefits from their current revenues. As the papers by both Fane and Nasution make clear, the authorities' attitude to capital inflow has always remained somewhat ambivalent. Direct foreign investment was strongly encouraged in the early years of the Soeharto regime, but then was subjected to more and more controls as nationalistic sentiment gained ground over the quest for efficiency. Very recently, most of these controls have been cut back, although several sectors still remain closed to foreign investment. Portfolio investment by foreigners also has been subject to controls: the share market was closed to them until December 1987, and it seems that nationalistic sentiment has again prevailed over economic considerations with the recent announcement that the government would not proceed with its plan to soften the regulation which now limits foreign ownership of listed companies to only 49 per cent (Bisnis Indon esia, 13 October 1994). Other aspects of controls on capital flows have been mentioned already. In the final paper in this section, I discuss yet another aspect of Indonesia's somewhat reluctant integration into the global financial market-namely, the current concern about the size of the foreign debt. I discuss the appropriateness of policies which seek to limit foreign borrowing on the grounds that Indonesia's foreign debt is currently 'too large', and argue that debt should not be looked at in isolation but in conjunction with the investments it makes possible. From this perspective, the question becomes whether the potential benefits of additional investment should be sacrificed because of the desire to avoid the risk associated with uncertain borrowing costs. On the grounds that many risks are well worth taking, I argue that such an approach would seem unnecessarily conservative. At the same time, however, I draw a ttention to the scope which exists for more conscious management of borrowing risks. The last two p apers present discussions of contrasting approaches to the problem of providing banking services at the very low end of the retail market. Soeksmono Martokoesoemo speaks

Introduction

17

from a wealth of experience as a former director of the central bank and adviser to Bank Rakyat Indonesia (BRI; literally, the 'Indonesian People's Bank') abou t the changing emphasis of the government's attempts to promote small-scale finance . He describes the failed Bimas credit program, which provided a large volume of heavily subsidised loans to farmers in the 1970s and early 1980s, much of which was n ever repaid. He discusses also the KIK/KMKP program, which aimed for many years to promote the development of small businesses by providing them with cheap loans, and which met with a similar fate. The latter program has been discontinued, and replaced by the previously mentioned requirement that all domestic banks should devote 20 per cent of their loans to small businesses. The Bimas story is perhaps more interesting, in that this program has been replaced by a new strategy which places equal emphasis on the importance of providing savings deposit facilities as it does on providing loans to the rural population. The other keys to the outstanding s uccess of the Kupedes-Simpedes (general village lending-village deposit mobilisation) strategy were the removal of government subsidies and the se tting of interest rates at close to market levels, in order to make the village units which handled the new program financially self-sustaining. In the second of these two papers, Henk Moll and Karel Palallo discuss a quite differen t scheme implemented through Bank Bukopin, the Indonesian Cooperatives Bank. This scheme relies heavily on subsidies from Dutch sources, in the form of interest free loans. It goes even further than Kupedes in setting a relatively high rate of interest for borrowers, but on the other hand there is virtually no attempt to tap vi llage savings. Whereas BRI's village units perform a genuine intermediation function by collecting funds from savers and lendin g them to other individuals and small businesses, Bukopin's approach begins with loans being financed by the outside loan, and then requires borrowers not only to repay their loans but also to save on a comp ulsory basis until their group has been able to repay the start-up loan in full. There is provision for voluntary saving as well, but the interest rate is too low to be attractive. The Bank itself seems rather unenthusiastic about the scheme (the authors claim that it covers its costs, but that it would be more profitable to deploy its resources elsewhere), and it seems unlikely it would persevere with the scheme if the subsidised loan Were to be withdrawn . This provides a dramatic contrast with BRI's

18

McLeod

village units program, the profitability of which appears far higher than that of the Bank's more orthodox activities. Conclusion In summary, the papers in this volume provide a wealth of detail concerning the evolution of the finance sector in Indonesia, and of the policies which have driven the remarkable changes witnessed. Various aspects which seem worthy of further research have been noted, and several suggestions for the further refinement of finance policy have been highlighted. The discussions are made all the more valuable by the diverse mix of academics, policy-makers and representatives of the private sector who have contributed; the readiness of senior Indonesian policy-makers to participate in the Indonesia Update conference and to contribute to this book is particularly welcome.

PART A: ECONOMIC AND POLITICAL DEVELOPMENT S

2 Recent economic developmen ts Mari Pangestu*

The Indonesian economy continued to perform very well in 1994. Growth of output was brisk, and inflation was reasonably well under control. The balance of payments has been generally strong; fears of a sustained fall in oil prices proved unfounded, although the disappointing growth performance of non-oil exports in 1993 (especially in textiles and garments) seems not yet to have been corrected . Management of the money supply has been reasonably successful (although money growth will probably need to be cut back if inflation is to be lowered), but it has been made difficult by large and fluctuating levels of capital flows to and from overseas-which call into question the appropriateness of current exchange rate policy . Introduction of a new five-year development plan and the second long-term (25 year) development plan have been highlights of economic policy-making in 1994, together with the introduction of new policy packages concerning foreign investment, trade, and small business finance . Of these, the foreign investment package seems by far the most significant. The trade package was regarded by many as a disappointment-es pecially by industries which are reliant on importable inputs-demonstrat ing the continuing difficulty faced by the government in promoting strong competition in several key areas in the real sector. Economic growth Growth slowed a little to 6.9 per cent in 1991 and 6.4 per cent in 1992, after booming in 1989 and 1990 at 7.5 per cent and 7.2 per cent,

,.

This chapter draws heavil y on, and summarises data presented in more detail in, Pangestu and Azis (1 994).

22

Pangestu

respectively. The estimated 6.5 per cent increase in real GDP in 1993 confirms that fears of a serious economic downturn as a result of the tight monetary policy in 1991 and early 1992 were overstated. Business confidence, especially on the part of domestic investors, recovered in the last quarter of 1993, and growth in 1994 is estimated to have been similar to that in 1993; more rapid expansion is not expected until1995. The manufacturing sector should continue to lead, growing at close to 10 per cent p.a. in response to strong domestic demand. Growth in agriculture should be close to the normal level of around 3 per cent. The mining sector is not expected to experience much expansion, as investment in this sector has been slow. The services sector (including construction) is expected to experience continued robust growth, partly in response to the high priority given by the government to infrastructure development and the privatisation of infrastructure projects. The budget and longer-term development plans

Budget Actual government spending is expected to be somewhat higher than anticipated in the budget for 1994/95, because of higher salaries for civil servants and higher debt service resulting from appreciation of the yen (in which about half of government debt is denominated). Thus it is likely that the budget outcome will show a slight deficit, which will probably be met by drawing on 'development reserves'. These amount to about Rp3 trillion, and derive from surpluses in the previous two annual budgets. In tum, the surpluses were made possible by oil sector revenues being higher than expected in 1991/92 owing to the Gulf War, and by higher than targeted tax collections in 1992/93; instead of spending this additional revenue in accordance with the usual balanced budget principle, the government chose to create reserves which could be set aside for spending in the future. Nevertheless, the budget continues to be conservative, as it was in the previous two years (Table 2.1). The nominal spending increase compared with the 1993/94 budget is only 11.9 per cent, or 3-4 per cent in real terms if inflation is around 8-9 per cent in the present fiscal year. In keeping with this conservatism, it was announced that civ il service salaries would not be raised (although food support for the army was increased, since this had already been announced prior to presentation of the budget).

Recent economic developments

23

Table 2.1: Budget forecasts (Rp trillion) 1993/94

1994/95

Growth(%)

Domestic revenues

52.8

59.7

13.2

Oil corporation tax Non oil Income tax Value added tax Land tax Tariffs Excise tax, other taxes and non-tax revenues Net profits from fuel sales

15.1 37.6 14.8 11.7 1.3 3.1

12.9 46.9 18.8 13.2 1.6 3.4

-15.0 24.6 26.9 13.3 23.4 10.9

6.5 0.2

7.2 2.6

11.4 1133.7

Routine expenditures

37.1

42.4

14.2

Debt service Civil servants' wages Other

16.7 10.9 9.5

18.0 13.0 11.4

7.5 19.4 19.8

Government savings

15.7

17.4

10.9

Development expenditures

25.2

27.4

8.6

Project Government departments Regional development Other Development budget reserves

9.1 9.3 5.9 0.9 0.0

10.0 10.0 6.8 0.6 0.0

9.7 7.4 15.7 -34.2

Foreign borrowings

9.6

10.0

4.8

62.3

69.7

11.9

Total

The pattern of development expenditures is indicative of the priorities of the government with regard to infrastructure development, regional development, alleviation of poverty, and decentralisation. These priorities are reflected in the higher than average increase in spenalng on transportation, energy, telecommunications, regional development, population and family welfare, and social welfare and health, than for all development expenditures combined (namely, 8.6 per cent). Infrastructure sectors

Pangestu

24

such as transportation, energy and telecommunications account for a significant proportion (36 per cent) of the development budget. On the other hand, despite increased emphasis on human resource development and science and technology, these sectors did not experience much increase, and still account for only a small proportion of total spending. Another important aspect is the shift toward greater regional autonomy in regional development policy. The growing emphasis in the last few years on decentralisation has been translated in the 1994/95 budget into increases in expenditures, and the retention of a greater proportion of land taxes, at the sub-district (kabupaten) level. Moreover, the renewed emphasis on poverty alleviation has led to the introduction of a new program for the development of poorer villages (INPRES Desa Tertinggal). The amount allocated, however, is relatively small (Rp395 billion), with the 20,000 villages involved receiving only about Rp20 million (a little under $10,000) each. The disbursement mechanism adopted relies on a 'bottom up' approach, in which the village council rather than the central government decides how the funds should be allocated and used. This approach is in line with the government's new emphasis on people's participation in development as part of its decentralisation efforts; it remains to be seen, however, how successful this approach will be. Longer term development plans

The sixth five year plan and second long-term (twenty five year) development plan were released at the beginning of fiscal year 1994 I 95. 1 Table 2.2 provides a summary of their main targets. Indonesia's population, 189 million at the end of the fifth five year plan, is expected to reach 258 million at the end of the next 25 years. Population growth is projected to continue its decline, so that by the end of the second long-term plan it will be only 0.88 per cent p.a. The labor force will nearly double in 25 years. Economic growth is expected to average 6.2 per cent in the sixth five year plan, whereas the average growth rate for the second long-term plan is projected to be 8.7 per cent p.a.

1 Booth

(1994) contains an extended discussion of these plans.

25

Recent economic developments Table 2.2: Major targets from sixth five-year plan and long-term development plan

End of fifth End of sixth End of longterm plan S year plan 5 year plan (2119) (1993/1994) (1999/2000)

Population 189 .1 1.66

204.4 1.51

258 .1 0.88

78 .8

91.4

147.9

Real growth rate during plan period(% p.a.) 6.6 GDP 2.4 Agriculture 10 .0 Manufacturing (including oil) 11.0 Non-oil manufacturing 7.2 Others

6.2 3.4 9.4 10.3 6.0

8.2 3.5 8.7 9.0 9.5

1,188 676

1487 775

5,046 2,631

20 .2 20.8 17.6 59.0

17.6 24.1 21.3 58.3

8.7 32.5 31.5 59.4

Number (millions) growth rate (average % p.a.) Labor force (millions)

Production

GOP/capita (1989/90 prices) Rp thousand $ Composition of GDP (%) Agriculture Manufacturing (including oil) Non-oil manufacturing Others

Source: Government of Indonesia (1994a)

This improvement in growth compared with past performance will be supported by the structural transformation of the economy that has already occurred, such that the share of the manufacturing sector has exceeded that of agriculture since 1991. Structural transformation is expected to continue, with the leading non-oil manufacturing sector projected to grow at 9-10 per cent p .a. over the next 25 years, and its share in GOP expected to rise to 31.5 per cent. Growth in agriculture should continue at around 3.5 per cent p.a., so that its share in GOP will decline to 8.2 per cent during this period. The remainder of GOP-more than 50 per cent-will be contributed by the services sector. The sectoral structure projected after the 25 years is similar to that of South Korea currently. What is not clear

26

Pangestu

at present is the path of industrialisation that will be pursued so as to generate increased efficiency and enhanced technological capability while, at the same time, achieving the rate of employment growth needed to raise incomes amongst the poor. Around 2.3 million persons are expected to enter the labour force each year throughout the 1990s. The Department of Manpower indicated recently that the level of 'open unemployment', defined as the percentage of the labour force (persons over fifteen years of age) looking for work and working less than one hour a week, was just 2 per cent. On the other hand, 'global unemployment', defined as the percentage of the labour force working less than 35 hours a week (and which therefore consists primarily of underemployment), was reported as 39 per cent. Given the daunting level of underemployment, and the growing number of persons who will need to be absorbed into the work force, generating jobs is one of the most challenging policy issues for the next quarter century. Inflation and money

Inflation Inflation, as measured by change in the consumer price index, reached 8.6 per cent for the first ten months of 1994, compared with 9.1 per cent in the same period last year. As was the case in 1993, a large part of the increase (3.7 per cent) occurred in the first quarter. The 1993 rise was due to higher fuel prices, electricity rates and public transport fares. By contrast, the increase in inflation in the first quarter of 1994 was influenced more by floods and the rising demand for consumer goods due to the ldul Fitri holiday in February, since increases occurred mainly in food prices and, to a lesser extent, clothing. After subdued price increases during the second quarter, inflation picked up again in the second half, partly because of the effect of drought on rice prices. The year-on-year rate of inflation was close to 10 per cent p.a. in the last quarter of 1994, prompting the President to instruct all government departments to do all they could to keep the full calendar year price increase to single digit level.

Monetary developments Growth rates of the money aggregates (M1 and M2) in the first half of 1994 (17.5 per cent p .a. and 10.1 per cent p .a, respectively) were considerably lower than in 1993, apparently because of large capital outflows in the first quarter. Growth accelerated in the third quarter, however, to 25.0 per cent and 28.9 per cent, respectively.

Recent economic developments

27

Lending, on the other hand, grew rapidly in the first half, at a rate of nearly 24 per cent p.a. through May . This is a result of lower interest rates; banks were beginning to lend more aggressively after the consolidation period from 1991 to mid 1993. Bank Indonesia had to act vigorously in 1993 and early 1994 to try to sterilise large disturbances to base money, which are capable of destabilising money supply growth. The main source of volatility was the balance of payments, which was heavily buffeted by capital flows . The latter, in turn, were influenced by the rapidly changing differential between domestic and foreign interest rates; by changing expectations about the future value of the rupiah (given volatility of world oil prices and the setback to Indonesia's non-oil export growth, discussed below); and by concerns about the soundness of the banking system. The flow of foreign investment to the rapidly expanding stock market also had an impact, and indeed has been cited as a reason for not going ahead with an earlier proposal to increase the proportion of shares in listed companies available for purchase by foreigners . Rupiah deposit rates declined from an average of 16.7 per cent p .a. (for the three-month maturity) at the beginning of 1993 to only 11.8 per cent at the end of the year, significantly narrowing the premium over dollar rates, and thus reducing the previously strong incentive for capital inflow . The differential between rupiah deposit rates and the Singapore inter-bank offer rate (SIBOR) for the three-month maturity fell from its peak of around 19 per cent to only 6 per cent in May 1994. If the rupiah was expected to depreciate against the dollar at a rate of about 6 per cent p .a. (the current target announced by the Minister for Finance), this would have left no margin to cover country risk.2 As late as September 1993, the depreciation expectation had probably been closer to 3 per cent p .a. which, together with a higher interest differential (10 per cent), had implied a very wide margin of about 7 per cent available to cover risk. Given such dramatic changes in interest rate

2

The rupiah depreciated against the dollar by 3.6 per cent during the first ten months of 1994, w hich is an annualised rate of 4.3 per cent p.a .-much higher than the 2.3 p er cent recorded for the whole of 1993. For the six months through October, howeve r, the annual rate of depreciation was only 3.5 per cent--considerably lower than the announced targe t.

Pangestu

28 Table 2.3: Factors affecting base money,a 1992-94 (Rp trillion)

Net Foreign Assets

Net Domestic Credit

SBPUb

SB!c

Base Money

1992 Q4

33.0

-0.6

2.9

20.6

14 .7

1993 Q1 Q2 Q3 Q4

36.4 34 .5 34.8 37.8

-0.6 -2.3 -1.8 1.7

3 .1 1.6 2.0 1.4

23.0 18.7 18.7 23.3

16.0 15.1 16.2 17.6

39.3 40.0 37.8 33 .6 32.7 32.6 32.9 34 .7 34 .7

1.1 0.4 -2.2 -2.0 -1.3 -1.6 -2.7 -2.7 -3.1

1.2 2.5 3.1 4.3 3.1 3.4 3.8 2.9 3.5

24 .5 24.2 19 .8 17.4 16 .1 15 .2 14.4 14 .8 14 .1

17.1 18.7 19.0 18.5 18.5 19.2 19.6 20.1 21.0

1994

jan Feb Mar Apr May june July Aug Sep

Table 2.3 (continued over) differentials, it is not surprising that rapid capital inflow would eventually give way to outflow. 3 Domestic rates rose to 13.5 per cent by the end of October, however, such that the rate differential widened to nearly 8 per cent; this seemed sufficient to restore calm on the balance of payments. Table 2.3 shows that Bank Indonesia's net foreign assets, strongly influenced by capital inflow, grew rapidly throughout 1993 and into 1994, expanding by some Rp5.2 trillion in the five months to February. But in the next three months there was an even greater declin e, of Rp7.3 trillion. These movements contributed huge changes

3There

has been much less optimism about Asian stock markets in general in

1994 than in 1993 on th e part of the international investment community,

whi ch has also reduced foreign portfolio investment in Indonesian stocks.

29

Recent economic developments Table 2.3 (continued) Change from end of previous period as % of previous period base moneyd Net Foreign Assets

Net Domestic Credit

Money Market Operationse

Base Money

1993 Q1 Q2 Q3 Q4

22.9 -12.2 2.0 18.9

0.2 -10.9 3.0 21.7

-14.6 17.4 2.5 -32 .1

8.4 -5.6 7.6 8.5

1994 Jan Feb Mar Apr May June July Aug Sep

8 .6 3.6 -11.7 -22.1 -4.6 -0.6 1.6 9.0 -0.1

-3.3 -3.9 -13.8 0.9 3.5 -1.5 -5.8 0.0 -1.7

-8.4 9.7 27.3 18.7 0.9 5.9 6.2 -6.2 6.2

-3.1 9.4 1.8 -2.4 -0.3 3.8 1.9 2.9 4.4

Notes:

Source:

a Base Money = Net Foreign Assets + Domestic Credit + SBPU - SBI b Money Market Securities c Bank Indonesia Certificates d For method of calculating contributions to change in base money see McLeod (1993b:103) e Money market operations= Change in SBPU- Change in SBI Bank Indonesia, Weekly Report, various issues

to base money: 19 per cent in Q4: 1993, and -22 per cent in April1994 alone. At the same time, changes in domestic credit extended by Bank Indonesia were also substantial. These mainly took the form of large fluctuations in government deposits (net of borrowings) at the central bank, and contributed changes in base money as large as 22 per cent in Q4:1993 (somewhat more than the impact of balance of payments transactions), and 14 per cent in March 1994. With stabilisation and the slight rebound of domestic interest rates from mid-year, however, net foreign assets also stabilised. In the five months to September, changes in domestic credit were also relatively small, and so the scale of money market operations was able to become more modest.

30

Pangestu

Bank Indonesia's operations in the money market to a large extent were able to offset the impact of these other factors on base money. The issue of SBis (Bank Indonesia Certificates) absorbed Rp5.8 trillion in the four months to January 1994, while a run-down of SBPUs (Money Market Securities) outstanding absorbed a further Rp0.8 trillion. Thereafter, these money market instruments were used to compensate for the drain caused by the combined effect of changes in net foreign assets and domestic credit, adding a total of Rp10.3 trillion to base money in the next four months. Together, they contributed changes in base money as large as -32 per cent in Q4:1993, 27 per cent in March 1994, and 19 per cent in April. The net result is that base money was reasonably well under control in the first half of 1994, growing at an annual rate of under 13 per cent p .a. in the five months through May-considerably less than the 20 per cent growth registered in 1993. Growth of base money accelerated significantly in the next few months, however, such that the rate of increase through September was as high as 26.6 per cent p.a.

Interpreting international reserves figures International reserves reported by Bank Indonesia rose by $0.7 billion in 1993, from $11.6 billion to $12.4 billion . They increased further by $0.4 billion early in 1994, before falling back by $0.9 billion to $11.8 billion in April, and stabilising at about that level. It is difficult to know how to interpret these data, however, because they are adjusted according to BI's estimate of 'hot money' flowsi.e. short-term capital inflows and outflows in response to changing interest rate differentials and exchange rate expectations (McLeod 1993a:23). The precise basis for these adjustments has not been explained. Some idea of their extent can be gained, however, by looking at changes in the dollar value of BI's net foreign assets during the same period. This rose by $1.9 billion (almost three times the rise in reported reserves) during 1993, from $16.0 billion to $17.9 billion, and by a further $0.8 billion through January and February t0 peak at $18.7 billion. It fell subsequently by $3.5 billion to the end of May (almost Jour times the fall in reported reserves), to $15.2 billion. These comparisons would appear to confirm that international capital mobility has a much stronger impact on Indonesia's international reserves than is apparent from the official reserves figures, and further emphasise the difficulty in operating an independent monetary policy when the exchange rate is heavily

Recent economic developments

31

mana ged (Fane 1994:12). The policy issue h ere is whether Bank Indonesia sh ould continue to unde rtake capital flow s terilisation operations throu gh its money market instruments. The alternatives are, first, to allow much greater interest rate vola tility (permitting rates to fall when there is strong capital inflow, and to rise when there is an outflow); or second, to allow th e exchan ge rate to move freely, thus rem ov ing the m on e tary impact of capital flows. The balance of payments O verv i ew In recent months the most important macroeconomic issue affecting Indonesia has been the prospects for the balance of payments in the face of a slowdown in growth of non-oil exports. This, combined with fairly steady oil exports and increasing imports of goods and services, has resulted in a slight increase in the current account deficit (which had d eclined from a peak close to $4 billion in 1990/91) from $2.6 billion in 1992 /93 to $2.9 billion in 1993/94. This is not as yet cause for concern, since it is still well within the range of acceptable levels as a percentage of GOP. The deficit is more than offset by high capital inflow, which amounted to over $6 billion in 1993/94, with most occurring in the non-governm en t sector. N et official capi tal inflow am o unted to less than $0.8 billion, b eca use official foreign borrowing is roughly offset by amortisation of previous loans. N e t non-gov ernment capital inflows, however, amounted to over $5.5 billion .4 Details of the composition are not ye t available, but it is likely that the proportion is rou ghly on e-third from direct foreign investment, onethird from n e t foreign borrowing, and one-third from net other capital flows (comprising portfolio inves tment) . Internationa l trade Oil prices were weak early in 1994, although they rebounded in June. In 1993, oil exports had declined by 8.3 per cent compared with the previous year, and in the first five months of 1994 were 2.5 per cent lower than in the same period in 1993. The price of oil was $15.51 per barrel in the last (March) quarter of 1993/94 compared with $18.35 in the first quarter, resulting in an average price for 1993/94 4

Unfor tuna tely, the figure for 'errors and o missions' in the 1993 /94 ba la nce of payments was of a s imil ar size to th a t of the recorded current account deficit, making interpretation of these data fra ught with difficulty.

32

Pangestu

of $16.64. The price increased to an average of more than $17 per barrel in June and July, so the average for the 1994/95 fiscal year will likely exceed the government budget assumption of $16. More important, however, is the fall in growth of non-oil exports, since they now account for 74 per cent of total exports. Many analysts, including van der Eng (1993:7), had earlier noted the downward trend in non-oil export growth, which was becoming evident in the middle of last year. However, concern was only voiced by the government at the beginning of 1994, in response to the absolute decline in the January figure from a year earlier. Non-oil exports fell by 11.9 per cent to $1.89 billion in January, from $2.15 billion a year earlier, and from $2.43 billion in December 1993. There is a seasonal pattern whereby non-oil exports tend to decline in January, but owing to sluggish growth since early 1993 the January decline in 1994 was far more accentuated. Between February and May the rate picked up slightly, however, so that the outcome for the period January to May shows positive growth over the corresponding period in 1993-albeit still low at 2.8 per cent p.a .. But the year-on-year growth to date continued to fall; by May it was only 6 per cent p.a., compared with the 16.2 per cent growth recorded in calendar 1993. 5 Causes of the non-oil export decline The government first indicated its concern about the decline in nonoil export growth when the January figures were announced in April. 6 The President stressed the need to study the causes of decline, and an interdepartmental team headed by the Coordinating Minister for Industry and Trade was established. There are a number of possible explanations for the slowdown. The first is sluggish economic recovery in several major markets. The recession is not yet over in the Japanese and European economies, and while the US economy has recovered, demand for Indonesian goods is still growing more slowly than previously. According to the Secretariat of the General Agreement on Tariffs and Trade (GATT), 5 McLeod

(1994) discusses difficulties in discerning new trends in Indonesia's trade performance resulting from the manner in which the official statistics are presented.

6An indication of government concern is that since May, figures on the trade surplus and deficit with various trading partners have also been announced.

Recent economic developments

33

world exports of goods increased by only 2.5 per cent in 1993 compared with 4.5 per cent in the previous year. Regions in which trade is expanding rapidly include the US, Asia and Latin America. If Western Europe and Japan recover soon, then world trade could return to 5 per cent growth but, if not, the figure could remain close to the 2.5 per cent of 1993. A second possible cause is the decline in export-oriented investments . This is difficult to measure, since only approved investment statistics are available. Approved foreign investments declined from $10.3 billion in 1992 to $8.1 billion in 1993. These figures need to be interpreted with care, however. The high figure for 1992 had been strongly influenced by two very large projects-the expansion of Freeport Indonesia's mining operations in Irian Jaya and the Chandra Asri olefins plant (Macintyre and Sjahrir 1993 :11) .7 Approve d domestic investments, on the other hand, picked up in 1993 after declining from a peak in 1990. The relaxation of monetary policy and the accompanying fall in interest rates may provide some explanation for this, although general domestic recovery has also contributed; some investment activity may have been put on hold until the composition and policy direction of the new cabinet became known. In any case, the rise appears to be continuing. Notwithstanding the increase in approved investments, owing to lag and other effects, realisation of inv es tment may' still be declining, as reflected in import growth. After rapid expansion in the period 1989-91, averaging above 20 per cent p .a. as a result of the investment boom at that time, the growth rate of imports fell sharply in 1992 to 5.5 per cent and in 1993 to only 3.8 per cent. In fact, imports of capital goods declined in 1992 and 1993. The earlier slowdown in investment approvals and realisations (as indicated b y capital goods imports) can be linked to both external and domestic developments. There was a decline in total outward investment from Japan-one of Indonesia's major sources of inves tment-and, m ore importantly, a significant diversion of investment to China. Domestica lly there was a perception that Indonesia's investm ent climate was deteriorating. There have been 7

It sho uld be noted tha t there was a dramatic increase in 1994, with approved forei gn investments reaching $23 billio n in the te n months to October. The increase reflec ted a number of large infrastructure projects (including electricity gen eration p lants), oi l refineries, a nd chem ica ls plants.

34

Pangestu

increased problems with the customs and duty exemption mechanisms, and the October 1993 deregulation package made the divestment requirements for foreign investment stricter. 8 A third, and probably minor, factor in declining export growth was the slower depreciation of the rupiah against the US dollar of 2.3 per cent in 1993, which implied decreasing competitiveness, given that inflation was 10.2 per cent in that year. These general factors appear to have affected some sectors more than others, and a more disaggregated analysis suggests that the decline in non-oil export growth can be linked to stagnation of textiles and garments exports. Table 2.4 shows the growth of the fourteen largest non-oil export categories, which jointly account for around two-thirds of non-oil exports. Most non-oil products continued to experience robust growth in 1993. Exports of plywood and other processed wood grew by over 30 per cent, owing mainly to higher prices. Exports of consumer electronics, such as audio-visual products, increased by 62 per cent, and are now close to $1 billion. This was due to the realisation of exports from a number of large export-oriented investments (e.g. by Sony, Kotobuki-Matsushita and Samsung). Exports from other light industries such as footwear, and resource based industries such as furniture and furniture components, also continued to grow rapidly, as did the 'other industries' category (61 per cent). However, some sub-sectors did not fare so well. Mineral export growth was almost negligible, for example, owing to lower world prices for nearly all of Indonesia's minerals, including copper, nickel, coal, aluminium and tin. The most significant decline was for textiles. The growth of garments and 'other textile products' remained positive, but was much lower than in previous years, while exports of fabrics actually d eclined significantly. As a result, textile and garments exports as a whole grew by just 2 per cent, compared with growth rates above 30 per cent in previous years. The

8The

p rovisions of this p ackage, known as 'Pakto 93' (Department of Finance 1993), it1clud ed a streng then ing of divestment requirements for 100 per cent foreign-owned companies, from 5 per cent to 20 per cent for firms in bonded zones, and from 20 per cent to 51 per cent for o ther firms . On the other hand, the p ackage also eased a previous restriction by reducing from $50 million to $2 million the minimum equi ty requirement for initially 100 per cent foreignowned firms producing intermediate goods.

Recent economic developments

35

Table 2.4: Growth of major non-oil exports ($million) 1992

Total non-oil exports Agriculture Fresh/frozen prawns Manufactures Plywood Other processed wood Textile and garments Garments Fabrics Other textile products Crumb rubber Audio visual Footwear Furniture & components Vegetable oils Other industries Mining, non-oil Copper Coal

1993

1993

1994

Jan-Apr Jan-Apr

Growth 1992-93 ( %)

Growth 1993-94 Jan-Apr(%)

23.30

27.08

8.59

8.69

16.2

1.1

2.21 0.76

2.64 0.87

0.70 0.28

0.69 0.32

19.5 15.1

-1.4 14.5

19.61 3.23 0.64 6.06 3.19 2.09 0.78 0.89 0.57 1.32 0.48

22.94 4.22 0.86 6.18 3.51 1.82 0.86 0.87 0.92 1.66 0.67

7.43 1.20 0.35 2.16 1.22 0.62 0.32 0.30 0.25 0.57 0.20

7.47 1.44 0.42 1.62 0.87 0.43 0.31 0.30 0.40 0.56 0.23

17.0 30.7 34.6 2.0 10.1 -13.3 10.2 -3.1 61.8 25.5 37.5

0.5 19.9 19.0 -25.1 -28.4 -30.6 -2.3 -0.9 59.7 -2.2 11.9

0.67 0.82

0.71 1.31

0.24 0.16

0.26 0.16

6.2 60.9

9.9 2.2

1.45 0.73 0.60

1.46 0.69 0.64

0.45 0.23 0.18

0.51 0.28 0.19

0.7 -5.0 7.0

14.1 21.2 7.6

Source: BPS, Buletin Ringkas, July 1994

decline in growth of textile and garment exports has continued into 1994, with the total value for the January to May period down by 25 per cent compared with the same period last year. Exports of footwear also experienced negative growth of -2 per cent for the same period.

Decline in textile and garment exports Despite the substantial diversification of Indonesia's exports from oil to non-oil and within non-oil, especially for manufactured products, the large share of textiles-17 per cent of total exportsmeans that a slowing of its growth affects the overall growth rate. The main reason for the slowdown appears to be falling prices. Unit values peaked in 1992 for the important items, and then in almost all cases declined in 1993, with the most drastic fall occurring in

36

Pangestu

synthetic fabric. The growth in the volume of exports was still reasonable at 19 per cent in 1993, even though lower than the breakneck pace of previous years. There appear to be several causes of the setback in textile and garment exports. In the case of textiles, there was a substantial fall in polyester fibre prices in 1993, ostensibly due to 'dumping' by Korea in the world market. The price of polyester filament on the Tokyo market declined from ¥443/kg in the fourth quarter of 1992 to ¥310/kg in the fourth quarter of 1993. Thus the decline in unit values for synthetic yarn was caused by a fall in the price of its raw material. Several other factors were also significant, including sluggish international markets; rising competition from China, Bangladesh, India and even Vietnam, resulting in lower prices; and the increased problems with government procedures to clear goods through customs and to process duty drawbacks. In mid 1992, the duty drawback application system was changed so that the process now applied to each import shipment, instead of to a consolidated application at the end of the period. This has created additional administration and, in the case of electronics, where the components number in the thousands, it involves a lot of documentation. Furthermore, owing to the large number of applications, there were long delays in obtaining the drawback. The additional overheads and lengthy procedures affected costs and the timeliness of delivery by exporters. The delays were compounded by inefficiencies in the quota allocation system-a problem which has never adequately been resolved. It would appear that garment exporters at the low end of the market will face problems because of competition and will need to move up-market. Medium and high-end garment exporters indicate that they continue to enjoy an increase in unit values and, while competition is keen, as long as they maintain quality, improve management and keep to their delivery timetables, they can still compete. Their main problem continues to be bureaucratic delays associated with trade and the allocation of quotas; these costs are estimated by some to be adding about 25 per cent to firms' overheads. In the case of fabrics, therefore, once the input price stabilises, unit export values ·may be lower but will not continue to decline, and volume growth should remain robust. However, some concerns remain for the textile industry. One observation made by a member of the Indonesian Textile Association was that domestic demand will

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increase and, unless investment in the industry picks up, export capacity could be diverted to domestic demand. There are strong indications of a decline in investments, as evidenced by a decline in textile machinery imports. Another concern voiced by the upstream component of the industry is fear of increased protection, and therefore higher costs, for its raw materials, especially petrochemicals. Outcome of the Uruguay Round and its impact on Indonesia An important aspect of the recently concluded Uruguay Round of the GATT is the obligatory commitment of each country to reduce tariffs and non-tariff barriers, including those in agriculture and textiles. Indonesia has chosen to bind 94 per cent of tariff items-or 91.6 per cent of import value-at a ceiling rate of 40 per cent. This is the highest permitted binding rate and, since the average unweighted tariff now is around 20 per cent, the commitment to bind at this level is not particularly significant in terms of reducing tariff protection. A small percentage of tariff lines are not bound and are not subject to the reduction in non-tariff barriers. The items on this exclusion list include explosives, products from upstream industries such as chemicals, and other products still enjoying high protection, such as motor vehicles, steel, and aircraft. However, Indonesia also offered to remove most non-tariff barriers and surcharges over a period of 10 years--even though it was not obliged to do so. This must be seen in a positive light, in line with the general direction of deregulation currently being pursued by the government. The opening up of world trade in agriculture poses a challenge for Indonesian agricultural products to compete in the world market. At the same time, the opening up of the domestic market should improve the efficiency of domestic production . Nevertheless, Indonesia has exploited its special status as a developing country to limit its commitments in the agriculture sector, especially in the case of primary food products such as rice. Indonesia's intention is to change the existing non-tariff barrier against rice imports to a very high tariff, and to allow imports of 70,000 tons per year-which is very small by comparison with the more general requirement of 3 per cent of domestic demand as the minimum level of market access for imports. The commitment to cut protection in the textiles sector is mainly concerned with removing the bilateral quotas governing textiles trade so that it will once again be governed by the multilateral

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system. The elimination of quotas is scheduled to take place over ten years, with most of the reduction (51 per cent) occurring towards the end of this period. Even though this will result in an expansion of export markets, only competitive exporters will benefit from this increased market access, and Indonesia will face keen competition from countries such as China and India. Indonesia also needs to study other developments under the general rubric of the rules governing international trade, so that appropriate preparations for adjustment can be made. The important aspects of rules and procedures in relation to technical standards, dumping, customs valuation, pre-shipment inspection, origin, import licensing, and subsidies and countervailing measures, need to be well understood . In general these rules hav e been improved, with increased transparency of criteria, clearer explanation of procedures, and an attempt to limit the time for investigations by introducing sunset clauses. Other than those relating to rules, new issues related to investment, trade, services, and intellectual property rights also need to be observed carefully. The Uruguay Round outcomes in relation to liberalisation of the services sector varied from very open (e.g. professional services) to not open at all (e.g. audio-visual services). Given Indonesia's previous commitment to liberalise the services sector, once again it seems unlikely there will be much impact on the present level of protection of domestic services. A final aspect that needs to be well understood is the new permanent institution that will monitor and arbitrate the implementation of the multilateral rules of international trade, including how it will resolve disputes. In the post-Uruguay Round era, various other aspects of international trade potentially could be monitored under the GATT which will affect Indonesia. These include the possibility that market access might be linked with requirements to meet environmental standards and various standards related to workers' welfare. Deregulation The 2 June investment deregu lation package On 2 June 1994 the government announced a major investment deregulation package, PP No. 20/1994, signed on 19 May (Government of Indonesia 1994b). Table 2.5 provides a summary of the new and old regulations. The main element of the package is a substantial relaxation of the divestment requirements for foreign

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investors. For sectors that are open to foreign investment, the foreign investor now has two choices. One is to form a joint venture with 95 per cent ownership and with no further divestment required thereafter. The alternative is to form a wholly foreign-owned subsidiary, in which case some divestment must be undertaken within 15 years. The amount of divestment is not stipulated, and the Minister for Industry, Tungky Ariwibowo, has stated that 'even a one per cent divestment is sufficient' (JP, 4 June 1994). Existing foreign investors can avail themselves of the more favourable regulations. The deregulation represents a major policy shift: previously the maximum initial foreign ownership permitted in a joint venture was 80 per cent, except in the case of export-oriented investments (95 per cent), and of investments over $50 million located in Batam or Eastern Indonesia, and of $2 million in supporting industries, where 100 per cent initial foreign ownership was permitted. On divestment, the previous general rule was that divestment of foreign ownership down to 49 per cent in 20 years was required except for export-oriented investments in export processing zones and Batam. Under the new regulations, it is up to the foreign investor to decide whether to have a domestic partner, what the composition of foreign-domestic ownership should be, and whether and by how much to divest to domestic entities. This removes the problems associated with finding a domestic partner and forcing substantial divestment on foreign investors, which have discouraged the transfer of the latest technology and entry of small and medium sized investors with specialised knowledge. The second part of the deregulation is the elimination of minimum investment requirements. From the beginning of the open door policy in 1967 until the 1989 deregulation, the minimum size of foreign investment was set at $1 million. In May 1989 this was lowered to $250,000 for certain sectors such as distribution of the joint venture's products. The third part is the opening up of nine sectors previously closed to foreign investment-sea ports; production, transmission and distribution of electricity; telecommunications; shipping; civil aviation; drinking water; railways; nuclear power generation; and the mass media. The only requirement is that foreign investors must come in as part of a joint venture. All these sectors were closed to foreign investment in the 1967 Foreign Investment Law, on the basis that they affected the welfare of society at large, and for security

40

Pangestu Table 2.5: Summary of foreign investment deregulation package

Ownership

Previous Regu lation

New Regulation

Joint venture

Maximum 80% foreign share, except 95% for export-oriented projects (since 1986).

Maximum 95% in general.

100% foreign ownership

Not allowed except for: - Batam (since 1989) - in zone developed for growth triangle - located in Eastern Ind . - > $50 million (since April1992) - for projects of $2 million in supplier industries (since October 1993).

Allowed generally, except for nine sectors considered to affect the livelihood of the wider public.

Divestment of Foreign Ownership

Shareholding by Indonesian entities to reach 51% in 20 years as general rul e, except for: - Batam, other zones and 100% export-oriented firm s: 5% - Bonded zone: 20% in 20 years, beginning from year 10 - 100% foreign ownership if investment und er $2 million: 20% in 20 years beginning from year 10.

No divestment for joint ventures mandated; for 100% foreign owned companies, some divestment in 15 years, but extent determined by investor.

Minimum capital

$1 million in general. Minimum No minimum set. lowered to $250,000 for: -labor intensive (minimum 50 workers) and 65% produ ct exported or suppli er industry - certain services For lowe r minimum, general rule on joint venture m ax imum foreign participation (80%) and divestment appl y.

Renewal of 30 year Renewal of 30 years in the case of Clarification about renewal; as licence expansion counted from date of long as activity continues to be expansion. Renewal procedure not beneficial to Indonesia. Interclarified . departmental approval process involved.

41

Recent economic developments Table 2.5 (continued) Ownership

Previous Regulation

New Regulation

Clarified that location priority is Implicit pressure to loca te in industrial es tates or bonded zones. industrial estates or bonded zones. Domestic partner may use own land . Existing PMA finn may set up a Possible, but have to go through Setting up new company by existing the same procedure as new PMA. new company with either PMA or PMDN status; approval from PMA BKPM sufficient.

Location of investment

Purchase of shares in existing companies by joint ventures, 100% PMA,foreign nationals, or foreign companies established overseas

Strengthening of BKPM Various regulations put out by BKPM enabling purchase of shares regulations by government and ministerial regulations. in existing companies through direct investment or capital market. Foreign nationals never specified howeve r.

Sectors open for foreign investment

Sea ports, electricity, telecommunica tions, shipping, civil aviation, drinking water, railways, nucl ear power generation, and mass media previously all closed.

Now open for joint venture and in certain cases 100% foreign ownership.

reasons. But foreign investment has already taken place in some of these sectors, such as telecommunications and electricity so that to some extent the regulation only ratified what was already practised .9 There is still of course a 'negative list' of sectors closed to foreign investment. This replaced the complicated priority list in May 1989, and has been gradually shortened ever since. One sector that 9

There have already been statements that the foreign investment law will be combined with the law on domestic investment. Since there are no ownership or sectoral restrictions in the domestic investment law, this regulation is seen as a first step toward 'national trea tment' of foreign investment. The explanation accompanyin g the regulation in fact states that article 7, paragraph 2, is intend ed to remove the difference between foreign investment (PMA), domestic investment (PMDN), and non-PMA/PMDN (Government of Indonesia 1994). The remova l of the differences is in turn intended to simplify the administration of licences.

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remains closed to foreigners is domestic distribution and retailing. This has long been a sector which foreign investors would like to see opened. However, for the time being this still appears to be a sensitive issue, because of concern to protect small retailers and wholesalers. 10 A fourth feature of the package is that foreign investment licences are still given for only 30 years. Renewal can be obtained from the Minister for Investment Coordination, provided the entity is still involved in an economic activity that is 'beneficial to national economic development', and after advice from the Ministry in the area under which the investment falls. Finally, 100 per cent foreign-owned firms can now invest in all areas in Indonesia. Where a bonded zone or industrial estate already exists, priority should be given to location of investments there, but this is merely a recommendation, and not a mandatory requirement as previously. Several reasons have been advanced for the deregulation, which is significant in view of the sensitivity of the divestment issue in the past. Divestment of foreign ownership was introduced into the law in 1967 and more specific requirements (as to the amount to be divested and the time limit) were applied in the aftermath of the 1974 anti-Tanaka riots .11 Indonesia has always seen foreign investment as a supplement, and nationalist sentiment dictates a 'balancing' of the foreign presence. Until recently there appears to have been strong resistance to change, but two events can perhaps be seen as precipitating the initiative. The first was increased competition from China, evidenced by the decline in foreign investment interest in the las t two years. There was a growing realisation that the investment climate had to be made more attractive to compete with China. The strong and vocal reaction of foreign investors to the reversal in divestment requirements in the October 1993 package underlines this point. The second event was the sharp fall in growth of non-oil exports discussed above, which was thought to be related to the decline in export-oriented investments. Another reason given at the time of the announcement 1°Foreign firms have fo und w ays to become involved in retail activity, nevertheless (McLeod 1993a:40).

11 Protests

against forei g n inves tme nt occ urred during the visit of Japanese Prime Minister Tana ka in 1974.

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of the deregulation was the investment target for the sixth fiveyear plan of Rp 660 trillion , of which 73 per cent is targeted to come from the private sector (foreign and domestic). Reactions to the package so far have b een mixed. Most of the controversy appears to be rela ted to the opening of the mass media to foreign investment. In an ex traordinary turn of events, the Minister for Information reacted almost immediately by noting that this was inconsistent w ith the Press Law of 1982, and complained that he had not been cons ulted about the package. Since laws take precedence over reg ul a tions, he would continue to exclude foreign investment in the media (A WS J, 7 June 1994). Some, including the Minister for Justice, have asked whether the opening up of the other sectors previously closed to 100 p er cent foreign ownership was also inconsistent with the 1967 Foreign Inv estment Law. It is unfortunate that these disagreements occ urred, because they distracted attention from the largely positi ve a nd significant changes in ownership, divestment and minimum investment requirements. Foreign investors have in fact reacted very positively. Of course there are s till questions raised about implementation of the deregulation and the processing of foreign investment licences. Given the current s ta te of confusion, including apparent inconsistencies and questions needing clarification, it is desirable that the technical regulations for PP20 be announced as soon as possible.

The 27 June trade deregulation package The keenly awaited trade deregulation package was announced on 27 June 1994. There are tariff reductions on 739 items, and reductions in 121 tariff surcharges, 12 wh ile 27 items on the approved importers list may now be imported by general importers. N evertheless, the package does not contain the significan t reductions in protection that were expected in lin e wi th the subs tantial inves tment package announced earlier. 13

12

0f the 220 ex isting surcharges, 108 were eliminated , 13 reduced a nd 99 remain. 13

Tariffs o n 38 items containin g alco hol were increased, and five alcoholic items were shifted from gene ral importe r to approved importer status. The stated objective was to minimi se the nega tive social effects of excessive alcohol consumption, especia ll y by th e yo unger generation, al though it was not

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The major baromete r of progress on trade deregulation is whether non-tariff barriers or high tariffs in agriculture (e.g. rice, wheat, soybeans), food and beverages (e.g. wheat flour), and the paper products and automotive sectors are reduced or at least phased out over some specified timetable. There were no big tariff reductions on major agricultural commodities, however, and of the 27 items which were changed from approved importer to general importer status, only two are agricultural products (based on lactose) previously administered by Bulog, and the remaining 25 are a very narrow range of relatively minor industrial items. In the sectors which are most heavily protected, once again, little progress seems to have been made. Indeed, import arrangements moved in the direction of even greater restrictiven ess in the case of one important agricultural commodity, garlic, which changed from approved importer status to having Bulog as the sole importer. No explanation for this was offered, and there is no obvious benefit to the economy. While tariffs on rice and wheat flour and sugar were reduced to zero, non-tariff barriers continue to protect domestic producers of these commodities, so the prices to users will continue to be much higher than world prices. On the other hand, the tariff on soybean meal imports was cut by 5 per cent, and the protective quantitative restriction was softened by cutting the minimum proportion of locally produced meal that users of this input must mix with the imported product from 40 per cent of the total to 30 per cent. As the government pointed out, these changes reduce users' production costs while continuing to protect ' the domestic industry'. Previously, however, van der Eng (1993:23) noted that the 'domestic industry' consists of a single firm, PT Sarpindo, which has a monopoly on crushing soybeans. The company is owned by some of Indonesia's most powerful conglomerates. Purchasers of these agricultural imports include not just ultimate consumers but, most imp ortantly, d ownstream users such as the food processing industry, and chicken and livestock producers. The high cost of inputs is often identified as one of the reasons for lack of competitiveness in these industries. In one prominent part of the new package, tariffs on various imported inputs and capital goods (i.e. machinery and equipment, explained how res trictin g the number of importers could be expected to contribute to this outcome.

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including spare parts and components for assembly) were reduced, ostensibly to support the d evelopm ent of industry-'especially small-scale and medium sized firms' (according to the press statement issued with the n ew package). This assertion seems rather hollow, however. Among the items for which duties were reduced are textile m achinery and its components, spare parts for trucks and semi-trailers, and components for the assembly of heavy equipment. Large firm s import all these items, so the tariff reductions will benefit large and small firms alike. Reducing tariffs on inputs relative to those on output increases effec tive protec tion, thus crea ting worse distortions than the structure of nominal tariffs would suggest. 14 By dressing up these tariff adjustments as b ein g d esign ed to help smaller firms, the government's announcem ent therefore deflects attention from the fact that they seem in fact to be retrogressive in terms of the efficiency objectives of trad e lib eralis ation . Moreover, they are certainly retrogressive in terms of the equity objective. By far the most effective way to lessen the incidence of poverty in Indonesia is to increase the demand for la bour; making capital goods cheaper by reducing their tariffs works in exactly the opposite direction, by encouraging businesses to use machines in place of workers. Export activity is given ad ditional support by way of improvements in reg ulation s tha t will facilitate subcontracting of production and leasing of m achin ery from outside the bonded zones and EPTE (Entrepot Produksi untuk Tujuan Ekspor). 15 The value added tax on goods sold to bonded zon es and EPTE from outside has also been eliminated. Th es e improvements answer a frequent complaint of exporters abo ut difficulties in sourcing domestically. It had been faster and ch eap er for them to import and obtain the duty exemption than to so urce dom es tically, and in some cases the products they imported h ad actuall y been made in Indonesia. The development of compe titive d omestic suppliers of parts and components is essential for th e continued competitiveness of 14

Except if the inp u t tariffs re main higher than the output tariff. This seems unlikely, since the new input ta riffs are low, ranging from 0-25 per cent.

15

EPTE are stand -alone ex po rt process ing units that can consist of a single fa ctory or e ntity. They w e re firs t introduced in Febru ary 1993 and, after a period of uncertainty o w in g to lack o f clarity abo ut the criteria fo r their establishment, a number of exis ting ex po rters have now obtained EPTE s tatus.

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Indonesia's exports of manufactured products. Domestic industries that supply exporters, many of them small and medium in size, can grow and learn by having to meet the high quality standards of exporters who compete in world markets. Many of these exporters will be foreign companies which can supply local firms with information on changes in needs and technology, as well as providing technical assistance. The improvements should also encourage foreign investment in supplier industries. Another part of the package is aimed at investments. Duty-free imports of capital equipment and raw materials can now be obtained for the purposes of expansion, as long as the expansion is at least 30 per cent of existing capacity. This is intended to lessen the practice by foreign investors of setting up new investments rather than expansions in order to obtain the duty-free import facility. In 1993 the government indicated that there would be no more large policy packages, but a number of small ones. The 27 June package is an example of such an approach. An important difference is that there is an explicit m ention of gradualism: tariff reduction will be done in stages, with a 5 per cent minimum reduction each time. There is also an attempt to curb new demands for protection by indicating that new entrants will not be able to seek higher tariffs. While one can question whether this approach will actually be implemented, it still seems a positive development. Policy makers may h ave chosen the present approach because of the need to balance the interests of different parties that will be affected. Despite potential gains to consumers and downstream users, it is arguably not desirable to reduce protection too rapidly, since the adjustment and dis location costs might be excessive . Nevertheless, there is also a lot to be said for greater transparency and a bold commitment to reducing protection. The issues are, of course, how gradually protection should be reduced, and how the process should be made transparent. One way to achieve the objective of gradual reduction in protection is to pre-announce a schedule of tariff reductions and, more importantly, the phasing out of non-tariff barriers over a certain period of time. This approach makes the phasing-out process more transparent, and also prevents new entrants from obtaining protection.

The 27 June small business finance package Along with the trad e package, a range of new measures aimed at assisting small and m edium scale enterprises was announced. In 1989,

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state-owned enterprises had been asked to allocate 1-5 per cent of their profits to develop small scale enterprises and cooperatives. The new package announced a widening of the criteria for the use of these funds, the elimination of the maximum limit of RpSOO million per state-owned enterprise, and the strengthening of monitoring. There were also some improvements with regard to venture capital. 16 The government-owned venture capital firm, PT Bahana, will have its funding base strengthened. Venture capital firms will be set up at province and kabupaten levels to bring them closer to potential partners, and these firms will be funded by PT Bahana, private investors, and part of the profit allocations from stateowned enterprises. More importantly, dividends and capital gains from venture capital operations will not be subject to income tax. The supply of initial capital to small scale firms and cooperatives can be in the form of equity or loans, and it is envisaged that equity participation will come from PT Bahana. The main issue h ere is whether provision of venture capital by this specialist government institution is an appropriate way to support small scale enterprises and cooperatives, which tend to be weak in management, marketing, and general business skills. The belief that the only serious obstacle facing small firms is a lack of funds is now widely recognised to be ill founded (McLeod 1991:208), and the now defunct KIK/KMKP program (which provided cheap loans to small businesses, but was eventually abandoned because of mounting losses) is a painful reminder of the danger of designing policy on this basis. PT Bahana appears to have achieved virtually nothing in terms of successful financing of small firms with good, innovative ideas in the two decades of its existence (McLeod 1984:77), and injecting more capital into Bahana itself is likely to be a case of throwing good money after bad. There are hundreds of thousands of small firms in Indonesia, and it is fanciful to imagine that Bahana can reach more than a tiny fraction of them, notwithstanding the intention to establish a network of 'miniBahanas' at province and kabupaten levels. Presumably this 16

Venture capital is fundin g provided in the form of equity to firms judged to have good ideas (for product or technology innova tions and the like), but Which lack sufficient internal funds to make them operational, and are unable to get access to bank loans. The equi ty participation is intended to be divested once the new investmen t becomes profitable, and the profit to the venture capital provider takes the form of capita l gains on the sale of its equity.

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network will be staffed mainly by people drawn from the civil service, and others who also lack the special business and engineering skills required for successful venture capital operations. The notion that better success will be achieved than in the past through careful monitoring of the use of funds, therefore, appears unduly optimistic.

3 Organising the transition: Indonesian politics in 1993/94 Richard Robison

With the excitement of parliamentary elections in 1992 and the Presidential election in 1993 out of the way, it may appear on the surface that political life in Indonesia during 1993-94 had paused for breath. Yet to some extent formal political events like elections are, in any country, distractions from the real business of politics, and in a very real sense the year just passed can be seen as one in which the fundamental political debates, conflicts and issues of contemporary Indonesia were to reassert themselves. For some time the overriding focus of political activity in Indonesia has been upon the tasks of managing and influencing the succession to the post-Soeharto era. For the various elites of wealth and power that have emerged under the New Order, the examples of transition in the former Soviet Union and Yugoslavia have been particularly salutary lessons. If one objective binds them together it is a determination that the transition should be orderly, and that the essential features of the social order remain intact. Yet, despite their agreement on stability and order as primary objectives, there is a wide range of views within elite circles about how the transition should be organised, the roles that various groups and interests should play, and the form that the new political regime should take. The system of authoritarian corporatism dominated by the socalled iron triangle of President, military and bureaucracy which has characterised much of the New Order period has already undergone important changes. Although the veto power of the military should not be underestimated, nor its coercive apparatus considered dispensable to the present government, its influence has clearly faded . At the same time, there has been an increasing

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Robison

concentration of political and economic power in the hands of important families emerging from that strata of politicobureaucrats dominating the state apparatus. The succession, therefore, involves more than political mechanisms or a change of leadership; it is about constructing a new political shell for social forces incubated in the past three decades. The power of these families continues to be dependent, however, upon direct and instrumental control of the state and its resources. They are not yet a ruling class whose social power transcends the rise and fall of governments. In the latter years of the Soeharto period, therefore, the political task for these families is not simply to guarantee an orderly transition or to reproduce the social and economic order, but also to ensure their own continuing power within such a system by maintaining such control of the state. One possible option is to create a dominant party of the wealthy and powerful, able to secure power within a representative political system. Powerful patronage-based parties within systems of electoralism have been effective political mechanisms for the ascendant oligarchies in the Philippines and Pakistan. Electoralism and party competition has also proven an ideal political shell for the vigorous new capitalist families in Thailand. While much attention has been given to the prospects for democratisation in Indonesia's fluid political environment, however, reform leading to a system of representative electoralism is unlikely. Although there is a growing middle class, and a vigorous liberal intelligentsia which has set the public agenda for the analysis of political ideas and dominated public criticism of the current regime, their potential for carrying out a democratic political revolution is limited. This is partly because there are no institutions within which reformists can work effectively. The organic statism of the New Order known as Pan casila admits no such concept as a loyal opposition. All formal political activity is restricted to a set of corporatist institutions and subjected to a common national interest supposedly known and articulated by the state and its officials. 1 1 '0 rga nic s ta tism ' is that conserva tive v iew of society as an organism in w h ich all elements functionally contribute to a common good. By definition, this no tion excludes the possibility of a legitima te opposition, as well as both libera l and Marxis t no tions of conflict of socia l interests. Social forces are either function a l o r dysfunctional. The task of the s tate is to transcend vested

Indonesian politics in 1993/94

51

Hence, all political parties are required to join this common corporate project and, under Law 3 of 1985, to accept as their guiding principles the Pancasila. In practical terms this means that political parties cannot form freely around a discrete set of philosophies, principles or interests. There can be no Liberal Party, no Labor Party, no Conservative Party. Liberals are therefore scattered amongst all three parties permitted under Law 3 of 1973, each of which is a mixture of statist-corporatist, conservative, populist and liberal opinion. Nor can parties win government or, in practice, initiate their own legislation in parliament or veto that of the President. The President is not popularly elected but chosen by a N ational Consultative Assembly (MPR) that includes a majority of appointed members. In general, therefore, parties are not- as they have been in Thailand-a path to power for political entrepreneurs, or •the emerging middle classes and the bourgeoisie, or even gangsters, enabling these groups to bypass the established bureaucratic and military institutions that had for so long dominated power (Anderson 1990; Hewison 1993). There is another critical difference between the circumstances of the Thai democratisation and the situation in Indonesia. In Thailand the democratic movement-or more accurately, the movement towards parliamentarianism or electoralism- was one in which an extensive and growing bourgeoisie played a central role. Confident that their social power was entrenched in the very structures of social and economic life, and no longer reliant on the coercive power of the state, they saw every advantage in a system of electoralism. In Indonesia, the bourgeoisie have not yet reached this stage of confidence and hegemony. In part this is because they are predominantly Chinese in ethnic origin, and therefore socially and politically vulnerable. Many of the largest conglomerates continue to rely on rent-seeking and specific relationships with powerholders. Those indigenous (pribumi) capitalists who have managed to construct corporate groups also remain largely reliant on systems of patronage and protection. The key groups in the political equation are the major families which now straddle the state apparatus and interests and implement the 'common good'. By 'corporatism' is meant those political institutions which implement the organic statist ideology: hierarchical groups defined by function, in which membership is compulsory.

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the world of business. Most notable among these is the Soeharto family, but there are an increasing number of other lesser groups which extend in descending importance down to regional and local levels. In the economic sphere these groups are insuring themselves against the increasing pressures for regularisation of the state apparatus by increasing their overseas investments and preparing their companies for listing on the stock exchanges. Politically, however, there is nothing to be gained in entering a democratic alliance if its aim is to accelerate this process or even to open the political arena to radical populists or fundamentalist Muslims. Electoralism has no attractions for them as long as they retain the prospect of controlling the current state apparatus through its existing corporatist institutions. Rather than a shift towards electoralism or democratisation, what is happening in Indonesia is a shift in the nature of state corporatism from one dominated by the officials and institutions of the state to one dominated by new social groupings: the major families, 'notables' and 'nomenclatura' who have emerged from the intersection of the strata of state officials, the bourgeoisie, and the middle classes. The plan seems to involve two parts. The first is to transform the military and the state bureaucracy into instruments of the political authority of the powerful families within the existing structures of authoritarian corporatism. The second is to convince strategic sections of the rising middle classes that their interests, their ambitions and their careers are well served within the corporatist structures-to recruit them as the new mandarins of an authoritarian corporatist state under their leadership . For some time, Soeharto has been clearing the decks for such a transition. His first achievement has been progressively to remove from the military those die-hards whose primary loyalties have lain with the military-as-institution and who have insisted most strongly on the principle of dwifungsi (dual function), which guarantees a central and somewhat autonomous role for the military in the political and social management of Indonesia. For these officers, a limited political openness and a restriction of Presidential power benefits their position. Around them there has emerged an ideology of nationalist populism which has included hostility to the development of powerful civilian oligarchiesnotably that of the Soehartos-involving appeals for greater equality and social justice.

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This is a process that began in earnest with the ending in 1988 of General Moerdani's period as Commander of the Armed Forces (ABRI). Several former Soeharto adjutants and relatives were moved into senior positions, including Wismoyo Arismunandar and Kentot Harsono (Crouch 1992:54). Additional moves expected include the transfer of Jakarta Commander Hendropriyono and the Special Forces (Kopassus) commander Agum Gumelar to positions of lesser authority. Both reputedly have been involved in political activity hostile to Soeharto, including providing support for student demonstrations and for Megawati Sukarnoputri's successful challenge for POI leadership (discussed below). In the place of hard-line institutionalists we are seeing the rise of a new echelon of military commanders, including ABRI commander, Feisal Tanjung and the new Kassospol (Social and Political Affairs Command) chief, Hartono. These represent a category of Muslim-oriented officers whose position, while embracing institutional loyalties to ABRI, appears more accepting of a corporatist regime in which civilian oligarchies are dominant. Soeharto has also given much attention to drawing strategic elements of the burgeoning middle classes into the regime. While generally supporting the regime for its success in generating economic growth and maintaining social order, the middle classes nevertheless have been excluded hitherto from meaningful entry into the political arena. By offering the prospect of political careers for the moderate middle class the government is not only opening channels of recruitment alternative to the military and civil bureaucracies, but is pre-empting and defusing the intensity of growing democratic sentiment and populist opposition. To some extent Golkar has proven to be an avenue for advancement for emerging middle class political careerists and regional 'notables' outside the bureaucratic and military channels that had for so long monopolised access to advancement and power. However, Golkar has never really tapped the emerging new Muslim-oriented (or, as some describe it, 'Muslim-friendly') middle class, which constitutes a potential political constituency of vast proportions. Either excluded from, or uncomfortable with, the existing channels and institutions, Soeharto has drawn them in through the Association of Muslim Intellectuals, ICMI, an organisation under the leadership of Research and Technology Minister, B.J. Habibie, and funded by state-sponsored yayasans (foundations). Although a loose association of individuals with

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political views ranging from liberal reformist to quite conservative opinion, ICMI is a new channel of political patronage through which a new coterie of bureaucrats and political careerists are finding a place in the sun. An increasing number have found their way into senior positions in the bureaucracy and into the Cabinet. For Soeharto, ICMI is not only a mechanism for recruiting new cadres. It also enables him to appeal to moderate Islam as a new constituency (Hefner, 1993, Forum Keadilan 16 September 1993). However, the road to orderly transition is not a smooth one. The general issue of relationships between the state, its officials and big business continues to raise difficulties for an incipient ruling class trying to legitimise itself and gather broad support from emerging social forces. In particular, the growing economic power of large Chinese conglomerates and the exponential rate of growth of the business interests of the President's family are targets for resentment and criticism. As well, the capacity of the corporatist state to handle a rapidly growing working class and its labour organisations is under question. The rather crude assumptions and strategies embodied in the so-called security approach are proving less effective as the complexity of industrial society increases. This does not apply only to labour. The middle classes chafe at power which is often arbitrary and brushes aside the law when it suits. Another important issue is corruption. This is not only a moral and political issue of some passion. The operation of a modern capitalist economy brings increased structural pressure for the accountability of the state and its officials, as the collective interests of business, which require a common regulatory framework, come into conflict with the interests of those capitalists whose economic position continues to rest upon appropriation of public office and authority. How, then, is the state to balance authority and control with the task of attracting a broader civilian constituency? How much autonomy and freedom can corporatist organisations, including the political parties and other state associations such as the Chamber of Commerce and Industry (Kadin) be given before they upset the authority of the state and its leading elements? How should the military be reconstituted? As a barracks army or a prcetorian guard for the new oligarchies? Can the growing demand for freedoms and rights and the growing awareness of citizenship be incorporated into the regime? Is there a contradiction between freedom of the press, the nature of the regime, and the interests of its leading elements?

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Will increasing accountability and transparency within the state apparatus undermine the power of the major families? The unravelling of these issues and struggles has been embodied in a number of events in the past twelve months. These include the Golkar Congress of October, 1993; the Indonesian Democratic Party (POI) Congresses of July and December, 1993; the murder of labour activist, Marsinah, and the subsequent legal proceedings; the case of corruption and collusion in the dealings of the state bank, Bapindo, which broke in February, 1994, and brought to a climax eight months of public controversy about bad debts in state banks; the Medan riots of April, 1994; and the closure of three leading magazines by the government in June, 1994. The Golkar congress The state political party, Golkar, is a critical instrument in Soeharto's political plans. It forms a substantial voting bloc in the MPR, which elects the President. It is a major avenue for careers outside the civil and military bureaucracies, and an instrument of patronage and of ideological and social control. A struggle for control has been under way for some time between ABRI, the association of state bureaucrats (KORPRI), and other organisations of the state apparatus, and powerful figures supported by Soeharto. The issue is whether Golkar is to remain a party of the state apparatus, or to become a party of cadres dominated by the new 'notables'. Originally established as a mechanism to extend the control of the military and the bureaucracy into the social sphere, Golkar was clearly the instrument of the state apparatus, competing in elections against the (state approved and largely controlled) opposition parties. It was built upon institutional membership of ABRI, KORPRI, and a variety of corporatist front groups-including the state Youth Association, KNPI, and the Veterans Association, Kosgoro. Golkar was controlled by its Board of Patrons, of which Soeharto was Chairman, and funded largely by a foundation headed by Soeharto. In 1983 Soeharto supported the candidacy of State Secretary, Sudharmono, for the Chairmanship of Golkar, against the wishes of the military. Sudharmono was to bring into Golkar a number of civilians, including Sarwono Kusumaatmadja, Rachmat Witoelar and Marzuki Darusman, who brought a reformist, social democratic approach to the party, and attempted to shift power within it from the state institutions to its own cadres . In other words they

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attempted to create a more autonomous and independent party which was a source of power in itself (Robison 1993: 64-68; Eksekutif, August 1992). However, 1988 saw the ending of the influence of these reformers. Soeharto and Sudharmono made it clear that their vision of Golkar did not include its autonomy from the state apparatus or greater power for its cadres; rather, they saw it as an institution for social control and a channel for recruiting civilians into the regime. While Sudharmono was seen as a non-military Chairman, he could not be portrayed as any less authoritarian in his outlook or his actions. As one prominent Indonesian political figure described it to the author, Sudharmono was Indonesia's Andropov: the consummate authoritarian bureaucrat. In 1988, Sudharmono was replaced by Wahono, a fairly bland General who seemed to be a compromise between Soeharto and ABRI. The influence of the military appeared to rise again within the party. Given that the period 1993-98 was to be critical in terms of the transition, the configuration of power to be decided in the 1993 Congress was all-important. The events leading up to the Golkar Congress, and the postmortems, were major topics of interest in the Jakarta press from June to December, 1993. What is of interest here is not so much the minutiae of the Congress but the broad changes in direction that took place. Ironically, the move for greater independence from ABRI and KORPRI was to be argued most forcibly by two former military men, Sumitro and Rudini (Jakarta Post, 14 and 15 October 1993), and by the then head of Kassospol, Hariyoto (DeTik, 20-26 October 1993). Sarwono (now Minister for the Environment) was to modify his previous stance by arguing merely that emerging social forces must be drawn in as an integral part of Golkar, together with ABRI and the bureaucracy. In other words, the emerging middle classes and 'notables' should become another leg of the regime, as Golkar cadres. For the state to resist rising demands for participation, he argued, would be to create the potential for social frustration (Republika, 17 October 1993). The real changes in Golkar were to come from Soeharto himself and the families. Soeharto was to retain control of the Dewan Pembina (Board of Patrons). The seven p erson committee of Jormateurs established to select a new Chairman and Executive Board was headed by Habibie, and included a mixture of military and civ ilian bureaucrats . The Dewan Pimpinan Pusat (Central

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Executive Board), which was to lay down policy and put in place the management of Golkar for its next term, included a mixture of individuals, many with links to ICMI and to various state sponsored mass organisations including the youth fronts, KNPI and AMPI, and the former military trade union organisation, SOKSI. There were several business people and some retired military personnel and bureaucrats (Tempo, 9 October 1993). Significantly, Bambang Trihatmodjo and Siti Hardiyanti Rukmana, two of the Soeharto children, were also included. Both now boasted their own front groups within Golkar: Bambang headed FKPPI, an association of children of former military officers, while Siti headed a youth front, Kirab Remaja (Editor, 4 October 1993). These new mass organisations were significant, not for their size or influence, but because they did not represent institutions within the state apparatus or 'functional' categories such as youth, women, and so on. Instead, they were the first glimpses of conscious political activity by new right wing social elites. With the appointment of Harmoko, Minister of Information and a major businessman in the media industry, as Chairman of Golkar, the critical three positions of authority in the party were in the hands of civilians (Harmoko, Habibie and Soeharto), representing the powerful new bureaucrat-cum-capitalist families. Where then does Golkar stand now? It is clear that Soeharto does not intend Golkar to constitute a source of power in its own right or to offer its cadres the opportunity to create an autonomous political institution. It remains a state party, reliant on the support of the major institutions of the state apparatus. As the Chair of KORPRI stated, 'KORPRI will not tolerate any of its members voting for parties other than Golkar' Uakarta Post, 1 December 1993). The question is whether the balance of control lies with these institutions or with the families. The 1993 congress saw the increasing influence of the children of bureaucrats and organisations whose links were becoming progressively based on kinship (Editor, 4 November, 1993). Initially moving in with Sudharmono, whose State Secretariat had been so important in allocating government procurement, greater numbers of pribumi businessmen had also appeared in party ranks and for some time had been called upon to support it financially (Prospek, 7 September 1991) . These new 'notables' were, according to many

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observers, particularly able to benefit from the patronage wielded by Golkar. 2 This apparent shift in power, however, is qualified. The military hardliner and former Deputy Chairman of the ABRI faction in parliament, Sembiring Meliala, in a rash but perhaps perceptive outburst, noted that ABRI still controlled the bulk of regional Golkar organisations, and that individuals like Harmoko and Habibie in reality had no base of power other than Soeharto (DeTik, 27 October-2 November 1993). As soon as Soeharto went, ABRI would, in the terms of this logic, simply step in again to take over. This is perhaps more perceptive than might first appear. The critical task for the major families now is to link their control at the top with the ambitions and interests of the burgeoning notables at the middle and lower levels in the regions and the smaller towns. It is unclear whether they yet understand this or whether it is a concept that can be reconciled with the authoritarian and organic view of the world within which they operate. The POI congresses The strong showing of the PDI in the 1992 elections has raised the question of whether it will become a vehicle for a vigorous, reformist opposition able to break the authoritarian corporatist mould and to short-circuit the plans of Soeharto, perhaps in league with military dissidents. The constraints upon parties are, however, substantial. Law 3 of 1973 designated two non-state parties to contest elections. They were constrained by regulations prohibiting them from campaigning outside the designated election periods, and the government was to prove extremely influential in determining party leadership. By designating one party, the United Development Party (PPP), as the receptacle for the various former Muslim parties and the other, the Indonesian Democratic Party (PDI), as the new vehicle for all the former non-Islamic parties, mainly the old Indonesian Nationalist 2 Yuwono Sudarsono noted that '[i]ntense bargaining within Golkar's inner core organisations became more apparent as each faction attempted to allocate a variety of spoils [including] directorships in business firms, bank licensing concessions, the odd credit line to establish foundations, favours to cronies and their kin through seed money to start a business, a consulting firm or a franchise with a multi-national ', [and so on] (Indon es ian Obse rver, 8 September 1993).

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Party (PNI), the state was to create two fairly bland amalgams that did not inherit the character or loyalties of the old groupings. Indeed, the Nadhatul Ulama-the largest former Islamic partybecame so disenchanted with the PPP that eventually it withdrew. Law 3 of 1985, requiring all mass organisations to accept Pancasila as their central ideology, further obliterated the identity of the parties. They were also handicapped by a lack of finance, and indeed were to receive much of their funds from the state. Nor could they match the patronage in jobs, business opportunities and regional budgetary allocations commanded by Golkar. Hence the opposition parties were to become vehicles for the expression of opposition to the government, rather than cohesive expressions of particular social and political ideologies and policies. In both parties, pro-government elements in protracted leadership struggles did not hesitate to use government support in their efforts to gain control. Yet, around the POI in particular, there began to emerge a sense that a coalescence of younger and socially progressive forces was taking place. As well as the long-time party bureaucrats, interesting reformers from a variety of social backgrounds and perspectives began to enter the party. Orthodox economic liberals like Kwik Kian Gie and the businessman Laksamana Sukardi were balanced by more outspoken social democrats like Kristiya Kartika, and encouraging electoral advances were made in 1992. The Party Congress of July 1993 in Medan was therefore a challenge for both the party and the government. Could the government retain the POI as a politically ineffective but important legitimising element within the corporatist state, and contain the apparent reformist surge that was threatening to reconstitute it as the focal point for genuine political reform? Could the reformist and progressive elements in the party impose a greater degree of cohesion and organisational discipline on the party? The Congress degenerated into confusion and even physical melees, however, exposing the lack of discipline and cohesion in the party. Chairman Soerjadi was re-elected by acclaim in a controversial and bitter outcome, despite public statements of opposition from government and military spokespersons. The result was not accepted by the government- which cited the chaos and confrontation as reasons for appointing a caretaker board, pending a second Congress to be held in Surabaya in December.

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In a dramatic move, Megawati Sukarnoputri, a daughter of former President Sukarno, entered the contest. She was to bring with her a wave of popular support-and the commitment of 256 of the 303 regional chapters of the PDI. Budi Harjono, whose power base lay in the party bureaucracy, was widely regarded as the government candidate. Faced with the surge of popular support for Megawati that even spilled outside the PDI, his task became almost i!l1possible. Both the military and the Ministry of Home Affairs were openly involved in the wheeling and dealing. The Minister was in a difficult position, however. If he intervened too heavily and too openly in the Congress to force an unpopular decision, he risked not only the disintegration of the PDI but also any claim to a functioning system of elections and parties in Indonesia. The nomination of Megawati eventually went forward from the Congress UP 1, 2, 4, 6, 7, 8, 9, 11, 13 and 14 December 1993). The action then shifted to Jakarta. After a series of meetings which involved Megawati and Minister of Home Affairs, Yogie Memet, and the Minister and the President, Megawati's nomination was accepted by the government. Interestingly, Megawati also met with Siti Hardiyanti Rukmana, the President's daughter, during this period of apparent scrutiny and negotiation (Tempo, 25 December 1993). What did all this mean? Could it be interpreted-as it has been by some optimists-as a shift in the balance of power between the government and an increasingly vigorous civil society, or was it yet another manifestation of the power struggle between the President and elements of the military? Was Megawati's triumph evidence that the government was less able to control the political parties and other front groups? Is the PDI likely to take advantage of its success in choosing its own leader to become an increasingly focused party with a genuinely alternative agenda? By the admission of some of its own leading members, the PDI lacks organisation and cohesion (DeTik, 11-17 August 1993). To the extent that it had a discrete identity, this does not rest with its policy agenda so much as its broad image of populist egalitarianism, which identifies it as a progressive vehicle for registering social and political frustration and resentment. While Megawati's political philosophy appears little different from the populism of Pancasila, it is the egalitarian rather than the authoritarian aspects that are emphasised. She brings to the party the mystique of Sukarno populism and its potential to galvanise

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popular support, which may make it increasingly attractive to progressive reformers and political entrepreneurs in the uncertain years ahead. The stage is set for the next few years. The government is faced with a critical task of political management. If it is too successful in its control of the PDI, the party's credibility will suffer, and the growing progressive constituency will be convinced that its various interests cannot be pursued within the institutions of the existing political system. For the PDI, the task is to unify the diverse mix of populists and liberals, to attract more high profile defections and to professionalise the party organisation within a coherent strategy. If the centre began to unravel, the PDI could then occupy a strategic position.

The Marsinah case Since the ending of the oil boom the growth of the manufacturing sector has led to a dramatic growth in the number of industrial workers. Between 1980 and 2000 the share of GDP claimed by manufacturing is expected to increase from 9 per cent to 23 per cent (World Bank 1993a:13). Given this growing reliance on manufacturing, an efficient and productive workforce is increasingly essential. Yet the mechanisms for incorporating labour into the political system and managing industrial relations are proving inadequate from a variety of perspectives. They are based upon the proposition that organised labour is inherently subversive of the national interest. Easily categorised as being beyond the law because of its historical association with the Indonesian Communist Party (PKI), labour has been contained within one state-sponsored trade union, SPSI, and controlled where necessary by the intervention of the military in strikes and negotiations with employers. The Marsinah case was to bring to the surface-and into the international arenathe increasing contradictions in the government's belief that labour and the urban working class in general can only be handled through mechanisms of coercion and control. Between 5 and 9 May, 1993, the labour activist, Marsinah, was abducted and murdered in a particularly brutal and calculated manner. Little immediate action was taken by the police or the government, but as national scrutiny intensified rather than abating and as the case became increasingly known internationally, pressure for action grew. At a time when the US Congress was threatening

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economic sanctions over labour rights issues, the Indonesian government was susceptible. In October, a series of arrests were suddenly made. The nine individuals charged with Marsinah's murder or with accessory to the fact included two of the owners of the firm concerned, and seven employees, including security guards. The arrests were welcomed initially, but inconsistencies in the police case gradually became apparent, and support turned to widespread cynicism. The sudden burst of action by the police was to be increasingly regarded as an attempt to present as a criminal aberration what was in fact a normal and long-established practice of military and police intimidation of organised labour which, in this case, had gone wrong. When they came to trial, the accused alleged maltreatment by the security forces and police in extracting confessions. That criticism of the police case was most forcefully put by the Legal Aid Institute (LBH) was ironic, in the sense that LBH had long been a critic of government inaction on human rights casesand very active in trying to force the government to take action in this particular instance. Nevertheless, like most observers, LBH was highly suspicious of the police version of events, and was convinced that the arrests and interrogations contravened the law (Tempo, 19 March 1994). The political significance of the Marsinah case is that it raises again the question of the role of the police and the military in civil affairs. In pursuing the so-called 'security approach', the military argues that Indonesia remains vulnerable to destabilisation from a variety of forces which do not accept the legitimacy of the social order, including Muslim fundamentalists and social radicals. Such claims of continuing emergency are the normal stock-in-trade of security apparatus everywhere and, when accepted, justify an extraordinary approach to law and order. In Indonesia, daily life continues to be invaded by security regulations which require various permits and approvals for the establishment of public organisations, the holding of meetings and lectures, certain forms of travel, and the holding of public protests-not to mention the requirement for publishing licences. Increasingly, however, the heavy-handed nature of the security approach is provoking unexpected responses. The failure of the government to take seriously human rights issues has opened the door for non-government organisations like LBH to play an important public role and to attract considerable international support. While the growing middle class is restrained by fear of

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disorder, it is also resentful of the arbitrary power of the security forces. Calls for accountability of officials and for adherence to rule of law come into inevitable conflict with the need of this apparatus to claim the right to extra-legal activity on the basis of continuing emergency conditions. This contradiction is most apparent in the sphere of governmentlabour relations. Increasing numbers of strikes and disputes attest to the inadequacy of current strategies for containing labour unrest. As the official SPSI labour organisation proves increasingly irrelevant to worker interests, other organisations have emerged to channel worker demands . The Marsinah case is an illustration that Indonesia is well into that phase of industrial capitalism where the coercive power of the state and its corporatist institution is an increasingly inadequate instrument for coping with complex social issues and conflicts. Several problems require resolution, namely: the inadequacy of the legal framework; the lack of will to enforce those laws that are in place; and the absence of an effective system of mediation and negotiation in labour disputes. To some extent, the government has already responded, by annulling a 1986 Ministerial Decree which explicitly allowed for military involvement in labour disputes UP 18 January 1994). Opportunity for mili~ary involvement still exists, however, within the terms of the regulations relating to the military security body, BAKORSTANAS. The importance of this issue is that it spills over into the arena of general political reform, raising such critical questions as accountability and representation. The Marsinah case raises not only questions of labour rights, but the issues of rule of law, citizenship, and the political role of the military. Coming together with increasing disputes over land ownership and expropriation, and freedom of the press, the capacity of the existing political mechanisms to deal with new social issues and tensions is more and more being called into question. State Banks and the Bapindo case Throughout the New Order period, one of the central political issues has been the emergence of large corporate conglomerates and the role played by powerful officials in their rise. The Bapindo case raises once again the issues of corruption, collusion and the plunder of the public purse by the powerful and the wealthy. It is central to the succession process, because the social power of the new families and

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oligarchies and their allies in business is constructed upon the sorts of processes that characterised the Bapindo scandal. The imposition of accountability and transparency would fundamentally damage this social ascendancy. In the 1970s and 1980s, Chinese Indonesian conglomerates were to establish themselves in the framework of protective policies of industrial mercantilism and rent-seeking practices that gave them access to a variety of trade monopolies, forestry concessions, state procurement contracts, and other forms of state favours (Robison 1986, Shin Yoon Hwan 1989). Pribumi business was able to catch some of the crumbs as state contractors under the patronage of Ibnu Sutowo in the 1970s, and under the terms of Presidential Decrees Keppres 10 and 14a in the late 1970s and early 1980s, which gave priority to pribumi business in a scheme of state procurement managed by a team within Sudharmono's State Secretariat under Ginandjar Kartasasmita (now Minister for Development Planning). The early 1980s were also to see the full flowering of the business groups of the families of powerful officials of which those of the Soeharto family were by far the most extensive. The appropriation of state power by officials and powerholders, and its use in building corporate empires outside normal legal structures, became a political issue for a variety of groups. Calls for accountability of the state and its officials, and for greater transparency of its procedures, were made increasingly by reformist and populist critics of the regime, including students, some technocratic elements in the bureaucracy, and liberal economic reformers such as Kwik Kian Gie, Rizal Ramli and Sjahrir. A gulf was developing within the ranks of business between the rentseekers and those manufacturers whose competitiveness was undermined by import monopolies and tariffs, or who gained no advantage from the networks of patronage and favour. The fact that most of the big conglomerates were Chinese added a further dimension to the political volatility of the issue, allowing xenophobic sentiments to be mobilised. Because diri gis t e economic policies and rent-seeking relationships between the state, its officials and business are so integral to the power of conglomerates and the major capitalist families, reform is fraught with difficulty . Nevertheless, deregulation gathered pace in the mid-1980s following the collapse of oil prices, and was expected to erode the systems of dirigisme and rent-seeking practices that sustained th e patronage networks and

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the conglomerates. Indeed, import monopolies were dismantled to a degree that surprised observers: among their casualties were some extremely well-connected business groups and families . In general, however, the growth of conglomerates appeared to accelerate in the period of deregulation. In part this was due to the conglomerates' increased access to investment finance, both national and international, as the financial sector was deregulated. Total bank assets grew rapidly in the period 1989-91 in both the state sector and in the mushrooming private banking sector. Borrowing from both domestic sources (primarily the state banks) and from overseas underpinned the surge of the big conglomerates in this period. The money supply increased to a level that finally provoked a sharp tightening of monetary policy by the government in 1991. Increasing foreign debt was a particular problem, and a special team was established under Presidential Decree 39/1991 to scrutinise applications for foreign borrowings related to state projects. While the technocrats tried to hold back the flow at one level, the haemorrhaging was to continue at another. State banks were to play an important role in financing large investments by conglomerates and politically powerful families in major staterelated projects. Among the more notorious examples were a Bank Bumi Daya loan of $550 million for the Chandra Asri petrochemical project of the forestry king, Prajogo Pangestu, and a Bank Indonesia loan of $345 million to Tommy Soeharto to finance a controversial clove trading monopoly. As early as 1992, the government had obtained an agreement for a World Bank loan of $307 million for injection into the state banking sector, to which it added Rp200 billion from the state budget (Sender 1993:72-77). The spectre of bad debts at the state banks had begun to emerge with the collapse of the food products giant, Mantrust, and the cigarette company, Bentoel, in 1990. In May and June, 1993, Kwik Kian Gie raised the issue in Kompas (4 May and 24 June), claiming that the state banks' bad d ebts stood at around Rp10 trillion at least-or 7 per cent of all loans. He was also to detail the range of devices used by borrowers to raise massive loans from state banks w ith little collateral and projects of doubtful viability. In July 1993, lists of problem loans w ere circulated, alleged to come from officials within Bank Indonesia and/ or the Ministry of Finance. They gave a picture of horrific levels of bad and doubtful loans. The s tate d evelopment bank, Bapindo, was alleged to have

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bad or doubtful loans of Rp2,453 billion, or 28.7 per cent of total outstanding loans. Yet even this figure was not as high as those for the much larger Bank Bumi Daya, Bank Dagang Negara, and Bank Rakyat Indonesia. The Barito Group, owned by the forestry and petrochemicals tycoon, Prajogo Pangestu, was listed as having loans of around Rp3.8 trillion from state banks, of which 24 per cent was in the bad or doubtful loan category. In the list of borrowers for which bad and doubtful loans exceeded Rp100 billion, a largely unknown corporate group-the Golden Key Group-was ranked twelfth, holding loans amounting to Rp796 billion, of which Rp274 billion was classified bad or doubtfui.J The Jakarta press took up the story with a vengeance. The huge extent of state bank loans to the textile, petrochemical and forestry industries was d e tailed . A picture was drawn of widespread disregard for banking regulations and collusion between officials, powerful patrons and borrowers, and the dubious nature of many of the projects receiving state bank funds was highlighted . While debates between officials and commentators over the exact amount of bad and doubtful debts were inconclusive, two things were agreed: the state banks had a serious problem of non-performing loans, and the processes of making loans were questionable-to say the least. It also seemed clear that the government was not prepared to take firm action (Tempo, 3 July 1993; Prospek, 3 July 1993; AWSJ, 3 July 1993; Warta Ekonomi, 5 July 1993; JP , 5 July 1993). The issue gradually subsided. It appeared that technocrat reformers within the banking system had been unsuccessful in making headway on questions of accountability and transparency, and old habits began to resurface . In September 1993, it was announced that Tommy Soeharto had favourably negotiated the replacement of his loan for the BPPC clove trading monopoly from Bank Ind onesia with one from Bank Bumi Daya . Bank Dagang Negara announced it was to add $47 million to its original loan of $89 million for a luxury hotel projec t of the Kodel group, which had

3 Althou g h

the va lidity o f the li s ts w as d e ni ed by sev e ral of the n a med bo rro w e rs, in pa rti cul a r the to p-of-th e-li s t Prajogo Pa nges tu , there was a remarkable consistency among the m. Jud ging fr om the revelations to come out of the subsequ ent Bapind o trial s and a recent sta te me nt by the Governor of Bank Ind o nesia th a t s ta te ba nk bad loa ns s tood at $9.2 billi o n in Nove mbe r, 1993, the li s ts w o uld ap pea r to conta in a g rea t dea l o f truth.

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been at a standstill for two years for lack of finance (A WSJ, 16 September and 20 December, 1993). However, in a dramatic development in February 1994, the issue was to be once again ignited . Arnold Baramuli, a p rib u m i businessman and Golkar member of parliament, alleged that a state bank had made a loan without collateral, which had resulted in a loss of $650 million. After statements by the Governor of Bank Indonesia and the Minister for Finance, it was revealed that Bapindo had loaned $430 million to the Golden Key group, that the loan had violated banking regulations, and that the total debt to the state was $614 million (including accrued interest). A 'red clause' facility to draw a letter of credit for $241 million had been issued for the import of equipment for a proposed petrochemical plant, but it appeared that no attempt had been made to import the equipment. 4 In an orgy of intense media scrutiny, the BapindoGolden Key scandal and the subsequent court proceedings were dissected in great detail (Tempo, 19 and 26 February, 5 and 12 March, and 2 April, 1994; FEER 3 March and 23 June, 1994; AWSJ, 9 and 11 May, 1994). More interestingly, it emerged that Tommy Soeharto had been a partner in the project when the loan had been negotiated, and remained a partner of Golden Key's owner, Eddy Tansil, in other ventures. In addition, a series of letters to Bapindo from former Coordinating Minister for Political Affairs and National Security, Sudomo, supporting the Tansil loan application, and subsequent revelations from defendants in the case that former Finance Minister Sumarlin had also lent his support to the application, highlighted an embarrassing trail into the heart of power. The letters from Sudomo were reproduced with great fanfare in newspapers and magazines (Tempo, 26 February 1994; Bisnis Indonesia, 27 February 1994). What then is the outcome of the Bapindo affair, and what are its political implications? State banks have long been an integral part of the relationship between powerful political figures and major business groups. Together with the allocation of trade and other monopolies, loan allocation has been a central plank in the patronage networks that sustain political power and cement 4

ln the normal course of events, the letter of credit could not have been drawn until the equipment had been delivered, after which it would serve to help secure the bank's loan.

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networks of support. Yet the very fact that the investigation of Bapindo was allowed to proceed in the first place, and that such a public media scrutiny and series of trials was tolerated, suggests that the state banks as central institutions of rent-seeking may be coming under quite fundamental pressure. Perhaps the most important force for reform is the need to maintain the overall health of the economy, even if only to sustain opportunities for rent-seeking-a case of keeping alive the goose that lays the golden eggs. In recent years there has been increasing competition for budgetary resources, particularly as the demand for public infrastructure spending grows. This squeeze on fiscal resources is being exacerbated as debt servicing becomes an increasingly large item of budgetary expenditure, exceeding the flow of loans and aid grants. 5 The use of state banks as a mechanism for the plunder of the public purse is therefore less sustainable now, and the continual injection of public funds into the state banking system to support chronic high levels of bad loans is less affordable. How will this affect the power base of the major families? The government may simply resist reform, prepared to see a continuing run-down of the state banking sector, rather than fundamentally undermine the families' sources of economic leverage. Indeed, while changes have been made to the management of the state banksincluding replacement of all of their Chief Executive Officers since the loan scandal first broke-most observers are sceptical that the Bapindo trials will bring many of the large defaulters to account, or will get to the root of the problem itself (AWSJ, 9 May 1994). On the other hand, the Bapindo case may speed up the process whereby large corporate conglomerates and the major families minimise their reliance on rent-seeking, by internationalising and 5 Development

funds (aid grants and loans) rose from 24.6 per cent of development expenditure in 1981/82 to a peak of 81.5 per cent in 1988/89, before declining to 44.4 per cent in 1992/93 (Nota Keuangan, 1994/95: 119). In 1992/93 development funds totalled Rp10.7 trillion, while debt servicing reached Rp15.2 trillion. The latter will rise to Rp18 trillion in 1994/95, while non-grant aid will decline to Rp9.7 trillion (Fane 1994: 27). Debt servicing stood at 3.4 per cent of the total budget in 1980/81, rising to 30.4 per cent in 1987/88 before falling back to 28.3 per cent in 1992/93 (Nasution 1992: 424). While these figures may be manageable in terms of macroeconomic management, the point is that fiscal resources remain under significant pressure in the post oil boom era.

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going public. This is a critical consideration for the new families and their allies in the transition process. Medan In Medan in April 1994, following several months of disquiet on the labour front, a workers' demonstration ended in violence and the destruction of houses, shops, cars and other property in the Chinese district. One ethnic Chinese businessman was killed. Organised by local non-government organisations and the SBSI (an industrial organisation established as a competitor to the officially sanctioned workers' union, SPSI, but not recognised by the state), the demonstrations had begun peacefully, but degenerated after failed attempts to meet with the Provincial Governor and an unexplained diversion into the Chinese district. ABRI commander Feisal Tanjung declared the action subversive and destructive, linking the SBSI with the former PKI (Tempo, 30 April 1994). The event was to raise again two of the most important themes running through contemporary Indonesian political life: f{ustration of the desire of labour to organise and the outsider status of Indonesia's ethnic Chinese minority. What was surprising to many about the outbreak was not that labour was prepared to demonstrate, nor that ethnic Chinese became a target in emotionally charged circumstances, but that the military and police allowed matters to get out of hand. Increasing apprehension on the part of Chinese business can only have negative consequences for confidence in economic and social stability. However, fear of instability and reminders of the fragile nature of social and political order strengthen the position of both the military and a government under pressure for liberal reform in a time of transition. This point is not lost on political observers in Indonesia. The closures of Tempo, DeTik and Editor Perhaps the most dramatic development, particularly in terms of its international exposure and impact, was the banning of three magazines, Tempo, DeTik and Editor, in June, 1994. After several years of relative openness, the Indonesian press had become among the most vital and interesting in Asia, and editors widely applauded the new spirit of freedom. The media had explored in detail such issues as corruption, links between government and business, and the nature and extent of the conglomerates. Questions

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of democratisation, human rights and labour reform had also been aired, giving prominence to the critical views of reformers such as Mulya Lubis and Buyung Nasution. Stories about the Petisi 50 group led by Ali Sadikin, prohibited through the 1980s, were now permitted.6 Why, then, were the magazines banned? Does the move represent a general reversal of the openness policy that can be expected to spread to other areas, or is it a specific reaction to particular stories published by the offending magazines? Official government explanations invoke technical breaches in the case of Editor, a departure by DeTik from its licence to publish crime stories and, for Tempo, repeated stories that supposedly endangered national stability, including stories about religious and racial minorities (Antara, 21 June 1994). The real reasons are still the subject of conjecture. As Harold Crouch has mentioned, the openness policy extended far beyond press freedoms (Canberra Times, 4 July, 1994). Parliament has been more open and critical, peasants and their supporters have become more vocal on questions of land disputes and the building of dams, labour is becoming more active, and there has been real competition in the election of a new Provincial Governor (in Kalimantan). While Crouch rightly states that the closures are not necessarily an indication of a general clamp-down, there is undeniably a contradiction between the organic-statist ideals of a political system that is based upon the idea of a common interest and the free flow of ideas, including those that may deny the whole organic-statist proposition. Press scrutiny and criticism at a time when the government is engaged in the sensitive business of organising the transition had become increasingly damaging. Reporting of the Bapindo scandal had confirmed the political manipulation of the state banking sector and the links between officials, senior political figures and ethnic Chinese business tycoons. The more recent press dissection of the purchase of 39 former East German warships has been potentially more damaging because it drew in Minister Habibie, 6

The Petisi 50 group was so named after a 'Statement of Principle' with 50 signatories was issued in 1980, containing a wide range of criticisms of Soeharto's rule. Leading figures included former Jakarta Mayor Ali Sadikin, retired General Dharsono, and former military commander A.H. Nasution. The group was to constitute a conservative, Muslim-oriented reformist opposition.

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exposing to considerable public criticism the man widely regarded as Soeharto's choice for the succession. It was this story in Tempo that many observers have claimed to be the spark for the closures, drawing in the two other magazines (which also had been highly critical of the government on this and other issues, including the Bapindo scandal). In brief, the warships had been purchased by Habibie on behalf of the government. Habibie's initial proposal involved expenditure of $1.1 billion. After negotiations involving the Finance Ministry and ABRI commander Feisal Tanjung, however, a final budget of $482 million was presented. The vast bulk of this sum was for repairs and refurbishment of the ships in Indonesia, opening opportunities for procurement and contracts which benefited Habibie's Agency for the Assessment and Application of Technology (BPPT) and the state shipyards company (PAL) which fell under his umbrella. The ships themselves had cost only $12.7 million. Despite the dramatic reduction, Finance Minister Mar'ie Muhammad was prepared only to allocate $319 million. His revised budget made several cuts to procurement and repair work, including a reduction in expenditure on repairs by PAL from $64 million to $9.5 million (Tempo, 11 June 1994). The press scrutiny revealed considerable dissatisfaction within the government over the purchase of what were generally considered dilapidated ships and the extravagant proposed expenditure on repairs. Reporting of quarrels between Habibie, the Finance Minister and the military (notably, Defence Minister, Edi Sudradjat) over the deal appeared to place Habibie in an intolerable position. It provided another opportunity for a resurfacing of long-standing military resentment of its loss of control over procurement-first to the State Secretariat, and then to Habibie's BPPT-and equally long-standing antagonism of the economic technocrats to Habibie's nationalist strategies. 7 Following fears by economists in the World Bank and elsewhere that the economic nationalism of Habibie would invade and consume government economic policy have proven generally unfounded, Habibie's high technology ventures continue, nevertheless. For example, the viability of the aircraft manufacturing venture, ITPN, has come under constant questioning. These concerns have heightened with revelations about a controversial Rp400 billion interest-free loan provided for ITPN from the governments' special reafforestation fund (Kompas, 5 July 1994).

7While

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on the heels of the Bapindo case, it was placing groups and individuals central to Soeharto's management of the transition under great pressure. Without doubt the closures will ensure a more cautious press, for the coming months at least. Certainly the warships will be taken off the front pages and the Bapindo trials will not be pursued so vigorously. Soeharto will be given a more benign environment in which to manage the succession. In the long term, however, the media-whether owned by new mandarins or the old-will find it difficult to resist the commercial imperatives that govern any large business. Successful capitalist media enterprises may not be able to avoid the stories that sell newspapers and TV programmes in a society with an increasingly literate and demanding middle class. In an era of increasing intemationalisation of information made possible by the new technologies, local media are likely to be frozen out if they are subjected to greater restrictions than their global competitors. Ironically, several of the biggest players in the media industry are from the Soeharto family. The TV network, RCTI, and the newspaper, Media Indonesia, have been among the most critical and interesting. Bambang Trihatmodjo's Palapa satellites carry a variety of media outlets, including Star TV and CNN, that lie outside the control of the Ministry of Information. Their presence on the satellites is necessary for commercial viability, however. What will happen to the banned magazines? One thesis being propounded in Jakarta is that the media are being reconstituted to reflect the interests and values of the so-called 'new mandarins' and, we might add, the 'new families', by reorganising ownership. It has not taken long for new suitors to appear in the quest to inherit Tempo. Bob Hasan was reportedly the first on the scene; others said to be interested include Hasjim Djoyohadikusumo. But families have been strangely reticent in moving in-giving some credence to stories that Soeharto himself has decided that a move on Tempo by the families would be politically damaging, given the rawness of the wounds. Another suggested scenario is that the new Muslimoriented mandarins close to Habibie will move in, consolidating their successful advance into the media world with the establishment of Republika, a newspaper financed by the Abdi Bangsa Foundation, headed by Habibie. 8 8Information

on the Byzantine politics of the closures and the manoeuvres by groups hoping to gain access to the market which followed, was gathered in

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The most plausible scenario is the reopening of Tempo with a reorganised editorial board and ownership structure, with the bulk of the old staff still in place. Whatever the eventual outcome, the closures reveal the limits of middle class power, and the capacity of the government to turn the tap of keterbukaan (openness) off and on. It also reveals the increasing impotence of the military as a power countervailing the President. Conclusion Focusing on tangible events has enabled most of the themes of political life in 1993 / 4 to be drawn into a series of concrete snapshots. The overriding theme is that of a regime attempting to set in place the conditions for its survival beyond Soeharto. In this process, the subordination of the military and t~1e bureaucracy to the interests of a rising oligarchy of families and civilian mandarins is a central feature. Habibie, ICMI, and the appeal to moderate Islam as a new constituency, are critical features of the process. Many liberal reformers have placed great hopes in attempts by the US to influence events by tying trade to labour reform and human rights. Despite initial apprehension, Indonesia has called this bluff, perhaps following the lead of China, and found it to be of little substance. Under increasing pressure from its own business lobby, the need to ensure access to the rapidly growing Asian markets has ensured that economic interests remain paramount in the formulation of US foreign policy. While this means that the hopes of liberal reformers in Indonesia that foreign pressure will greatly assist their cause may be unduly optimistic, Indonesia's increasing integra tion into the international economy has been important in a more structural sense. The need to attract foreign investment has meant that issues of accountability and transparency in relationships between state and business can no longer be ignored. In particular, the development of a stock exchange seeking to attract international participation has begun to make some impact on the transparency of business activities. The Dili massacre in 1991, the Medan riots, and the Marsinah case all cause concern among potential inv es tors, b ecause they signal the possibility of instability and a government not quite in control. While foreign discussions in June and July with several leading figures in the Jakarta press World, including some from the banned publications. Several were convinced that the closure of Tempo at least had been planned for some time.

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investors may not care whether a government is democratic or not, they do demand predicability, and are reluctant to become associated with governments that have unsavoury international reputations. Most important, the events of the past year reveal disjunctures between an authoritarian corporatist political system based on organic notions of social organisation and an increasingly complex industrial capitalist society. The Soeharto vision may be sustainable until 1998 in terms of its political capacity to deal with opponents and reformers. What is more threatening are the structural pressures for regularisation of the state apparatus and the mediation and resolution of deepening social tensions. In the longer term it is questionable that the current political institutions can support a reorganisation of power in which the military and civil bureaucracy are subordinated to the power of an oligarchy of families and rising notables. The tendencies towards a political vacuum may be rescued either by the formation of a truly dominant party of the rich and powerful-either or both Golkar and the POI-or by the re-entry of the military into the centre of the equation to begin the whole New Order process again.

PART B: FINANCE AS A KEY SECTOR IN INDONESIA'S DEVELOPMENT

I:

The Reform Process

4 Financial reform: achievements, problems, and prospects Ali Wardhana

It gives me great pleasure to be here today and to have this

opportunity to discuss Indonesia's financial development and prospects. At the outset, let me note that I have taken the liberty of changing the title that was suggested for my presentation, namely: 'Financial Deregulation Too Much? Not Enough?'. The original title seemed to suggest a simple either I or answer to what is really a complicated set of questions. Although we often use the te.rm ourselves, I felt that it was inappropriate to label what has happened in Indonesia, or in a number of other countries for that matter, simply as 'deregulation'. A more accurate label might be 'regulatory reform'. Some of the early writers in the field of finance and dev elopment, such as Edward Shaw (1973) and Ron McKinnon (1973), emphasised almost exclusively the elimination of certain controls as the key to the development of the financial system. They called this process financial liberalisation. Today, we would call it deregulation . But as the experience of several Latin American countries in the late 1970s and the United States' savings and loan industry in the 1980s have made clear, reforming a financial system is fundamentally a two-pronged process. On the one hand, it involves the removal of direct controls over prices, quantities and activities, combined with an easing of the process that governs the entry of new firms. The result should be that economic choices will be determined mainly through the interaction of market forces. On the other hand, it requires the imposition of prudential regulations that ensure that clear and sufficient information is available to all, reducing excessive risk and minimising opportunities for fraud and manipulation at the expense of the general public.

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It is probably correct to characterise the very first steps taken by the Indonesian Government in June 1983 as deregulation. These initial steps consisted of the removal of direct central bank control over the state banks' interest rates, and over credit allocation by all banks. Subsequent measures affecting the financial system involved a two-pronged change: measures were introduced that further reduced direct control, while steps were also taken to introduce a reliance on indirect rule or action, either by strengthening prudential regulations or by improving the system of indirect monetary management. This later stage is best characterised as regulatory reform.

Aims of reform The reforms that the Government of Indonesia has implemented over the past decade have reflected, on the whole, a consistent desire to achieve three basic objectives: i)

to move toward a predominantly market based financial system;

i i)

to provide effective protection as needed for the general public so that they could benefit more fully from the services offered by the financial system; and

iii) to build a financial system that would support stable and healthy growth of the national economy. I do not mean to suggest that these reforms reflected a fully worked-out master plan, nor would I claim that every measure implemented over the past decade has been fully consistent with these three objectives. But I do think it is fair to say that these have been the guiding principles, and that those of us who have been involved in the development of financial policies and regulations have done our best to follow them. In any attempt to evaluate the achievements of a reform process, it is useful to begin by estab lishing a framework within which to judge the impact of deregulatory policies. Traditional theory of regulation states that government interventions to correct market failures will serve the public interest. The presence of natural monopolies, externalities (either positive or negative), and the prevalence of asymmetric information, are all standard indications of market failures. They have been accepted as valid reasons for gov ernment intervention. Yet even here a word of caution is in order.

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While it is easy to show that in the presence of market failures social welfare will not be at a maximum, the conclusion that regulations to deal with these market failures will necessarily improve social welfare rests upon the assumption that those implementing the regulations or managing the regulated firms have the ability and foresight to manage the assets under their influence or control in such a way as to raise social welfare. Policy makers and economists have become increasingly aware that even where market failures exist, it is no easy task to devise a regulatory framework that will improve economic efficiency and welfare. Government regulators are not always wise, fair, and efficient. Hence it is far from obvious that actions to overcome market failure will necessarily be welfare improving. Rather, it is often the case that the interventions, no matter how well intended, reduce welfare rather than overcome the welfare losses associated with market failure. In any analysis of Indonesia's financial reform, these issues need to be kept in mind. A major concern for any government is that the financial sector should not be characterised by severe instability, and that reform measures should not increase the instability of the system. Periodic financial upheavals and bank failures, common in many nineteenth century economies, are not unknown today. The savings and loan debacle in the United States, the collapse of Bank Credit Lyonnais, the bank failures in Japan and elsewhere, are but a few examples of how potential instability continues to haunt many financial systems. Indonesia is of course no exception. The recent failure of Bank Summa has now been followed by the exposure of a substantial swindle involving one of our state banks, Bapindo. All such upheavals create uncertainty in the financial markets, raising costs and perceptions of risk. Given the pervasive nature of finance as an input into all economic activities, failures in the financial markets will not only put pressure on the financial sector, but may also impair the performance of the entire economy. A question to be addressed is whether, given the important role assigned to the financial system and the persistence of bank failures, government should play a stronger regulatory role in the financial sector than one would assign to it in other sectors? It has also been suggested that financial transactions are different from other economic transactions in that they involve an initial period of lending or investment, followed by subsequent periods when there are repayments and earnings. Inherent in any

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financial transaction is the fact that lenders are likely to have less complete information about borrowers and the intended use of borrowed funds than the borrowers themselves. This condition, referred to as asymmetric information, places a premium on obtaining accurate information for financial transactions. Because of the difficulties of appropriating the returns to information and because the expenditures incurred on obtaining information can be viewed as a fixed cost, the presence of asymmetric information is in fact another instance of market failure. Financial markets, because of the presence of asymmetric information, are not like markets for conventional goods and services. They seem to differ in ways that make market failure endemic. If so, does this suggest that government should take an active role in managing the financial sector? 1 Although regulation may be imperfect, would performance of a less regulated market be superior? Theories of regulation suggest that deregulation will enhance efficiency in one of two ways. First, inefficient operations that developed because of regulations, and because firms were insulated from actual and potential competition, would be curtailed. Second, rent-seeking behaviour on the part of well-organised groups benefiting from regulations would be eliminated (Winston 1993). Any evaluation of financial deregulation in Indonesia should thus attempt to identify the efficiency gains. But any such assessment must overcome a fundamental problem: regulated and deregulated environments always exist side by side. Since the process of deregulation proceeds over time, the shift from a more regulated regime to a less regulated regime may occur over several years, without the regime ever becoming totally deregulated. For this reason, simply comparing the economic changes that some groups undergo as a result of greater deregulation is not enough. Among other limitations, such comparisons fail to account for the effects of simultaneous changes in the economy as a whole. Since it is generally impossible to isolate all other effects, the appropriate approach is to estimate the effect of a regulatory change on some group-say, savers-at any point in time, and compare that with the effec t the alternative policy (a more regulated financial system) might have had on them during the same time. Difficult as 1

This argument is developed at length in Stiglitz (1994).

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more assessments of that kind might be, they are the best available means of evaluating the costs and benefits of deregulation. Some of these issues should be the focus of any discussion of the role of government in Indonesia's financial sector and, in particular, of whether regulatory reform has reduced that role too far-or whether further reductions would improve the efficiency of the financial system. Let me speculate for a moment that, in the true spirit of economists everywhere, we will reach the conclusion that there should be movement in both directions and preferably at the same time. Thus we will probably conclude that more government intervention is called for in some areas and much less in others. And perhaps that is correct. Review of reforms Let me turn now to a review of Indonesia's financial sector reform. Initially the reform measures were focused on removal of credit and interest rate controls on the banking system, while developing indirect, market-oriented instruments of monetary policy to replace the ineffective credit ceilings (McLeod 1993b:l19-122). These first steps resulted in a significant increase in deposit mobilisation and lending activities, especially of the private banks. Also, Bank Indonesia introduced new money mari